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 November 29, 2003
Commission file number: 0-18926
INNOVO GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2928178
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
5804 East Slauson Avenue, Commerce, California 90040
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (323) 725-5516
Securities registered pursuant to Section 12 (b) of the Act: NONE
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.10 par value (Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. 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 by Rule 12b-2 of the Act.) Yes [ ] No [ X ]
The aggregate market value of the voting and non-voting common stock held by
non-affiliates of the registrant based on the closing price of the registrant's
common stock on the NASDAQ Stock Market, Inc. as of May 30, 2003, was
approximately $43,267,092.
The number of shares of the registrant's common stock outstanding as of February
25, 2004 was 25,793,850.
Documents incorporated by reference: Portions of the registrant's definitive
proxy statement to be filed with the Securities and Exchange Commission within
120 days after the end of the fiscal year are incorporated by reference in Part
III of this Annual Report on Form 10-K.
INNOVO GROUP INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED NOVEMBER 29, 2003
Table of Contents
Item
Number Page
- ------ ----
PART I
Item 1. Business 1
Item 2. Properties 26
Item 3. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder 27
Matters
Item 6. Selected Consolidated Financial Data 29
Item 7. Management's Discussion and Analysis of Financial Condition and Results of 30
Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 53
Item 8. Financial Statements and Supplementary Data 54
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 54
Item 9A. Controls and Procedures 54
PART III
Item 10. Directors and Executive Officers of the Registrant 56
Item 11. Executive Compensation 56
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 56
Item 13. Certain Relationships and Related Transactions 56
Item 14. Principal Accountant Fees and Services 56
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 57
Signature Page
PART I
Forward-Looking Statements
Statements contained in this Annual Report on Form 10-K and in future filings
with the Securities and Exchange Commission, or the SEC, in our press releases
or in our other public or shareholder communications that are not purely
historical facts are forward-looking statements. Statements looking forward in
time are included in this Annual Report on Form 10-K pursuant to the "safe
harbor" provision of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements include, without limitation, any statement that may
predict, forecast, indicate, or imply future results, performance, or
achievements, and may contain the words, "believe", "anticipate", "expect",
"estimate", "intend", "plan", "project", "will be", "will continue", "will
likely result", and any variations of such words with similar meanings. These
statements are not guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict, therefore, actual results
may differ materially from those expressed or forecasted in any such
forward-looking statements.
Factors that would cause or contribute to such differences include, but are not
limited to, the risk factors contained or referenced under the headings
"Business," "Risk Factors" and "Managements Discussion and Analysis of Financial
Condition and Results of Operations" set forth in this Annual Report on Form
10-K. Since we operate in a rapidly changing environment, new risk factors can
arise and it is not possible for our management to predict all such risk
factors, nor can it assess the impact of all such risk factors on our business
or the extent to which any factor, or combination of factors, may cause actual
results to differ materially from those contained in any forward-looking
statements. Given these risks and uncertainties, readers are cautioned not to
place undue reliance on forward-looking statements that only speak as of the
date of this filing.
We undertake no obligation to publicly revise these forward-looking statements
to reflect events, circumstances or the occurrence of unanticipated events that
occur subsequent to the date of this Annual Report on Form 10-K. As used in this
Annual Report on Form 10-K, the terms "we", "us", "our", and "Innovo Group"
refer to Innovo Group Inc. and our subsidiaries and affiliates, unless the
context indicates otherwise.
ITEM 1. BUSINESS
Our principal business activity involves the design, development and worldwide
marketing of high quality consumer products for the apparel and accessory
markets. We do not manufacture any apparel or accessory products but outsource
the manufacturing to third parties. We sell our products to a large number of
different retail, distributors and private label customers around the world.
Retail customers and distributors purchase finished goods directly from us.
Retail customers then sell the product through their retail stores and
distributors sell our products to retailers in the international market place.
Private label customers outsource the production and sourcing of their private
label products to us and then sell through their own distribution channels.
Private label customers are generally retail chains who desire to sell apparel
and accessory products under their own brand name. We work with our private
label customers to create their own brand image by custom designing products. In
creating a unique brand, our private label customers may provide samples to us
or may select styles already available in our showrooms. We believe we have
established a reputation among these private label buyers for the ability to
arrange for the manufacture of apparel and accessory products on a reliable,
expeditious and cost-effective basis. Our branded label products, which include
accessories and apparel, are designed, developed and marketed by us internally
pursuant to the license agreement under which we have licensed the brand and/or
mark. We then outsource the manufacturing and distribution of the branded
products. We sell our branded products to the retail customers or distributors.
We are then obligated to pay a certain percentage of royalties on our net sales
of the branded products to the licensor. We believe that we have established a
reputation for our ability to produce a quality branded product in the
marketplace.
We operate our consumer products business through three wholly-owned, operating
subsidiaries, Innovo, Inc., or Innovo, Joe's Jeans, Inc., or Joe's, and Innovo
Azteca Apparel, Inc., or IAA. Our products are currently manufactured by
independent contractors located in Los Angeles, California, Mexico and Asia,
including, Hong Kong, China, Korea, Vietnam and India. The products are then
distributed out of our warehouse facilities located in Los Angeles or directly
from the factory to the customer. For the fiscal year ended November 29, 2003,
or fiscal 2003, approximately 22% of our apparel and accessory products were
manufactured outside of North America. The rest of our accessory and apparel
products for fiscal 2003 were manufactured in the United States (approximately
21%) and Mexico (approximately 57%). All of our products manufactured in Mexico
are manufactured by Azteca Productions International, Inc., or Azteca, and/or
its affiliates, as discussed below. Azteca is controlled by two of our
significant stockholders, Hubert Guez and Paul Guez.
Our operations are comprised of two reportable segments: apparel and accessory,
with the operations of our Joe's and IAA subsidiaries representing the apparel
segment and our Innovo subsidiary conducting business in the accessory segment.
Segment revenues are generated from the sale of consumer products by Joe's, IAA
and Innovo. Our corporate activities are represented by the operations of Innovo
Group Inc., our parent company, or IGI, and our real estate operations are
conducted through our wholly-owned subsidiaries, Leasall Management, Inc., or
Leasall, and Innovo Realty, Inc., or IRI. Our real estate operations do not
currently require a substantial allocation of our resources and are not a
significant part of our management's daily operational functions. Thus, our real
estate
1
operations are not currently defined as a distinct operating segment, but are
classified as "other" along with our other corporate activities.
Strategic Relationship with two of our significant stockholders, Hubert Guez and
Paul Guez, and affiliated companies
Beginning in the summer of 2000, we entered into a series of transactions with
two of our significant stockholders, Hubert Guez and Paul Guez, and their
affiliated companies, such as Azteca and/or Commerce Investment Group LLC, or
Commerce. The Guez brothers and their affiliated companies have in the aggregate
more than 50 years of experience in the apparel industry with a specialty in
denim apparel and related products. As discussed in greater detail below, our
strategic relationship with the Guez brothers and their affiliated companies has
had many tangible benefits for us.
Our relationship with the Guez brothers began in the summer of 2000, when the
Guez brothers through their affiliated company, Commerce, which the Guez
brothers control, invested in our company. Pursuant to a stock and warrant
purchase agreement, Commerce acquired 2,863,637 shares of our common stock and
3,300,000 common stock purchase warrants. An investor rights agreement also
provides Commerce with a contractual right to nominate three individuals to our
board of directors. Commerce has not exercised this right at this time. Based on
a Schedule 13D/A filed by Commerce, the Guez brothers and their affiliates with
the Securities and Exchange Commission on January 20, 2004, Commerce, the Guez
brothers and their affiliates own in the aggregate approximately 17.57% of our
common stock.
As part of Commerce's equity investment in our company, we entered into several
other arrangements with Commerce in order to reduce our manufacturing and
distribution costs and to increase the effectiveness and capacity of our
distribution network. Pursuant to a supply agreement and a distribution
agreement with Commerce, we agreed to purchase all of our accessory products,
which at the time primarily consisted of denim tote bags and aprons, from
Commerce and to have Commerce distribute these products out of its Los Angeles
distribution facility. Commerce manufactures our accessory products out of its
facilities located in Mexico. These agreements were renewed in August 2002 for
an additional two year term and are automatically renewed for additional two
year terms unless terminated by either party with 90 days notice. See "Note 1 -
Business Description - Restructuring of Operations" in the Notes to Consolidated
Financial Statements for a further discussion of the equity investment by and
the terms of the supply and distribution agreements with Commerce.
The strategic relationship entered into with Commerce allowed us to close our
domestic manufacturing and distribution facilities and to move forward with
diversifying our product mix and offerings to include apparel products as
opposed to only accessory products. In an effort to enter into the apparel
market quickly and efficiently we, through IAA, acquired Azteca's knit apparel
division in August 2001 in exchange for 700,000 shares of our common stock and
promissory notes in the amount of $3.6 million. See "Note 3 - Acquisitions -
Azteca Production International, Inc. Knit Division" in the Notes to
Consolidated Financial Statements for a further discussion of this acquisition.
In February 2001, we continued to expand our apparel business by acquiring a
ten-year license for the "Joe's" and "Joe's Jean's" brands from JD Design, LLC
and forming our Joe's subsidiary. See "Business - License Agreements and
Intellectual Property" for a further discussion of this license agreement. Joe's
has exploited this license agreement by creating, designing and marketing
high-end denim apparel products. Our strategic relationship with the Guez
brothers allowed us to quickly and efficiently exploit this license and enter
into the denim apparel market by outsourcing the manufacture and distribution of
the denim apparel products created pursuant to the license to Commerce and its
affiliates.
During fiscal 2001 and 2002, the combined accessory and denim apparel products
purchased from and other services provided by Commerce and/or its affiliates
were approximately $5.7 million and $16.0 million, respectively, or 90% and 80%,
respectively, of our manufacturing and distribution costs for such periods.
During fiscal 2003, our dependence on Commerce and its affiliates decreased for
these services but still constituted 68% of our manufacturing and distribution
costs for fiscal 2003, or approximately $47.9 million of accessory, craft and
denim apparel products from and other services provided by Commerce and/or its
affiliates. While we now use additional suppliers to meet our needs, we intend
to continue to take advantage of Commerce's expertise with denim products so
long as we believe it is in our best interest.
On July 17, 2003, we, through IAA, entered into an asset purchase agreement, or
Blue Concept APA, with Azteca and the Guez brothers. Pursuant to the Blue
Concept APA, we acquired Azteca's Blue Concept division, or the Blue Concept
Division, for a $21.8 million seven-year convertible promissory note, subject to
adjustment, or Blue Concept Note. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations - Recent Acquisitions and
Licenses and - Long Term Debt" and "Note 9 - Long Term Debt - Promissory Note to
Azteca in connection with Blue Concept Division Acquisition" in the Notes to
Consolidated Financial Statement" for a further discussion of certain terms of
this acquisition and the Blue Concept Note. In accordance with the APA and
NASDAQ rules, we are conducting a special stockholders meeting on March 5, 2004,
to approve the conversion of approximately $12.5 million of the Blue Concept
Note into a maximum of 4,166,667 shares of our common stock. In addition, as
part of the transaction, we entered into another supply agreement with an Azteca
affiliate to purchase products to be sold by our Blue Concept Division. See
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of
certain terms of this supply agreement.
2
We have continued to expand our denim product mix by entering into an assignment
with Blue Concept LLC, which is controlled by Paul Guez, for all the rights
benefits and obligations of a license agreement between Blue Concept LLC and
B.J. Vines, Inc., the owner of the Betsey Johnson(R) brand, for exclusive right
to design, market and distribute women's jeans and coordinating denim related
apparel, such as t-shirts and tops under the Betsey Johnson(R) brand name in the
United States, its territories and possessions, and Canada. We did not
compensate Paul Guez for this assignment.
During fiscal 2003, we moved our headquarters and principal executive offices
from 5900 S. Eastern Avenue, Suite 120, Commerce, California 90040 to 5804 East
Slauson Avenue, Commerce, California 90040. The 5804 East Slauson Avenue space
is utilized under a verbal agreement with Azteca, pursuant to which we pay to
Azteca a fee for allocated expenses associated with our use of office and
warehouse space and expenses incurred in connection with maintaining such office
and warehouse space. These allocated expenses include, but are not limited to:
rent, security, office supplies, machine leases and utilities. In addition, we
have verbal agreements with Azteca and/or its affiliates regarding the supply
and distribution of other apparel products we sell.
Other Third Party Manufacturers
As discussed above, historically, we have primarily used Commerce and its
affiliates for our manufacturing needs. In fiscal 2003, we significantly
diversified our apparel products to include a wider array of products,
including, but not limited to, denim products. These non-denim products,
however, including some denim products, are purchased from third party
independent suppliers, including, Commerce and/or its affiliates. While we now
use numerous suppliers to meet our needs, we intend to continue to take
advantage of Commerce's and its affiliate's expertise with denim products if it
is in our best interest.
Headquarters
As discussed above, our headquarters and principal executive offices are located
at 5804 East Slauson Avenue, Commerce, California 90040 and our telephone number
at this location is (323) 725-5516. We also have operational offices and/or
showrooms in Los Angeles, New York, Knoxville, and Hong Kong and third party
showrooms in New York, Los Angeles, Tokyo and Paris.
General Development of Business
Innovo, a Texas corporation, was formed in April 1987 to manufacture and
domestically distribute cut and sewn canvas and nylon consumer products for the
utility, craft, sports licensed and advertising specialty markets. In 1990,
Innovo merged into Elorac Corporation, a "blank check" company, which was
renamed Innovo Group Inc., a Delaware corporation.
In 1991, we acquired the business of NASCO, Inc., or NASCO, a Tennessee
corporation, a manufacturer, importer and distributor of sports-licensed sports
bags, backpacks, and other sporting goods, located in Springfield, Tennessee.
NASCO, subsequently renamed Spirco, Inc., or Spirco, was also engaged in the
marketing of fundraising programs to school and youth organizations. The
fundraising programs involved the sale of magazines, gift wraps, food items and
seasonal gift items.
In 1992, we formed NASCO Products International, Inc., or NPII, a Tennessee
corporation. NPII was formed to focus on the distribution of Innovo Group's
accessory products in the international marketplace. NPII does not currently
have any business activities and we are in the process of dissolving NPII.
In 1993, we sold the youth and school fundraising business of Spirco to QSP,
Inc. During its fiscal year ending 1992, Spirco had incurred significant trade
debt from the losses it incurred in marketing fundraising programs and from
liabilities incurred by NASCO prior to its acquisition by us that were not
disclosed at that time. On August 27, 1993, Spirco filed for reorganization
under Chapter 11 of the U.S. Bankruptcy Code. Neither we, nor Innovo, nor NPII
were a party to such bankruptcy filing by Spirco. Spirco's plan of
reorganization was confirmed by the court on August 5, 1994, and became
effective on November 7, 1994.
In 1994, we formed Leasall, a Tennessee corporation. Leasall acquired Spirco's
equipment and plant and assumed the related equipment and mortgage debt. Leasall
still owns and leases to third parties the plant purchased from Spirco, which
served as our former headquarters in Springfield, Tennessee. Subsequent to the
bankruptcy reorganization, we merged Spirco into us. This merger resulted in us
acquiring direct ownership in the remaining assets of Spirco that Leasall did
not purchase. The Spirco claims, which we had guaranteed, received full payment
through the issuance of shares of our common stock.
In the latter part of 1998, we closed our domestic manufacturing and
distribution facilities in Springfield, Tennessee and relocated our corporate
headquarters, manufacturing and distribution facilities to Knoxville, Tennessee.
We closed the Springfield facility based on our need for a more suitable
facility for our manufacturing needs as well as our need, at that particular
time, for a more skilled labor force to meet our production requirements.
Additionally, in 1998, we brought in additional investors and new management,
and these individuals resided in Knoxville, Tennessee.
3
During fiscal 2000, we restructured our operations by closing our domestic
manufacturing and distribution facilities in Knoxville, Tennessee and realigning
our operational structure to focus on sales and marketing. We also raised
additional working capital and converted certain indebtedness into equity. The
restructuring was undertaken as a condition to the equity investment by
Commerce. In an effort to reduce product costs and increase gross profit, we
shifted our manufacturing to third-party foreign manufacturers, a majority of
which included Commerce's affiliates, and outsourced our distribution to
Commerce's affiliates in an effort to increase the effectiveness and capacity of
our distribution network. See "Business - Strategic Relationship with two of our
significant stockholders, Hubert Guez and Paul Guez, and affiliated companies"
and "Note 1 - Business Description - Restructuring of Operations" in our Notes
to Consolidated Financial Statements for a further discussion of our
relationship with the Guez brothers and the equity investment by and the terms
of the supply and distribution agreements with Commerce.
In February of 2001, we acquired from JD Design LLC, or JD Design, the license
rights to the JD logo and the Joe's Jeans(R) mark for all apparel and accessory
products. In connection with this acquisition, in March of 2001, we formed Joe's
Jeans, Inc., or Joe's, a Delaware corporation, to focus on the design,
production and worldwide marketing of high fashion apparel products bearing the
"Joe's Jeans" brand. See "Note 3 - Acquisitions - Joe's Jeans License" in the
Notes to the Consolidated Financial Statements.
In August of 2001, we, through our newly formed wholly-owned subsidiary, IAA,
acquired Azteca's knit apparel division in order to enter into the apparel and
design business for the private label and retail market. See "Note 3 -
Acquisitions - Azteca Productions International, Inc. Knit Division" in the
Notes to the Consolidated Financial Statements.
In April 2002, we, through our newly formed wholly-owned subsidiary, IRI, to
facilitate the purchase of limited partnership interests, which limited
partnerships were investing in real estate apartment complexes located
throughout the United States. See "Business-Real Estate Transactions" for a
further discussion of IRI's limited partnership interests.
In May 2002, Joe's formed Joe's Jeans Japan, Inc., or JJJ, a Japanese
corporation, to facilitate the distribution of the Joe's(R) and Joe's Jeans(R)
brand in Japan. On July 1, 2003, Joe's entered into a Master Distribution and
Licensing Agreement, or Distribution and Licensing Agreement, with Itochu
Corporation, or Itochu, pursuant to which Itochu obtained certain manufacturing
and licensing rights for the Joe's(R) and Joe's Jeans(R) marks. See "Business
- -License Agreements and Intellectual Property" for a further discussion of the
Distribution and Licensing Agreement with Itochu.
Additionally, in May 2002, Innovo formed Innovo Hong Kong Limited, or IHK, a
Hong Kong corporation. IHK was formed to assist our accessory division with the
design, development and sourcing of accessory products out of East Asia. IHK
also acts as the overseas base for apparel sourcing by virtue of its location in
Hong Kong.
On August 1, 2002, IAA entered into an exclusive 42-month worldwide agreement
for the Bow Wow license, granting IAA the right to produce and market products
bearing the mark and likeness of the popular stage and screen performer, Bow
Wow, formerly known as Lil' Bow Wow. See "Business -License Agreements and
Intellectual Property" for a further discussion of the Bow Wow License.
On February 13, 2003, IAA entered into a 44 month exclusive license agreement
for the United States, its territories and possessions with the recording artist
and entertainer Eve for the license of the Fetish(TM) mark for use with the
production and distribution of apparel and accessory products. See "Business
- -License Agreements and Intellectual Property" for a further discussion of the
Fetish(TM) license.
On July 17, 2003, IAA entered into the Blue Concept APA, with Azteca, Hubert
Guez and Paul Guez, whereby IAA acquired the Blue Concept Division from Azteca.
See "Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" and "Management's Discussion and
Analysis of Financial Conditions and Results of Operations - Long Term Debt" for
further discussion of the terms of the acquisition of the Blue Concept Division
from Azteca.
During fiscal 2003, we consummated five private placements of our common stock
resulting in net proceeds of approximately $17,540,000, after deducting
commissions. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations - Equity Financings" and Item 5 "Market for
Registrant's Common Equity and Related Stockholder Matters" for a further
discussion of the terms of our equity financings.
Due to our growth during the past three years, in addition to the five private
placements of our common stock discussed above, we entered into a series of
transactions to provide us with additional working capital. On June 1, 2001 and
September 10, 2001, we, through our three main operating subsidiaries, Joe's,
Innovo, and IAA, entered into a financing agreement with CIT Commercial
Services, a unit of CIT Group, Inc., or CIT for the factoring of our account
receivables. In August 2002, Joe's and Innovo entered into inventory and
security agreements with CIT which established inventory based lines of credit
for Joe's and Innovo. As a result of the need for additional working capital, on
or about June 10, 2003, we amended our existing financing facilities, to be
effective as of April 11, 2003, with CIT. We have also established a letter of
credit facility with CIT. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" for
further discussion of our financing agreements with CIT.
4
Summary of Significant Fiscal 2003 Developments
General Overview
Our net sales increased to $83,129,000 in fiscal 2003 from $29,609,000 in fiscal
2002, or a 181% increase. This increase is primarily attributable to the
following factors: (i) first time sales of our Fetish(TM) and Shago(R) branded
products; (ii) sales generated from the Blue Concept Division that we acquired
in July 2003; and (iii) continued growth in the developing, sourcing and
distributing of our existing products, such as Joe's Jeans, to new and existing
customers. Our significant net sales increase of 181% was substantially offset
by the initial expenses incurred for this growth, such as: (i) wages from new
hiring needs to support the development of the Fetish(TM) by Eve and Shago(R) by
Bow Wow lines; (ii) increased payroll expenses from the employees we absorbed in
connection with the Blue Concept Division acquisition; (iii) excess inventory
purchased for Fetish(TM) and Shago(R) products; and (iv) inventory writedowns
within Joe's and Innovo caused by operational and distribution inefficiencies.
As a result of these and other costs, as well as the necessity to write off
excess inventory, the result was a net loss of $8,255,000 for fiscal 2003. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a discussion of our financial performance in fiscal 2003.
Accessory
During fiscal 2003, Innovo, which is responsible for our accessory products,
grew its business significantly compared to fiscal 2002. The growth is a result
of Innovo's increased private label and craft sales, initial distribution of our
Fetish(TM) brand of accessories in November 2003. Prior to fiscal 2002, Innovo
did not produce fashion accessory products for the private label market. In
fiscal 2003, Innovo experienced an increase in net sales to $14,026,000 in
fiscal 2003 from $12,072,000 in fiscal 2002, or a 16% increase. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for further discussion of Innovo's financial performance for fiscal
2003.
Apparel
Joe's
During fiscal 2003, Joe's continued to establish domestic and international
brand recognition in the high-end fashion apparel industry. In fiscal 2003,
sales of Joe's products increased to $11,476,000 in fiscal 2003 from $9,179,000
in fiscal 2002, or a 25% increase. On July 1, 2003, Joe's entered into a
Distribution and Licensing Agreement with Itochu pursuant to which Itochu
obtained certain manufacturing and licensing rights for the Joe's(R) and Joe's
Jeans(R) marks. As a part of the transaction, Itochu agreed to purchase the
existing inventory of JJJ for approximately $1 million, assume the management
and operations of JJJ's showroom in Tokyo and employ certain employees of JJJ.
As of November 29, 2003, we continued to operate JJJ and will continue to do so
until all operations have ceased. Upon the cessation of all operating
activities, we intend to dissolve the JJJ subsidiary. We will continue to sell
product in Japan through the Distribution and Licensing Agreement with Itochu.
See "Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses." See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations" for further
discussion of Joe's financial performance for fiscal 2003.
IAA
IAA increased its sales to $57,627,000 in fiscal 2003 from $8,358,000 in fiscal
2002, or a 589% increase. The growth is primarily a result of an increase in
revenues from IAA's private label division and in part from first time sales of
Shago(R) and Fetish(TM) apparel products. See "Business - License Agreements and
Intellectual Property" for a further discussion of our license agreements with
Bravado International, Inc. for Shago(R) which we entered into in October 2002,
and with Blondie Rockwell, Inc. for Fetish(TM) which we entered into in February
2003. A substantial amount of the increase in the revenue from our private label
business was a result of our sales subsequent to our acquisition of the Blue
Concept Division by IAA. See "Management's Discussion and Analysis of Financial
Conditions and Results of Operations - Recent Acquisitions and Licenses.
Additionally, on July 17, 2003, our IAA subsidiary entered into an APA with
Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the Blue Concept
Division from Azteca. Pursuant to the terms of the APA, IAA paid $21.8 million
for the Blue Concept Division, subject to adjustment as discussed further in
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of the
acquisition of the Blue Concept Division from Azteca. The purchase price was
paid through the issuance of the Blue Concept Note which is a seven-year
convertible promissory note. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations - Long Term Debt" for further
discussion of the terms of the Blue Concept Note. Also, see "Management's
Discussion and Analysis of Financial Conditions and Results of Operations" for
further discussion of IAA's financial performance for fiscal 2003.
5
Principal Products and Revenue Sources
Our products are created and our revenues are derived through sales from our
Innovo, IAA, and Joe's subsidiaries in the accessory segment and apparel
segment, respectively.
Our net sales by segment for the last three years are shown in the table below:
2003 2002 2001
Accessories 17% 41% 61%
Apparel 83% 59% 39%
--------------------
Total 100% 100% 100%
--------------------
Accessory
Innovo
Innovo, headquartered in Knoxville, Tennessee, designs, develops and markets
accessory consumer products such as fashion handbags, purses, wallets,
backpacks, duffle bags, sports bags, belts, hats and scarves for department
stores, mass merchandisers, specialty chain stores and private label customers.
Additionally, Innovo markets craft products including tote bags and aprons to
mass merchandisers and craft specialty stores. Innovo's products generally are
accompanied by one of Innovo's own logos such as Daily Denim(TM), Dragon Fly
Denim(TM), Clear Gear(TM), Friendship(TM) and Tote Works(TM), the brand of a
private label customer, or the brand of a third party licensor such as Bongo(R),
Shago(R) and Fetish(TM). Innovo's net sales in the accessory segment increased
to $14,026,000 in fiscal 2003 from $12,072,000 for fiscal 2002, or a 16%
increase. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Net Sales" for a further discussion of Innovo's sales in
the accessory segment.
In fiscal 2002, Innovo entered the private label accessory business. As of
November 29, 2003, Innovo produced private label products primarily for American
Eagle Outfitters, Inc. and Limited Brands, Inc.'s Express division. Private
label business accounted for approximately 35% of Innovo's net sales in fiscal
2003 compared to 27% in fiscal 2002. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" for a further discussion of
Innovo's accessory sales. Innovo anticipates continued growth in the private
label market as a result of Innovo's ability to provide quality accessory
products that are fashionably desirable at competitive prices; however, there
can be no assurances that Innovo will be able to increase its market share in
the private label business.
While Innovo initially obtained the license rights to the Bongo(R) mark in the
second quarter of fiscal 2001, in November 2002, Innovo solidified and extended
its relationship with the owner of the Bongo(R) brand, by signing a four-year
license agreement with IP Holdings LLC for the Bongo(R) mark. The agreement
gives Innovo multi-year extension options based on certain performance criteria
for the bag and small pvc/leather goods categories. See "Business - License
Agreements and Intellectual Property" for a further discussion of the License
Agreement for the Bongo (R) mark. Since that time, Innovo has launched the
Bongo(R) line to department stores and specialty stores across the United
States, including Sears, Roebuck and Co., Beall's, Inc., Hecht's, Foley's, and
Robinsons-May. In fiscal 2003, Innovo's Bongo(R) accessory product line
experienced growing demand in the retail marketplace. Gross sales associated
with the Bongo(R) product line continued to grow significantly in fiscal 2003
and represented approximately 21% of Innovo's total gross sales for fiscal 2003.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Net Sales" for a further discussion of Innovo's net sales for its
Bongo(R) product line.
Innovo's IHK subsidiary is headquartered in Hong Kong and assists Innovo with
the development, design and sourcing of the products sold by Innovo to its
customers. IHK allows Innovo to minimize the amount of time required to design,
develop and source its products, thus allowing Innovo to react quickly to
changing markets conditions and to deliver its products in a timely manner.
In addition, in fiscal 2003, as part of our license agreement for the license of
the Fetish(TM) brand, our Innovo subsidiary produced Fetish(TM) branded
accessories such as purses and wallets. The Fetish(TM) branded accessories
accounted for a small percentage of Innovo's overall net sales in fiscal 2003.
See "Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Net Sales" for a further discussion regarding sales associated with
Fetish(TM) products. See "Business - License Agreements and Intellectual
Property" for further discussion of this license agreement.
In fiscal 2003, Innovo experienced increased demand for its craft product lines
due to Innovo's ability to increase its business with its existing customers
such as Wal-Mart, Michaels Stores, Inc., A.C. Moore Arts & Crafts and added an
additional customer, Hobby Lobby. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Net Sales" for a further
discussion of Innovo's sales for its craft product line.
6
The following are the principal products that Innovo distributes in the United
States to the accessory and craft market:
FASHION ACCESSORY GENERAL ACCESSORIES CRAFTS
----------------- ------------------- ------
Purses Travel and Tote Bags Tote Bags
Hand Bags Waist Packs Adult and Children's Aprons
Duffle Bags Duffle Bags Christmas Stockings
Wallets Stadium Totes/Cushions Gourmet/BBQ Aprons
Beach Bags Insulated Lunch Bags
Tote Bags Soft Coolers
Gloves Pencil Cases
Backpacks
Waist Packs
Hats
Scarves
Apparel
Joe's
Joe's, headquartered in Commerce, California was formed in 2001 to design,
develop, and market high-fashion apparel products under the Joe's(R) and Joe's
Jeans(R) brand. Joe's products are typically part of a collection that includes
pants, denim jeans, shirts, sweaters, jackets and other apparel products. In
fiscal 2002, Joe's focused its efforts on establishing the Joe's brand in both
the domestic and international marketplace by continuing to offer its customers
and consumers a fashion forward, quality product. In fiscal 2002, Joe's created
JJJ in an effort to establish the Joe's brand in the Japanese marketplace.
Additionally, in fiscal 2002, Joe's successfully entered the Canadian and
European markets through the use of international distributors, and contributed
to expand within these markets in fiscal 2003 and expanded distribution to other
countries such as Australia and Korea. On July 1, 2003, Joe's entered into a
Distribution and Licensing Agreement with Itochu ("Itochu Agreement"), pursuant
to which Itochu obtained certain manufacturing and licensing rights for the
"Joe's" and "Joe's Jeans" marks. As a part of the transaction, Itochu agreed to
purchase the existing inventory of JJJ for approximately $1 million, assume the
management and operations of JJJ's showroom in Tokyo and employ certain
employees of JJJ. As of November 29, 2003, we continue to operate JJJ and will
continue to do so until all operations have ceased. Upon the cessation of all
operating activities, we intend to dissolve the JJJ subsidiary. We will continue
to sell our products in Japan through our Distribution and Licensing Agreement
with Itochu. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations -Recent Acquisitions and Licenses."
Joe's believes that it has developed a customer base upon which Joe's can grow
its business going forward. Joe's products are sold in the United States and
abroad to upscale retailers and boutiques such as Barneys New York, Inc.,
Bloomingdale's, Inc., Loehmann's, Inc., Nordstrom, Inc., Saks Incorporated,
Intermix and Fred Segal in the United States and other complimentary retailers
in the international market.
Joe's products are primarily marketed to retailers through third party showrooms
located in New York, Los Angeles, and Paris and through its own showroom in
Tokyo. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Net Sales" for a further discussion of Joe's sales.
Joe's product lines include, but are not limited to, the following:
WOMEN MEN
----- ---
Denim Jeans Denim Jeans
Denim Skirts Knit Shirts
Denim Jackets
Leather Jackets
Knit Shirts
Sweaters
Handbags
7
IAA
IAA, headquartered in Commerce, California, was formed in August 2001 to focus
on marketing products to the private label apparel market. IAA has since
diversified to focus not only on its private label business but also the
development of branded apparel products.
As of November 29, 2003, IAA's private label business primarily designed,
sourced and marketed denim jeans for Warnaco, Target Corporation's Mossimo
brand, and, as part of its acquisition of the Blue Concept Division, to American
Eagle Outfitters, Inc., or AEO. Through the Blue Concept Division, IAA sells
primarily denim jeans to AEO, a national retailer. IAA's sales increased to
$57,627,000 in fiscal 2003 from $8,358,000 in fiscal 2002, or a 589% increase. A
large portion of the increase in IAA's sales during fiscal 2003 is attributable
to sales generated from AEO since July 2003, the date of the Blue Concepts
Division acquisition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Net Sales" for a further discussion of
IAA's sales.
IAA's private label product lines primarily consist of knit tops and denim
bottoms for both the men's and women's market. The branded sportswear product
lines are focused around fashion oriented tops and bottoms. The product lines
include, but are not limited to the following:
TOPS BOTTOMS
---- -------
Knit Fashion Shirts Fleece Sweatpants
Fashion T-Shirts Knit Pants
Basic T-Shirts Denim Jeans
Fleece Sweatshirts Velour Pants
Thermal Pullovers Sweat Suits
Velour Shirts
Sports Jersey's
Dresses
Blouses
Since establishing IAA's branded division and through year ended November 29,
2003, IAA has entered into license agreements with: (1) recording artist and
entertainer Bow Wow for the right to produce apparel and accessory products
under the Shago(R) mark; (2) the recording artist and entertainer Eve for the
right to produce apparel and accessory products under the Fetish(TM) mark; and
(3) Mattel, Inc. for the right to produce apparel and accessory products under
the Hot Wheels(R) mark. IAA entered into the license agreement for the Bow Wow
license in October of fiscal 2002; the license agreement with Eve in February of
2003; and the license agreement with Mattel in August of 2002. IAA began
shipping its Shago(R) apparel and accessory products in May 2003, and its
Fetish(TM) apparel and accessory products in August 2003. To date, IAA has not
shipped any of its Hot Wheels apparel or accessory products, primarily in
response to feedback from retail buyers at the time of the line's launch in
August 2003 suggesting that consumer demand for the proposed Hot Wheels(R)
product line was insignificant. Pursuant to these license agreements, IAA has
the right to sublicense the accessory category to its affiliated subsidiary
Innovo. See "Business - License Agreements and Intellectual Property" for a
further discussion of the license agreements with Bow Wow, Eve, and Mattel, Inc.
Product Development and Sourcing
Accessory
Innovo
Innovo develops the designs and artwork for all products through its in-house
design staff. Innovo's fashion and licensed accessory products are produced with
the logos or other designs licensed from licensors or produced bearing the
Innovo's own private brands such as Daily Denim(TM), Clear Gear(TM),
Friendship(TM) and Tote Works(TM). See "Business-License Agreements and
Intellectual Property" for a further discussion of Innovo's fashion and licensed
accessory products.
Innovo markets its craft products, without artwork, to be sold for finishing by
retail craft customers. Innovo's craft products are purchased from Commerce or
its affiliates. They manufacture our craft products in Mexico and we also import
some of our craft products from China. Innovo is obligated, as defined in the
supply agreement with Commerce, to purchase all of its craft products from
Commerce through August 2004. In fiscal 2003, Innovo purchased approximately
$2.7 million of craft products from Commerce.
Innovo's sourcing office, IHK, manages much of the design and development of its
products that are sourced out of East Asia. Innovo's products are distributed
out of Los Angeles through an agreement with an affiliate of Commerce or the
products may be shipped directly to Innovo's customers from the country of
origin of the manufactured products.
Innovo obtains its fashion accessory products from overseas suppliers located
mainly in China through short term manufacturing agreements. The independent
contractors that manufacture our products are responsible for obtaining the
necessary supply of raw materials and for manufacturing the products to our
specifications. See "Business-Import and Import Restrictions" for further
discussion
8
of supply of raw materials and manufacturing.
We primarily utilize overseas contractors that employ production facilities
located in China. As a result, our products are subject to certain restrictions
imposed by the Chinese government. To date, we have not been adversely affected
by such restrictions; however, there can be no assurance that future changes in
such restrictions by the Chinese government would not adversely affect us, even
if only temporarily, while we shifted production to other countries or regions
such as Mexico, Korea, Taiwan or Latin America. As anticipated, in fiscal 2003,
all of our sales were derived from imported products that are subject to United
States import quotas, inspection or duties. See "Business--Import and Import
Restrictions."
Apparel
Joe's
Joe's product development is managed internally by a team of designers led by
Joe Dahan, which is responsible for the creation, development and coordination
of the product group offerings within each collection. Joe's typically develops
four collections per year for spring, summer, fall and holiday, with certain
basic styles offered throughout the year. Joe Dahan is an instrumental part of
Joe's design process. The loss of Joe Dahan could potentially have a material
adverse impact on Joe's. In the event of the loss of Joe Dahan, Joe's believes
it could find alternative sources for the development and design of Joe's
products, although there can be no assurances. See "Risk Factors-- The loss of
the services of Mr. Joe Dahan could have a material adverse effect on Joe's
business."
Joe's products are sourced through Commerce or its affiliates or from domestic
contractors generally located in the Los Angeles area. Joe's is not
contractually obligated to purchase its products from Commerce. Joe's staff,
however, controls the production schedules in order to ensure quality and timely
deliveries. Commerce is responsible for the acquisition of the raw materials
necessary for the production of Joe's goods. In the event that Commerce is
unable to acquire the necessary raw materials, Joe's believes that there are
alternative sources from which the raw materials could be acquired. We are
currently reviewing the option of sourcing products from international sources
and/or directly sourcing the products from domestic suppliers. During fiscal
2003, Joe's purchased approximately $2.2 million of goods from Commerce. See
"Business - Strategic Relationship with two of our significant stockholders,
Hubert Guez and Paul Guez, and affiliated companies" for a further discussion of
the supply agreement with Commerce. In fiscal 2003, Joe's changed its inventory
strategy from buying finished goods to buying raw materials and outsourcing the
manufacturing of its own goods as a result of no longer being able to purchase
finished goods from our domestic supplier. Joe's cost to buy raw materials and
outsource the manufacturing of its own goods was significantly higher than its
cost to buy finished goods. In the long term, Joe's believes that this
alteration in inventory strategy will be beneficial since this inventory
strategy should decrease the defects associated second quality goods, which have
a lower cost per unit than first quality goods. Sales of second quality goods
lead to lower gross margins.
While Joe's believes that there are currently alternative sources from which to
outsource the production of Joe's products, in the event the economic climate or
other factors resulted in significant reduction in the number of local
contractors in the Los Angeles area, Joe's business could be negatively
impacted. At this time, Joe's believes that it would be able to find alternative
sources for the production of its products if this was to occur, however, no
assurances can be given that a transition could be completed without a
disruption to Joe's business.
IAA
IAA's private label product development is managed by IAA's internal design and
merchandising staff or in conjunction with the design teams of the customer.
IAA's products are sourced from Mexico through independent contractors, through
Commerce and its affiliates or through independent overseas contractors. During
fiscal 2003, IAA purchased approximately $18.2 million of goods from Commerce
and its affiliates. See "Business - Strategic Relationship with two of our
significant stockholders, Hubert Guez and Paul Guez, and affiliated companies"
IAA's branded division's products are developed by its in-house design team or
through the use of independent freelance designers. IAA's branded division
sources a majority of its products from Mexico and the Far East, including
countries such as China, South Korea, Vietnam and India. IAA's purchases in the
international markets will be subject to the risks associated with the
importation of these type products. See "Business-Import and Import
Restrictions."
IAA relies on Commerce and its affiliates' ability to source and supply its
products. IAA expects its reliance on Commerce and its affiliates to decrease in
the future as it begins to purchase more of its products from third party
suppliers. During fiscal 2003, IAA purchased from Commerce and its affiliates
approximately $41.8 million, or 76%, of its products compared to $16.0 million,
or 80%, of its products in fiscal 2002.
IAA and AZT International SA de CV, a Mexico corporation and wholly-owned
subsidiary of Azteca, or AZT, entered into a two-year, renewable, non-exclusive
supply agreement, or Supply Agreement, for products to be sold by IIA through
the Blue Concept Division. Under the terms of the Supply Agreement, we have
agreed to market and sell the products to be purchased from AZT to certain of
our
9
customers, more particularly IAA customers of the Blue Concept Division. See
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for further discussion regarding
this supply agreement.
We generally purchase our products in U.S. dollars. However, as a result of
using overseas suppliers, the cost of these products may be affected by changes
in the value of the relevant currencies. See "Risk Factors - Our business is
exposed to domestic and foreign currency fluctuations."
Notwithstanding the supply agreement for craft products with Commerce, we do not
have any long-term supply agreements with independent overseas contractors, but
we believe that there are a number of overseas and domestic contractors that
could fulfill our requirements. See "Item 1 - Business Description -
Restructured Operations" in the Notes to the Consolidated Financial Statements
for a further discussion of the supply agreement with Commerce and its
affiliates.
While we attempt to mitigate our exposure to manufacturing, the use of
independent contractors does reduce our control over production and delivery and
exposes us to the other usual risks of sourcing products from independent
suppliers. Our transactions with our foreign manufacturers and suppliers are
subject to the risks of doing business abroad. Imports into the United States
are affected by, among other things, the cost of transportation and the
imposition of import duties and restrictions. The United States and the
countries in which our products are manufactured may, from time to time, impose
new quotas, duties, tariffs or other restrictions, or adjust presently
prevailing quotas, duty or tariff levels, which could affect our operations and
our ability to import products at current or increased levels. We cannot predict
the likelihood or frequency of any such events occurring. See "Business - Import
and Import Restrictions."
License Agreements and Intellectual Property
Accessory
Innovo
On March 26, 2001, Innovo entered into a two-year exclusive license agreement
with Michael Caruso & Company, the original owner of the rights to the Bongo(R)
mark, pursuant to which Innovo obtained the right to design, manufacture and
distribute bags and small leather/pvc goods bearing the Bongo(R) mark. According
to the original terms of the license agreement, the license was to expire on
March 31, 2003. However, in November 2002, Innovo entered into an amendment
effective April 1, 2003 with IP Holdings LLC, the assignee of the Bongo(R) mark,
to extend the term of the license agreement to March 31, 2007. The extended
agreement offers Innovo the potential for multi-year extensions tied to certain
performance criteria.
Innovo pays a five percent royalty and a two percent advertising fee on the net
sales of Innovo's goods bearing the Bongo(R) mark. Pursuant to the terms of the
license agreement, Innovo is required to pay minimum royalties in the amount of
$312,500 prior to the expiration of the license agreement. In accordance with
the terms of the agreement, Innovo has the exclusive right to sell, market,
distribute, advertise and promote the Bongo(R) products in the United States,
including its territories and possessions, Mexico, Central and South America and
Canada. The licensor has the right to terminate the agreement in the event
Innovo breaches any material terms of the agreement.
In fiscal 2003, Innovo's collegiate and Major League Baseball sports-licensed
accessory products were discontinued because we are placing more time and
resources towards developing more fashion oriented product lines that we believe
will have greater potential in the marketplace. This cancellation has not had a
material adverse effect on Innovo's products or revenues for fiscal 2003, as
they represented a small portion of products and revenues in prior years.
Due to the cancellation of its sports-licensed accessory products, Innovo has
placed more time and resources towards developing more fashion oriented product
lines that Innovo believes will have greater potential in the marketplace.
Innovo's craft line includes tote bags imprinted with the E.A.R.T.H. ("EVERY
AMERICAN'S RESPONSIBILITY TO HELP") BAG(R) mark. E.A.R.T.H. Bags(R) are marketed
as a reusable bag that represents an environmentally conscious alternative to
paper or plastic bags. Sales of E.A.R.T.H. Bags(R), while significant in
Innovo's early years, have not been significant in the last five years. Innovo
still considers the mark to be an asset.
Furthermore, pursuant to the license agreements entered into by IAA, Innovo, as
a sublicensee, has the right to produce accessories for the branded label market
bearing the Shago(R), Fetish(TM) and Hot Wheels(R) marks pursuant to the terms
of those license agreements. See "License Agreements and Intellectual Property -
IAA" for a further discussion of the Shago(R), Fetish(TM) and Hot Wheels(R)
license agreements.
10
Apparel
Joe's
In February 2001, Joe's acquired the license rights to the JD logo and the Joe's
Jeans(R) mark for all apparel and accessory products. The license agreement with
JD Design, LLC, or JD Design, has a ten-year term with two ten-year renewal
periods upon there being no material default at the end of each period.
Additionally, pursuant to the terms of the agreements, Joe Dahan is to receive a
three percent royalty on the net revenues of sales of Joe's(R) and Joe's
Jeans(R) products, subject to additional royalty amounts in the event certain
sales and gross profit thresholds are met on an annual basis.
On July 1, 2003, Joe's entered into a Distribution and Licensing Agreement with
Itochu, pursuant to which Itochu obtained certain manufacturing and licensing
rights for the "Joe's" and "Joe's Jeans" marks. As a part of the transaction,
Itochu agreed to purchase the existing inventory of JJJ for approximately $1
million, assume the management and operations of JJJ's showroom in Tokyo and
employ certain employees of JJJ. As of November 29, 2003, we continue to operate
JJJ and will continue to do so until all operations have ceased. Upon the
cessation of all operating activities, we intend to dissolve the JJJ subsidiary.
We will continue to sell product in Japan through our Distribution and Licensing
Agreement with Itochu. See "Management's Discussion and Analysis of Financial
Conditions and Results of Operations -Recent Acquisitions and Licenses" for
further discussion regarding this license and distribution agreement.
As the licensee and on behalf of JD Design, we have applied for protection with
the United States Patent and Trademark Office, as well as with various foreign
jurisdictions, such as Australia, Canada, the European Union, Japan, Korea and
New Zealand, for trademark protection for certain of "Joe's" logos and "Joe's
Jeans" marks for apparel and accessory products. As of November 29, 2003, two
trademark registrations have been issued in the United States and five trademark
registrations have been issued internationally. We continue to prosecute two
pending trademark applications in the United States and 24 pending trademark
applications internationally that we believe are necessary to protect these
trademarks fully.
IAA
On August 1, 2002, IAA entered into an exclusive 42-month worldwide agreement
for the Bow Wow license, granting IAA the right to produce and market products
bearing the Shago(R) mark and likeness of the popular stage and screen
performer. The IAA division has created and marketed a wide range of apparel for
boys and plans on doing the same for girls. The license agreement between IAA,
Bravado International Group, the agency with the master license and rights to
Bow Wow, and LBW Entertainment, Inc. calls for the performer to make at least
one public appearance every six months during the term of the agreement to
promote the Bow Wow products, as well as use his best efforts to promote and
market these products on a daily basis. Additional terms of the license
agreement allows IAA to market boys and girls products bearing the Bow Wow brand
to all distribution channels, the right of first refusal on all other Bow Wow
related product categories during the term of the license agreement, and the
right of first of refusal on proposed transactions by the licensor with third
parties upon the expiration of the agreement. The agreement calls for IAA to pay
an eight percent royalty on the nets sales of goods bearing Bow Wow related
marks. IAA is obligated to pay a minimum net royalty in the amount of $75,000 on
or before January 31, 2005. In the event IAA defaults upon any material terms of
the agreement, the licensor shall have the right to terminate the agreement.
Furthermore, IAA has the right to sublicense the accessory product's category to
Innovo.
On February 13, 2003, our IAA subsidiary entered into a 44 month exclusive
license agreement for the United States, its territories and possessions with
the recording artist and entertainer Eve for the license of the Fetish(TM) mark
for use with the production and distribution of apparel and accessory products.
We have guaranteed minimum net sales obligations for apparel and accessories of
$8 million in the first 18 months of the agreement, $10 million in the following
12 month period and $12 million in the 12 month period following thereafter.
According to the terms of the agreement we are required to pay an eight percent
royalty and a two percent advertising fee on the nets sales of products bearing
the Fetish(TM) logo. In the event we do not meet the minimum guaranteed sales,
we will be obligated to make royalty and advertising payments equal to the
minimum guaranteed sales multiplied by the royalty rate of eight percent and the
advertising fee of two percent. Such minimum royalty payments will equal $2.4
million in the aggregate over the term of the license agreement. We also have
the right of first refusal with respect to the license rights for the Fetish(TM)
mark in the apparel and accessories category upon the expiration of the
agreement, subject to us meeting certain sales performance targets during the
term of the agreement. Additionally, we have the right of first refusal for the
apparel and accessory categories in territories in which we do not currently
have the license rights for the Fetish(TM) mark.
In July 2002, IAA entered into a five-year license agreement with Mattel, Inc.
to produce Hot Wheels(R) branded adult apparel and accessories in the United
States, Canada and Puerto Rico to be targeted to men and women in the junior and
contemporary markets, or the Hot Wheels(R) License. IAA may terminate the Hot
Wheels(R) License in any year by paying the remaining balance of that year's
minimum royalty guarantees plus the subsequent year's minimum royalty
guarantees. The total minimum royalties due for the entire 5 years term is $1.05
million in the aggregate. Royalties paid by IAA earned in excess of the minimum
royalty requirements for any one given year may be credited towards the
shortfall amount of the minimum required royalties in any subsequent period
during the term of the license agreement. According to the terms of the Hot
Wheels(R) License, IAA has the right to sublicense the accessory product's
category to Innovo. The Hot Wheels(R) License calls for a royalty rate of seven
percent royalty and a two percent advertising fee on the net sales of goods
bearing the Hot Wheels(R) mark. In the event IAA defaults upon any material
terms, the licensor shall have the right to terminate the agreement. In fiscal
2003, IAA had no sales under this license agreement. The absence of sales from
the Hot Wheels(R) License was primarily due to insignificant orders placed for
the product at the initial launch of the line at the MAGIC apparel trade show in
Las Vegas in August 2003 as a result of apparent interest in the consumer
marketplace. While, as of November 29, 2003, we are still contractually
obligated under the Hot Wheels(R) License, we have been in discussion with
Mattel regarding these and other concerns surrounding the consumer demand for
the product.
11
The following sets forth certain information concerning the license agreements
currently held by us:
Licensor/Mark Types of Products Geographical Areas Minimum Royalties Expiration Date
------------- ----------------- ------------------ ----------------- ---------------
JD Design LLC Apparel and accessories Worldwide N/A 2/11/31
(Joe's Jeans)
Blondie Rockwell, Inc. Apparel and accessories United States, its $2.4 million in the 7/31/06
(Eve, Fetish(TM)) Territories and possessions aggregate
Bravado International Apparel and accessories United States $75,000 prior to 2/1/06
Group, Inc. 1/31/05
(Bow Wow, Shago(R))
IP Holdings LLC Bags, small leather/pvc United States, its $312,500 prior to 3/31/07
(Bongo(R)) goods territories and possessions, expiration
Mexico, Central and South
America, Canada
Mattel, Inc. Apparel and accessories United States, Canada and $1.05 million in the 12/31/07
(Hot Wheels(R)) Puerto Rico aggregate
We believe that we will continue to be able to obtain the renewal of all
material licenses; however, there can be no assurance that competition for an
expiring license from another entity, or other factors will not result in the
non-renewal of a license. As we continue to expand our business in the
international marketplace, our trademarks or the trademarks we license may not
be able to be adequately protected. See "Risk Factors -- Our trademark and other
intellectual property rights may not be adequately protected outside the United
States."
Customers
Accessory
Innovo
During fiscal 2003, Innovo sold products to a mix of mass merchandisers,
department stores, craft chain stores and other retail accounts. We estimate
that Innovo's products are carried by over 548 customers in over 6,000 retail
outlets in the United States. In marketing Innovo's products, Innovo attempts to
emphasize the competitive pricing and quality of its products, its ability to
assist customers in designing marketing programs, its short lead times and the
high success rate our customers have had with our products. Generally, Innovo's
accounts are serviced by Innovo's sales personnel working with marketing
organizations that have sales representatives that are compensated on a
commission basis. Innovo's New York City showroom is used to showcase all
product lines developed by Innovo and to help facilitate sales for all accounts.
In fiscal 2003, Innovo sold its products to private label customers such as
American Eagle Outfitters, Inc., Claire's Stores, Inc. and Hot Topic. Innovo
currently sells it products to retailers such as Wal-Mart, Inc., A.C. Moore Arts
& Crafts, Hobby Lobby, Joanne's, Inc., Michaels Stores, Inc., Sears, Roebuck and
Co., 579 Stores, Beall's, Inc., The May Department Stores Company, which
includes, Hecht's, Foley's, and Robinsons-May, J. C. Penney Company, Inc.,
Claire's Stores, Inc., The Wet Seal, Inc., and Federated Department Stores,
Inc., which includes Macy's East and Macy's West.
For fiscal 2003, Innovo's three largest customers, American Eagle Outfitters,
Inc., Wal-Mart, Inc. and Michaels Stores, Inc. accounted for approximately 62%
of its net sales. The loss of any of these three customers would have a material
adverse effect on Innovo.
Apparel
Joe's
Joe's products are sold to consumers through high-end department stores and
boutiques located throughout the world. For Joe's domestic sales, Joe's has
entered into sales agreements with third party showrooms where retailers review
the latest collections offered by Joe's and place orders. The showrooms provide
Joe's with purchase orders from the retailers. Joe's then distributes the
products from its Los Angeles distribution facility. Joe's currently has
domestic agreements with showrooms in Los Angeles and New York and these
12
showrooms have representatives throughout the United States.
Joe's products are sold in Japan through its subsidiary JJJ. JJJ operates a
company-operated showroom in Tokyo through which Joe's products are sold to
retailers. On July 1, 2003, Joe's entered into a Distribution and Licensing
Agreement with Itochu, pursuant to which Itochu obtained certain distribution
and licensing rights for the "Joe's" and "Joe's Jeans" marks. We will continue
to sell product in Japan through our Distribution and Licensing Agreement with
Itochu. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations -Recent Acquisitions and Licenses" for further discussion
regarding this license and distribution agreement. Additionally, Joe's is
currently selling its products in Europe, Canada, Australia and Korea through
distributors who purchase the product directly from Joe's and then distribute
the product in to the local markets. Revenues generated by JJJ represented
approximately 26% of Joe's total net sales in fiscal 2003. See Management's
Discussion and Analysis of Financial Conditions and Results of Operations - Net
Sales" for further discussion of Joe's net sales.
We currently sell to domestic retailers such as Barneys New York, Inc., Saks
Incorporated, Federated Department Stores, Inc. which includes, Bloomingdale's,
Inc. and Macy's, Inc., Intermix, Fred Segal and Loehmann's and in Japan to
retailers such as Sanei International, Interplanet, Free's Shops, Isetan,
Mitsukoshi New York Runway and Barneys New York, Inc.
Also, on February 16, 2004, Joe's entered into a Master Distribution Agreement,
or MDA, with Beyond Blue, Inc., or Beyond Blue, whereby Joe's granted Beyond
Blue exclusive distribution rights for Joe's products outside the United States.
The MDA provided for the continuation of existing distribution agreements, such
as the Itochu Agreement. The MDA was entered into in an effort to capitalize
upon Joe's international brand recognition, to utilize Beyond Blue's experience
in international distribution of high-end fashion denim apparel lines and to
manage international distribution through the use of sub-distributors and sales
agents in foreign markets. See "Business - Subsequent Events" for further
discussion of the MDA between Joe's and Beyond Blue.
The Joe's Jeans website (www.joesjeans.com) has been built to advance the
brand's image and to allow consumers to review the latest collection of
products. Joe's currently uses both online and print advertising to create brand
awareness with customers as well as consumers.
For fiscal 2003, Joe's three largest customers accounted for approximately 21%
of its net sales. The loss of any of these customers would not have a material
adverse affect on Joe's.
IAA
IAA develops apparel products for the private label and branded product markets.
At year ended November 29, 2003, IAA primarily distributed its private label
products primarily to Target Corporation's Mossimo division, or Target, and
American Eagle Outfitters, Inc., or AEO.
During fiscal 2003, sales to Target Corporation, AEO, and Warnaco, which IAA
ceased selling products to in fiscal 2003, represented approximately 18%, 48%
and 10%, respectively, of IAA's net sales.
Pursuant to the license agreements for Shago(R), Fetish(TM) and Hot Wheels(R),
IAA may sell apparel and accessory products to certain agreed upon channels of
distribution set forth in the various license agreements. Currently, IAA
distributes its Shago(R) apparel and accessory products to Federated Department
Stores, Inc., which includes Macy's East and Macy's West, Jimmy Jazz and City
Blues. IAA distributes its Fetish(TM) apparel and accessory products to
Federated Department Stores, Inc., which includes Macy's East and Macy's West,
Robinsons-May, Demo, Up Against the Wall, Epic and Man Alive.
We do not enter into long-term agreements with any of our customers. Instead, we
receive individual purchase order commitments from our customers. A decision by
the controlling owner of a group of stores or any other significant customer,
whether motivated by competitive conditions, financial difficulties or
otherwise, to decrease the amount of merchandise purchased from us, or to change
their manner of doing business with us, could have a material adverse effect on
our financial condition and results of operations. See "Risk Factors--A
substantial portion of our net sales and gross profit is derived from a small
number of large customers."
Our business has historically been seasonal by nature. While we believe that as
a result of our growing product lines and expanding business model, our business
should be less seasonal in future periods. Furthermore, a majority of our
revenues are generated during our third and fourth quarters. See
"Business-Seasonality of Business and Working Capital" for further discussion of
the seasonality of our business.
Seasonality of Business and Working Capital
We have historically experienced and expect to continue to experience seasonal
fluctuations in sales and net earnings. Historically, a significant amount of
our net sales and a majority of our net earnings have been realized during the
third and fourth quarter. In the second quarter in order to prepare for peak
sales that occur during the third quarter, we build inventory levels, which
results in higher
13
liquidity needs as compared to the other quarters in the fiscal year. If sales
were materially different from seasonal norms during the third quarter, our
annual operating results could be materially affected. Accordingly, our results
for the individual quarters are not necessarily indicative of the results to be
expected for the entire year.
Due to our growth during fiscal 2003, we entered into a series of transactions
to provide us with additional working capital. On June 1, 2001 and September 10,
2001, we, through our three main operating subsidiaries, Joe's, Innovo, and IAA,
entered into financing agreements with CIT Commercial Services, a unit of CIT
Group Inc, or CIT for the factoring of our account receivables. In August 2002,
Joe's and Innovo each entered into certain amendments to their respective
factoring agreements, which included inventory security agreements, to permit
each subsidiary to obtain advances of up to 50% of the eligible inventory up to
$400,000 each. As a result of necessity for additional working capital, on or
about June 10, 2003, the existing financing facilities with CIT for our
subsidiaries were amended, to be effective as of April 11, 2003, primarily to
remove the fixed aggregate cap of $800,000 on their inventory security
agreements to allow for Innovo and Joe's to borrow up to 50% of the value of
certain eligible inventory. In connection with these amendments, IAA entered
into an inventory security agreement with CIT based upon the same terms as Joe's
and Innovo. Cross guarantees were executed by and among the subsidiaries and we
also entered into a guarantee for our subsidiaries' obligations in connection
with the amendments to the existing credit facilities. We have also established
a letter of credit facility with CIT. As of November 29, 2003, we had a loan
balance with CIT of $8,786,000, the majority of which was collateralized against
non-recourse factored receivables. As of November 29, 2003, we had $8,536,000 of
factored receivables with CIT and an aggregate amount of $2,149,000 of unused
letters of credit outstanding. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources"
for further discussion of our financing agreements with CIT.
Additionally, in fiscal 2003, we consummated five private placements of our
common stock resulting in net proceeds of approximately $17,540,000, after
deducting commissions. During our first private placement completed on March 19,
2003 we issued 165,000 shares of our common stock to 17 accredited investors at
$2.65 per share, raising net proceeds of approximately $407,000. During our
second private placement completed on March 26, 2003, we issued 63,500 shares of
our common stock to 5 accredited investors at $2.65 per share, raising net
proceeds of approximately $156,000. During our third private placement completed
on July 1, 2003, we issued 2,835,481 shares to 34 accredited investors at $3.33
per share, raising net proceeds of approximately $8,751,000. As part of this
private placement, and in addition to commissions paid, warrants to purchase
300,000 shares of our common stock at $4.50 were issued to the placement agent,
Sanders Morris Harris, Inc. During our fourth private placement completed on
August 29, 2003, we issued 175,000 shares of our common stock to 5 accredited
investors at $3.62 per share, raising net proceeds of approximately $592,000. As
part of this private placement, and in addition to commissions paid, warrants to
purchase 17,500 shares of our common stock at $3.62 were issued to the placement
agent, Pacific Summit Securities. During our fifth private placement which was
completely funded on or before November 29, 2003, but completed on December 1,
2004, we issued 2,996,667 shares of our common stock to 14 accredited investors
at $3.00 per share, and warrants to purchase 599,333 shares of our common stock
to certain of these investors at $4.00 per share raising net proceeds of
approximately $10,704,000. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations -Equity Financings" and "Risk
Factors - Equity Financings" and Item 5 "Market for Registrant's Common Equity
and Related Stockholder Matters" for a further discussion of our equity
financings.
These equity financings and amended financing agreements with CIT were necessary
to support our growth in fiscal 2003. Such growth is associated with our
obligations pursuant to the license agreements for the Shago(R) and Fetish(TM)
marks, respectively. Based upon our historical growth, we may need to obtain
additional working capital in order to meet our operational needs in fiscal
2004. We believe that we will be able to address these needs by increasing the
availability of funds offered to us under our financing agreements with CIT or
other financial institutions or by obtaining additional capital through debt or
equity financing. See "Managements Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital Resources." We believe
that any additional capital, to the extent needed, may be obtained from the sale
of equity securities or through short-term working capital loans. However, there
can be no assurance that this or other financing will be available if needed.
The inability of us to be able to fulfill any interim working capital
requirements would force us to constrict our operations.
Backlog
Although we may, at any given time, have significant business booked in advance
of ship dates, customers' purchase orders are typically filled and shipped
within two to six weeks. As of November 29, 2003, there were no significant
backlogs.
Competition
The industries in which we operate are fragmented and highly competitive in the
United States and on a worldwide basis. We compete for consumers with a large
number of apparel and accessory products similar to ours. We do not hold a
dominant competitive position, and our ability to sell our products is dependent
upon the anticipated popularity of our designs, the brands our products bear,
the price and quality of our products and our ability to meet our customers'
delivery schedules.
We believe that we are competitive in each of the above- described segments with
companies producing goods of like quality and pricing, and that new product
development, product identity through marketing, promotions and low price points
will allow us to maintain our
14
competitive position. However, many of our competitors possess substantially
greater financial, technical and other resources than us , including the ability
to implement more extensive marketing campaigns. Furthermore, the intense
competition and the rapid changes in consumer preferences constitute significant
risk factors in our operations. As we expand globally, we continue to encounter
additional sources of competition. See "Risk Factors--We face intense
competition in the worldwide apparel and accessory industry."
Imports and Import Restrictions
Our transactions with our foreign manufacturers and suppliers are subject to the
risks of doing business abroad. Imports into the United States are affected by,
among other things, the cost of transportation and the imposition of import
duties and restrictions. The countries in which our products might be
manufactured may, from time to time, impose new quotas, duties, tariffs or other
restrictions, or adjust presently prevailing quotas, duty or tariff levels,
which could affect our operations and our ability to import products at current
or increased levels. We cannot predict the likelihood or frequency of any such
events occurring. The enactment of any additional duties, quotas or restrictions
could result in increases in the cost of our products generally and might
adversely affect our sales and profitability.
Our import operations are subject to constraints imposed by bilateral textile
agreements between the United States and a number of foreign countries,
including Hong Kong, China, Taiwan and Korea. These agreements impose quotas on
the amount and type of goods that can be imported into the United States from
these countries. Such agreements also allow the United States to impose, at any
time, restraints on the importation of categories of merchandise that, under the
terms of the agreements, are not subject to specified limits. Our imported
products are also subject to United States customs duties and, in the ordinary
course of business, we are from time to time subject to claims by the United
States Customs Service for duties and other charges.
We monitor duty, tariff and quota-related developments and continually seek to
minimize its potential exposure to quota- related risks through, among other
measures, geographical diversification of our manufacturing sources, the
maintenance of overseas offices, allocation of overseas production to
merchandise categories where more quota is available and shifting of production
among countries and manufacturers.
Because our foreign manufacturers are located at greater geographic distances
from us than our domestic manufacturers, we are generally required to allow
greater lead time for foreign orders, which reduces our manufacturing
flexibility. Foreign imports are also affected by the high cost of
transportation into the United States.
In addition to the factors outlined above, our future import operations may be
adversely affected by political instability resulting in the disruption of trade
from exporting countries, any significant fluctuation in the value of the dollar
against foreign currencies and restrictions on the transfer of funds.
Human Resources
As of February 1, 2004, we had 201 full-time employees. IGI employed 11
individuals, Innovo employed 65 individuals, Joe's employed 38 individuals, and
IAA employed 87 individuals located in our various offices.
Real Estate Transactions
IRI
In April 2002, IRI acquired a 30% limited partnership interest in each of 22
separate partnerships. These partnerships simultaneously acquired 28 apartment
complexes at various locations throughout the United States consisting of
approximately 4,000 apartment units, or Properties. A portion of the aggregate
$98,080,000 purchase price was paid through the transfer of 195,295 shares of
our $100, 8% Series A Redeemable Cumulative Preferred Stock, or the Series A
Preferred Shares, to the sellers of the Properties. The balance of the purchase
price was paid by Metra Capital, LLC, or Metra Capital, in the amount of
$5,924,000, or the Metra Capital Contribution, and through proceeds from a Bank
of America loan, in the amount $72,625,000.
We had originally issued the Series A Preferred Shares to IRI in exchange for
all shares of its common stock. IRI then acquired a 30% limited partnership
interest in each of the 22 separate limited partnerships in exchange for the
Series A Preferred Stock, which then transferred the Series A Preferred Shares
to the sellers of the Properties.
Some of our stockholders, including one of our substantial stockholders, Messrs.
Paul Guez, and Simon Mizrachi and their affiliates have invested in each of the
22 separate partnerships. Each of Messrs. Guez and Mizrachi, together with their
respective affiliates, own 50% of the membership interests of Third Millennium.
Third Millennium is the managing member of Metra Capital, which owns 100% of the
membership interest in each of the 22 separate limited liability companies, or
collectively, the General Partners and together with Metra Capital, the Metra
Partners, that hold a 1% general partnership interest in each of the 22 separate
limited partnerships that own the Properties. Metra Capital also owns 69% of the
limited partnership interest in each of the 22 separate limited partnerships.
Messrs. Guez and Mizrachi and their affiliates own 19% of the membership
interest of Metra Capital. Based on the Schedule 13D/A filed by Messrs.
15
Simon Mizrachi and Joseph Mizrachi on October 30, 2003, and the Schedule 13D/A
filed by Hubert Guez and Paul Guez on January 20, 2004, the Mizrachi's
beneficially owned approximately 1% of our shares and the Guez's beneficially
own 17.57% of our shares in the aggregate. Effective February 21, 2003, the
Mizrachi's ceased to be the beneficial owners of more than five percent of our
securities. Furthermore, in connection with investments made by (1) Commerce and
other investors affiliated with Hubert Guez and Paul Guez, or collectively, the
Commerce Group, and (2) Mr. Joseph Mizrachi and Simon Mizrachi through three
entities controlled by the Mizrachi's, in 2000, each of the Commerce Group and
Mr. Joseph Mizrachi have the right to designate three individuals or one
individual, respectively, for election to our board of directors.
Pursuant to each of the limited partnership agreements, the Metra Partners
receive at least quarterly (either from cash flow and/or property sale proceeds)
an amount sufficient to provide the Metra Partners (1) a 15% cumulative compound
annual rate of return on the outstanding amount of the Metra Capital
Contribution that has not been previously returned to them through prior
distributions of cash flow and/or property sale proceeds and (2) a cumulative
annual amount of .50% of the average outstanding balance of the average
outstanding balance of the mortgage indebtedness secured by any of the
Properties. In addition, in the event of a distribution solely due to a property
sale proceeds after the above distributions have been made to the Metra
Partners, Metra Partners also receive an amount equal to 125% of the amount of
the Metra Capital Contribution allocated to the Property sold until the Metra
Partners have received from all previous cash flow or property sale
distributions an amount equal to its Metra Capital Contribution.
Third Millennium receives on a quarterly basis from cash flows and/or property
sale proceeds an amount equal to $63,000 until it receives an aggregate of
$252,000.
After the above distributions have been made, and if any cash is available for
distribution, IRI is to receive at least quarterly in the case of cash flow
distributions and at the time of property sale distributions an amount
sufficient for it to pay the 8% coupon on the Series A Preferred Shares and then
any remaining amounts left for distribution to redeem a portion or all of the
Series A Preferred Shares.
After all of the Series A Preferred Shares have been redeemed ($19.5 million),
future distributions are split between Metra Partners and IRI, with Metra
Partners receiving 70% of such distribution and IRI receiving the balance. In
addition, IRI receives a quarterly sub-asset management fee of $85,000.
The 8% Series A Preferred Shares coupon is funded entirely and solely through
partnership distributions as discussed above. If sufficient funds are not
available for the payment of a full quarterly 8% coupon, then partial payments
shall be made to the extent funds are available. Unpaid dividends accrue.
Partnership distribution amounts remaining after the payment of all accrued
dividends must be used by us to redeem outstanding the Series A Preferred
Shares. The Series A Preferred Shares have a redemption price of $100 per share.
In the event that the partnership distributions received by us are insufficient
to cover the 8% coupon or the redeem the Series A Preferred Shares, we will have
no obligation to cover any shortcomings so long as all distributions from the
partnership are properly applied to the payment of dividends and the redemption
of the Series A Preferred Shares. We may however be liable to the holders of the
Series A Preferred Shares for the breach of certain covenants, including, but
not limited to, if IRI fails (i) to deposit distributions from the partnerships
into a sinking fund which funds are to be distributed to the holders of the
Series A Preferred Shares as a dividend or redemption of the Series A Preferred
Shares or (ii) to enforce its rights to receive distributions from the limited
partnerships. If, after all of the Properties are sold and the proceeds of the
sale of the Properties and cash flow derived from such Properties have either
been applied to the payment of the 8% coupon and the redemption of the Series A
Preferred Shares or deposited into the sinking fund for that purpose, and the
total amount of funds remaining in the Sinking Fund is insufficient to pay the
full 8% coupon and the full Redemption Price for all then outstanding the Series
A Preferred Shares, then we, or IRI, must pay $1.00 in total into the Sinking
Fund and the Redemption Price will be adjusted so that it equals (x) the total
amount in the sinking fund available for distribution, minus (y) all direct
costs of maintaining the Sinking Fund and making distributions therefrom,
divided by (z) the number of then outstanding Preferred Shares. The adjusted
Redemption Price will represent full and final payment for the redemption of all
the Series A Preferred Shares.
We have not given accounting recognition to the value of our investment in the
limited partnerships, because we have determined that the asset is contingent
and will only have value to the extent that cash flow from the operations of the
properties or from the sale of underlying assets is in excess of the 8% coupon
and redemption of the Series A Preferred Shares. As discussed above, we are
obligated to pay the 8% coupon and redeem the Series A Preferred Shares from our
partnership distributions, prior to us being able to recover the underlying
value of our investment. Additionally, we have determined that the Series A
Preferred Shares will not be accounted for as a component of equity as the
shares are redeemable outside of our control. No value has been ascribed to the
Series A Preferred Shares for financial reporting purposes as we are obligated
to pay the 8% coupon or redeem the shares only if we receive cash flow from the
limited partnerships adequate to make the payments. We have included the
quarterly management fee paid to IRI in other income using the accrual basis of
accounting.
During fiscal 2003, IRI had no operations or transactions other than its
quarterly sub-asset management fee as discussed above.
16
Financial Information about Geographical Areas
See "Note 13 - Segment Disclosures -Operations by Geographic Area" in the Notes
to Consolidated Financial Statements for further discussion of financial
information about geographical areas.
Available Information
Our World Wide Web address is www.innovogroup.com, and we maintain a website at
that address. We make available on or through our World Wide Web website,
without charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15 (d) of the Securities Exchange Act of 1934, as
amended, as soon as reasonably practicable after such reports are electronically
filed with or furnished to the SEC. Although we maintain a website at
www.innovogroup.com, we do not intend that the information available through our
website be incorporated into this Annual Report on Form 10-K. In addition, any
materials filed with, or furnished to, the SEC may be read and copied at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 or
viewed on line at www.sec.gov. Information regarding the operation of the Public
Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.
Executive Officers
The following table sets forth certain information regarding our executive
officers:
Name Age Position
- ---- --- --------
Samuel J. (Jay) Furrow, Jr...... 30 Chief Executive Officer and Director
Patricia Anderson............... 43 President and Director
Marc B. Crossman................ 32 Chief Financial Officer and Director
Shane Whalen.................... 33 Chief Operating Officer
Samuel J. (Jay) Furrow, Jr. has served as our Chief Executive Officer since July
2002 and a member of our Board of Directors since January 1999. Prior to that,
Mr. Furrow served as our President from December 2000 until July 2002, served as
our Chief Operating Officer from April 1999 until July 2002, our Acting Chief
Financial Officer from August 2000 until July 2002, and our Vice-President for
Corporate Development and In-House Counsel from August 1998 until April 1999.
Patricia Anderson has served as our President since July 2002 and a member of
our Board of Directors since August 1990. Ms. Anderson has also served as
President of Innovo since 1987. Prior to that, Ms. Anderson served as our Chief
Executive Officer from December 2000 until July 2002, our President from August
1990 until December 2000, and Chairman of our Board of Directors from August
1990 until August 1997.
Marc B. Crossman has served as our Chief Financial Officer since March 2003 and
a member of our Board of Directors since January 1999.
Shane Whalen has served as our Chief Operating Officer since April 2003.
Subsequent Events
On February 6, 2004, we, through IAA, entered into an assignment with Blue
Concept LLC, which is controlled by Paul Guez for all the rights benefits and
obligations of a license agreement between Blue Concept LLC and B.J. Vines,
Inc., the licensor of the Betsey Johnson(R) apparel brand. The license agreement
provides for the exclusive right to design, market and distribute women's jeans
and coordinating denim related apparel, such as t-shirts and tops, under the
Betsey Johnson(R) brand name in the United States, its territories and
possessions, and Canada. The license agreement allows for an initial four-year
term with a renewal option subject to certain sales levels being met. We are
required to pay royalties of eight percent on net sales and spend two percent of
net sales on advertising. The license agreement provides that certain minimum
guaranteed royalties and minimum net sales must be met in each annual period.
The minimum royalties to be paid in the aggregate are $1.28 million and minimum
net sales range form $2.5 million to $5.5 million. The agreement may be renewed
upon expiration of the initial 4 year term for an additional three years. We
anticipate introducing the Betsey Johnson(R) products in the third quarter of
2004.
On February 16, 2004, Joe's entered into a Master Distribution Agreement ("MDA")
with Beyond Blue, Inc., or Beyond Blue, whereby Joe's granted Beyond Blue
exclusive distribution rights for Joe's products outside the United States.
Beyond Blue, a Los Angeles-based company that specializes in international
consulting, distribution and licensing for apparel products, secured an
exclusive right to distribute Joe's products outside the United States, subject
to current license agreements such as the license with Itochu and Joe's Canadian
distributor remaining in place. Under the MDA, Beyond Blue will be establishing
sub-distributors and sales agents in certain international markets through
sub-distribution agreements. These sub-distribution agreements shall govern, but
not be limited to, such items as: (i) minimum sample charges paid by each
sub-distributor; (ii) minimum advertising requirements to be borne by each
sub-distributor; and (iii) an assignment provision that allows Joe's to take
over the sub-distribution agreements in the event that Beyond
17
Blue defaults under the MDA. The MDA also provides for the continuation of
existing distribution agreements, such as the Itochu Agreement. The term of the
MDA shall be for three years, subject to Beyond Blue purchasing certain minimum
amounts of product from Joe's during three annual periods, with the first annual
period being for 18 months.
18
Certain Risk Factors
The following risk factors should be read carefully in connection with
evaluating our business and the forward-looking statements contained in this
Annual Report on Form 10-K. Any of the following risks could materially
adversely affect our business, our operating results, our financial condition
and the actual outcome of matters as to which forward-looking statements are
made in this Annual Report on Form 10-K.
Risk Factors Relating to our Common Stock
We do not anticipate paying dividends on our common stock in the foreseeable
future.
We have not paid any dividends nor do we anticipate paying any dividends on our
common stock in the foreseeable future. We intend to retain earnings, if any, to
fund our operations and to develop and expand our business.
We have a substantial number of authorized common and preferred shares available
for future issuance that could cause dilution of our stockholder's interest and
adversely impact the rights of holders of our common stock.
We have a total of 40,000,000 shares of common stock and 5,000,000 shares of
"blank check" preferred stock authorized for issuance. As of February 25, 2004,
we had 14,135,150 shares of common stock and 4,806,000 shares of preferred stock
available for issuance. In fiscal 2003, we raised net proceeds of $17,540,000
through the sale of 6,235,648 shares of our common stock and 916,833 shares of
common stock purchase warrants in private placement transactions. On March 5,
2004, we are holding a special meeting of our stockholders to approve the
conversion of $12.5 million in principal amount of indebtedness from a
convertible promissory note issued in connection with the purchase of the Blue
Concepts Division from Azteca into a maximum of 4,166,667 shares of our common
stock. We expect to continue to seek financing which could result in the
issuance of additional shares of our capital stock and/or rights to acquire
additional shares of our capital stock. Those additional issuances of capital
stock would result in a reduction of your percentage interest in us.
Furthermore, the book value per share of our common stock may be reduced. This
reduction would occur if the exercise price of the options or warrants or the
conversion ratio of the preferred stock was lower than the book value per share
of our common stock at the time of such exercise or conversion.
The addition of a substantial number of shares of our common stock into the
market or by the registration of any of our other securities under the
Securities Act may significantly and negatively affect the prevailing market
price for our common stock. The future sales of shares of our common stock
issuable upon the exercise of outstanding warrants and options may have a
depressive effect on the market price of our common stock, as such warrants and
options would be more likely to be exercised at a time when the price of our
common stock is greater than the exercise price.
Our board of directors has the power to establish the dividend rates,
preferential payments on any liquidation, voting rights, redemption and
conversion terms and privileges for any series of our preferred stock. The sale
or issuance of any shares of our preferred stock having rights superior to those
of our common stock may result in a decrease in the value or market price of our
common stock. The issuance of preferred stock could have the effect of delaying,
deferring or preventing a change of ownership without further vote or action by
our stockholders and may adversely affect the voting and other rights of the
holders of our common stock.
We are controlled by our management and other related parties.
As of February 4, 2004, our executive officers and directors beneficially owned
approximately 24.82% of our outstanding securities. Furthermore, in connection
with investments made by (1) Commerce and other investors affiliated with Hubert
Guez and Paul Guez, or collectively, the Commerce Group, and (2) Mr. Joseph
Mizrachi in fiscal 2000, both Commerce Group and Mr. Mizrachi each have the
right to designate three individuals and one individual respectively, for
election to the board of directors. If any or all of the Commerce Group or
Mizrachi designated directors are elected, then the Board has the obligation to
appoint at least one Commerce and/or Mizrachi designated director to each of its
committees. Based on the Schedule 13D/A filed by Messrs. Simon Mizrachi and
Joseph Mizrachi on October 30, 2003, the Mizrachi's beneficially owned
approximately 1.2% of our shares and the Schedule 13D/A filed by Messrs. Hubert
Guez and Paul Guez on January 20, 2004, the Guez's beneficially owned
approximately 17.56% of our shares in the aggregate. As of February 21, 2003,
the Mizrachi's ceased to be the beneficial owners of more than 5% of our
securities. In the event that our stockholders approve the conversion of the
Blue Concept Note into a maximum of 4,166,667 shares of our common stock at the
special meeting of stockholders that we are holding on March 5, 2004, as
discussed above in "Business - Strategic Relationship with two of our
significant stockholders, Hubert Guez and Paul Guez, and affiliated companies,"
then the Guez's will beneficially own approximately 33.73% of our common stock
in the aggregate. We are unable to predict the effect that sales into the market
of 4,166,667 shares may
19
have on the then prevailing market price of our common stock. On February 25,
2004, the last reported sale price of our common stock on the Nasdaq SmallCap
Market was $2.85. During the four week period prior to February 25, 2004, the
average daily trading volume of our common stock was 80,755 shares. It is likely
that market sales of the 4,166,667 shares offered for sale (or the potential for
those sales even if they do not actually occur) may have the effect of
depressing the market price of our common stock. As a result, the potential
resale and possible fluctuations in trading volume of such a substantial amount
of our stock may affect the share price negatively beyond our control.
Because of their stock ownership and/or positions with us, these persons have
been and will continue to be in a position to greatly influence the election of
directors, and thus, control our affairs. Additionally, our bylaws limit the
ability of stockholders to call a meeting of the stockholders. These bylaw
provisions could have the effect of discouraging a takeover of us, and therefore
may adversely affect the market price and liquidity of our securities. We are
also subject to a Delaware statute regulating business combinations that may
hinder or delay a change in control. The anti-takeover provisions of the
Delaware statute may adversely affect the market price and liquidity of our
securities.
Our common stock price is extremely volatile and may decrease rapidly.
The trading price and volume of our common stock has historically been subject
to wide fluctuation in response to variations in actual or anticipated operating
results, announcements of new product lines or by us or our competitors, and
general conditions in the apparel and accessory industry. In the 52 week period
prior to November 29, 2003, the closing price of our common stock has ranged
from $2.33 - $7.80. In addition, stock markets generally have experienced
extreme price and volume trading volatility in recent years. This volatility has
had a substantial effect on the market prices of securities of many companies
for reasons frequently unrelated to the operating performance of the specific
companies. These broad market fluctuations may significantly and negatively
affect the market price of our common stock.
If we cannot meet the Nasdaq SmallCap Market maintenance requirements and Nasdaq
Rules, Nasdaq may delist our common stock which could negatively affect the
price of the common stock and your ability to sell the common stock.
In the future, we may not be able to meet the listing maintenance requirements
of the Nasdaq SmallCap Market and Nasdaq rules, which require, among other
things, minimum net tangible assets of $2 million, a minimum bid price for our
common stock of $1.00, and stockholder approval prior to the issuance of
securities in connection with a transaction involving the sale or issuance of
common stock equal to 20 percent or more of a company's outstanding common stock
before the issuance for less than the greater of book or market value of the
stock. If we are unable to satisfy the Nasdaq criteria for maintaining listing,
our common stock would be subject to delisting. Trading, if any, of our common
stock would thereafter be conducted in the over-the-counter market, in the
so-called "pink sheets" or on the National Association of Securities Dealers,
Inc., or NASD, "electronic bulletin board." As a consequence of any such
delisting, a stockholder would likely find it more difficult to dispose of, or
to obtain accurate quotations as to the prices, of our common stock.
If Nasdaq delists our common stock you would need to comply with the penny stock
regulations which could make it more difficult to sell your common stock.
In the event that our securities are not listed on the Nasdaq SmallCap Market,
trading of the common stock would be conducted in the "pink sheets" or through
the NASD's Electronic Bulletin Board and covered by Rule 15g-9 under the
Securities Exchange Act of 1934. Under such rule, broker/dealers who recommend
these securities to persons other than established customers and accredited
investors must make a special written suitability determination for the
subscriber and receive the subscriber's written agreement to a transaction prior
to sale. Securities are exempt from this rule if the market price is at least
$5.00 per share.
The Securities and Exchange Commission adopted regulations that generally define
a penny stock as any equity security that has a market price of less than $5.00
per share, with certain exceptions. Unless an exception is available, the
regulations require the delivery, prior to any transaction involving a penny
stock, of a disclosure schedule explaining the penny stock market and the risks
associated with it. If our common stock were considered a penny stock, the
ability of broker/dealers to sell our common stock and the ability of our
stockholders to sell their securities in the secondary market would be limited.
As a result, the market liquidity for our common stock would be severely and
adversely affected. We cannot assure you that trading in our securities will not
be subject to these or other regulations in the future which would negatively
affect the market for such securities.
Risk Factors Relating to our Operations
Due to our negative cash flows we could be required to cut back or stop
operations if we are unable to raise or obtain needed funding.
Our ability to continue operations will depend on our positive cash flow, if
any, from future operations and on our ability to raise additional funds through
equity or debt financing. As of November 29, 2003, we have raised net proceeds
of approximately $17,540,000, in the aggregate through the sale of shares of
6,235,648 our common stock and 916,833 shares of common stock purchase warrants
in five private placement transactions and had an outstanding loan balance of
$8,786,000 with CIT with whom we have entered into
20
financing agreements. These sources of financing are used to fund our continuing
operations and for working capital. As of November 29, 2003, we had $8,536,000
of factored receivables with CIT and $2,149,000 of unused letter of credit
outstanding in the aggregate. While we had a $332,000 liability with CIT as of
November 29, 2003 due to the amount of factored receivables, our financial
position may change such that there may be the need for us to continue to raise
needed funds through a mix of equity and debt financing to fund its operations
and working capital. Equity financing will usually result in existing
stockholders becoming "diluted" or owning a smaller percentage of the total
shares outstanding as of the date of such dilution. A high degree of dilutions
can make it difficult for the price of our common stock to rise rapidly, among
other things. Dilution also lessens a stockholder's voting power.
We do not know if we will be able to continue to raise additional funding or if
such funding will be available on favorable terms. We could be required to cut
back or stop operations if we are unable to raise or obtain needed funding.
Our cash requirements to run our business have been and will continue to be
significant.
Since 1997, our negative operating cash flow and losses from continuing
operations have been as follows:
(Negative) positive Cash
Flow
from Operating (Losses) income
Activities of from
Continuing Operations Continuing Operations
--------------------- ---------------------
Fiscal Year Ended:
- ------------------
November 29, 2003 ($ 9,857,000) ($8,317,000)
November 30, 2002 $1,504,000 $ 572,000
December 1, 2001 ($ 632,000) ($ 618,000)
November 30, 2000 ($ 4,598,000) ($ 5,056,000)
November 30, 1999 ($ 2,124,000) ($ 1,340,000)
November 30, 1998 ($ 1,238,000) ($ 2,267,000)
November 30, 1997 ($ 1,339,000) ($ 1,729,000)
Since November 30, 1997, we have experienced negative cash flow from our
operating activities except for the year ending November 30, 2002. As of
November 29, 2003, we had an accumulated deficit of approximately $41,824,000.
Although we have undertaken numerous measures to increase sales and operate more
efficiently, we may experience further losses and negative cash flows. We can
give you no assurance that we will in fact operate profitably in the future.
We must expand sales of our existing products and successfully introduce new
products that respond to constantly changing fashion trends and consumer demands
to increase revenues and attain profitability.
Our success will depend on our ability to expand sales of our current products
to new and existing customers, as well as the development or acquisition of new
product designs and the acquisition of new licenses that appeal to a broad range
of consumers. We have little control over the demand for our existing products,
and we cannot assure you that the new products we introduce will be successfully
received by consumers. For example, in the past year, we have acquired licenses
to design and market apparel and accessory products for the recording artists
and entertainers known as "Bow Wow" and "Eve", respectively. Each artist's
apparel is sold under the Shago(R) and Fetish(TM) brand. We have spent
considerable resources to develop and market each of these brands. We believe,
but there can be no assurance, that there will be demand for products such as
apparel and accessories associated with "Bow Wow" or "Eve." See "Business -
License Agreements" for further discussion of our license agreements for
Shago(R) and Fetish(TM).
Any failure on our part to anticipate, identify and respond effectively to
changing consumer demands and fashion trends could adversely affect the
acceptance of our products and leave us with a substantial amount of unsold
inventory or missed opportunities. If that occurs, we may be forced to rely on
markdowns or promotional sales to dispose of excess, slow-moving inventory,
which may negatively affect our ability to achieve profitability. At the same
time, our focus on tight management of inventory may result, from time to time,
in our not having an adequate supply of products to meet consumer demand and may
cause us to lose sales.
A substantial portion of our net sales and gross profit is derived from a small
number of large customers.
Our 10 largest customers accounted for approximately 52% and 67% of our gross
sales during fiscal 2002 and fiscal 2003, respectively. We do not enter into any
type of long-term agreements with any of our customers. Instead, we enter into a
number of individual purchase order commitments with our customers. A decision
by the controlling owner of a group of stores or store or any other significant
customer, whether motivated by competitive conditions, financial difficulties or
otherwise, to decrease the amount of merchandise purchased from us, or to change
their manner of doing business with us, could have a material adverse effect on
our
21
financial condition and results of operations.
We are dependent on certain contractual relationships to generate revenues.
Our sales are dependent to a significant degree upon the contractual
relationships we can establish with licensors to exploit, on generally a
non-exclusive basis, proprietary rights in well-known logos, marks and
characters. Although we believe we will continue to meet all of our material
obligations under such license agreements, there can be no assurance that such
license rights will continue or will be available for renewal on favorable
terms. Failure to obtain new licenses or extensions on current licenses or to
sell such products, for any reason, could have a significant negative impact on
our business. As of November 30, 2002 and November 29, 2003, $61,938,000 (or
75%) and $16,092,000 (or 54%), respectively, of our gross revenues were
generated from licensed apparel and accessory products.
We are primarily dependent upon revenues from a certain number of licenses,
namely our licenses to produce the Joe's Jeans(R), Bongo(R), Fetish(TM) and
Shago(R) accessory and apparel products. As of November 29, 2003, we recorded
$5,917,000 in sales of products under our Shago(R) and Fetish(TM) licenses. Our
first product line to ship under the Shago(R) license was delivered to retailers
during August 2003, making the fall product line our first line under the
Shago(R) license. Our first product line to ship under the Fetish(TM) license
was delivered to retailers during May 2003, making the summer product line our
first line under the Shago(R) license. During that same period, we recorded
$2,534,000 and $11,476,000 in sales of product under our Bongo(R) license and
Joe's Jeans(R) license, respectively. See "Business - License Agreements and
Intellectual Property" for further discussion of our license agreements.
We are currently dependent on supply and distribution arrangements with Commerce
Investment Group, LLC, or Commerce, and its related entities to generate a
substantial portion of our revenues.
During fiscal 2000, we entered into supply and distribution arrangements with
Commerce and its affiliated entities, whom collectively, we will refer to as the
Commerce Group. Under the terms of the distribution arrangements, Commerce
purchased our equity securities and we became obligated to manufacture and
distribute all of our craft products with the Commerce Group for a two-year
period. The distribution arrangements contained an automatic renewal for an
additional two-year term. In fiscal 2002, we renewed these arrangements for
another two years. In July 2003, we entered into another supply agreement with
an Azteca affiliate, AZT International SA de CV, a Mexico corporation, or AZT.
Pursuant to this agreement, we are obligated to purchase certain products,
particularly the products that are sold by us under our division known as Blue
Concept Division acquired on July 17, 2003 from AZT. In addition, we have verbal
agreements with Azteca and/or its affiliates regarding the supply and
distribution of our other apparel products, including certain denim products for
our Fetish(TM) and Shago(R) branded accessory and apparel lines. We utilize
warehouse space in Los Angeles from Azteca. The loss of our supply and
distribution arrangements with the Commerce Group could adversely affect our
current supply and distribution responsibilities, primarily because if we, due
to unforeseen circumstances that may occur in the future, are unable to utilize
the services for manufacturing, warehouse and distribution provided by the
Commerce Group, such inability may adversely affect our operations until we are
able to secure manufacturing, warehousing and distribution arrangements with
other suppliers that could provide the magnitude of services to us that the
Commerce Group currently provide.
Commerce is an entity controlled by Hubert Guez and Paul Guez, whom we will
refer to as the Guez Brothers, who are affiliates of us. Based on a Schedule
13D/A filed by the Guez brothers with the SEC on January 20, 2004, the Guez
Brothers beneficially own approximately 17.57% of our outstanding common stock
in the aggregate. In the event of the conversion of the promissory note at the
March 5, 2004 special stockholders meeting into a maximum of 4,166,667 shares,
we believe that the Guez brothers will beneficially own approximately 33.73% of
our outstanding common stock in the aggregate. See Business - Strategic
Relationship with two of our significant stockholders, Hubert Guez and Paul
Guez, and affiliated companies" for a further discussion of our relationship
with the Guez brothers.
We outsource a substantial amount of our products to be manufactured to
Commerce. In fiscal 2002, we purchased approximately $16 million in goods and
services from Commerce Group or approximately 80% of our manufacturing and
distribution costs. As of November 29, 2003, we purchased approximately $47.9
million in goods and services from Commerce Group, or 68% of our manufacturing
and distribution costs.
Should we, due to unforeseen circumstances that may occur in the future, be
unable to utilize the services for manufacturing, warehouse and distribution
provided by Commerce Group, such inability may adversely affect our operations
until we are able to secure manufacturing, warehousing and distribution
agreements with other suppliers that could provide the magnitude of services
that Commerce Group currently provides to us.
The seasonal nature of our business makes management more difficult, severely
reduces cash flow and liquidity during parts of the year and could force us to
curtail our operations.
Our business is seasonal. The majority of our marketing and sales activities
take place from late fall to early spring. Our greatest volume of shipments and
sales occur from late spring through the summer, which coincides with our second
and third fiscal quarters. Our cash flow is strongest in the third and fourth
fiscal quarters. Unfavorable economic conditions affecting retailers during the
fall and holiday
22
seasons in any year could have a material adverse effect on our results of
operations for the year. We are likely to experience periods of negative cash
flow throughout each year and a drop-off in business commencing each December,
which could force us to curtail operations if adequate liquidity is not
available. We cannot assure you that the effects of such seasonality will
diminish in the future.
The loss of the services of key personnel could have a material adverse effect
on our business.
Our executive officers have substantial experience and expertise in our business
and have made significant contributions to our growth and success. The
unexpected loss of services of one or more of these individuals could also
adversely affect us. We are currently not protected by a key-man or similar life
insurance covering any of our executive officers, nor do we have written
employment agreements with our Chief Executive Officer, Chief Financial Officer,
Chief Operating Officer or President. If, for example, any one of these
executive officers should leave us, his or her services would likely have a
substantial impact on our ability to operate, on a daily basis because we would
be forced to find and hire similarly experienced personnel to fill one or more
of those positions, and daily operations may suffer temporarily as a result.
Furthermore, with respect to Joe's, while we maintain an employment agreement
with Joe Dahan, its president, should Mr. Dahan, leave Joe's, his experience,
design capabilities, and name recognition in the apparel and accessory industry
could materially adversely affect the operations of Joe's, since Joe's relies
heavily on his capabilities to design, direct and produce product for the Joe's
brand.
Our business could be negatively impacted by the financial instability or
consolidation of our customers.
We sell our product primarily to retail, private label and distribution
companies around the world based on pre-qualified payment terms. Financial
difficulties of a customer could cause us to curtail business with that
customer. We may also assume more credit risk relating to that customer's
receivables. Our inability to collect on our trade accounts receivable from any
one of these customers could have a material adverse effect on our business or
financial condition. More specifically, we are dependent primarily on lines of
credit that we establish from time to time with customers, and should a
substantial number of customers become unable to pay their respective debts as
they become due, we may be unable to collect some or all of the monies owed by
those customers.
Our current practice is to extend credit terms to a majority of our customers,
which is based on such factors as past credit history with us, reputation of
creditworthiness within our industry, and timelines of payments made to us. A
small percentage of our customers are required to pay by either credit card or
C.O.D., which is also based on such factors as lack of credit history,
reputation (or lack thereof) within our industry and/or prior negative payment
history. For these customers to whom we extend credit, typical terms are net 30
to 60 days. Our management exercises professional judgment in determining which
customers will be extended credit, which is based on industry practices
applicable to our business, financial awareness of the customers with whom we
conduct business, and business experience of our industry. As of November 29,
2003, we had $3,388,000 in accounts receivable from our customers.
Furthermore, in recent years, the retail industry has experienced consolidation
and other ownership changes. Some of our customers have operated under the
protection of the federal bankruptcy laws. While to date these changes in the
retail industry not had a material adverse effect on our business or financial
condition, our business could be materially affected by these changes in the
future.
Our business could suffer as a result of manufacturer's inability to produce our
goods on time and to our specifications.
We do not own or operate any manufacturing facilities and therefore depend upon
independent third parties for the manufacture of all of our products. Our
products are manufactured to our specifications by both domestic and
international manufacturers. During fiscal 2002, approximately 24% of our
products were manufactured in the United States and approximately 76% of our
products were manufactured in foreign countries compared to 13% and 87%,
respectively, as of November 29, 2003. The inability of a manufacturer to ship
orders of our products in a timely manner or to meet our quality standards could
cause us to miss the delivery date requirements of our customers for those
items, which could result in cancellation of orders, refusal to accept
deliveries or a reduction in purchase prices, any of which could have a material
adverse effect on our financial condition and results of operations. Because of
the seasonality of our business, and the apparel and fashion business in
particular, the dates on which customers need and require shipments of products
from us are critical, as styles and consumer tastes change so rapidly in the
apparel and fashion business, particularly from one season to the next. Further,
because quality is a leading factor when customers and retailers accept or
reject goods, any decline in quality by our third-party manufacturers could be
detrimental not only to a particular order, but also to our future relationship
with that particular customer.
Our business could suffer if we need to replace manufacturers.
We compete with other companies for the production capacity of our manufacturers
and import quota capacity. Some of these competitors have greater financial and
other resources than we have, and thus may have an advantage in the competition
for production and import quota capacity. If we experience a significant
increase in demand, or if an existing manufacturer of ours must be replaced, we
may have to expand our third-party manufacturing capacity. We cannot assure you
that this additional capacity will be available when required on terms that are
acceptable to us or similar to existing terms which we have with our
manufacturers, either from a production
23
standpoint or a financial standpoint. We enter into a number of purchase order
commitments each season specifying a time for delivery, method of payment,
design and quality specifications and other standard industry provisions, but do
not have long-term contracts with any manufacturer. None of the manufacturers we
use produces our products exclusively.
Should we be forced to replace one or more of our manufacturers, particularly a
manufacturer that we may rely upon for a substantial portion of its production
needs, such as Commerce, then we may experience an adverse financial impact, or
an adverse operational impact, such as being forced to pay increased costs for
such replacement manufacturing or delays upon distribution and delivery of our
products to our customers, which could cause us to loose customers or loose
revenues because of late shipments.
If an independent manufacturer or license partner of ours fails to use
acceptable labor practices, our business could suffer.
While we require our independent manufacturers to operate in compliance with
applicable laws and regulations, we have no control over the ultimate actions of
our independent manufacturers. While our internal and vendor operating
guidelines promote ethical business practices and our staff periodically visits
and monitors the operations of our independent manufacturers, we do not control
these manufacturers or their labor practices. The violation of labor or other
laws by an independent manufacturer of ours, or by one of our license partners,
or the divergence of an independent manufacturer's or license partner's labor
practices from those generally accepted as ethical in the United States, could
interrupt, or otherwise disrupt the shipment of finished products to us or
damage our reputation. Any of these, in turn, could have a material adverse
effect on our financial condition and results of operations. In particular, the
laws governing garment manufacturers in the State of California impose joint
liability upon us and our independent manufacturers for the labor practices of
those independent manufacturers. As a result, should one of our independent
manufacturers be found in violation of state labor laws, we could suffer
financial or other unforeseen consequences.
Our trademark and other intellectual property rights may not be adequately
protected outside the United States.
We believe that our trademarks, whether licensed or owned by us, and other
proprietary rights are important to our success and our competitive position. In
the course of our international expansion, we may, however, experience conflict
with various third parties who acquire or claim ownership rights in certain
trademarks. We cannot assure that the actions we have taken to establish and
protect these trademarks and other proprietary rights will be adequate to
prevent imitation of our products by others or to prevent others from seeking to
block sales of our products as a violation of the trademarks and proprietary
rights of others. Also, we cannot assure you that others will not assert rights
in, or ownership of, trademarks and other proprietary rights of ours or that we
will be able to successfully resolve these types of conflicts to our
satisfaction. In addition, the laws of certain foreign countries may not protect
proprietary rights to the same extent as do the laws of the United States.
We cannot assure the successful implementation of our growth strategy.
As part of our growth strategy, we seek to expand our geographic coverage,
strategically acquiring select licensees and enhancing our operations. We may
have difficulty hiring and retaining qualified key employees or otherwise
successfully managing the required expansion of our infrastructure in our
current United States market and other international markets we may enter.
Furthermore, we cannot assure you that we will be able to successfully integrate
the business of any licensee that we acquire into our own business or achieve
any expected cost savings or synergies from such integration.
Our business is exposed to domestic and foreign currency fluctuations.
We generally purchase our products in U.S. dollars. However, we source most of
our products overseas and, as such, the cost of these products may be affected
by changes in the value of the relevant currencies. Changes in currency exchange
rates may also affect the relative prices at which we and our foreign
competitors sell products in the same market. We currently do not hedge our
exposure to changes in foreign currency exchange rates. We cannot assure you
that foreign currency fluctuations will not have a material adverse impact on
our financial condition and results of operations. For example, we are subject
to currency fluctuations in Japan and Hong Kong. In fiscal 2002, our earnings
were negatively impacted by $41,000 due to currency fluctuations in Japan and
Hong Kong. As of November 29, 2003, our earnings were positively impacted by
$154,000 due to currency fluctuations in Japan and Hong Kong.
Our ability to conduct business in international markets may be affected by
legal, regulatory, political and economic risks.
Our ability to capitalize on growth in new international markets and to maintain
the current level of operations in our existing international markets is subject
to risks associated with international operations. Some of these risks include:
- the burdens of complying with a variety of foreign laws and
regulations,
- unexpected changes in regulatory requirements, and
24
- new tariffs or other barriers to some international markets.
We are also subject to general political and economic risks associated with
conducting international business, including:
- political instability,
- changes in diplomatic and trade relationships, and
- general economic fluctuations in specific countries or markets.
We cannot predict whether quotas, duties, taxes, or other similar restrictions
will be imposed by the United States, the European Union, Canada, China, Japan,
India, Korea or other countries upon the import or export of our products in the
future, or what effect any of these actions would have on our business,
financial condition or results of operations. Changes in regulatory,
geopolitical policies and other factors may adversely affect our business in the
future or may require us to modify our current business practices.
We face intense competition in the worldwide apparel and accessory industry.
We face a variety of competitive challenges from other domestic and foreign
fashion-oriented apparel and accessory producers, some of whom may be
significantly larger and more diversified and have greater financial and
marketing resources than we have. We do not currently hold a dominant
competitive position in any market. We compete with competitors such as
Kellwood, Jones Apparel Group, and VF Corp. primarily on the basis of:
- anticipating and responding to changing consumer demands in a timely
manner,
- maintaining favorable brand recognition,
- developing innovative, high-quality products in sizes, colors and
styles that appeal to consumers,
- appropriately pricing products,
- providing strong and effective marketing support,
- creating an acceptable value proposition for retail customers,
- ensuring product availability and optimizing supply chain efficiencies
with manufacturers and retailers, and
- obtaining sufficient retail floor space and effective presentation of
our products at retail.
A downturn in the economy may affect consumer purchases of discretionary items,
which could adversely affect our sales.
The fashion apparel and accessory industry in which we operate is cyclical. Many
factors affect the level of consumer spending in the apparel, accessories and
craft industries, including, among others:
- general business conditions,
- interest rates,
- the availability of consumer credit,
- taxation, and
- consumer confidence in future economic conditions.
Consumer purchases of discretionary items, including accessory and apparel
products, including our products, may decline during recessionary periods and
also may decline at other times when disposable income is lower. A downturn in
the economies in which we sell our products, whether in the United States or
abroad, may adversely affect our sales.
25
Impact of potential future acquisitions.
From time to time, we have pursued, and may continue to pursue, acquisitions.
Most recently, we acquired our Blue Concept Division from Azteca Production
International, Inc., which is owned by our affiliates, Mr. Hubert Guez and Mr.
Paul Guez. We issued a $21.8 million convertible note for the acquisition, which
has increased our long-term debt by over 600%. See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations - Long-Term Debt" for
further discussion regarding our long-term debt. Additional acquisitions may
result in us becoming substantially more leveraged on a consolidated basis, and
may adversely affect our ability to respond to adverse changes in economic,
business or market conditions.
ITEM 2. PROPERTIES
Our headquarters for our Innovo subsidiary is located in approximately 5,000
square feet of office space located near downtown Knoxville, Tennessee. The
space leased in Knoxville is owned by an entity that is controlled by the
Chairman of Innovo Group's Board of Directors, Sam Furrow. See "Certain
Relationships and Related Transactions-New Facility Lease Arrangements."
Our Los Angeles offices are located in an office complex in Commerce,
California. We utilize office space and office equipment under a cost sharing
arrangement with Commerce and its affiliates. Under the terms of the verbal
agreement, we are allocated a portion of costs incurred by Commerce and its
affiliates for rent, security, office supplies, machine leases and utilities. In
fiscal 2003, IAA recorded $318,000 for such expenses.
We currently lease office space for our accessory showroom in New York City, New
York on an annual basis.
Joe's products are displayed in showrooms in New York City and Los Angeles
through a sales representation arrangement. Therefore, we do not lease or own
the space in which Joe's products are sold in the United States.
Our Joe's Jeans Japan subsidiary currently rents office/showroom space located
in Tokyo, Japan. Under the arrangement, JJJ paid for the entire year in advance.
On June 30, 2003, JJJ terminated its former lease for two additional spaces that
served as JJJ's operational office and the other served as a showroom to market
Joe's products and consolidated into one space.
In July, 2003, we entered into a sublease for approximately 10,886 square feet
of office space in New York City, New York located at 512 7th Avenue, 23rd
Floor, New York, New York. This sublease expires on July 31, 2009. We may elect
to renew this lease for an additional period that ends on February 28, 2015. We
believe that there will be suitable facilities available to us should additional
space be needed in any or all of our facilities.
Our previous headquarters and manufacturing facilities were located in
Springfield, Tennessee. The Springfield facilities are currently owned by
Leasall. The main Springfield complex is situated on seven acres of land with
approximately 220,000 square feet of usable space, including 30,000 square feet
of office space and 35,000 square feet of cooled manufacturing area. The
Springfield facilities are currently being leased to third party tenants. As of
February 18, 2004, approximately 28.2% of the facilities were leased to a third
party, for an aggregate monthly income of approximately $4,500. During fiscal
2002, Innovo Group made several capital improvements to the Springfield
facility, including but not limited to, putting a new roof on the facility.
While the rental income during the year decreased as a result of the
renovations, we are anticipating an increase in demand for rental space within
the facility.
On April 5, 2002, we, through IRI, we closed on a transaction pursuant to which
IRI purchased limited partner interests in 22 limited partnerships.
Subsequently, the limited partnerships purchased 28 apartment buildings
consisting of approximately 4,000 apartment units located in various states
throughout the United States. See "Business - Real Estate Transactions" for a
further discussion of this real estate transaction.
ITEM 3. LEGAL PROCEEDINGS
We are a party to lawsuits and other contingencies in the ordinary course of our
business. We do not believe that it is probable that the outcome of any
individual action would have a material adverse effect in the aggregate on our
financial condition. We do not believe that it is likely that an adverse outcome
of individually insignificant actions in the aggregate would be sufficient
enough, in number or magnitude, to have a material adverse effect in the
aggregate on our financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
26
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is currently traded under the symbol "INNO" on The Nasdaq
SmallCap Market maintained by The Nasdaq Stock Market, Inc., or Nasdaq. The
following sets forth the high and low bid quotations for our common stock in
such market for the periods indicated. This information reflects inter-dealer
prices, without retail mark-up, mark-down or commissions, and may not
necessarily represent actual transactions. No representation is made by us that
the following quotations necessarily reflect an established public trading
market in our common stock:
Fiscal 2003 High Low
First Quarter $3.53 $2.33
Second Quarter $3.06 $2.55
Third Quarter $5.90 $2.63
Fourth Quarter $7.80 $3.18
Fiscal 2002 High Low
First Quarter $2.67 $1.63
Second Quarter $2.25 $1.43
Third Quarter $3.09 $1.85
Fourth Quarter $4.00 $2.40
Fiscal 2001 High Low
First Quarter $1.16 $0.81
Second Quarter $1.12 $1.03
Third Quarter $2.06 $1.23
Fourth Quarter $2.67 $2.25
As of February 4, 2004, there were approximately 1,016 record holders of our
common stock. Although we will continually use our best efforts to maintain our
listing on The Nasdaq SmallCap Market, there can be no assurance that we will be
able to do so. If in the future, we are unable to satisfy the Nasdaq criteria
for maintaining our listing, our securities would be subject to delisting, and
trading, if any, of our securities would thereafter be conducted in the
over-the-counter market, in the so-called "pink sheets" or on the National
Association of Securities Dealers, Inc., or NASD, "Electronic Bulletin Board."
As a consequence of any such delisting, a stockholder would likely find it more
difficult to dispose of, or to obtain accurate quotations as to the prices, of
our common stock. See "Risk Factors - If we cannot meet the Nasdaq SmallCap
Market maintenance requirements and Nasdaq Rules, Nasdaq may delist our common
stock which could negatively affect the price of the common stock and your
ability to sell the common stock."
We have never declared or paid a cash dividend and do not anticipate paying cash
dividends on our common stock in the foreseeable future. In deciding whether to
pay dividends on our common stock in the future, our board of directors will
consider such factors they may deem relevant, including our earnings and
financial condition and our capital expenditure requirements.
For the year ended November 29, 2003, we consummated five private placements of
our common stock to a limited number of "accredited investors" pursuant to Rule
506 of Regulation D under the Securities Act of 1933, as amended, or the
Securities Act, resulting in net proceeds of approximately $17,540,000, after
all commissions and expenses (including legal and accounting) to us. Our first
private placement, completed on March 19, 2003 to 17 accredited investors,
raised net proceeds of approximately $407,000 at $2.65 per share. Our second
private placement, completed on March 26, 2003 to 5 accredited investors, raised
net proceeds of approximately $156,000 at $2.65 per share. Our third private
placement, completed on July 1, 2003 to 34 accredited investors, raised net
proceeds of approximately $8,751,000 at $3.33 per share. Our fourth private
placement was completed on August 29, 2003 to 5 accredited investors, and raised
net proceeds of approximately $592,000 at $3.62 per share. Our fifth private
placement was completely funded on or before November 29, 2003, but not
completed until December 1, 2003, to 14 accredited investors, and raised net
proceeds of approximately $10,704,000 at $3.00 per share and warrants at $4.00
per share. We issued 165,000 shares, or the I Shares, as a result of the first
private placement. Capital Wealth Management, LLC or Capital Wealth, acted as
the placement agent on a best efforts basis for the first private placement. In
consideration of the services rendered by Capital Wealth, they were paid 7% of
the gross proceeds, plus expenses, for a total of approximately $31,000. We
issued 63,500 shares, or the II Shares, as a result of the second private
placement. Capital Wealth acted as the placement agent on a best efforts basis
for the second private placement. In consideration of the services rendered,
Capital Wealth was paid 7% of the gross proceeds, plus expenses, for a total of
approximately $12,000. We issued 2,835,481 shares, or the III Shares, as a
result of the third private placement. Sanders Morris Harris, Inc., or SMH,
acted as the placement agent on a best efforts basis for the third private
placement. In consideration of the services rendered by SMH, SMH was paid 7% of
the gross proceeds, plus expenses, for a total of approximately $691,000, and
also received a five year warrant entitling SMH to purchase 300,000 shares of
common stock at $4.50 per share which is exercisable on January 1, 2004. We
issued 175,000 shares, or the IV Shares, as a result of
27
the fourth private placement. Pacific Summit Securities, Inc., or PSS, acted as
the placement agent on a best efforts basis for the fourth private placement. In
consideration of the services rendered by PSS, PSS was paid 6% of gross
proceeds, plus expenses, for a total of approximately $42,000, and also received
a warrant entitling PSS to purchase 17,500 shares of our common stock at $3.62
per share which is exercisable on January 1, 2004. We issued 2,996,667 shares
and warrants to purchase an additional 599,333 shares of common stock to these
certain investors at $4.00 per share, or the V Shares, and together with the I
Shares, the II Shares, the III Shares and the IV Shares, we will refer to them
as the 2003 Placement Shares, as a result of the fifth private placement.
SunTrust Robinson Humphrey Capital Markets Division, or SunTrust, acted as the
placement agent on a best efforts basis for the fifth private placement. In
consideration of the services rendered by SunTrust, SunTrust was paid 6% of
gross proceeds, plus expenses, for a total of approximately $683,000. Each of
the warrants issued to SMH and PSS includes a cashless exercise option, pursuant
to which the holder thereof can exercise the warrant without paying the exercise
price in cash. If the holder elects to use this cashless exercise option, it
will receive a fewer number our shares than it would have received if the
exercise price were paid in cash. The number of shares of common stock a holder
of the warrant would receive in connection with a cashless exercise is
determined in accordance with a formula set forth in the applicable warrant. We
intend to use the proceeds from the transactions for general corporate purposes.
The buyers of the 2003 Placement Shares have represented to us that they
purchased the 2003 Placement Shares for their own account, with the intention of
holding the 2003 Placement Shares for investment and not with the intention of
participating, directly or indirectly, in any resale or distribution of the 2003
Placement Shares. The 2003 Placement Shares were offered and sold to the buyers
in reliance upon Regulation D, which provides an exemption from registration
under Section 4(2) of the 1933 Act. Each buyer has represented to us that he or
she is an "Accredited Investor," as that term is defined in Rule 501(a) of
Regulation D under said Act.
Engagement of Research Firm
In or around February 2002, we engaged Barrow Street Research, Inc., or Barrow,
an independent New York City-based research firm to prepare and issue a basic
research report on us to better inform the investing public of our long term
prospects. We paid Barrow $6,000 for writing and disseminating its report,
inclusion of the report on Barrow's website for the remainder of fiscal 2002, as
well as continued coverage of us by Barrow in fiscal 2002, which included a
mid-year update of our prospects. We also engaged Barrow to prepare a business
plan for us. We paid Barrow $13,209 for (i) the preparation of the business plan
and (ii) reimbursement of expenses. We did not, at any time, issue our
securities to Barrow as compensation for its services and is not aware of any
holdings of our securities by Barrow or its affiliates. We currently do not have
any relationships, financial or otherwise, with any research firms that publish
reports about us.
The information required by Part II, Item 5 relating to Equity Compensation
Plans is incorporated herein by reference to our Definitive Proxy Statement.
28
ITEM 6. SELECTED FINANCIAL DATA
The table below (includes the notes hereto) sets forth a summary of selected
consolidated financial data. The selected consolidated financial data should be
read in conjunction with the related consolidated financial statements and notes
thereto.
Years Ended
(in thousands, except per share data)
--------------------------------------------------------------------------------
11/29/03 11/30/02 12/01/01 11/30/00 11/30/99
-------- -------- -------- -------- --------
Net Sales $ 83,129 $ 29,609 $ 9,292 $ 5,767 $ 10,837
Cost of Goods Sold 70,153 20,072 6,335 5,195 6,252
-------- -------- -------- -------- --------
Gross Profit 12,976 9,537 2,957 572 4,585
Selling, General & Administrative (2) 19,264 8,092 3,189 4,863 5,401
Depreciation & Amortization 1,227 256 167 250 287
-------- -------- -------- -------- --------
Income (Loss) from Operations (7,515) 1,189 (399) (4,541) (1,103)
Interest Expense (1,216) (538) (211) (446) (517)
Other Income 526 235 84 30 280
Other Expense (68) (174) (3) (99) -
-------- -------- -------- -------- --------
Income (Loss) before Income Taxes (8,273) 712 (529) (5,056) (1,340)
Income Taxes 44 140 89 - -
-------- -------- -------- -------- --------
Income (Loss) from Continuing Operations (8,317) 572 (618) (5,056) (1,340)
Discontinued Operations - - - - (1)
Extrordinary Items (1) - - - (1,095) -
Net Income (Loss) $ (8,317) $ 572 $ (618) $ (6,151) $ (1,341)
Income (Loss) per Share from Continuing
Operations
Basic $ (0.49) $ 0.04 $ (0.04) $ (0.62) $ (0.22)
Diluted $ (0.49) $ 0.04 $ (0.04) $ (0.62) $ (0.22)
Weighted Average Shares Outstanding
Basic 17,009 14,856 14,315 8,163 5,984
Diluted 17,009 16,109 14,315 8,163 5,984
Balance Sheet Data:
Total Assets $ 46,365 $ 15,143 $ 10,247 $ 7,416 $ 6,222
Long-Term Debt 22,344 3,387 4,225 1,340 2,054
Stockholders' Equity 16,482 5,068 4,519 3,758 1,730
(1) Represents the loss from the early extinguishments of debt in fiscal 2000.
(2) Amount includes a $145,000 impairment write down of long-term assets in 1999
as well as $293,000 related to the termination of a capital lease and $100,000
for the settlement of a lawsuit in 1999, and a $600,000 impairment write down of
long-term assets in fiscal 2000.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction and Overview
This discussion and analysis summarizes the significant factors affecting our
results of operations and financial conditions during the fiscal years ended
November 29, 2003, November 30, 2002, and December 1, 2001. This discussion
should be read in conjunction with our Consolidated Financial Statements, Notes
to Consolidated Financial Statements and supplemental information in Item 8 of
this Annual Report on Form 10-K. The discussion and analysis contains statements
that maybe considered forward-looking. These statements contain a number of
risks and uncertainties as discussed here, under the heading "Forward-Looking
Statements" of this Annual Report on Form 10-K that could cause actual results
to differ materially.
Executive Overview
Our principle business activity involves the design, development and worldwide
marketing of high quality consumer products for the apparel and accessory
markets. We do not manufacture any apparel or accessory products. We sell our
products to a large number of different retail, distributors and private label
customers around the world. Retail customers and distributors purchase finished
goods directly from us. Retail customers then sell the products through their
retail stores and distributors sell our products to retailers in the
international market place. Private label customers outsource the production and
sourcing of their private label products to us and then sell through their own
distribution channels. Private label customers are generally retail chains who
desire to sell apparel and accessory products under their own brand name. We
work with our private label customers to create their own brand image by custom
designing products. In creating a unique brand, our private label customers may
provide samples to us or may select styles already available in our showrooms.
We believe we have established a reputation among these private label buyers for
the ability to arrange for the manufacture of apparel and accessory products on
a reliable, expeditious and cost-effective basis.
Reportable Segments
For the years ended November 29, 2003 and November 30, 2002, we operated in two
segments: apparel and accessories. The apparel segment is conducted by our Joe's
and IAA subsidiaries. The apparel segment represents the operations of our
two-wholly owned subsidiaries, Joe's and IAA, both of which are involved in the
design, development and marketing of apparel products. The accessory segment,
which represents the historical business of our Company, is conducted by our
Innovo subsidiary. The apparel and accessory operating segments have been
classified based upon the nature of their respective operations, customer base
and the nature of the products sold.
Our real estate transactions and our other corporate activities are categorized
under "other" and are represented by the operations of Innovo Group Inc., the
parent company, and our two-wholly owned subsidiaries, Leasall and IRI, which
conduct our real estate operations. Our real estate operations do not currently
require a substantial allocation of our resources and are not a significant part
of management's daily operational functions.
Our Principle Sources of Revenue
Joe's
Since its introduction in 2001, Joe's has gained national and international
recognition, primarily in the women's denim market. However, since this
introduction and beginning in fiscal 2003, Joe's has expanded its offerings to
include women's sportswear and men's apparel items. While Joe's experienced
excess inventory in fiscal 2003, which we discuss in detail below, Joe's has
entered fiscal 2004 with a focus on solidifying its international reputation. To
this effect, Joe's has recently signed a Master Distribution Agreement with
Beyond Blue, Inc. or Beyond Blue, for exclusive distribution of Joe's products
in territories outside the United States. Beyond Blue is a reputable apparel
company that specializes in distribution and licensing of high-end fashion
products. We believe that this relationship will allow Joe's to gain greater
recognition in those international markets where Joe's products are currently
sold, as well as expand into other international markets.
IAA
Under our IAA subsidiary, we design and market branded apparel products under
various license agreements. We currently license and market the Fetish(TM) by
Eve and Shago(R) by Bow Wow apparel lines, which is sold to better departments
stores, such as Macy's and the Federated Department Stores, Inc.'s stores. These
products are exploited through the high-end fashion and urban markets, which
have proven successful for other well known brands such as Sean John(R),
Rocawear(R) and Phat Farm(R). Eve and Bow Wow, both as world-renowned recording
artists and actors, provide marketing and exposure for their respective brands
through their talents and celebrity status. While we have yet to generate sales
during a full fiscal year for either line, we believe that the creation of these
brands
30
in fiscal 2003 and the positive reception from retail buyers and the consumer
marketplace will allow us to derive greater sales as brand awareness increases.
Further, while we experienced production and delivery inefficiencies in our IAA
branded business during the fourth quarter of fiscal 2003, which we discuss in
greater detail below, that hindered better sales, we believe we have corrected
these issues and will be able to improve the results of our branded business in
fiscal 2004. We are currently seeking similar opportunities to capitalize on our
resources and experience in the branded apparel market. During the first quarter
of 2004, we entered into a license agreement to product denim and denim-related
apparel for the Betsey Johnson(R) brand. This license allows us to utilize our
strengths in producing denim apparel, and provides another avenue to increase
our sales in fiscal 2004.
The private label business represents our strongest source of sales under IAA
and a company as a whole, primarily because of our knowledge and experience
within the denim apparel business. Through private label arrangements, we sell
primarily denim products to AEO and Target. We anticipate growth in private
label sales in fiscal 2004, primarily because we will have conducted a full
fiscal year of sales to AEO in connection with the Blue Concept Division
acquisition.
Innovo
Our accessories business is conducted through our Innovo subsidiary. As we
continue to produce craft accessories to sell to large retailers such as
Wal-Mart and Michaels Stores, Inc., we have been able to contribute to the
branded apparel licenses we pursue through our IAA subsidiary.
While our overall operations expanded in depth, sophistication and complexity
and our net sales grew significantly during fiscal 2003 and our fourth quarter,
respectively, we generated significant losses for these periods. Management is
confident that certain activities conducted during fiscal 2003, such as the
launch of the Fetish(TM) brand and the Blue Concept Division acquisition, have
created assets and a foundation which will benefit us on a going-forward basis
and further establish us as a quality apparel and accessory marketer. We believe
the reasons for the disappointing financial results during the fourth quarter of
2003 have been identified and should be mitigated in future periods.
Results of Operations
We completed our acquisition of the Blue Concept Division from Azteca on July
17, 2003. The results of operations of the Blue Concept Division are included in
our operating results from the date of acquisition. Accordingly, the financial
position and results of operations presented and discussed herein are not
directly comparable between years. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Recent Acquisitions and
Licenses" for a further discussion of the Blue Concept acquisition.
The following table sets forth certain statements of operations data for the
years indicated (in thousands):
Years Ended
(in thousands)
--------------------------------------------------------------
11/29/03 11/30/02 $ Change % Change
-------- -------- -------- --------
Net Sales $ 83,129 $ 29,609 $ 53,520 181%
Cost of Goods Sold 70,153 20,072 50,081 250
-------- -------- -------- --------
Gross Profit 12,976 9,537 3,439 36
Selling, General & Administrative 19,264 8,092 11,172 138
Depreciation & Amortization 1,227 256 971 379
-------- -------- -------- --------
Income (Loss) from Operations (7,515) 1,189 (8,704) (732)
Interest Expense (1,216) (538) (678) 126
Other Income 526 235 291 124
Other Expense (68) (174) 106 (61)
-------- -------- -------- --------
Income (Loss) before Income Taxes (8,273) 712 (8,985)
Income Taxes 44 140 (96) (69)
Net Income (Loss) $ (8,317) $ 572 $ (8,889) (A)
(A) Not Meaningful
31
Comparison of Fiscal Year Ended November 29, 2003 to Fiscal Year Ended November
30, 2002
Fiscal 2003 Overview
While our net sales grew by 181% during fiscal 2003, we incurred $8,317,000 of
losses during this period. Although we incurred significant losses in fiscal
2003, we believe that many of the efforts during 2003, such as the creation of
the IAA branded business and our lauch of such brands as Fetish(TM) and the Blue
Concept Division acquisition, have established us as designers, developers and
worldwide marketers of high quality consumer products for the apparel and
accessory markets. As further discussed below, we have identified the issues
associated with our losses in fiscal 2003 and we are taking steps to address
these issues.
The primary reasons for our net loss in fiscal 2003 were the following:
o We experienced lower gross margins due to: (i) an increase in the
percentage of our overall sales coming from our lower margin private label
accessory and apparel, and craft products businesses; and (ii) increased
inventory markdowns related to excess inventory that we were unable to sell;
o Increased employee wages of $3,643,000 primarily attributable to: (i)
hiring needs for the launch of Fetish(TM) and Shago(R); (ii) hiring needs to
support the growth of the Joe's(R) and Joe's Jeans(R) brand; and (iii) the
hiring of 31 employees which we absorbed as a result of the Blue Concept
Division acquisition;
o Advertising, marketing, tradeshow and related costs of $1,732,000
incurred in order to market the Joe's(R) and Joe's Jeans(R) brand and to launch
the Fetish(TM) and Shago(R);
o Significant increases in legal, accounting, and other professional fees
which increased due to the increase in business activity during fiscal 2003, as
well as increased insurance expenses of $965,000; and
o Increase in interest expense of $678,000 and depreciation and
amortization costs of $971,000 primarily associated with the acquisition of the
Blue Concept Division.
In order to support our 181% growth in our sales, our expenses increased
significantly during fiscal 2003. To support our expanded business platform, we
(i) hired an additional 110 employees in fiscal 2003; (ii) incurred increased
royalty and commission expense as a result of strong sales of our new branded
accessory and apparel lines; and (iii) incurred a substantial increase in
advertising expenditures to establish and market our Fetish(TM), Shago(R) and
Joe's(R) branded products. In an effort to align our personnel needs with our
operational needs, we have undertaken measures to reduce our payroll expenses
subsequent to November 29, 2003. Furthermore, we expect that advertising costs
associated with the launch, establishment and expansion of our branded products
will decrease in the aggregate in fiscal 2004.
Internal distribution problems and weakening demand for certain branded apparel
products from IAA's branded division primarily contributed to our net loss in
fiscal 2003. As a result of the overall success of the initial delivery of
Shago(R) products in the summer of 2003, we hired additional employees to
support the demand and increased the amount of Shago(R) apparel to be
manufactured. Unfortunately, during the second delivery of our Shago(R) apparel
in the fall of 2003, we started to receive indications that favorable consumer
response had weakened for these fall 2003 deliveries. As a result of weakening
demand, we did not sell all of our fall 2003 Shago(R) inventory. With further
indications of weakening demand, we immediately tried to reduce the original
Shago(R) fall 2003 deliveries and/or manufacturing orders in an attempt to limit
our exposure to unsold inventory. We were able to cancel some of the goods;
however, a majority of the Shago(R) products were in production or had already
been shipped, requiring us to accept the products into our inventory.
Although demand had weakened, we had received indications from our retailers
that we would still be able to sell our slower moving Shago(R) products to the
better retailers at a discount, or, in the alternative, sell these products to
discounters either at or above our cost.
While we experienced initial success with this strategy, we discovered that we
would not be able to move these goods at a price above our cost, which would
result in a write-down on this inventory. As a result, we believed that it was
in our best interest to sell these goods through alternate distribution channels
in an effort to turn this excess inventory into cash. Following the end of
fiscal 2003, those goods have been sold, but the year end financial results
reflect reserves taken at what management believes is the fair market value of
those goods at the end of fiscal 2003. Goods were moved out of our inventory,
but losses were taken as a result of selling these goods below cost.
32
With respect to our efforts to sell the Fetish(TM) branded products, we
experienced a similar situation with respect to excess inventory. We initially
launched our Fetish(TM) products for the fall 2003 season, and our first
delivery was an overall success. We did, however, have excess inventory that was
anticipated to be moved to discount retailers. In an effort to support the
reputation of the Fetish(TM) brand in the consumer and retail marketplace, we
did not immediately move the product into alternative markets. As a result, we
did not begin to move the excess Fetish(TM) fall inventory until the beginning
of December 2003.
The second delivery for Fetish(TM) products, or the Holiday delivery, was
scheduled to be delivered between November 15, 2003 and December 15, 2003. A
portion of this delay was due to production problems and, when shipped, a
portion of the goods was held in customs. This required us to reconfigure a
significant number of our orders to address customers' needs since some of the
purchased products were no longer available. The production delays were
primarily a function of the design department for Fetish(TM) not completing the
design of the Holiday line in a timely manner, thereby reducing production time.
These problems resulted in excess inventory since a large portion of the
products could not be shipped prior to the end of the Holiday delivery season.
Rather than risk holding the goods and attempting to sell them slowly with no
assurance of successfully doing so, we chose to move these goods, even though
often at a loss. Consequently, our finncial results for the fourth quarter of
fiscal 2003 reflect the necessary inventory reserves as what we believe to be
the fair market value of the goods.
Another operational factor leading to our financial losses for fiscal 2003 was
the unexpected and significant number of returns and charge-backs we received on
the Fetish(TM) products Holiday delivery. This problem was attributable to
Fetish(TM) products Holiday delivery delays and the substitutions and delivery
problems attributable to certain styles being held in customs. While we did
experience some returns and charge-backs on our Shago(R) inventory, the amount
was insignificant compared to the Fetish(TM) inventory returns and charge-backs.
While IAA was responsible for a large portion of our losses during fiscal 2003
and our fourth quarter, our Innovo subsidiary also experienced inventory reserve
issues due to slow moving inventory for its Bongo(R) and Fetish(TM) accessory
products. This was due to weaker Bongo(R) sales during fiscal 2003 and similar
design, production and delivery delays and issues discussed above for our
Fetish(TM) products. Also, our Joe's subsidiary's financial performance was
negatively impacted due to an inventory write-down for slow moving inventory
sold after our fiscal 2003 year end.
Our fiscal 2003 net loss was also attributable to certain other adjustments ,
namely:
o The recording of a charge for the Hot Wheels(R) royalty guarantees due
to the fact we have generated no sales under this license agreement,
and are in discussions with Mattel regarding the future of this
license agreement and a reserve against the potential royalty
obligations.
o An increase in our bad debt reserve to address concerns of the
likelihood of collection of certain outstanding accounts.
We are making a focused effort to address these operational issues. In February
of 2004, we promoted Pierre Levy, who has over 20 years' of management
experience in the apparel industry, as our General Manager of Apparel Operations
to oversee all aspects of apparel related operations as we move into fiscal
2004. We believe his experience will minimize the design, production and
delivery issues that we experienced in fiscal 2003.
In connection with our discussion below of the results of our operations in
fiscal 2003 compared to fiscal 2002 below, we explain in greater detail the
reasons for the net loss incurred in fiscal 2003.
As discussed above, we classify our business in two reportable segments. The
following table sets forth certain statements of operations data by segment for
the periods indicated:
33
November 29, 2003 Accessories Apparel Other (A) Total
------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 14,026 $ 69,103 $ - $ 83,129
Gross Profit 3,095 9,881 - 12,976
Depreciation & Amortization 39 1,087 101 1,227
Interest Expense 214 946 56 1,216
November 30, 2002 Accessories Apparel Other (A) Total
------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 12,072 $ 17,537 $ - $ 29,609
Gross Profit 3,393 6,144 - 9,537
Depreciation & Amortization 21 183 52 256
Interest Expense 140 339 59 538
2003 to 2002 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
(in thousands)
Net Sales $ 1,954 16% $51,566 294% $ - N/A $53,520 181%
Gross Profit (298) (9) 3,737 61 - N/A 3,439 36
Depreciation & Amortization 18 86 904 494 49 94 971 379
Interest Expense 74 53 607 179 (3) (5) 678 126
(A) Other includes corporate expenses and assets and expenses related to real
estate operations
Net Sales
Net sales increased to $83,129,000 in fiscal 2003 from $29,609,000 in fiscal
2002, or a 181% increase. The primary reasons for the increase in our net sales
were due: (i) to increased sales to our private label customers in both the
apparel and accessories segments, a large portion of which is attributable to
sales generated as a result of the Blue Concept Division acquisition; (ii)
growth in Joe's and Joe's Jeans branded apparel products; (iii) growth in sales
of our craft products; and (iv) initial sales from our Fetish(TM) and Shago(R)
branded apparel and accessory products.
Accessory
Innovo
Sales for our accessory segment increased to $14,026,000 in fiscal 2003 from
$12,072,000 in fiscal 2002, or a 16% increase. The increase is primarily a
result of higher sales of Innovo's private label and craft accessories products.
Net Sales
($ in thousands) % of Total Net Sales
-------------------- ----------------------
2003 2002 % Chg. 2003 2002
-------------------- --------- ----------------------
Craft $ 5,372 $ 4,417 22% 38% 37%
Private Label 4,856 3,317 46% 35% 27%
Bongo 2,534 3,125 -19% 18% 26%
Fetish 192 - N/A 1% 0%
Other Branded 1,072 1,213 -12% 8% 10%
--------------------
Total Branded 3,798 4,338 -12% 27% 36%
--------------------
Total Net Sales $ 14,026 $ 12,072 16% 100% 100%
Craft Accessories. Innovo's net sales from its craft business increased to
$5,372,000 in fiscal 2003 from $4,417,000 in fiscal 2002, or a
34
22% increase. Craft accessories sales accounted for 38% of Innovo's sales in
fiscal 2003. Sales of craft accessories increased due to increased sales to our
existing customer base, which was a function of our customers opening new
stores. In fiscal 2004, we expect sales to continue to increase as our customers
continue to aggressively expand their store bases and we take on new customers.
However, we anticipate sales of craft products to decline as a percentage of
Innovo's total net sales because of anticipated growth from our private label
and branded accessories products.
Private Label Accessories. Innovo's net sales from its private label business
increased to $4,856,000 in fiscal 2003 from $3,317,000 in fiscal 2002, or a 46%
increase. Private label accessories sales accounted for 35% of Innovo's sales in
fiscal 2003. This increase was due to (1) sales to new private label customers,
(2) increased sales to existing customers, and (3) a full fiscal year of sales
to a new retail customer we acquired at the end of fiscal 2002. In fiscal 2004,
we expect sales to private label customers to increase as we continue to expand
sales with existing customers and increase our customer base.
Branded Accessories. Innovo's net sales from its branded accessory business
decreased to $3,798,000 in fiscal 2003 from $4,338,000 in fiscal 2002, or a 12%
decrease. Branded accessories sales accounted for 27% of Innovo's sales in
fiscal 2003. Innovo's branded accessories carry the following brand names:
Bongo(R), Fetish(TM), Friendship(TM) and Clear Gear(TM). Sales of branded
accessories declined primarily as a result of a decline in the Bongo(R) line of
bags, which in 2003 represented the majority of branded accessory sales. The
decline in sales of Bongo(R) bags was a result of a decline in sales of junior
branded bags in the mid-tier retailers such as The May Department Stores
Company, Sears, Roebuck and Company, and J.C. Penney Company, Inc. While sales
of Fetish(TM) accessories offset a portion of the decline of net sales of
Bongo(R) bags, Fetish(TM) accessories did not start shipping until November
2003, the last month of Innovo's fiscal 2003. In fiscal 2004, we anticipate
sales of certain branded accessories, such as Friendship(TM) and Clear Gear(TM),
to decrease as we continue to sell off existing inventory, and we anticipate
that this decrease will be offset by the growth in our Bongo(R) and Fetish(TM)
accessories. In fiscal 2004, we anticipate branded accessories sales to increase
as a result of: (i) increased sales of Bongo(R) bags based on our initial
projections for the back-to-school season; and (ii) generating sales of
Fetish(TM) bags for the full year of fiscal 2004 compared to just one month of
sales in fiscal 2003.
Apparel
Joe's
Joe's net sales increased to $11,476,000 in fiscal 2003 from $9,179,000 in
fiscal 2002, or a 25% increase.
Net Sales
($ in thousands) % of Total Net Sales
--------------------- ---------------------
2003 2002 % Chg. 2003 2002
--------------------- ------------ ---------------------
Domestic $ 6,075 $ 5,398 13% 53% 59%
Joe's Jeans Japan 3,018 1,902 59% 26% 21%
International Distributors 2,383 1,879 27% 21% 20%
---------------------
Total International Markets 5,319 3,781 41% 46% 41%
---------------------
Total Net Sales $11,476 $ 9,179 25% 100% 100%
---------------------
Domestic. Joe's domestic net sales increased to $6,057,000 in fiscal 2003 from
$5,398,000 in fiscal 2002, or a 13% increase. This increase occurred despite the
presence of pricing pressures for our products in the domestic market. The
increase in sales is attributable to higher unit demand for Joe's products. The
number of units shipped in the domestic market increased to 146,000 units in
fiscal 2003 from 120,000 units in fiscal 2002, or a 22% increase. In fiscal
2004, we plan to take the following steps to further increase sales
domestically: (1) expand our collection of products, to include not only pants
in different materials other than denim, but also tops such as shirts and
jackets; (2) expand our denim pants line to include four fits that are tailored
to different body types; and (3) increase advertising spending to include not
only print ads, but also billboards.
Joe's Jeans Japan. Joe's net sales in Japan increased to $3,018,000 in fiscal
2003 from $1,902,000 in fiscal 2002, or a 59% increase. The majority of the
increase is attributable to sales by JJJ of approximately $1,000,000 of
discounted inventory to Itochu. During the third fiscal quarter of 2003, Joe's
decided to terminate its direct sales operations in Japan in favor of entering
into a licensing and distribution agreement with Itochu for the licensing of
Joe's and the Joe's Jeans brands in Japan. See "Management's Discussion &
Analysis - Recent Acquisitions and Licenses" for a further discussion regarding
the Joe's Jeans licensing agreement. In fiscal 2004, Joe's Jeans Japan does not
anticipate having any sales. However, as discussed below, we believe that our
sales in Japan will grow as a result of the agreement with Itochu.
35
International Distributors. Joe's net sales to international distributors
increased to $2,383,000 in fiscal 2003 from $1,879,000 in fiscal 2002, or a 27%
increase. Currently, Joe's products are sold internationally in Canada, Japan,
Australia, France, England and Korea. The increase in international sales is
attributable to sales to Itochu. In fiscal 2003, Joe's shipped $1,477,000 to
Itochu. Excluding sales to Itochu, sales to international distributors declined.
Sales to France, which represents our second largest international market behind
Japan, declined to $350,000 in fiscal 2003 from $937,000 in fiscal 2002, or a
63% decrease. In fiscal 2004, we expect sales to international distributors to
increase as a result of adding Itochu as our international distributor in Japan
and as a result of partnering with Beyond Blue to increase Joe's distribution in
the international marketplace. Beyond Blue will be responsible for the
management of the existing relationships with Joe's international distributors
and will work to open new territories by obtaining additional international
sub-distributors and sales agents.
IAA
IAA's net sales increased to $57,627,000 in fiscal 2003 from $8,358,000 in
fiscal 2002, or a 589% increase. IAA segregates its operations between two
businesses: private label and branded apparel. IAA's increase in net sales is
attributable to an increase in sales from the private label business, most
notably due to sales of the Blue Concept division acquired from Azteca, Hubert
Guez and Paul Guez in July 2003. Also, as a result of the license agreements
entered into during fiscal 2002 and 2003, IAA generated approximately 11% of its
net sales from its branded business, which began shipping branded apparel in May
of fiscal 2003.
Net Sales
($ in thousands) % of Total Net Sales
--------------------- ----------------------
2003 2002 % Chg. 2003 2002
--------------------- -------- ----------------------
Branded $ 5,917 $ - (A) 10% 0%
Private Label (Existing) 23,950 8,358 187% 42% 100%
Private Label (Blue Conpets) 27,760 - (A) 48% 0%
---------------------
Total Private Label 51,710 8,358 519% 90% 100%
---------------------
Total Net Sales $57,627 $8,358 589% 100% 100%
---------------------
(A) Not Meaningful
Private Label. IAA's net sales from its private label business increased to
$51,710,000 in fiscal 2003 from $8,358,000 in fiscal 2002, or a 519% increase.
The increase in sales is attributable to an increase in sales to the private
label division's existing customer base and sales generated in connection with
the Blue Concepts acquisition in July 2003. Approximately one-third (1/3) of the
increase in the private label division's sales is attributable to sales from the
division's existing customer base with the balance of the growth coming from the
Blue Concepts acquisition. In fiscal 2004, we expect sales from the private
label division to increase as a result of the benefit of a full year's
contribution of sales from the purchase of Blue Concepts versus only four months
in fiscal 2003.
Branded. IAA's net sales from its branded apparel business was $5,917,000 in
fiscal 2003. IAA did not have branded apparel sales in fiscal 2002. Branded
apparel sales accounted for 11% of IAA's net sales in fiscal 2003. During fiscal
2003, IAA's branded apparel carried the following brand names: Shago(R) by Bow
Wow, Fetish(TM) by Eve and Hot Wheels(R) by Mattel, IAA did not generate sales
from its Hot Wheels(R) branded apparel line. See "Business - License Agreements
and Intellectual Property" for further discussion regarding the Hot Wheels(R)
license. IAA commenced shipping its Shago(R) apparel and Fetish(TM) apparel
lines in May 2003 and in September 2003, respectively. The Shago(R) and
Fetish(TM) apparel products were shipped to retailers such as better department
stores and specialty stores in the United States. In fiscal 2004, the Company
expects to increases sales in its branded division through (1) sales of
Fetish(TM) apparel for the full fiscal year; (2) sales of Shago(R) branded
apparel potentially through alternative channels of distribution, including
mid-tier department and specialty stores, and (3) sales from new licensed
apparel, such as the Betsey Johnson(R) license. See "Business - Subsequent
Events" for further discussion regarding the Betsey Johnson(R) license.
Gross Margin
Our gross profit increased to $12,976,000 in fiscal 2003 from $9,537,000 in
fiscal 2002, or a 36% increase. The increase was due to our increase in net
sales. Overall, gross margin, as a percentage of net sales, decreased to 16% in
fiscal 2003 from 32% in fiscal 2002. The decline was attributable to: (i) a
higher percentage of our total sales coming from our private label accessory and
apparel products, as well as our craft products, and (ii) significant inventory
markdowns taken in the fourth quarter of fiscal 2003. Generally, private label
apparel, accessories and craft product lines have lower gross margins than our
branded product lines. Our private label accessory and apparel and craft
products represented approximately 75% of our total sales in fiscal 2003
compared to 54% of our total sales in fiscal 2002. Additionally, in fiscal 2003,
we recorded a fourth quarter charge of $3,875,000, or 5% of net sales, related
to of out-of-season and
36
second quality inventory in the Joe's, Innovo, and IAA divisions. In fiscal
2004, we believe that gross margins will be lower than our historical averages
due to a higher percentage of sales coming from sales to private label
customers. The increase in sales to private label customers is primarily the
result of the acquisition of the Blue Concept Division, which sells private
label apparel to retailers, particularly American Eagle Outfitters, Inc.
Accessory
Innovo
Innovo's gross profit decreased to $3,095,000 in fiscal 2003 from $3,393,000 in
fiscal 2002, or a 9% decrease. Innovo's gross margin decreased to 22% in fiscal
2003 from 28% in fiscal 2002. The decrease in gross margin is a result of a
greater percentage of sales coming from lower margin products and a charge
related to out-of-season inventory. Our craft and private label accessory
products have traditionally experienced lower gross margins than our branded
accessory products. Our craft and private label accessory product represented
74% of net sales in fiscal 2003 compared to 64% of net sales in fiscal 2002. In
addition, we recorded a charge of $335,000 in the fourth quarter related to
out-of-season and slow moving Fetish(TM), Shago(R) and Bongo(R) accessories,
which reduced gross margins by 2%. Approximately 80% of the charge recorded to
mark down out-of-season and slow moving inventory was related to Bongo(R)
products. The decline in Bongo(R) sales relative to our expectations of growth
resulted in over-ordering of excess Bongo(R) inventory. Further, we anticipate
that branded products will grow faster than total sales for the accessories
business, which would result in a greater portion of net sales attributable to
branded accessories in fiscal 2004 than in fiscal 2003.
Apparel
Joe's
Joe's gross profit decreased to $4,087,000 in fiscal 2003 from $4,515,000 in
fiscal 2002, or a 9% decrease. Joe's gross margins decreased to 36% in fiscal
2003 from 51% in fiscal 2002. Joe's gross margin decrease was primarily
attributable to the following factors: (i) JJJ sold the majority of its
inventory, equaling approximately $1,000,000, to Itochu, which approximated our
book value. See "Business - License Agreements and Intellectual Property" for
further discussion of this sale of JJJ inventory; (ii) we recorded a charge of
$143,000 related to second-quality inventory in Japan in the third quarter of
fiscal 2003; (iii) we recorded a charge of $287,000 related to out-of-season
fabric; (iv) we recorded a charge of $247,000 related to second-quality goods
and damaged goods in the U.S to mark down the value of the goods carried on our
books to market value; and (v) our cost of goods sold increased as a result of
no longer being able to purchase finished goods from our domestic supplier,
which resulted in the need to change our inventory purchasing strategy during
the second quarter of fiscal 2003 from buying finished goods to buying raw
materials and outsourcing the manufacturing of our goods. Joe's cost to buy raw
materials and outsource the manufacturing of its own goods was significantly
higher than its cost to buy finished goods. The above referenced charges in the
U.S. and in Japan reduced gross margins by 6%.
IAA
IAA's gross profit increased to $5,794,000 in fiscal 2003 from $1,629,000 in
fiscal 2002, or a 256% increase. However, gross margin decreased to 10% from 19%
in fiscal 2002. The decrease in gross margin is primarily attributable to the
following factors: (i) lower gross margins associated with sales of private
label apparel products, primarily sales to AEO as part of the Blue Concept
Division. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Recent Acquisitions and Licenses" for further discussion
of the Blue Concept Division acquisition; (ii) we recorded a charge of $33,000
related to slow moving inventory in our private label division; and (iii) we
recorded a charge of $3,134,000 to markdown out-of-season Shago(R) and
Fetish(TM) inventory carried on our books to its estimated market value. This
$3,134,000 charge was due to not only our over-estimation of the demand in the
marketplace for our initial deliveries of Shago(R) and Fetish(TM) branded
apparel products, but also our production delays that caused certain customers
to cancel their orders. In aggregate, the charges related to inventory lowered
gross margins by 5%.
Selling, General and Administrative Expense
Selling, general and administrative ("SG&A") expenses increased to $19,264,000
in fiscal 2003 from $8,092,000 in fiscal 2002, or a 138% increase. The SG&A
increase is largely a result of the following factors: (i) an increase in
advertising expenditures to establish and market our Fetish(TM), Shago(R) and
Joe's(R) branded products through both advertising and tradeshows; (ii) the
hiring of 31 employees as a result of the Blue Concept Division acquisition;
(iii) the hiring of 60 employees to support or facilitate the establishment of
and increase sales for Fetish(TM), Shago(R) and Joe's(R) branded products; (iv)
the hiring of 19 employees to support our Far East outsourcing operations and 4
employees to increase our management personnel; (v) increased royalty and
commission expense associated with our existing and new branded accessory and
apparel lines; (vi) increased outside legal, accounting and other professional
fees as a result of continued growth of the business in fiscal 2003; and (vii)
increased insurance costs primarily as a result of increase in our general
liability and D & O insurance.
As discussed in greater detail below, we incurred the following SG&A expenses in
fiscal 2003: (i) $1,732,000 of expense in fiscal 2003
37
from $491,000 of expense in fiscal 2002, or a 253% increase, to establish and
market our branded products through advertising and tradeshows; (ii) $6,475,000
of expense in fiscal 2003 from $2,832,000 of expense in fiscal 2002, or a 129%
increase, for hiring additional employees and wage increases; (iii) $2,032,000
of expense in fiscal 2003 from $1,568,000 of expense in fiscal 2002, or a 30%
increase, for royalties and commissions associated with our existing and new
branded accessory and apparel lines; (iv) $1,577,000 of expense in fiscal 2003
from $611,000 of expense in fiscal 2002, or a 158% increase, for increased
legal, accounting and other professional fees; and (vi) $240,000 of expense in
fiscal 2003 from $134,000 in fiscal 2002, or a 79% increase, for increased D & O
and general liability insurance.
Accessory
Innovo
Innovo's SG&A expenses increased to $3,345,000 in fiscal 2003 from $2,854,000 in
fiscal 2002, or a 17% increase. This SG&A expense increase is primarily
attributable to wage increases. Innovo's employee wages increased to $1,284,000
in fiscal 2003 from $842,000 in fiscal 2002 or a 52% increase. Wage increases
are a result of the following factors: (i) hiring of two additional salespersons
to replace outsourced sales personnel working on a commission only basis, which
accounted for $152,000 of the wage expense increase; (ii) wage increases for
existing employees, which accounted for $50,000 of the wage expense increase;
(iii) hiring of new employees in functions including purchasing, data entry,
merchandising, designing and accounting, which accounted for $200,000 of the
wage expense increase; and (4) the hiring of additional employees added to the
Hong Kong sourcing office, which accounted for $40,000 of the wage expense.
Further, as a result of shifting to using in-house sales personnel instead of
outsourcing sales to sales representatives that work for commissions, wage
increases were partially offset by lower commission expenses. Commission expense
declined to $130,000 in fiscal 2003 from $292,000 in fiscal 2002, or a 26%
decrease.
Due to the expansion of the branded accessories product line, three other SG&A
expense categories increased, namely: (i) product sample expenses; (ii) contract
labor; and (iii) rent. First, expenses to make samples of future products
increased to $137,000 in fiscal 2003 from $54,000 in fiscal 2002, or a 154%
increase. Sample expense increased due to additional development of branded
accessories such as Fetish(TM) accessories. Second, in addition to using our own
design and development personnel for branded accessories, we also used contract
labor. As a result, contract labor expense increased to $46,000 in fiscal 2003
from $12,000 in fiscal 2002, or a 283% increase. Finally, rental expense
increased to $191,000 in fiscal 2003 from $120,000 in fiscal 2002, or a 59%
increase. The increase in rent is primarily attributable to an increase in rent
to expand the New York showroom to include support for the branded accessories
lines.
Apparel
Joe's
Joe's SG&A expenses increased to $5,426,000 in fiscal 2003 from $3,245,000 in
fiscal 2002, or a 67% increase. This increase is primarily attributable to the
following factors: (i) a wage and benefits expense increase in connection with
the hiring of additional employees in order to expand Joe's product lines from
denim pants to a full sportswear collection of pants and tops bearing the
Joe's(R) brand for Spring 2004; (ii) severance payments paid in connection with
the termination of operations in Japan pursuant to the agreement with Itochu.
See "Business - License Agreements and Intellectual Property" for further
discussion of the Itochu agreement; (iii) increases in legal and accounting fees
due to the termination of operations in Japan in connection with the Itochu
agreement; (iv) increased expenditures on marketing and advertising the Joe's(R)
and Joe's Jeans(R) brand; (v) increased apparel sample costs; and (vi) increased
royalty and factoring expenses due to increased sales of Joe's products.
More specifically, Joe's employee wages and related benefits expenses increased
to $1,794,000 in fiscal 2003 from $1,140,000 in fiscal 2002, or a 57% increase,
as a result of hiring 11 new employees to support the growth in Joe's business.
Severance payments totaling $274,000 were paid in the second and third quarters
of 2003 to certain employees as part of a separation payment in connection with
the termination of operations in Japan, compared to no severance payments being
made in fiscal 2002. Joe's legal and accounting expenses increased to $434,000
in fiscal 2003 from $82,000 in fiscal 2002, or a 429% increase, and were
attributable to the termination of operations in connection with the Itochu
agreement. Joe's expenses associated with marketing and advertising, including
trade show expenditures, increased to $706,000 in fiscal 2003 from $426,000 in
fiscal 2002, or a 66% increase. Sample costs were $291,000 in fiscal 2003,
compared to no sample costs in fiscal 2002. This expense is due to changes in
inventory strategy in the second quarter of fiscal 2003 whereby Joe's began
purchasing raw materials and outsourcing the manufacturing of its goods as
opposed to purchasing finished goods. As a result of this change in inventory
strategy, Joe's began buying its own samples. By contrast, in fiscal 2002 our
supplier of finished goods bore the cost of producing samples. Finally, as a
result of higher net sales, Joe's royalty expense increased to $339,000 in
fiscal 2003 from $277,000 in fiscal 2002, or a 22% increase. and Joe's factoring
expense under its factoring arrangement with CIT Commercial Services increased
to $72,000 in fiscal 2003 from $41,000 in fiscal 2002, or a 76% increase.
IAA
38
IAA's SG&A expenses increased to $7,541,000 in fiscal 2003 from $761,000 in
fiscal 2002, or an 891% increase. The increase in SG&A expenses is primarily
attributable to the growth in IAA's branded apparel business and the acquisition
of the Blue Concept Division.
IAA had higher employee costs associated with the expansion of its branded
apparel business and the acquisition of the Blue Concept Division, increasing
its employee count by adding 80 new employees. The expansion into the branded
apparel business required us to fill certain positions such as designers for
Shago(R) and Fetish(TM), which were necessary to bring the products to
production and, ultimately, to the marketplace. As a result, employee wages and
benefits increased to $2,362,000 in fiscal 2003 from $522,000 in fiscal 2002, or
a 352% increase. Of the $2,362,000 in total wages, $1,082,000, or 46%, was
associated with employees working on branded apparel products; $708,000, or 30%,
was associated with employees joining the private label division in connection
with the Blue Concept Division acquisition, with the remaining 24% of the total
wages associated with the private label division's existing operations.
During fiscal 2003, we incurred $989,000 of expense to market and promote our
branded apparel products, including: (i) $498,000 spent on billboard
advertising, photo shoots in connection with Fetish(TM) and Shago(R), and
national print publications, such as Vibe, Honey and Women's Wear Daily, from no
advertising expenses incurred in fiscal 2002; and (ii) $491,000 incurred in
connection with the semi-annual trade show MAGIC held in Las Vegas, Nevada to
build and erect the booth used to launch the Fetish(TM), Shago(R) and Hot
Wheels(R) lines; and (iii) $431,000 for samples, production and development of
its apparel products, compared to no expenses for these sample and development
costs in fiscal 2002.
During fiscal 2003, we incurred $1,061,000 of royalties and commissions for
Shago(R) and Fetish(TM) branded apparel sales, which commenced shipping in the
second and fourth quarters of fiscal year 2003, respectively. In future periods
we anticipate that royalties and commissions will increase as we expect sales of
branded apparel to increase. With the exception of $21,000 spent in fiscal 2002
allocated toward minimum royalty guarantees in connection with the Hot Wheels(R)
and Shago(R) lines, no commissions were expensed during fiscal 2002 since we
generated no sales from branded apparel during fiscal 2002.
Factoring expenses under IAA's inventory- and receivables-based line of credit
agreements with CIT increased to $342,000 in fiscal 2003 from $130,000 in fiscal
2002, or a 163% increase. This increase was due to the increase in sales.
Travel, meals and entertainment expense increased to $408,000 in fiscal 2003
from $18,000 in fiscal 2002, or a 2,167% increase, as a result of the larger
employee and customer base.
Legal expenses increased $161,000 in fiscal 2003 from $2,000 in fiscal 2002, or
a 7,950% increase, as a result of increased costs associated with the
development of the branded apparel business.
IAA incurred $231,000 of bad debt expense for uncollectible accounts in fiscal
2003 compared to no bad debt expense in fiscal 2002.
As a part of the acquisition of the Blue Concept Division, IAA pays to Azteca a
fee for allocated expenses associated with the use of its office space and
expenses incurred in connection with maintaining office space. These allocated
expenses include, but are not limited to: rent, security, office supplies,
machine leases and utilities. During fiscal 2003, we incurred $694,000 of
expense to Sweets Sportswear LLC pursuant to an earn-out agreement associated
with the Blue Concepts acquisition. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Recent Acquisitions and
Licenses" for further discussion regarding the acquisition of the Blue Concepts
Division. We expect earn-out expense to increase as we anticipate sales growth
from the Blue Concept Division, particularly as we will benefit from a full year
of sales in fiscal 2004 compared to only four months of sales in fiscal 2003. As
a part of the acquisition of Blue Concepts, IAA pays Azteca Productions
International a fee for allocated expenses associated with the use of its
infrastructure. Such allocated expenses include but are not limited to rent,
security, office supplies, machine leases and utilities. In fiscal 2003, IAA
recorded $318,000 for such expenses. The balance of the approximate $689,000 of
additional SG&A in fiscal 2003 is attributable to the growth of our business
from IAA having net sales of $8,358,000 and 7 employees in fiscal 2002 to
$57,627,000 net sales and 87 employees in fiscal 2003.
Other
IGI
IGI, which reflects our corporate expenses and operates under the "other"
segment, does not have sales. IGI's expenses, excluding interest, depreciation
and amortization, increased to $2,812,000 in fiscal 2003 from $1,375,000 in
fiscal 2002, or a 105% increase. IGI's management level wages, and related taxes
and benefits increased to $859,000 in fiscal 2003 from $295,000 in fiscal 2002,
or a 191% increase, primarily as a result of hiring five additional management
level employees, including a Chief Financial Officer and a Chief Operating
Officer, to provide the infrastructure necessary to manage our growth. Also,
insurance expense increased to $240,000 in fiscal 2003 from $134,000 in fiscal
2002, or a 79% increase. Legal, accounting and professional fees increased to
$933,000 in fiscal 2003 from $406,000 in fiscal 2002, or a 130% increase, as a
result of the Company's increased business needs in fiscal 2003. Travel, meals
and entertainment expense increased to $266,000 in fiscal 2003 compared to
$143,000 in fiscal 2002, or a 86% increase, as a result of the travel associated
with senior management coordinating the opening of a New York office for the IAA
subsidiary, and the
39
commuting and relocation costs associated with the hiring of the Chief Financial
Officer.
Leasall
Leasall's SG&A expense increased to $130,000 in fiscal 2003 from $21,000 in
fiscal 2002, or a 519% increase, primarily due to $98,000 of expenses incurred
to maintain and operate our former manufacturing facility and headquarters
located in Springfield, Tennessee, which is now partially leased to third party
tenants. The balance of the $32,000 was spent by Leasall on Tennessee property
taxes and insurance.
IRI
IRI's SG&A expense decreased to $8,000 in fiscal 2003 from $64,000 for fiscal
2002, or a 700% decrease. IRI's SG&A expense is primarily comprised of legal and
accounting fees.
Depreciation and Amortization Expenses
Our depreciation and amortization expenses increased to $1,227,000 in fiscal
2003 from $256,000 in fiscal 2002, or a 379% increase. The increase is primarily
attributable to (1) the depreciation and amortization associated with the
purchase of the Blue Concepts division and (2) the purchase of a booth for the
tradeshow, MAGIC. More specifically, in connection with the Blue Concepts
acquisition in fiscal 2003, the Company amortized $848,000 of the intangible
assets based upon the fair value of the majority of the gross profit associated
with existing purchase orders at closing and the intangible value of the
customer list obtained. We also depreciated $50,000 of the expense related to
the purchase of the booth for the MAGIC tradeshow. The remaining depreciation
and amortization expense of $329,000 is due to (i) deprecation of $76,000 in
connection with the Springfield, Tennessee facility and related leasehold
improvements, (ii) amortization of $48,000 in connection with the licensing
rights to the Joe's(R) and Joe's Jeans(R) marks acquired on February 7, 2001,
(iii) amortization of $95,000 from the purchase of the knit division from Azteca
on August 24, 2001, and (iv) depreciation of $110,000 related to small
operational assets such as furniture, fixtures, machinery and software.
Interest Expense
Our combined interest expense increased to $1,216,000 in fiscal 2003 from
$538,000 in fiscal 2002, or a 126% increase. Our interest expense is primarily
associated with: (i) $359,000 of interest expense from our factoring and
inventory lines of credit and letter's of credit from CIT used to help support
our working capital increases; (ii) $182,000 of interest expense from the knit
acquisition purchase notes issued in connection with the purchase of the knit
division from Azteca in fiscal 2001; (iii) $30,000 of interest expense from two
loans totaling $500,000 provided by Marc Crossman, our Chief Financial Officer,
to the Company on February 7, 2003 and February 13, 2003; (iv) $26,000 of
interest expense from a $476,000 mortgage on our former manufacturing facility
and headquarters in Springfield, Tennessee; (v) $482,000 of interest expense
incurred as a result of the $21,800,000 convertible note issued as a part of the
purchase of the Blue Concepts acquisition in July of 2003. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for a further discussion of these
financing arrangements; (vi) $139,000 of interest expense incurred from
discounts given to customers who paid their invoices early; and (vii) interest
income of $2,000.
Other Income
We had other income, net of other expenses, of $458,000 in fiscal 2003 from
$61,000 in fiscal 2002, or a 651% increase.
IRI
Other income in fiscal 2003 included $329,000 of income from a quarterly
sub-asset management fee that IRI received pursuant to a sub-asset management
agreement entered into on April 5, 2002, in connection with the acquisition by
IRI of a 30% limited partnership interest in 22 separate limited partnerships,
which acquired 28 apartment complexes at various locations throughout the United
States. Part of the consideration accepted by the sellers in the Limited
Partnership Real Estate Acquisition was 195,000 shares of the Company's $100
Redeemable 8% Cumulative Preferred Stock, Series A, or the Series A Preferred
Stock. We are not entitled to any cash flow or proceeds from the sales of the
properties until all shares of the Series A Preferred Stock have been redeemed.
Until such time, we only receive the quarterly sub-asset management fee. IRI
generated $173,000 of income from the sub-asset management fee in fiscal 2002.
See "Business - Real Estate Transactions".
Joe's and Leasall
Additionally, we had $153,000 of other income from Joe's in fiscal 2003 compared
to $41,000 of other expense in fiscal 2002. The vast majority of Joe's other
income was unrealized Japanese currency translation income of $137,000.
Offsetting a portion of other income was net rental expenses of $21,000 from
tenants who are occupying our former manufacturing facility located in
Springfield, Tennessee.
40
Net Income
We generated a net loss of $8,317,000 in fiscal 2003 compared to net income of
$572,000 in fiscal 2002. The net loss in fiscal 2003 versus net income in fiscal
2002 is largely the result of the following factors: (i) lower gross margins,
due to (a) over-estimations by management in its inventory purchases and (b)
significant charges taken against excess inventory; (ii) increased employee
wages of $3,643,000; (iii) increased advertising, marketing, tradeshow and
related costs of $1,241,000 incurred in order to market the Joe's brand and
launch the Shago(R) by Bow Wow and Fetish(TM) by Eve brands; (iv) increased
royalties and commissions associated with our branded products and the earnout
associated with the Blue Concepts purchase of $1,539,000; (v) increases in
legal, accounting, and other professional fees and insurance of $965,000; (vi)
an increase in interest expense of $681,000 and depreciation and amortization
costs of $973,000 primarily associated with the acquisition of the Blue Concepts
division from Azteca in fiscal 2003 as discussed in greater detail above.
Results of Operations
The following table sets forth certain statement of operations data for the
years indicated:
Years Ended
(in thousands)
--------------------------------------------------------------
11/30/02 12/01/01 $ Change % Change
-------- -------- -------- --------
Net Sales $ 29,609 $ 9,292 $ 20,317 219%
Cost of Goods Sold 20,072 6,335 13,737 217
-------- -------- -------- --------
Gross Profit 9,537 2,957 6,580 223
Selling, General & Administrative 8,092 3,189 4,903 154
Depreciation & Amortization 256 167 89 53
-------- -------- -------- --------
Income (Loss) from Operations 1,189 (399) 1,588 (398)
Interest Expense (538) (211) (327) 155
Other Income 235 84 151 180
Other Expense (174) (3) (171) (A)
-------- -------- -------- --------
Income (Loss) before Income Taxes 712 (529) 1,241 (235)
Income Taxes 140 89 51 57
Net Income (Loss) $ 572 $ (618) $ 1,190 (A)
(A) Not Meaningful
Comparison of Fiscal Year Ended November 30, 2002 to Fiscal Year Ended December
1, 2001
Overview
In fiscal 2002, we increased our sales and reported an overall profit for the
year ended November 30, 2002. We experienced growth in all three of our main
consumer products operating subsidiaries and moved forward in our efforts to
strengthen our presence in the apparel market.
Our accessory division, Innovo, experienced an increase in sales as a result of
our entry into the private label business, growth from the Bongo(R) product line
and an increase in its legacy craft division. In fiscal 2002, Innovo focused on
strengthening its sourcing capabilities through the establishment of IHK.
During fiscal 2002, our Joe's subsidiary continued to experience strong demand
for its product lines in the international marketplace. In May of 2002, Joe's
established JJJ to distribute its products in the Japanese market. Additionally,
we began to distribute our Joe's products in Europe and Canada.
Our IAA subsidiary increased its sales in fiscal 2002 as a result of growth in
its business with its private label customers such as Target Corporation and J.
Crew, Inc. During the period, in an effort to expand into branded products, IAA
obtained the license rights to Bow
41
Wow from Bravado International Group, the agency with the master license rights
to Bow Wow, and LBW Entertainment, Inc. and to the Hot Wheels(R) brand from
Mattel, Inc.
Our net income for the fiscal year ended 2002 was $572,000, or $0.04 per share,
compared to a loss of $618,000, or $0.04 per share, for the fiscal year ended
2001, as a result of our ability to increase our revenues, maintain our gross
margins and to control our increase in expenses.
Reportable Segments
During fiscal 2002 and fiscal 2001, we operated in two segments, accessories and
apparel. The accessories segment represents our original core business and is
conducted by our Innovo subsidiary. The apparel segment operates under Joe's and
IAA. Our real estate operations and corporate activities are categorized under
"other." The operating segments have been classified based upon the nature of
their respective operations, customer base and the nature of the products sold.
The following table sets forth certain statement of operations data by segment
for the years indicated (in thousands):
November 30, 2002 Accessories Apparel Other (A) Total
---------------------------------------------------
(in thousands)
Net Sales $12,072 $17,537 $ -- $29,609
Gross Profit 3,393 6,144 -- 9,537
Depreciation & Amortization 21 183 52 256
Interest Expense 140 339 59 538
December 1, 2001 Accessories Apparel Other (A) Total
---------------------------------------------------
(in thousands)
Net Sales $ 5,642 $ 3,650 $ -- $ 9,292
Gross Profit 1,749 1,208 -- 2,957
Depreciation & Amortization 45 35 87 167
Interest Expense 32 79 100 211
2002 to 2001 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
-----------------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 6,430 114% $13,887 380% $ -- N/A $20,317 219%
Gross Profit 1,644 94 4,936 409 -- N/A 6,580 223
Depreciation & Amortization (24) (53) 148 423 (35) (40) 89 53
Interest Expense 108 338 260 329 (41) (41) 327 155
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
Net Sales
Our net sales increased to $29,609,000 in fiscal 2002 from $9,292,000 for fiscal
2001, or an increase of 219%. This increase is attributable to sales by our
three main operating subsidiaries, Innovo operating in the accessory segment and
Joe's and IAA operating in the apparel segment.
Accessory
Innovo
Innovo's net sales increased to $12,072,000 in fiscal 2002 from $5,642,000 in
fiscal 2001, or an increase of 114%. Innovo's gross sales for fiscal 2002 were
$12,216,000. The increase is attributable to our entry into the private label
accessory business, growth in sales of Innovo's craft products, and higher sales
from its Bongo(R) accessory products.
Innovo's accessory craft business increased as a result of Innovo's ability to
sell a greater amount of its new and existing products to new and existing
customers. In fiscal 2002, Innovo focused upon increasing the quality of its
products and improving the marketing strategy associated with the Innovo's
products. Innovo's craft business gross sales increased to $4,577,000 in fiscal
2002 from $2,831,000 in fiscal 2001, or a 62% increase. Innovo's craft business
represented approximately 37% of Innovo's total gross sales for fiscal 2002.
42
Innovo's Bongo(R) product line experienced an increase in sales partly as a
result of fiscal 2002 being Innovo's first full twelve month cycle of business
with the Bongo(R) product line. Gross sales generated by the Bongo(R) product
line of $3,101,000 represented approximately 25% of Innovo's total gross sales
for fiscal 2002.
Innovo began selling its products to private label customers in fiscal 2002.
Innovo's two main private label customers for fiscal 2002 were American Eagle
Outfitters, Inc. and Limited Brands, Inc.'s Express division. Innovo's private
label business gross sales of $3,218,000 represented approximately 26% of
Innovo's gross sales for fiscal 2002.
Apparel
Joe's
Joe's net sales increased to $9,179,000 in fiscal 2002 from $1,519,000 in fiscal
2001, or an increase of 504%. Joe's product line experienced an increase in
sales partly as a result of fiscal 2002 being Joe's first full 12 month business
cycle. For fiscal 2002, Joe's product mix consisted primarily of women's denim
based jeans, skirts and jackets and men's denim jeans. Joe's is continuing to
diversify its product offerings to meet the changing trends in the high fashion
apparel markets and believes, although there can be no assurances, that its new
product line is designed to meet the current fashion trends and the expectations
of its customers and the consumer.
During fiscal 2002, Joe's experienced increase demand in both the domestic and
international marketplaces. Joe's net sales domestically increased to $5,398,000
in fiscal 2002 from $1,519,000 in fiscal 2001, or an increase of 255%. This
increase is primarily a result of the maturity and development of the Joe's
brands in the marketplace. Joe's continues to attract customer and consumer
awareness as a result of its design and quality characteristics. Management
believes the desirability of products bearing the Joe's(R) brand and the
characteristics associated therewith are resulting in increased demand from
Joe's customers.
In fiscal 2002, Joe's expanded into the international marketplace through the
formation of Joe's Jeans Japan, Inc., or JJJ, and through the use of
international distributors. JJJ is headquartered in Tokyo, Japan where we
operate a showroom and operational offices. Net sales by JJJ in the amount of
$1,902,000 represented approximately 21% of Joe's total net sales. Additionally,
Joe's marketed its products in Europe and Canada through the use of
international distributors who purchase Joe's products and then distributed the
product to retailers in the distributor's local markets. Sales in the
international market, excluding sales by JJJ, represented approximately 10% of
Joe's total sales for fiscal 2002.
IAA
IAA's net sales increased to $8,358,000 for fiscal 2002 from $2,130,000 for
fiscal 2001, or an increase of 292%. IAA was formed in August 2001 in connection
with acquisition of the knit division from Azteca. IAA's product line
experienced an increase in sales partly as a result of fiscal 2002 being IAA
first full 12 month business cycle and an increase in sales of IAA's private
label apparel products to its two main customers, J. Crew, Inc. and Target
Corporation's Mossimo division. IAA's products in fiscal 2002 primarily
consisted of denim jeans and knit shirts.
In an attempt to expand its product business, in fiscal 2002, IAA entered into a
license agreements with Bow Wow and Mattel for the creation of apparel and
accessory products bearing the Shago(R) and Hot Wheels(R) brand, respectively.
IAA's branded products did not have any sales in fiscal 2002.
Gross Margin
Our overall gross margin remained at 32% for fiscal 2002 compared to 32% for
fiscal 2001.
Accessory
Innovo
Innovo's gross margin decreased to 27% for fiscal 2002 from 31% for fiscal 2001,
or a decrease of 2%. Innovo's gross margin is largely a function of Innovo's
product mix for the given period, however, during the fiscal 2002, Innovo's
gross margin was negatively impacted from the west coast dock strike. As a
result of the west coast dock strike, Innovo was obligated to incur increased
airfreight of $303,000, which affected our gross margin by three percentage
points. In addition, we were required to give customer discounts as a result of
the late shipment of products. Innovo's product categories have historically had
a gross margin in the 30% range, with some product categories being higher and
some lower. Innovo's branded product have traditionally experienced higher
margin than its craft and private label business, which usually have similar
gross margins.
Apparel
43
Joe's
Joe's gross margins decreased to 50% for fiscal 2002 from 57% for fiscal 2001,
or a decrease of 7%. The decrease reflects an increase in sales in the
international marketplace, which are often sold at a discount. Additionally,
Joe's gross margin was negatively impacted as a result of an increase in cost
for some of the more fashion oriented products in Joe's product line. In an
effort to maintain high margins, Joe's usually attempts to pass the higher cost
of certain goods to its customer by charging a higher sales price for such
products.
IAA
IAA's gross margins increased to 20% for fiscal 2002 from 16% for fiscal 2001,
or an increase of 4%. IAA's sales in fiscal 2002 primarily consisted of denim
jeans and knit shirts to private label customers. IAA's sales to its private
label customers usually have lower margins than the sales of our other
divisions. We anticipate that IAA's branded apparel will experience higher gross
margins than its private label apparel because it can obtain higher prices for
its branded apparel products.
The increase in IAA's gross margins offset decreases in Joe's and Innovo's gross
margins. This attributed an overall increase in the collective gross margin. Our
collective gross margin may fluctuate in future periods based upon which
segments operating subsidiary and operating division accounts for a larger
percentage of sales.
Selling, General and Administrative Expense
Our selling, general and administrative, or SG&A, expenses increased to
$8,092,000 in fiscal 2002 from $3,189,000 in fiscal 2001, or approximately a
176% increase. The increase in SG&A expenses is largely a result of an increase
in expenses to support our sales growth during the period. During the period, we
incurred an increase in wages to $2,832,000 in fiscal 2002 from $1,026,000 in
fiscal 2001, or an increase of 176%. We hired new employees to handle the growth
in our accessory and apparel business. In addition, advertising expenses
increased to $287,000 in fiscal 2002 from $114,000 in fiscal 2001, or an
increase of 152%, travel expenses increased to $342,000 in fiscal 2002 from
$152,000 in fiscal 2001, or an increase of 125%, professional fees increased to
$611,000 in fiscal 2002 from $285,000 in fiscal 2001, or an increase of 114%,
and sales shows and samples expenses increased to $389,000 in fiscal 2002 from
$88,000 in fiscal 2001, or an increase of 342%. These increased expenses were
all related to our sales growth in fiscal 2002.
Accessory
Innovo
Innovo's SG&A expenses increased to $2,854,000 in fiscal 2002 from $1,441,000
fiscal 2001, or an increase of 98%. Innovo's increase in SG&A expenses is
largely attributable to expenses which were necessary to support or associated
with Innovo's increase in sales primarily attributable to its Bongo(R) product.
During fiscal 2002, Innovo's wages increased to $842,000 in fiscal 2002 from
$414,000 in fiscal 2001, or an increase of 103% as Innovo added staff members at
its headquarters in Knoxville and to its showroom in New York City.
Additionally, Innovo's wages increased from the addition of employees at
Innovo's sourcing office IHK in Hong Kong. Innovo's commission expense increased
to $292,000 in fiscal 2002 to $126,000 in fiscal 2001 or an increase of 132%
during the period due to the increase in commission based sales.
Royalty expenses for fiscal 2002 increased by 215% to $270,000 primarily due to
royalty expense associated with the sales of Bongo(R) related products. Innovo's
distribution costs also increased by approximately 50% during fiscal 2002
because it distributed a greater amount of product.
Nasco Products International, Inc.
Our accessory business in the international marketplace had previously been
conducted through our subsidiary, Nasco Products International, Inc., or NPII.
NPII had international license rights for certain sports and character related
trademarks. In fiscal 1999, NPII ceased operations in the international
accessory market. At such time, NPII was in disagreement with certain licensors
with respect to the terms and royalty commitments under the license agreements.
In 1999, NPII accrued $104,000 against the potential liability associated with
the agreements. For fiscal 2002, NPII reversed into SG&A expense the accrual due
to the fact there has not been material activity with respect to the agreements
over the last three fiscal years.
Apparel
Joe's
Joe's SG&A expenses increased to $3,245,000 in fiscal 2002 from $618,000 in
fiscal 2001, or an increase of 425%. Joe's wage expense increased to $1,140,000
during fiscal 2002 from $201,000 during fiscal 2001, or an increase of 467%.
Joe's wage expense was attributable to its increase in staff to support Joe's
growth. Joe's royalty and commission expenses increased to $981,000 in fiscal
2002
44
from $197,000, or an increase of 398%, as a result of Joe's increasing sales and
royalties and commissions associated therewith. During fiscal 2002, as part of
Joe's marketing campaign, Joe's participated in numerous sales shows and
advertised the Joe's brand in national print publications. As a result, Joe's
sales show expense increased by 232% to $166,000 in fiscal 2002 and its
advertising expenses increased by 294% to $264,000 in fiscal 2002 compared to
fiscal 2001. Joe's factoring expense increased to $41,000 in fiscal 2002 from
$8,000 in fiscal 2001, or an increase of 413% in response to the increase in the
number of receivables Joe's factored. Joe's SG&A expenses for fiscal 2002 also
include the additional expense of $540,000 associated with the operation of JJJ.
IAA
IAA's SG&A expenses increased to $761,000 in fiscal 2002 from $83,000 in fiscal
2001, or an increase of 817%, because fiscal 2002 was IAA's first full
twelve-month business cycle. IAA's wage expense increased to $522,000 in fiscal
2002 from $80,000 in fiscal 2001, or an increase of 553%. IAA sales sample
expense increases to $46,000 in fiscal 2002 from no sales sample expense in
fiscal 2001. IAA's factor expense increased to $130,000 in fiscal 2002 as a
result of an increase in the amount of receivables IAA factored and an extra
factor fee charged to IAA for the factoring of one of IAA's significant
customers.
Other
IGI
IGI, which reflects our corporate expenses and operates under the "other"
segment, does not have sales. For fiscal 2002, IGI's expenses, excluding
interest, depreciation and amortization, increased to $1,375,000 for fiscal 2002
from $1,171,000 in fiscal 2001, or an increase of 17%. IGI had a large increase
in its professional fees and insurance expenses in fiscal 2002. IGI's
professional fee's expense increased approximately 49% in fiscal 2002 compared
to fiscal 2001. The increase in professional fees is largely attributable to
additional legal and accounting fees. IGI's insurance expense increased by 22%
as a result of an increase in the cost of our Director and Officer insurance and
as a result of an increase in the cost of general liability insurance for our
growing operations. IGI's remaining expenses did not differ materially compared
to fiscal 2001.
IRI
During fiscal 2002, IRI had approximately $64,000 of professional fees which
were represented in the SG&A under our "other" segment. These professional fees
were primarily associated with the formation of IRI and professional fees
necessary for the completion of the investments made by IRI during the period.
See "Business- Real Estate Transactions."
Depreciation and Amortization Expenses
Our depreciation and amortization expenses increased to $256,000 in fiscal 2002
from $167,000 in fiscal 2001, or an increase of 53%. The increase is primarily
attributable to IAA's amortization of the non-compete agreement entered into in
August 2001, pursuant to the terms of the knit acquisition. The non-compete
agreement has been valued at $250,000 and is being amortized over two years,
based upon the term of the agreement. IAA's amortization expense increased to
$120,000 in fiscal 2002 from $35,000 in fiscal 2001, or an increase of 243%. See
Note 3 "Acquisitions," in the Notes to the Consolidated Financials.
Our combined deprecation expense totaled $86,000 in fiscal 2002, with Leasall's
depreciation of the Springfield, Tennessee facility representing $40,000 of the
depreciation total. The remaining depreciation expense in fiscal 2002 is
associated with the depreciation of small operational assets such as furniture,
fixtures, leasehold improvements, machinery and software.
Interest Expense
Our combined interest expense increased to $538,000 for fiscal 2002 from
$211,000 for fiscal 2001, or an increase of 155%. Our interest expense is
primarily attributable to our factoring and inventory lines of credit, the
promissory note issued in connection with the acquisition of the knit division
from Azteca and the promissory note associated with our former manufacturing
facility and headquarters in Springfield, Tennessee.
Accessory
Innovo
Innovo's interest expense increased to $140,000 in fiscal 2002 from $32,000 in
fiscal 2001, or an increase of 338%. This increase represents interest expense
incurred from borrowings under Innovo's factoring agreement and inventory line
of credit. See "Managements Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources."
Apparel
45
Joe's
Joe's interest expense was $29,000 in fiscal 2002 because Joe's does not factor
all of its receivables and thus does not borrow against these receivables under
its factoring agreement. Joe's carries these receivables as "house accounts."
Joe's interest expense does include borrowings under its inventory line of
credit. See "Managements Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources."
IAA
IAA's interest expense increased to $310,000 in fiscal 2002 compared to fiscal
2001 or an increase of 377%. This increase is attributable to IAA factoring a
vast majority of its receivables and then borrowing funds against these
receivables. See "Managements Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources." Additionally, IAA's
interest expense increased as a result of interest payments associated with the
promissory note issued as part of the purchase of the knit division from Azteca
and the creation of IAA. See Note 3, "Acquisitions" in the Notes to the
Consolidated Financials.
Other Income
Our "other income" decreased to $61,000 in fiscal 2002 from $81,000 in fiscal
2001, or a decrease of 25%.
Leasall
Our decrease in "other income" in fiscal 2002 is largely attributable to a
$90,000 expense that our Leasall subsidiary incurred as a result of repair
expenses associated with our former manufacturing facility and headquarters in
Springfield, Tennessee. See "Business--Properties." During fiscal 2002,
Leasall's operational expenses did not change materially. Leaseall's main
operational expenses are maintenance and taxes. However, during the year,
Leasall made significant renovations to the Springfield facility that totaled
approximately $425,000 of which $335,000 was capitalized and $90,000 was
expensed during fiscal 2002. Leasall's operations are part of our "other"
segment of business.
IRI
"Other Income" in fiscal 2002 includes $173,000 of income from a management fee
the IRI receives pursuant to an investment that we made through our IRI
subsidiary in the second quarter of fiscal 2002. IRI, which operates under our
"other" business segment was formed during fiscal 2002 and thus did not have
operations during fiscal 2001. During fiscal 2002, IRI had approximately $61,000
of professional fees which were represented in the SG&A expense under our
"other" segment. These professional fees were primarily associated with the
formation of IRI and professional fees necessary for the completion of the
investments made by IRI during the period. See "Business-Real Estate
Transactions."
The remaining other income is primarily associated with rental income generated
from tenants who are occupying our former manufacturing facility located in
Springfield, Tennessee.
Net Income
Our net income increased to $572,000 for fiscal 2002 from a net loss of $618,000
in fiscal 2001. Our profitability in fiscal 2002 is attributable to a
significant increase in sales in fiscal 2002 compared sales to fiscal 2001 and
our ability to maintain our gross margins during fiscal 2002. While our expenses
increased in fiscal 2002, our gross profits offset the increase in revenues,
thus, resulting in net income for the period.
Liquidity and Capital Resources
Our primary sources of liquidity are cash flows from operations, trade payables
credit from vendors and related parties equity financings and borrowings from
the factoring of accounts receivables and borrowing against inventory. Cash used
for operating activities was $9,857,000 for fiscal 2003 compared to cash
provided by operating activities of $1,504,000 for fiscal 2002. During the
period, we used cash to purchase inventory, extend credit to our customers
through accounts receivable, reduce related party payables and fund operating
expenses. Cash used in operating activities combined with cash used in investing
activities and repayment of debt was offset by cash generated through a related
party borrowing of $500,000, factor borrowings of $332,000 and the proceeds from
five equity issuances providing net proceeds of $17,540,000. During fiscal 2003,
we generated $7,026,000 of cash versus a use of cash of $70,000 for fiscal 2002.
We are dependent on credit arrangements with suppliers and factoring and
inventory based lines of credit agreements for working capital needs. From time
to time, we have obtained short-term working capital loans from senior members
of management and from members
46
of the Board of Directors, and conducted equity financing through private
placements.
Our primary capital needs are for working capital to fund inventory purchases
and extensions of our customers trade credit to our customers. During fiscal
2004, we anticipate funding working capital through the following: (1) utilize
our receivables and inventory based line of credit with CIT, (2) utilize trade
payables with our domestic and international suppliers, (3) manage our inventory
levels, and (4) reduce the trade credit we extend to our customers.
For fiscal 2003, we relied on the following primary sources to fund operations:
- A financing and inventory based line of credit agreements with CIT
- Cash balances
- Trade payables credit with our domestic and international suppliers
- Trade payables credit from related parties
- Five equity financings through private placements
On June 1, 2001, our subsidiaries, Innovo and Joe's, entered into accounts
receivable factoring agreements with CIT which may be terminated with 60 days
notice by CIT, or on the anniversary date, by Innovo or Joe's. Under the terms
of the agreements, Innovo or Joe's has the option to factor receivables with CIT
on a non-recourse basis, provided that CIT approves the receivable in advance.
Innovo or Joe's may, at their option, also factor non-approved receivables on a
recourse basis. Innovo or Joe's continue to be obligated in the event of product
defects and other disputes, unrelated to the credit worthiness of the customer.
Innovo or Joe's has the ability to obtain advances against factored receivables
up to 85% of the face amount of the factored receivables. The agreement calls
for a 0.8% factoring fee on invoices factored with CIT and a per annum rate
equal to the greater of the Chase prime rate plus 0.25% or 6.5% on funds
borrowed against the factored receivables. On September 10, 2001, IAA entered
into a similar factoring agreement with CIT upon the same terms.
On or about August 20, 2002, our Innovo and Joe's subsidiaries each entered into
certain amendments to their respective factoring agreements, which included
inventory security agreements, to permit the subsidiaries to obtain advances of
up to 50% of the eligible inventory up to $400,000 each. According to the terms
of the agreements, amounts loaned against inventory are to bear an interest rate
equal to the greater of the Chase prime rate plus 0.75% or 6.5% per annum.
On or about June 10, 2003, the existing financing facilities with CIT for these
subsidiaries were amended, to be effective as of April 11, 2003, primarily to
remove the fixed aggregate cap of $800,000 on their inventory security agreement
to allow for Innovo and Joe's to borrow up to 50% of the value of certain
eligible inventory calculated on the basis of the lower of cost or market, with
cost calculated on a first-in-first out basis. In connection with these
amendments, IAA, entered into an inventory security agreement with CIT based on
the same terms as Joe's and Innovo. IAA did not previously have an inventory
security agreement with CIT. Under the factoring arrangements, we, through our
subsidiaries, may borrow up to 85% of the value of eligible factored receivables
outstanding. The factoring rate that we pay to CIT to factor accounts, on which
CIT bears some or all of the credit risk, was lowered to 0.4% and the interest
rate associated with borrowings under the inventory lines and factoring facility
were reduced to the Chase prime rate. We have also established a letter of
credit facility with CIT whereby we can open letters of credit, for 0.125% of
the face value, with international and domestic suppliers provided we has
availability on its inventory line of credit. In addition, we also may elect to
factor with CIT its receivables by utilizing an adjustment of the interest rate
as set on a case-by-case basis, whereby certain allocation of risk would be
borne by us, depending upon the interest rate adjustment. We record our account
receivables on the balance sheet net of receivables factored with CIT, since the
factoring of receivables is non-recourse to us. Further, in the event our loan
balance with CIT exceeds the face value of the receivables factored with CIT, we
record the difference between the face value of the factored receivables and the
outstanding loan balance as a liability on our balance sheet as "Due to Factor".
Cross guarantees were executed by and among the subsidiaries, Innovo, Joe's, and
IAA and we entered into a guarantee for our subsidiaries' obligations in
connection with the amendments to the existing credit facilities. Our loan
balance as of November 29, 2003 with CIT was $8,786,000 and we had $8,536,000 of
factored receivables with CIT as of November 29, 2003. As of November 29, 2003,
an aggregate amount of $2,149,000 of unused letter of credit was outstanding.
In connection with the agreements with CIT, certain assets are pledged to CIT.
The pledged assets include inventory, merchandise, and/or goods, including raw
materials through finished goods.
Based on our anticipated internal growth for the upcoming fiscal 2004, we
believe that we have the working capital resources necessary to meet the
operational needs associated with such growth in the next twelve months. For the
year ended November 29, 2003, we raised additional working capital through five
equity financings. We believe that with the net proceeds from the equity
financings and the amended financing agreements with CIT, we have addressed our
short-term working capital needs. See "Management's Discussion and Analysis on
Financial Results and Operational Conditions--Equity Financing" for a further
discussion of the equity financings that
47
occurred in fiscal 2003.
However, if we grow beyond our current anticipated expectations, we believe that
it might be necessary to obtain additional working capital through debt or
equity financings. We believe that any additional capital, to the extent needed,
could be obtained from the sale of equity securities or short-term working
capital loans. There can be no assurance that this or other financings will be
available if needed. Our inability to fulfill any interim working capital
requirements would force us to constrict our operations. We believe that the
relatively moderate rate of inflation over the past few years has not had a
significant impact on our revenues or profitability.
Equity Financings
In fiscal 2003, we consummated five private placements of our common stock to a
limited number of "accredited investors" pursuant to Rule 506 of Regulation D
under the Securities Act of 1933, as amended (the "Securities Act"), resulting
in net proceeds of approximately $17,540,000 after all commissions and expenses
(including legal and accounting) to us. Our first private placement, completed
on March 19, 2003 to 17 accredited investors, raised net proceeds of
approximately $407,000 at $2.65 per share. Our second private placement,
completed on March 26, 2003 to 5 accredited investors, raised net proceeds of
approximately $156,000 at $2.65 per share. Our third private placement,
completed on July 1, 2003 to 34 accredited investors, raised net proceeds of
approximately $8,751,000 at $3.33 per share. Our fourth private placement was
completed on August 29, 2003 to 5 accredited investors, and raised net proceeds
of approximately $592,000 at $3.62 per share. Our fifth private placement was
completely funded on or before November 29, 2003, but was not completed until
December 1, 2003, to 14 accredited investors and raised net proceeds of
approximately $10,704,000 at $3.00 per share and warrants at $4.00 per share. We
issued 165,000 shares, or the I Shares, as a result of the first private
placement. Capital Wealth Management, LLC, or Capital Wealth, acted as the
placement agent on a best efforts basis for the first private placement. In
consideration of the services rendered by Capital Wealth, they were paid 7% of
the gross proceeds, plus expenses, for a total of approximately $31,000. We
issued 63,500 shares, or the II Shares, as a result of the second private
placement. Capital Wealth acted as the placement agent on a best efforts basis
for the second private placement. In consideration of the services rendered by
Capital Wealth, they were paid 7% of the gross proceeds, plus expenses, for a
total of approximately $12,000. We issued 2,835,481 shares, or the III Shares,
as a result of the third private placement. Sanders Morris Harris, Inc., or SMH,
acted as the placement agent on a best efforts basis for the third private
placement. In consideration of the services rendered by SMH, SMH was paid 7% of
the gross proceeds, plus expenses, for a total of $691,000, and also received a
five year warrant entitling SMH to purchase 300,000 shares of common stock at
$4.50 per share which is exercisable on January 1, 2004. We issued 175,000
shares, or the IV Shares, as a result of the fourth private placement. Pacific
Summit Securities, Inc., or PSS, acted as the placement agent on a best efforts
basis for the fourth private placement. In consideration of the services
rendered by PSS, PSS was paid 6% of gross proceeds, plus expenses, for a total
of approximately $42,000, and also received a warrant entitling PSS to purchase
17,500 shares of our common stock at $3.62 per share which is exercisable on
January 1, 2004. We issued 2,996,667 shares and warrants to purchase an
additional 599,333 shares of common stock to these certain investors at $4.00
per share, or the V Shares, and together with the I Shares, the II Shares, the
III Shares and the IV Shares, we will refer to them as the 2003 Placement
Shares. SunTrust Robinson Humphrey Capital Markets Division, or SunTrust, acted
as the placement agent on a best efforts basis for the fifth private placement.
In consideration of the services rendered by SunTrust, SunTrust was paid 6% of
gross proceeds, plus expenses, for a total of approximately $683,000. Each of
the warrants issued to SMH and PSS includes a cashless exercise option, pursuant
to which the holder thereof can exercise the warrant without paying the exercise
price in cash. If the holder elects to use this cashless exercise option, it
will receive a fewer number our shares than it would have received if the
exercise price were paid in cash. The number of shares of common stock a holder
of the warrant would receive in connection with a cashless exercise is
determined in accordance with a formula set forth in the applicable warrant. We
intend to use and have used the proceeds from the transactions for general
corporate purposes.
The buyers of the 2003 Placement Shares have represented to us that they
purchased the 2003 Placement Shares for their own account, with the intention of
holding the 2003 Placement Shares for investment and not with the intention of
participating, directly or indirectly, in any resale or distribution of the 2003
Placement Shares. The 2003 Placement Shares were offered and sold to the buyers
in reliance upon Regulation D, which provides an exemption from registration
under Section 4(2) of the 1933 Act. Each buyer has represented to us that he or
she is an "Accredited Investor," as that term is defined in Rule 501(a) of
Regulation D under said Act.
Short-Term Debt
Crossman Loan
On February 7, 2003 and on February 13, 2003, we entered into a loan agreement
with Marc Crossman, then a member of our board of directors and now also our
Chief Financial Officer. The loan was funded in two phases of $250,000 each on
February 7, 2003 and February 13, 2003 for an aggregate loan value of $500,000.
In the event of default, each loan is collateralized by 125,000 shares of our
common stock as well as a general unsecured claim on our assets. Each loan
matures six months and one day from the date of its respective funding, at which
point the principal amount loaned and any unpaid accrued interest is due and
payable in full without demand. Each loan carries an 8% annualized interest rate
with interest payable in equal monthly installments. The loan may be repaid by
us at any time during the term of the loan without penalty. Further, prior to
the maturity of each loan and the original due dates, we elected, at our sole
option, to extend the term of each loan for an additional period of six months
and one day. Our disinterested directors
48
approved each loan from Mr. Crossman. Subsequent to the year ended November 29,
2003 and prior to the maturity of the loans in February 2004, the parties agreed
to extend the term of each loan for an additional period of ninety days.
Further, pursuant to the extension amendments, Mr. Crossman has the sole and
exclusive option to continue to extend the terms of the loans for three
additional ninety day periods by giving us notice of such extension on or before
the due dates of the loan.
As of November 29, 2003, we had a loan balance with CIT of $8,536,000 the
majority of which was collateralized against non- recourse factored receivables.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for further discussion of our
financing agreements with CIT.
Long-Term Debt
Long-term debt consists of the following (in thousands):
2003 2002
---------------------
First mortgage loan on Springfield property $ 476 $ 558
Promissory note to Azteca (Blue Concepts) 21,800 --
Promissory note to Azteca (Knit Div. Note 1) 68 786
Promissory note to Azteca (Knit Div. Note 2) -- 2,043
---------------------
Total long-term debt $22,344 $3,387
Less current maturities 168 756
---------------------
Total long-term debt $22,176 $2,631
=====================
Springfield Property Loan
The first mortgage loan, held by First Independent Bank of Gallatin, is
collateralized by a first deed of trust on real property in Springfield,
Tennessee (with a carrying value of $1.2 million at November 29, 2003), and by
an assignment of key-man life insurance on our President, Pat Anderson, in the
amount of $1 million. The loan bears interest at 2.75% over the lender's prime
rate per annum and requires monthly principal and interest payments of $9,900
through February 2008. The loan is also guaranteed by the Small Business
Administration, or SBA. In exchange for the SBA guarantee, we, Innovo, Nasco
Products International, Inc., our wholly-owned subsidiary, and our President,
Pat Anderson, have also agreed to act as guarantors for the obligations under
the loan agreement.
Knit Acquisition Notes
In connection with the acquisition of the knit division from Azteca in 2001
(which, as noted below, is controlled by significant stockholders of ours,
Hubert and Paul Guez), we issued two promissory notes in the face amounts of
$1.0 million and $2.6 million, which bear interest at 8.0% per annum and require
monthly payments of $20,000 and $53,000, respectively. The notes have a
five-year term and are unsecured.
The $1.0 million note was subject to adjustment in the event that the actual net
sales of our newly formed knit division did not reach $10.0 million during the
18-month term following the closing date of them Knit Acquisition. The principal
amount was to be reduced by an amount equal to the sum of $1.5 million less 10%
of the net sales of our newly formed knit division during the 18 months
following the closing date of the Acquisition. For the 18-month period following
the closing of the knit acquisition, nets sales for the knit division exceeded
the $10 million threshold.
Both notes state that, in the event that we determine, from time to time, at the
reasonable discretion of management, that our available funds are insufficient
to meet the needs of our business, we may elect to defer the payment of
principal due under the promissory notes for as many as six months in any one
year (but not more than three consecutive months) and as many as eighteen
months, in the aggregate, over the term of the notes. The term of the notes will
automatically be extended by one month for each month the principal is deferred,
and interest shall accrue accordingly.
At the election of Azteca, the balance of the promissory notes may be offset
against monies payable by Azteca or its affiliates to us for the exercise of our
issued and outstanding stock warrants that are owned by Azteca or its affiliates
(including the Commerce Investment Group) prior to the closing date of the
acquisition.
Blue Concept Acquisition Note
In connection with the purchase of the Blue Concept Division from Azteca, IAA
issued a seven-year convertible promissory note for $21.8 million, or the Blue
Concept Note. The Blue Concept Note bears interest at a rate of 6% and requires
payment of interest only during the first 24 months and then is fully amortized
over the remaining five-year period. The terms of the transaction further allow
us,
49
upon shareholder approval, to convert a portion of the Blue Concept Note into
equity through the issuance of 3,125,000 shares of our common stock valued at
the greater of $4.00 per share or the market value of our common stock on the
day prior to the date of the shareholder meeting at which approval for this
conversion is sought, or the Conversion Price. In the event shareholder approval
is obtained, the Blue Concept Note will be reduced by an amount equal to the
product of the Conversion Price and 3,125,000, so long as the principal amount
of the Blue Concept Note is not reduced below $9.3 million and the shares issued
pursuant to the conversion will be subject to certain lock-up periods. Up to
1,041,667 additional shares may be issued upon the occurrence of certain future
contingencies relating to our stock price for the 30 day period ending March 6,
2005.
In the event that sales of the Blue Concept Division fall below $70 million
during the first 17 month period, or Period I, following the closing of the
acquisition, or $65 million during the 12 month period, or Period II following
Period I, certain terms of the APA allow for a reduction in the purchase price
through a decrease in the principal balance of the Blue Concept Note and/or the
return of certain locked-up shares of our common stock. In the event the Blue
Concept Note is reduced during Period I and the sales of the Blue Concept
Division in Period II are greater than $65 million, the Blue Concept Note shall
be increased by half of the amount greater than $65 million, but in no event
shall the Blue Concept Note be increased by an amount greater than the decrease
in Period I.
In the event the principal amount of the Blue Concept Note needs to be reduced
beyond the outstanding principal balance of such Blue Concept Note, then an
amount of the locked-up shares equal to the balance of the required reduction
shall be returned to us. For these purposes, the locked-up shares shall be
valued at $4.00 per share. Additionally, if during the 12 month period following
the closing, AEO is no longer a customer of IAA, the locked-up shares will be
returned to us, and any amount remaining on the balance of the Blue Concept Note
will be forgiven.
In the event the revenues of the Blue Concept Division decrease to $35 million
or less during Period I or Period II, IAA shall have the right to sell the
purchased assets back to Azteca, and Azteca shall have the right to buy back the
purchased assets for the remaining balance of the Blue Concept Note and any and
all Locked Up Shares shall be returned to us.
The following table sets forth our contractual obligations and commercial
commitments as of November 29, 2003 (in thousands):
Contractual Obligations Payments Due by Period
------------------------------------------------------------
Total Less than 1 1-3 years 4-5 years After 5 years
year
- -----------------------------------------------------------------------------------------------------------------
Long Term Debt 22,344 168 9,674 9,205 3,297
Operating Leases 2,812 616 1,479 717 --
Other Long Term Obligations-Minimum Royalties 3,322 832 2,490 -- --
Recent Acquisitions and Licenses
License Agreement for Fetish(TM) by Eve
On February 13, 2003, our IAA subsidiary entered into a 44 month exclusive
license agreement for the United States, its territories and possessions with
the recording artist and entertainer Eve for the license of the Fetish(TM) mark
for use with the production and distribution of apparel and accessory products.
We have guaranteed minimum net sales obligations of $8 million in the first 18
months of the agreement, $10 million in the following 12 month period and $12
million in the 12 month period following thereafter. According to the terms of
the agreement we are required to pay an eight percent royalty and a two percent
advertising fee on the nets sales of products bearing the Fetish(TM) logo. In
the event we do not meet the minimum guaranteed sales, we will be obligated to
make royalty and advertising payments equal to the minimum guaranteed sales
multiplied by the royalty rate of eight percent and the advertising fee of two
percent. We also have the right of first refusal with respect to the license
rights for the Fetish(TM) mark in the apparel and accessories category upon the
expiration of the agreement, subject to us meeting certain sales performance
targets during the term of the agreement. Additionally, we have the right of
first refusal for the apparel and accessory categories in territories in which
we do not currently have the license rights for the Fetish(TM) mark. We entered
into the license agreement of the Fetish mark because we believed it was strong
opportunity to expand and complimented our existing branded and accessory
business.
Itochu Distribution and License Agreement
On July 1, 2003, Joe's entered into a Master Distribution and Licensing
Agreement, or the Distribution and Licensing Agreement, with Itochu, pursuant to
which Itochu obtained certain manufacturing, licensing rights for the "Joe's"
and "Joe's Jeans" marks. The Distribution and Licensing Agreement grants Itochu
certain rights with respect to the manufacture, distribution, sale and/or
50
advertisement of certain Joe's apparel products, or Joe's Products, including
but not limited (i) a non-exclusive right to use the Joe's and Joe's Jeans marks
in connection with the manufacture of certain licensed Joe's and Joe's Jeans
products, which we will refer to as the Licensed Products, throughout the world,
and an exclusive right to use the Joe's and Joe's Jeans marks to manufacture the
Licensed Products in Japan; and (ii) an exclusive right to import and distribute
certain imported Joe's Products, which we will refer to as the Imported
Products, into Japan. These Imported Products will be purchased directly from
Joe's, with Itochu being obligated to purchase a minimum of $5.75 million of
Joe's over the 42 month term of the Agreement. Additionally, Itochu shall have
the right to develop, produce and distribute certain apparel products bearing
the Joe's and Joe's Jeans marks for which Joe 's shall receive a running royalty
payment for each contract year equal to the aggregate amount of six percent of
the net sales of all bottoms for both men and women of the Licensed Products,
and five percent of the net sales of all tops for both men and women of the
Licensed Products. As a part of the transaction, Itochu agreed to purchase the
existing inventory of JJJ for approximately $1 million, assume the management
and operations of JJJ's showroom in Tokyo and employ certain employees of JJJ.
We will continue to operate JJJ until all operations have ceased, including the
fulfillment of existing purchase orders from customers and the collection of all
outstanding accounts receivables. Upon the cessation of all operating
activities, we intend to dissolve the JJJ subsidiary. We will continue to sell
product in Japan through its licensing and distribution agreement with Itochu.
We believe that the Distribution and License Agreement with Itochu allows us to
more expediently grow the Joe's and Joe's Jeans brand and business in Japan
because Itochu, as a local Japanese corporation, is better suited to market and
distribute the Joe's and Joe's Jeans products in accordance with cultural tastes
and norms compared to JJJ which was controlled and operated out of Los Angeles,
California. We further believe that Itochu is well suited and capable of
developing additional products suited to the local environment, which we will
benefit from through additional royalty payments.
There exists no common ownership between us, our affiliates or subsidiaries with
Itochu, nor was compensation paid in the form of equity securities for any
portion of the Itochu transaction.
Blue Concept Division Acquisition
On July 17, 2003, IAA entered into an asset purchase agreement, or APA with
Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the division known as
the Blue Concept division, or the Blue Concept Division, of Azteca. The Blue
Concept Division sells primarily denim jeans to AEO, a national retailer. Hubert
Guez and Paul Guez, two of our substantial stockholders and parties to the APA,
together have a controlling interest in Azteca. Based upon the Schedule 13D/A
filed on January 20, 2004, Hubert Guez, Paul Guez and their affiliates
beneficially owned in the aggregate approximately 17.6% of our common stock on a
fully diluted basis.
Pursuant to the terms of the APA, IAA paid $21.8 million for the Blue Concept
Division, subject to adjustment as noted below. Pursuant to the APA, IAA
employed all of the existing employees of the Blue Division but did not assume
any of the Blue Concept Division's or Azteca's existing liabilities. The
purchase price was paid through the issuance of a seven-year convertible
promissory note, or the Blue Concept Note. See "Management's Discussion &
Analysis--Long Term Debt" for further discussion of the terms of the Blue
Concept Note.
As part of the transaction, IAA and AZT International SA de CV, a Mexico
corporation and wholly-owned subsidiary of Azteca, or AZT, entered into a
two-year, renewable, non-exclusive supply agreement, or Supply Agreement, for
products to be sold by our Blue Concept Division. Under the terms of the Supply
Agreement, we have agreed to market and sell the products to be purchased from
AZT to certain of our customers, more particularly the customers of our Blue
Concept Division. In addition to the customary obligations, the Supply Agreement
requires that: (i) the we will submit written purchase orders to AZT on a
monthly basis specifying (x) the products to be supplied and (y) a specified
shipping date for products to be shipped; (ii) we will give AZT reasonable time
allowances upon placing its purchase orders with AZT prior to delivery of the
products by AZT; (iii) AZT will receive payment immediately upon receipt by us
of invoices for our purchase orders; (iv)we will have a guaranteed profit margin
on a "per unit" basis; and (v) the products to be supplied shall be subject to
quality control measures by us and by the customer of the Blue Concept Division.
Management and the board of directors entered into the acquisition of the Blue
Concept Division for the following reasons: (i) the ability to enter into an
acquisition with a seller with which we have a long-standing relationship; (ii)
the ability to acquire a profitable business that has (x) a financial history of
producing conservative profit margins with significant revenues; (iii) a strong
customer relationship with AEO, (iv) the manufacturing relationships to produce
effectively and efficiently; and (v) was able to acquire the personnel and
talent of a profitable business. Further, although there can be no assurance the
Blue Concept Division is expected to increase our revenue growth and is expected
to maintain positive cash flows. For the year ended November 29, 2003, our Blue
Concept Division accounted for $27,760,000, or 33% of our net revenue.
Furthermore, the APA protects us if revenue expectations are not realized by
providing "downside" protections, such as guaranteed sales minimums, and a
buy-sell provision that allows for the sale of the business if revenues do not
reach $35 million. See "Management's Discussion & Analysis--Long Term Debt" for
further discussion of the above referenced "downside" protections.
As noted above, Azteca is controlled by our significant stockholders, Hubert
Guez and Paul Guez, brothers who were also individual
51
parties to the transaction.
Seasonality
Our business is seasonal. The majority of the marketing and sales activities
take place from late fall to early spring. The greatest volume of shipments and
sales are generally made from late spring through the summer, which coincides
with our second and third fiscal quarters and our cash flow is strongest in its
third and fourth fiscal quarters. Due to the seasonality of our business, often
our quarterly or yearly results are not necessarily indicative of the results
for the next quarter or year.
Management's Discussion of Critical Accounting Policies
We believe that the accounting policies discussed below are important to an
understanding of our financial statements because they require management to
exercise judgment and estimate the effects of uncertain matters in the
preparation and reporting of financial results. Accordingly, we caution that
these policies and the judgments and estimates they involve are subject to
revision and adjustment in the future. While they involve less judgment,
management believes that the other accounting policies discussed in Note 2 -
"Summary of Significant Accounting Polices" of the Consolidated Financial
Statements included in our Annual Report on Form 10-K for the year ended
November 29, 2003 are also important to an understanding of our financial
statements. We believe the following critical accounting policies affect our
more significant judgments and estimates used in the preparation of our
consolidated financial statements.
Revenue Recognition
Revenues are recorded on the accrual basis of accounting when title transfers to
the customer, which is typically at the shipping point. Innovo Group records
estimated reductions to revenue for customer programs, including co-op
advertising, other advertising programs or allowances, based upon a percentage
of sales. Innovo Group also allows for returns based upon pre-approval or in the
case of damaged goods. Such returns are estimated and an allowance is provided
at the time of sale.
Accounts Receivable--Allowance for Returns, Discounts and Bad Debts
We evaluate our ability to collect on accounts receivable and charge-backs
(disputes from the customer) based upon a combination of factors. In
circumstances where we are aware of a specific customer's inability to meet its
financial obligations (e.g., bankruptcy filings, substantial downgrading of
credit sources), a specific reserve for bad debts is taken against amounts due
to reduce the net recognized receivable to the amount reasonably expected to be
collected. For all other customers, we recognize reserves for bad debts and
charge-backs based on our historical collection experience. If collection
experience deteriorates (i.e., an unexpected material adverse change in a major
customer's ability to meet its financial obligations to us ), the estimates of
the recoverability of amounts due us could be reduced by a material amount.
For the year ended November 29, 2003, the balance in the allowance for returns,
discounts and bad debts reserves was $2,158,000 compared to $383,000 at November
30, 2002.
Inventory
We continually evaluate the composition of our inventories, assessing
slow-turning, ongoing product as well as product from prior seasons. Market
value of distressed inventory is valued based on historical sales trends of our
individual product lines, the impact of market trends and economic conditions,
and the value of current orders relating to the future sales of this type of
inventory. Significant changes in market values could cause us to record
additional inventory markdowns.
Valuation of Long-lived and Intangible Assets and Goodwill
We assess the impairment of identifiable intangibles, long-lived assets and
goodwill whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Factors considered important that could trigger an
impairment review include the following:
o a significant underperformance relative to expected historical or
projected future operating results;
o a significant change in the manner of the use of the acquired asset or
the strategy for the overall business; or
o a significant negative industry or economic trend.
When we determine that the carrying value of intangibles, long-lived assets and
goodwill may not be recoverable based upon the existence of one or more of the
above indicators of impairment, we will measure any impairment based on a
projected discounted cash
52
flow method using a discount rate determined by our management. No impairment
indicators existed as of November 29, 2003. Changes in estimated cash flows or
the discount rate assumptions in the future could require us to record
impairment charges for the assets.
Income Taxes
As part of the process of preparing our consolidated financial statements,
management is required to estimate income taxes in each of the jurisdictions in
which we operate. The process involves estimating actual current tax expense
along with assessing temporary differences resulting from differing treatment of
items for book and tax purposes. These timing differences result in deferred tax
assets and liabilities, which are included in our consolidated balance sheet.
Management records a valuation allowance to reduce its deferred tax assets to
the amount that is more likely than not to be realized. Management has
considered future taxable income and ongoing tax planning strategies in
assessing the need for the valuation allowance. Increases in the valuation
allowance result in additional expense to be reflected within the tax provision
in the consolidated statement of income. Reserves are also estimated for ongoing
audits regarding Federal, state and international issues that are currently
unresolved. We routinely monitor the potential impact of these situations and
believe that it is properly reserved.
Contingencies
We account for contingencies in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies". SFAS No. 5
requires that we record an estimated loss from a loss contingency when
information available prior to issuance of our financial statements indicates
that it is probable that an asset has been impaired or a liability has been
incurred at the date of the financial statements and the amount of the loss can
be reasonably estimated. Accounting for contingencies such as legal and income
tax matters requires management to use judgment. Many of these legal and tax
contingencies can take years to be resolved. Generally, as the time period
increases over which the uncertainties are resolved, the likelihood of changes
to the estimate of the ultimate outcome increases. Management believes that the
accruals for these matters are adequate. Should events or circumstances change,
we could have to record additional accruals.
Recently Issued Financial Accounting Standard
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. This Statement is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003 and is not expected to have a material impact on Innovo
Groups' consolidated results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. In particular, SFAS No. 149 clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a derivative
and when a derivative contains a financing component that warrants special
reporting in the statement of cash flows. SFAS No. 149 is generally effective
for contracts entered into or modified after June 30, 2003 and is not expected
to have a material impact on Innovo Group's consolidated results of operations
or financial position.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities." FIN 46 requires companies to evaluate variable
interest entities to determine whether to apply the consolidation provisions of
FIN 46 to those entities. Companies must apply FIN 46 to entities created after
January 31, 2003, and to variable interest entities in which a company obtains
an interest after that date. It applies in the first fiscal year or interim
period endings after December 15, 2003, to variable interest entities in which a
company holds a variable interest that it acquired before February 1, 2003.
Adoption of FIN 46 is not expected to have a material impact on Innovo Group's
consolidated results of operations or financial position.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks arising from transactions in the normal
course of our business, and from debt incurred in connection with the knit
acquisition and the acquisition of the Blue Concept Division form Azteca we have
made. See Note 3 "Acquisitions" in the Notes to the Consolidated Financial
Statements. Such risk is principally associated with interest rate and foreign
exchange fluctuations, as well as changes in our credit standing.
Interest Rate Risk
Our long-term debt bears a fixed interest rate. However, because our obligation
under our receivable and inventory financing agreements
53
bear interest at floating rates (primarily JP Morgan Chase prime rate), we are
sensitive to changes in prevailing interest rates. A 10% increase or decrease in
market interest rates that affect our financial instruments would have a
immaterial impact on earning or cash flows during the next fiscal year.
Foreign Currency Exchange Rates
Foreign currency exposures arise from transactions, including firm commitments
and anticipated contracts, denominated in a currency other than an entity's
functional currency, and from foreign-denominated revenues translated into U.S.
dollars. Our primary foreign currency exposures relate to the Joe's Jeans Japan
subsidiary and resulting Yen Investments. We believe that a 10% adverse change
in the Yen rate with respect to the US dollar would not have a material impact
on earning or cash flows during the next fiscal year because of the relatively
small size of the subsidiary compared to the rest of us.
We generally purchase our products in U.S. dollars. However, we source most of
our products overseas and, as such, the cost of these products may be affected
by changes in the value of the relevant currencies. Changes in currency exchange
rates may also affect the relative prices at which we and our foreign
competitors sell products in the same market. We currently do not hedge our
exposure to changes in foreign currency exchange rates. We cannot assure you
that foreign currency fluctuations will not have a material adverse impact on
our financial condition and results of operations.
Manufacturing and Distribution Relationships
We purchase a significant portion of finished goods and obtain certain
warehousing and distribution services from Commerce and its affiliates and
obtain credit terms which we believe are favorable. The loss of Commerce as a
vendor, or material changes to the terms, could have an adverse impact on our
business. Commerce and its affiliates are controlled by two of our significant
stockholders, Hubert Guez and Paul Guez.
Our products are manufactured by contractors located in Los Angeles, Mexico
and/or Asia, including, Hong Kong, China, Korea, Vietnam and India. The products
are then distributed out of Los Angeles or directly from the factory to the
customer. For the year ended 2003, 22% of our apparel and accessory products
were manufactured outside of North America. The rest of our accessory and
apparel products were manufactured in the United States (21%) and Mexico (57%).
All of our products manufactured in Mexico are manufactured by an affiliate of
Commerce, Azteca or its affiliates.
See "Management's Discussion & Analysis--Manufacturing, Warehousing, and
Distribution" for further discussion of our use of Commerce for such services.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is included in "Item 15. Exhibits, Financial
Statement Schedules and Reports on Form 8-K" of our consolidated financial
statements and notes thereto, and the consolidated financial statement schedule
filed on this Annual Report on Form 10-K.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
There have been no changes in or disagreements with our independent auditors,
Ernst & Young LLP.
ITEM 9A. CONTROLS AND PROCEDURES
As of November 29, 2003, the end of the period covered by this annual report on
Form 10-K, we carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Securities and Exchange Act Rule
15d-15.
A control system, no matter how well conceived and operated, can provide only
reasonable assurance that the objectives of the control system are met. Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls and procedures will prevent all
error and fraud. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues within the company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or
54
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Our Chief Executive Officer and Chief Financial Officer have concluded, based on
our evaluation of our disclosure controls and procedures, that our disclosure
controls and procedures under Rule 13a-15(e) and Rule 15d-15(e) of the
Securities Exchange Act of 1934 are effective, except as discussed below.
Subsequent to our evaluation, there were no significant changes in internal
controls or other factors that could significantly affect these internal
controls, except as discussed below.
Our independent auditors, Ernst & Young LLP, or Ernst & Young, have advised
management and the audit committee of our board of directors of the following
matters that Ernst & Young considered to be material weaknesses in our internal
controls, which constitute reportable conditions under standards established by
the American Institute of Certified Public Accountants: (i) lack of adequate
preparation of account reconciliations and analysis necessary to accurately
prepare annual financial statements; and (ii) shared accounting responsibilities
for accounting functions between our company and Azteca Production
International, Inc., or Azteca, and its related entities.
The primary reasons for the lack of adequate preparation of account
reconciliations and analysis to accurately prepare our annual financial
statements include, but are not limited to: (i) our significant growth in fiscal
2003 in both size and complexity, which significantly increased the number of
accounting transactions from prior reporting periods; for example, our net sales
increased from $29,609,000 in fiscal 2002 to $83,129,000 in fiscal 2003, or a
181% increase; in fiscal 2003 we acquired the Blue Concept Division; and we
began shipping branded products under our license agreements for the Fetish(TM)
and Shago(R) marks for the first time; (ii) the introduction of new operating
software to track production, delivery and sales of our products during the
third quarter of 2003; (iii) the loss of key accounting personnel during
completion of account reconciliations and analysis after our fiscal year end;
and (iv) certain accounting personnel were not sufficiently competent to
adequately reconcile and analyze certain accounts.
Our second material weakness resulted from our hiring of former Azteca
accounting employees in connection with the Blue Concept Division acquisition.
During this integration, some of the newly acquired accounting personnel have,
in their transitional roles, been responsible for the shared recording of
transactions between our company and Azteca, and/or its affiliates. We hired the
Azteca accounting personnel because we believed that their historical knowledge
of the Blue Concept Division accounting process and systems would help
facilitate the transition of recording the new transactions into our books and
records. Despite their historical knowledge, we discovered during the completion
of account reconciliations and analysis after our fiscal year end that this was
not the case.
These material weaknesses have been discussed in detail among the audit
committee of our board of directors, the board of directors, management and
Ernst & Young. We have assigned the highest priority to the correction of these
material weaknesses, and management and our audit committee are committed to
addressing and resolving them fully. On February 22, 2004, the audit committee
of our board of directors instructed management to improve the overall level of
our disclosure and internal controls by increasing the number and competency of
accounting personnel, including the hiring of a controller at IGI, who would
report directly to our Chief Financial Officer. The audit committee instructed
management to hire, subject to audit committee approval, a controller with
sufficient experience to function as the chief accounting officer of a public
company with appropriate public accounting experience. Management has begun the
hiring process and shall use its best efforts to find a suitable person prior to
the end of our second quarter of 2004.
In addition, prior to the report of our independent accountants we had already
taken the following actions to improve our disclosure controls and procedures
and internal controls: (i) hired a seasoned manager for our apparel division,
who will be able to supervise our continued growth and complexity and coordinate
information between operations and accounting; (ii) hired two new staff
accountants; and (iii) increased training of staff on our new operating
software. Also, we are currently transferring responsibility for recording
transactions between our company and Azteca and its affiliates to non-Azteca
related staff accountants and implementing internal controls to reconcile and
verify account balances and transactions between our company and Azteca and/or
its affiliates. In addition we are reviewing and revising our procedures for the
timely reconciliation of all accounts and for the appropriate review of account
reconciliation.
We are confident that our financial statements for the fiscal year ended
November 29, 2003 fairly present, in all material respects, our financial
condition, results of operations and cash flows.
55
PART III
Certain information required by Part III is omitted on this Annual Report on
Form 10-K since we intend to file our Definitive Proxy Statement for our next
Annual Meeting of Stockholders, pursuant to Regulation 14A of the Securities
Exchange Act of 1934, as amended, on our Definitive Proxy Statement no later
than March 29, 2004, and certain information to be included in the Definitive
Proxy Statement is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors, executive officers and
Section 16 reporting compliance is incorporated by reference from our Definitive
Proxy Statement.
Our Board of Directors has determined that at least one person serving on the
Audit Committee is an "audit committee financial expert" as defined under Item
401(h) of Regulation S-K. Suhail Rizvi, the Chairman of the Audit Committee, is
an "audit committee financial expert" and is independent as defined under
applicable SEC and Nasdaq rules.
Our Board of Directors adopted a Code of Business Conduct and Ethics for all of
our directors, officers and employees on May 22, 2003. Our Code of Business
Conduct and Ethics is available on our website at www.innovogroup.com/ or you
may request a free copy of our Code of Business Conduct and Ethics from:
Innovo Group Inc.
Attention: Chief Operating Officer
5804 East Slauson Avenue
Commerce, CA 90040
(323) 725-5526
To date, there have been no waivers under our Code of Business Conduct and
Ethics. We intend to disclose any amendments to our Code of Business Conduct and
Ethics and any waiver from a provision of the Code granted on a Form 8-K filed
with the SEC within five business days following such amendment or waiver or on
our website at www.innovogroup.com within five business days following such
amendment or waiver. The information contained or connected to our website is
not incorporated by reference into this Annual Report on Form 10-K and should
not be considered a part of this or any other report that we file or furnish to
the SEC.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 as to executive compensation is incorporated
by reference from our Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDERS MATTERS
The information required by Item 12 as to the security ownership of certain
beneficial owners and management and related stockholder matters is incorporated
by reference from our Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 as to certain relationships and related
transactions is incorporated by reference from our Definitive Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 as to principal accountant fees and services
is incorporated by reference from our Definitive Proxy Statement.
56
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of documents filed as a part of this Annual Report on Form 10-K:
1 and 2. Financial Statements and Financial Statement Schedules
Audited Consolidated Financial Statements: Page
- ------------------------------------------ ----
Report of Independent Auditors - Ernst & Young LLP F-1
Consolidated Balance Sheets at November 29, 2003 and November 30, 2002 F-2
Consolidated Statement of Operations for the years ended November 29, 2003,
November 30, 2002 and December 1, 2001 F-3
Consolidated Statements of Stockholders' Equity for the years ended November 29,
2003, November 30, 2002 and December 1, 2001 F-4
Consolidated Statement of Cash Flows for the years ended November 29, 2003 and
November 30, 2002 F-5
Notes to Consolidated Financial Statements F-7
Schedule II - Valuation of Qualifying Accounts F-32
(a)3. Exhibits (listed according to the number assigned in the table in Item 601
of Regulation S-K)
Exhibit
Number Description Document if Incorporated by Reference
- ------ ----------- -------------------------------------
2.1 Asset Purchase Agreement dated July 17, 2003 by and among Innovo Exhibit 2.1 to Current Report on Form 8-K
Azteca Apparel, Inc., Azteca Production International, Inc., Hubert dated July 18, 2003 filed on August 1, 2003
Guez and Paul Guez
2.2 Asset Purchase Agreement dated August 16, 2001 by and among Innovo Exhibit 2.1 to Current Report on Form 8-K
Group Inc., Innovo Apparel, Inc. and Azteca Production dated September 10, 2001
International, Inc.
3.1 Fifth Amended and Restated Certificate of Incorporation of the Exhibit 10.73 to Annual Report on Form
Registrant 10-K for the year ended November 30, 2000
filed on March 15, 2001
3.2 Amended and Restated Bylaws of Registrant Exhibit 4.2 to Registration Statement on
Form S-8 (file no. 33-71576) filed on
November 12, 1993
4.1 Article Four of the Registrant's Amended and Restated Exhibit 10.73 to Annual Report on Form
Certificate of Incorporation (included in Exhibit 3.1 10-K for the year ended November 30, 2000
filed herewith) 10-K for filed on March 15, 2001
4.2 Certificate of Resolution of Designation, Preferences and Other Exhibit 4.2 to Quarterly Report on Form
Rights, $100 Redeemable 8% Cumulative Preferred Stock, Series A 10-Q/A for the period ended June 1, 2002
dated April 4, 2002 filed on July 25, 2002
57
Exhibit
Number Description Document if Incorporated by Reference
- ------ ----------- -------------------------------------
4.3 Amendment to Certificate of Resolution of Designation, Preferences Exhibit 4.3 to Quarterly Report on Form
and Other Rights, $100 Redeemable 8% Cumulative Preferred Stock, 10-Q/A for the period ended June 1, 2002
Series A, dated April 14, 2002. filed on July 25, 2002
4.4 Form of Stock Purchase and Subscription Agreement between Innovo Exhibit 4.1 to Quarterly Report on Form
Group Inc. and purchasers dated as of March 19, 2003 and March 26, 10-Q for the period ended May 31, 2003
2003 filed on July 15, 2003
4.5 Placement Agent Agreement between Innovo Group Inc. and Sanders Exhibit 4.2 to Quarterly Report on Form
Morris Harris, Inc. dated June 23, 2003 10-Q for the period ended May 31, 2003
filed on July 15, 2003
4.6 Common Stock Purchase Warrant Agreement between Innovo Group Inc. Exhibit 4.3 to Quarterly Report on Form
and Sanders Morris Harris, Inc. dated June 30, 2003 10-Q for the period ended May 31, 2003
filed on July 15, 2003
4.7 Registration Rights Agreement between Innovo Group Inc and certain Exhibit 4.4 to Quarterly Report on Form
purchasers dated June 30, 2003 10-Q for the period ended May 31, 2003
filed on July 15, 2003
4.8 Placement Agent Agreement between Innovo Group Inc. and Pacific Exhibit 4.4 to Quarterly report on Form
Summit Securities dated July 30, 2003, as amended on August 6, 2003 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
4.9 Common Stock Purchase Warrant Agreement between Innovo Group Inc. Exhibit 4.5 to Quarterly Report on Form
and certain purchasers dated August 29, 2003 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
4.10 Registration Rights Agreement between Innovo Group Inc and certain Exhibit 4.6 to Quarterly Report on Form
purchasers dated August 29, 2003 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
4.11 Form of Securities Purchase Agreement dated December 1, 2003 Exhibit 4 to Current Report on Form 8-K
dated December 1, 2003 filed on December
2, 2003
10.1 Note executed by NASCO, Inc. and payable to First Independent Bank, Filed with Amendment No. 2 to the
Gallatin, Tennessee in the principal amount of $950,000 dated Registration Statement on Form S-1(file
August 6, 1992 no. 33-51724) filed November 12, 1992
10.2 Authorization and Loan Agreement from the U.S. Small Business Filed with Amendment No. 2 to the
Administration, Nashville, Tennessee dated July 21, 1992 Registration Statement on Form S-1 (file
no. 33-51724) filed November 12, 1992
10.3 Indemnity Agreement between NASCO, Inc. and First Independent Bank, Filed with Amendment No. 2 to the
Gallatin, Tennessee Registration Statement on Form S-1(file
no. 33-51724) filed November 12, 1992
10.4 Compliance Agreement between NASCO, Inc. and First Independent Filed with Amendment No. 2 to the
Bank, Gallatin, Tennessee Registration Statement on Form S-1(file
no. 33-51724) filed November 12, 1992
10.5 Assignment of Life Insurance Policy upon the life of Patricia Filed with Amendment No. 2 to the
Anderson-Lasko to First Independent Bank, Gallatin, Tennessee dated Registration Statement on Form S-1(file
July 31, 1992 no. 33-51724) filed November 12, 1992
10.6 Guaranty of Patricia Anderson on behalf of NASCO, Inc. in favor of Filed with Amendment No. 2 to the
First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Registration Statement on Form S-1(file
no. 33-51724) filed November 12, 1992
58
Exhibit
Number Description Document if Incorporated by Reference
- ------ ----------- -------------------------------------
10.7 Guaranty of Innovo Group Inc. on behalf of NASCO, Inc. in favor of Filed with Amendment No. 2 to the
First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Registration Statement on Form S-1(file
no. 33-51724) filed November 12, 1992
10.8 Guaranty of Innovo Group, Inc. on behalf of NASCO, Inc. in favor of Filed with Amendment No. 2 to the
First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Registration Statement on Form S-1(file
no. 33-51724) filed November 12, 1992
10.9 Guaranty of NASCO Products, Inc. on behalf of NASCO, Inc. in favor Filed with Amendment No. 2 to the
of First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Registration Statement on Form S-1(file
no. 33-51724) filed November 12, 1992
10.10 Merger Agreement between Innovo Group Inc and TS Acquisition, Inc. Exhibit 10.1 to Current Report on Form 8-K
and Thimble Square, Inc. and the stockholders of Thimble Square dated April 12, 1996 filed on April 29,
Inc. dated April 12, 1996 1996
10.11 Property Acquisition Agreement between Innovo Group Inc., TS Exhibit 10.2 to Current Report on Form 8-K
Acquisition, Inc., Philip Schwartz and Lee Schwartz dated April 12, dated April 12, 1996 filed on April 29,
1996 1996
10.12 Common Stock and Warrant Purchase Agreement between Innovo Group Exhibit 10.63 to Current Report on Form
Inc. and Commerce Investment Group LLC dated August 11, 2000 8-K/A dated August 11, 2000 filed on
September 15, 2000
10.13 Warrant Agreement between Innovo Group Inc. and Commerce Investment Exhibit 10.64 to Current Report on Form
Group LLC dated August 11, 2000 8-K/A dated August 11, 2000 filed on
September 15, 2000
10.14 Investor Rights Agreement between Innovo Group Inc., the Furrow Exhibit 10.65 to Current Report on Form
Group, the Board Members and Commerce Investment Group LLC dated 8-K/A dated August 11, 2000 filed on
August 11, 2000 September 15, 2000
10.15 Investor Rights Agreement dated October 31, 2000between Innovo Exhibit 10.75 to Annual Report on Form
Group Inc., the Furrow Group, the Board Members and Third 10-K for the period ended November 30,
Millennium Properties, Inc. JAML, LLC and Innovation, LLC [sic] 2000 filed on March 15, 2001
10.16 Common Stock and Warrant Purchase Agreement between Innovo Group Exhibit 10.79 to Quarterly Report on Form
Inc. and JD Design, LLC dated February 7, 2001 10-Q for the period ended March 3, 2001
filed on April 17, 2001
10.17 Stock Purchase Warrant between Innovo Group Inc. and JD Design, LLC Exhibit 10.80 to Quarterly Report on Form
dated February 7, 2001 10-Q for the period ended March 3, 2001
filed on April 17, 2001
10.18 Employment Agreement between Innovo Group Inc. and Joe Dahan dated Exhibit 10.81 to Quarterly Report on Form
February 7, 2001 10-Q for the period ended March 3, 2001
filed on April 17, 2001
10.19 Stock Incentive Agreement between Innovo Group Inc. and Joe Dahan Exhibit 10.82 to Quarterly Report on Form
dated February 7, 2001 10-Q for the period ended March 3, 2001
filed on April 17, 2001
10.20 License Agreement between Innovo Group Inc and JD Design, LLC dated Exhibit 10.83 to Quarterly Report on Form
February 7, 2001 10-Q for the period ended March 3, 2001
filed on April 17, 2001
10.21 Form of Investment Letter relating to purchase of $100 Redeemable Exhibit 10.85 to Quarterly Report on Form
8% Cumulative Preferred Stock, Series A, of Innovo Group Inc. dated 10-Q/A for the period ended June 1, 2002
April 4, 2002 filed on July 25, 2002
10.22 Form of Limited Partnership Agreement relating to Metra Capital LLC Exhibit 10.86 to Quarterly Report on Form
and Innovo Realty, Inc. as limited partners 10-Q/A for the period ended June 1, 2002
filed on July 25, 2002
59
Exhibit
Number Description Document if Incorporated by Reference
- ------ ----------- -------------------------------------
10.23 Form of Sub-Asset Management Agreement between Metra Management, Exhibit 10.87 to Quarterly Report on Form
L.P., Innovo Realty Inc. and a Sub-Asset Manager 10-Q/A for the period ended June 1, 2002
filed on July 25, 2002
10.24 Distribution of Cash Flow and Capital Events Proceeds Letter Exhibit 10.88to Quarterly Report on Form
Agreement dated April 5, 2002, between Innovo Realty, Inc., Innovo 10-Q/A for the period ended June 1, 2002
Group Inc., Income Opportunity Realty Investors, Inc., filed on July 25, 2002
Transcontinental Realty Investors, Inc., American Realty
Investors, Inc., and Metra Capital, LLC
10.25 Distribution of Capital Events Letter Agreement dated April 5, Exhibit 10.89 to Quarterly Report on Form
2002, between Metra Capital, LLC, Innovo Realty, Inc., Innovo Group 10-Q/A for the period ended June 1, 2002
Inc., Income Opportunity Realty Investors, Inc., Transcontinental filed on July 25, 2002
Realty Investors, Inc., and American Realty Investors, Inc.
10.26 Reimbursement of Legal Fees Letter dated April 5, 2002 between Exhibit 10.90 to Quarterly Report on Form
Innovo Realty, Inc., Innovo Group Inc., Income Opportunity Realty 10-Q/A for the period ended June 1, 2002
Investors, Inc., Transcontinental Realty Investors, Inc., American filed on July 25, 2002
Realty Investors, Inc. and Third Millennium Partners, LLC
10.27 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.85 to Form S-8 filed on January
Samuel J. Furrow dated June 5, 2001 17, 2003
10.28 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.86 to Form S-8 filed on January
Patricia Anderson-Lasko dated June 5, 2001 17, 2003
10.29 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.87 to Form S-8 filed on January
Samuel J. Furrow dated December 11, 2002 17, 2003
10.30 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.88 to Form S-8 filed on January
Patricia Anderson-Lasko dated December 11, 2002 17, 2003
10.31 Letter of Intent regarding License Agreement between Mattel, Inc. Exhibit 10.91 to the Annual Report on Form
and Innovo Group Inc. dated July 25, 2002 10-K for the year ended November 30, 2003
filed on March 17, 2003
10.32 License Agreement between Bravado International Group Inc. and Exhibit 10.93 to the Annual Report on Form
Innovo Azteca Apparel, Inc. dated October 15, 2002 10-K for the year ended November 30, 2003
filed on March 17, 2003
10.33 Trademark License Agreement between Blondie Rockwell, Inc. and Exhibit 10.96 to the Quarterly Report on
Innovo Azteca Apparel, Inc. dated as of February 13, 2003 Form 10-Q for the period ending March 1,
2003 filed on April 15, 2003
10.34 First Amendment to Trademark License Agreement between Blondie Exhibit 10.14 to Quarterly Report on Form
Rockwell, Inc. and Innovo Azteca Apparel, Inc. effective as of 10-Q/A for the period ended August 30,
September 8, 2003 2003 filed on October 17, 2003.
10.35 Second Amendment to Trademark License Agreement between Innovo Filed herewith
Group Inc. and Blondie Rockwell, Inc. dated effective as of
February 18, 2004
10.36 Promissory Note between Innovo Group Inc. and Marc Crossman dated Exhibit 10.97 to the Quarterly Report on
February 7, 2003 Form 10-Q for the period ending March 1,
2003 filed on April 15, 2003
60
Exhibit
Number Description Document if Incorporated by Reference
- ------ ----------- -------------------------------------
10.37 Promissory Note between Innovo Group Inc. and Marc Crossman dated Exhibit 10.98 to the Quarterly Report on
February 13, 2003 Form 10-Q for the period ending March 1,
2003 filed on April 15, 2003
10.38 Second Amendment to Promissory Note between Innovo Group Inc. and Filed herewith
Marc Crossman dated February 9, 2003
10.39 Second Amendment to Promissory Note between Innovo Group Inc. and Filed herewith
Marc Crossman dated February 9, 2003
10.40 Supply Agreement between Innovo Group Inc. and Commerce Investment Exhibit 10.1 to Quarterly Report on Form
Group, LLC dated August 11, 2000 10-Q for the period ended May 31, 2003
filed on July 15, 2003
10.41 Distribution Agreement between Innovo Group Inc. and Commerce Exhibit 10.2 to Quarterly Report on Form
Investment Group, LLC dated August 11, 2000 10-Q for the period ended May 31, 2003
filed on July 15, 2003
10.42 License Agreement between Innovo, Inc. and Michael Caruso & Exhibit 10.3 to Quarterly Report on Form
Company, Inc. dated March 26, 2001 and Amendment Letter dated July 10-Q for the period ended May 31, 2003
26, 2002 filed on July 15, 2003
10.43 Amendment to License Agreement between Innovo Inc. and IP Holdings Exhibit 10.92 to the Annual Report on Form
LLC dated effective as of April 1, 2003 10-K for the year ended November 30, 2003
filed on March 17, 2003
10.44 Factoring Agreement dated June 1, 2001 between Joe's Jeans, Inc. Exhibit 10.4 to Quarterly Report on Form
and CIT Commercial Services 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
10.45 Factoring Agreement dated June 1, 2001 between Innovo, Inc. and CIT Exhibit 10.6 to Quarterly Report on Form
Commercial Services 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
10.46 Factoring Agreement dated September 10, 2001 between Innovo Azteca Exhibit 10.5 to Quarterly Report on Form
Apparel, Inc. and CIT Commercial Services 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
10.47 Inventory Security Agreement dated August 20, 2002 between Joe's Exhibit 10.7 to Quarterly Report on Form
Jeans, Inc. and CIT Commercial Services 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
10.48 Inventory Security Agreement dated August 20, 2002 between Innovo Exhibit 10.8 to Quarterly Report on Form
Azteca Apparel, Inc. and CIT Commercial Services 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
10.49 Inventory Security Agreement dated August 20, 2002 between Innovo, Exhibit 10.9 to Quarterly Report on Form
Inc. and CIT Commercial Services 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
10.50 Amendment to Factoring Agreement originally dated June 1, 2001 Exhibit 10.6 to Quarterly Report on Form
between Joe's Jeans, Inc. and CIT Commercial Services dated 10-Q for the period ended May 31, 2003
effective April 23, 2003 filed on July 15, 2003
10.51 Amendment to Factoring Agreement originally dated June 1, 2001 Exhibit 10.8 to Quarterly Report on Form
between Innovo Inc. and CIT Commercial Services dated effective 10-Q for the period ended May 31, 2003
April 23, 2003 filed on July 15, 2003
61
Exhibit
Number Description Document if Incorporated by Reference
- ------ ----------- -------------------------------------
10.52 Amendment to Factoring Agreement originally dated September 10, Exhibit 10.7 to Quarterly Report on Form
2001 between Innovo Azteca Apparel, Inc. and CIT Commercial 10-Q for the period ended May 31, 2003
Services dated effective April 23, 2003 filed on July 15, 2003
10.53 Supply Agreement between Innovo Azteca Apparel, Inc. and AZT Exhibit 10.1 to Current Report on Form 8-K
International SA de CV dated July 17, 2003 dated July 18, 2003 filed on August 1, 2003
10.54 Master Distribution and Licensing Agreement between Joe's Jeans, Exhibit 10.3 to Quarterly Report on Form
Inc. and Itochu Corporation dated July 10, 2003 10-Q/A for the period ended August 30,
2003 filed on October 17, 2003
10.55 2000 Employee Stock Incentive Plan, as amended Exhibit 99.1 to Current Report on Form 8-K
dated July 18, 2003 filed on August 1, 2003
10.56 2000 Director Option Plan Attachment E to Definitive Proxy Statement
on Schedule 14A filed on September 19, 2000
10.57 Sublease Agreement between Innovo Group Inc. and WRC Media Inc. Filed herewith
dated July 28, 2003
10.58 Agreement of Lease between 500-512 Seventh Avenue Limited Filed herewith
Partnership and WRC Media, Inc. dated as of March 2000 relating to
Sublease Agreement filed as Exhibit 10.57 hereto
10.59 Assignment and Amendment of License Agreement, Amendment of Filed herewith
Guaranty and Consent Agreement among Innovo Azteca Apparel, Inc.,
B.J. Vines, Inc., and Blue Concept, LLC dated February 3, 2004
10.60 Letter License Agreement between B.J. Vines, Inc. and Blue Concept Filed herewith
LLC executed on January 8, 2004 relating to Assignment and
Amendment of License Agreement, Amendment of Guaranty and
Consent Agreement filed as Exhibit 10.59 hereto
10.61 Master Distribution Agreement between Joe's Jeans, Inc. and Beyond Filed herewith
Blue, Inc. dated effective as of January 1, 2004
14 Code of Business Conduct and Ethics adopted as of May 22, 2003 Filed herewith
21 Subsidiaries of the Registrant Filed herewith
23 Consent of Ernst & Young LLP Filed herewith
24.1 Power of Attorney (included on page 64) Filed herewith
31.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Filed herewith
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Filed herewith
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certification of the Chief Executive Officer and Chief Financial Filed herewith
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
62
(b). Reports on Form 8-K for the last fiscal quarter
Date Purpose
---- -------
September 30, 2003 To report an amendment the current report on Form 8-K filed on
August 1, 2003 to include financial statements of the Blue Concept
Division of Azteca Production International, Inc. as required by
Item 7(a).
October 15, 2003 To report a press release dated October 15, 2003 announcing our
financial results for the third quarter ended August 30, 2003.
October 17, 2003 To report an amendment the Form 8-K/A filed on September 30, 2003
to delete the last sentence of the third paragraph of Note 3 to
Financial Statements under sub-paragraph (a)(iii) of Item 7(a).
December 2, 2003 To report a press release dated December 2, 2003 announcing the
completion of a private placement of (i) 2,996,667 shares of its
common stock at a purchase price of $3.00 per share and warrants to
purchase an additional 599,333 shares of its common stock at an
exercise price of $4.00 per share, and (ii) attaching a form of
Securities Purchase Agreement dated December 1, 2003.
63
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.
INNOVO GROUP INC.
By: /s/ Samuel J. Furrow, Jr.
Samuel J. Furrow, Jr.
Chief Executive Officer
February 27, 2004
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Samuel J. Furrow, Jr., his or her
attorney-in-fact, each with the power of substitution for him or any and all
capacities, to sign any amendments to this Annual Report on Form 10-K and to
file the same with exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, hereby ratifying and confirming all
that each said attorney-in-fact, or his or her substitutes, may do or cause to
be done by virtue hereof. Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed by the following persons on
behalf of the registrant in the capacities and on the dates indicated.
Signature Capacity Date
--------- -------- ----
Chief Executive Officer (Principal
/s/ Samuel J. Furrow, Jr. Executive Officer) and Director February 27, 2004
---------------------------------------------------
Samuel J. Furrow, Jr.
Chief Financial Officer (Principal
/s/ Marc B. Crossman Financial Officer) and Director February 27, 2004
---------------------------------------------------
Marc B. Crossman
/s/ Patricia Anderson President and Director February 26, 2004
---------------------------------------------------
Patricia Anderson
/s/ Samuel J. Furrow Chairman of the Board of Directors February 25, 2004
---------------------------------------------------
Samuel J. Furrow
/s/ John Looney Director February 26, 2004
---------------------------------------------------
John Looney, M.D.
/s/ Daniel Page Director February 26, 2004
---------------------------------------------------
Daniel Page
/s/ Suhail R. Rizvi Director February 26, 2004
---------------------------------------------------
Suhail R. Rizvi
/s/ Kent Savage Director February 26, 2004
---------------------------------------------------
Kent Savage
/s/ Vincent Sanfilippo Director February 26, 2004
---------------------------------------------------
Vincent Sanfilippo
64
Innovo Group and Subsidiaries
Index to Consolidated Financial Statements
Audited Consolidated Financial Statements: Page
- ------------------------------------------ ----
Report of Independent Auditors - Ernst & Young LLP
Consolidated Balance Sheets at November 29, 2003 and November 30, 2002
Consolidated Statement of Operations for the years ended November 29, 2003,
November 30, 2002 and December 1, 2001 Consolidated Statements of Stockholders'
Equity for the years ended November 29, 2003, November 30, 2002
and December 1, 2001
Consolidated Statement of Cash Flows for the years ended November 29, 2003 and
November 30, 2002
Notes to Consolidated Financial Statements
Schedule II - Valuation of Qualifying Accounts
Report of Independent Auditors
Board of Directors
Innovo Group Inc.
We have audited the accompanying consolidated balance sheets of Innovo Group
Inc. and subsidiaries as of November 29, 2003 and November 30, 2002, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended November 29, 2003. Our
audits also included the financial statement schedule listed in the index at
Item 15(a). These financial statements and schedule are the responsibility of
Innovo Group Inc.'s management. Our responsibility is to express an opinion on
these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the 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. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Innovo Group Inc.
and subsidiaries as of November 29, 2003 and November 30, 2002 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended November 29, 2003 in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material respects
the information set forth therein.
/s/ Ernst & Young LLP
Los Angeles, California
February 20, 2004
F-1
INNOVO GROUP INC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
11/29/03 11/30/02
-------- --------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 7,248 $ 222
Accounts receivable, and due from factor net of allowance for
customer credits and allowances of $2,158 (2003) and $383 (2002) 1,683 2,737
Inventories 7,524 5,710
Prepaid expenses & other current assets 2,115 279
-------- --------
TOTAL CURRENT ASSETS 18,570 8,948
-------- --------
PROPERTY, PLANT and EQUIPMENT, net 2,067 1,419
GOODWILL 12,592 4,271
INTANGIBLE ASSETS, NET 13,058 487
OTHER ASSETS 78 18
-------- --------
TOTAL ASSETS $ 46,365 $ 15,143
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 6,128 $ 2,438
Due to factor 332 --
Due to related parties 579 4,250
Note payable to officer 500 --
Current maturities of long-term debt (including related parties) 168 756
-------- --------
TOTAL CURRENT LIABILITIES 7,707 7,444
LONG-TERM DEBT, less current maturities (including related parties) 22,176 2,631
Commitments and Contingencies
8% Redeemable preferred stock, $0.10 par value: Authorized shares-5,000,
194 shares (2003 and 2002) -- --
STOCKHOLDERS' EQUITY
Common stock, $0.10 par - shares, Authorized 40,000
Issued and outstanding 25,785 (2003), and 14,901 (2002) 2,579 1,491
Additional paid-in capital 59,077 40,343
Accumulated deficit (41,824) (33,507)
Promissory note-officer (703) (703)
Treasury stock, 71 shares (2003) and 58 shares (2002) (2,588) (2,537)
Accumulated other comprehensive loss (59) (19)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 16,482 5,068
-------- --------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 46,365 $ 15,143
======== ========
See accompanying notes
F-2
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended
------------------------------------------
11/29/03 11/30/02 12/01/01
-------- -------- --------
NET SALES $ 83,129 $ 29,609 $ 9,292
COST OF GOODS SOLD 70,153 20,072 6,335
-------- -------- --------
Gross profit 12,976 9,537 2,957
OPERATING EXPENSES
Selling, general and administrative 19,264 8,092 3,189
Depreciation and amortization 1,227 256 167
-------- -------- --------
20,491 8,348 3,356
INCOME (LOSS) FROM OPERATIONS (7,515) 1,189 (399)
INTEREST EXPENSE (1,216) (538) (211)
OTHER INCOME 526 235 84
OTHER EXPENSE (68) (174) (3)
-------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES (8,273) 712 (529)
INCOME TAXES 44 140 89
-------- -------- --------
NET INCOME (LOSS) $ (8,317) $ 572 $ (618)2
======== ======== ========
NET INCOME (LOSS) PER SHARE:
Basic $ (0.49) $ 0.04 $ (0.04)
Diluted $ (0.49) $ 0.04 $ (0.04)
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 17,009 14,856 14,315
Diluted 17,009 16,109 14,315
See accompanying notes
F-3
INNOVO GROUP INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Other Total
Common Stock Additional Promissory Comprehen- Stock-
------------------ Paid-In Accumulated Note Treasury sive holders'
Shares Par Value Capital Deficit Officer Stock Loss Equity
------- --------- ---------- ----------- ---------- -------- ---------- --------
Balance, November 30, 2000 13,721 $1,371 $ 38,977 $(33,461) $(703) $(2,426) $ -- $ 3,758
Issuance of common stock for acquisitions 1,200 120 1,249 -- -- -- -- 1,369
Common stock offering expenses -- -- (35) -- -- -- -- (35)
Expense associated with options and warrants -- -- 86 -- -- -- -- 86
Treasury Stock Purchased -- -- -- -- -- (41) -- (41)
Net Loss -- -- -- (618) -- -- -- (618)
------- ------ -------- -------- ----- ------- ---- --------
Balance, December 1, 2001 14,921 1,491 40,277 (34,079) (703) (2,467) -- 4,519
Net Income -- -- -- 572 -- -- -- 572
Foreign curreny translation adjustment -- -- -- -- -- -- (19) (19)
--------
Comprehensive income -- -- -- -- -- -- -- 553
Common stock offering expenses -- -- (25) -- -- -- -- (25)
Expense associated with options and warrants -- -- 91 -- -- -- -- 91
Cancelled shares (20) -- -- -- -- -- -- --
Treasury stock purchased -- -- -- -- -- (70) -- (70)
------- ------ -------- -------- ----- ------- ---- --------
Balance, November 30, 2002 14,901 1,491 40,343 (33,507) (703) (2,537) (19) 5,068
Net loss -- -- -- (8,317) -- -- -- (8,317)
Foreign curreny translation adjustment -- -- -- -- -- -- (40) (40)
--------
Comprehensive loss -- -- -- -- -- -- -- (8,357)
Proceeds from sale of stock, net 6,236 624 16,916 -- -- -- -- 17,540
Treasury stock purchased -- -- -- -- -- (51) -- (51)
Expense associated with options and warrants -- -- 101 -- -- -- -- 101
Exercise of stock options 50 5 77 -- -- -- -- 82
Exercise of warrants 4,598 459 1,640 -- -- -- -- 2,099
------- ------ -------- -------- ----- ------- ---- --------
Balance, November 29, 2003 25,785 $2,579 $ 59,077 $(41,824) $(703) $(2,588) $(59) $ 16,482
======= ====== ======== ======== ===== ======= ==== ========
See accompanying notes
F-4
INNOVO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended
----------------------------------------
11/29/03 11/30/02 12/01/01
-------- -------- --------
Net income (loss) $ (8,317) $ 572 $ (618)
Adjustment to reconcile net income (loss)
to cash provided by (used in) operating activities:
Depreciation 232 86 92
Loss on sale of fixed assets 9 90 2
Amortization of intangibles 943 122 35
Amortization of licensing rights 48 48 40
Stock compensation expenses 101 91 86
Provision for uncollectible accounts 1,775 219 128
Changes in current assets and liabilities:
Accounts receivable (721) (1,490) (882)
Inventories (1,814) (3,300) 933
Prepaid expenses and other (1,746) (117) (86)
Due to related parties (3,976) 3,444 698
Other long term assets (61) (3) 4
Accounts payable and accrued expenses 3,670 1,742 (1,064)
-------- ------- -------
Cash (used in) provided by operating activities $ (9,857) $ 1,504 $ (632)
F-5
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of fixed assets $ 6 $ -- $ 1,082
Proceeds from investment in real estate 1,013 436 --
Redemption of preferred shares (798) (436) --
Purchases of fixed assets (895) (622) (61)
Acquisition costs (62) -- (36)
-------- ------- -------
Cash (used in) provided by investing activities $ (736) $ (622) $ 985
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury stock $ (51) $ (70) $ (41)
Payments on notes payables and long term debt (744) (838) (1,164)
Factor borrowings 332 -- --
Proceeds from note payable to officer 500 -- --
Exercise of stock options 82 -- --
Proceeds from issuance of stock, net 17,540 (25) (35)
-------- ------- -------
Cash provided by (used in) financing activities $ 17,659 $ (933) $(1,240)
Effect of exchange rate on cash (40) (19) --
NET CHANGE IN CASH AND CASH EQUIVALENTS $ 7,026 $ (70) $ (887)
CASH AND CASH EQUIVALENTS, at beginning of period 222 292 1,179
-------- ------- -------
CASH AND CASH EQUIVALENTS, at end of period $ 7,248 $ 222 $ 292
======== ======= =======
Supplemental Disclosures of Cash Flow Information:
Cash Paid for Interest $ 1,008 $ 519 $ 110
Cash Paid for Taxes $ 89 $ 28 $ --
During fiscal 2002, the Company issued 195,295 shares of its cumulative
non-convertible preferred stock with an 8% coupon in exchange for real estate
partnership interests.
F-6
INNOVO GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business Description
Innovo Group Inc.'s (Innovo Group) principle business activity involves the
design, development and worldwide marketing of high quality consumer products
for the apparel and accessory markets. Innovo Group operates its consumer
products business through three wholly-owned, operating subsidiaries, Innovo,
Inc. (Innovo), Joe's Jeans, Inc. (Joe's), and Innovo Azteca Apparel, Inc. (IAA)
with Innovo Group and Joe's having two wholly-owned operating subsidiaries,
Innovo Hong Kong Limited (IHK) and Joe's Jeans Japan, Inc. (JJJ), respectively.
Innovo Group's products are manufactured by independent contractors located in
Los Angeles, Mexico and/or Asia, including, Hong Kong, China, Korea, Vietnam and
India. The products are then distributed out of Los Angeles or directly from the
factory to the customer.
During fiscal year 2001, Innovo Group changed its fiscal year end from November
30 of each year to the Saturday closest to November 30. For fiscal years 2003,
2002 and 2001, the years ended on November 29, 2003, November 30, 2002 and
December 1, 2001, respectively. These fiscal year periods are referred to as
2003, 2002 and 2001, respectively, in the accompanying Notes to Consolidated
Financial Statements.
Restructuring of Operations
In connection with a strategic equity investment by Commerce Investment Group,
LLC (Commerce) in 2000, Innovo Group shifted manufacturing to third-party
foreign manufacturers and outsourced certain distribution functions to Commerce
to increase the effectiveness of its distribution network and to reduce freight
costs. Innovo Group entered into certain supply and distribution agreements with
Commerce. These agreements provide for Commerce or its designated affiliates to
manufacture and supply specified products to Innovo Group at agreed upon prices.
In addition, Commerce provides distribution services to Innovo Group for certain
of its products for an agreed upon fee, including warehousing, shipping and
receiving, storage, order processing, billing, customer service, information
systems, maintenance of inventory records, and direct labor and management
services. These agreements were renewed for a two-year term ending fiscal 2004
and are renewable thereafter for consecutive two-year terms unless terminated by
either party with 90 days notice. There are no minimum purchase or distribution
obligations during these renewal periods.
Pursuant to the Commerce transaction and related agreements, Innovo Group
relocated its headquarters and distribution operations to Los Angeles,
California, and transitioned its manufacturing needs to Mexican production
facilities operated by an affiliate of Commerce. Innovo Group continues to
maintain its Innovo subsidiary operations, which focuses on accessory products,
in Knoxville, Tennessee, the site of its former headquarters.
Innovo Group experienced a significant operating loss and negative cash flow
from operations for the year ended November 29, 2003. Innovo Group historically
has funded operations by equity financing through private placements, credit
arrangements with suppliers and factoring agreements for working capital needs.
From time to time, Innovo Group has obtained short-term working capital loans
from senior members of management and/or members of the Board of Directors.
Other Operations
Innovo Group, through its wholly-owned operating subsidiary Leasall Management,
Inc. (Leasall) owns real property located in Springfield, Tennessee which
formerly served as Innovo Group's headquarters. Leasall currently leases this
property to third parties. In April 2002, Innovo Group, through its wholly owned
operating subsidiary, Innovo Group Realty Inc. (IRI), entered into a real estate
investment transaction by purchasing limited partnership interests in 22 limited
partnerships that subsequently acquired limited partnerships in 28 apartment
buildings consisting of approximately 4,000 apartment units. See Note 5.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Innovo Group and its wholly owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires
F-7
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. The most significant estimates affect the
evaluation of contingencies, and the determination of allowances for accounts
receivable and inventories. Actual results could differ from these estimates.
Revenue Recognition
Revenues are recorded when title transfers to the customer, which is typically
at the shipping point. Innovo Group records estimated reductions to revenue for
customer programs, including co-op advertising, other advertising programs or
allowances which are based upon a percentage of sales. Innovo Group also allows
for returns based upon pre-approval or for damaged goods. Such returns are
estimated and an allowance is provided at the time of sale.
Shipping and Handling Costs
Innovo Group outsources its distribution functions to an affiliate of Commerce
or, in certain cases, to other third party distributors. Shipping and handling
costs include costs to warehouse, pick, pack and deliver inventory to customers.
In certain cases Innovo Group is responsible for the cost of freight to deliver
goods to the customer. Shipping and handling costs were approximately
$1,834,000, $1,023,000 and $408,000 for the years ended 2003, 2002, and 2001,
respectively, and are included in cost of goods sold. Freight billed to
customers that is included in Innovo Group sales for the years ended 2003, 2002
and 2001 were $24,000, $201,000 and $77,000 respectively.
Earnings (loss) Per Share
Net income (loss) per share has been computed in accordance with Financial
Accounting Standard Board (FASB) Statement No. 128, "Earnings Per Share."
Comprehensive Income (loss)
Assets and liabilities of the Japan and Hong Kong divisions are translated at
the rate of exchange in effect on the balance sheet date. Income and expenses
are translated at the average rates of exchange prevailing during the year. The
functional currency in which Innovo Group transacts business is the Japanese yen
and Hong Kong dollar. Comprehensive income (loss) consists of net income (loss)
and foreign currency gains and losses resulting from translation of assets and
liabilities.
Advertising Costs
Advertising costs are expensed as incurred, or, in the case of media ads, upon
first airing, except for brochures and catalogues that are capitalized and
amortized over their expected period of future benefits.
Capitalized costs related to catalogues and brochures are included in prepaid
expenses and other current assets. Advertising expenses included in selling,
general and administrative expenses were approximately $985,000, $287,000, and
$114,000 for the years ended 2003, 2002, and 2001, respectively.
Advertising costs include items incurred in connection with royalty agreements
or amounts paid to licensors pursuant to royalty agreements. Included in prepaid
expenses is $985,000, representing prepaid advertising royalties pursuant to
license agreements for the year ended 2003.
Financial Instruments
The fair values of Innovo Group's financial instruments (consisting of cash,
accounts receivable, accounts payable, due to factor and notes payable) do not
differ materially from their recorded amounts because of the relatively short
period of time between origination of the instruments and their expected
realization. Management believes it is not practicable to estimate the fair
value of the first mortgage loan as the loan has a fixed interest rate secured
by real property in Tennessee. Innovo Group neither holds, nor is obligated
under, financial instruments that possess off-balance sheet credit or market
risk.
Impairment of Long-Lived Assets and Intangibles
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell.
F-8
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142 "Goodwill and Other Intangible
Assets," which establishes financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets. Innovo Group adopted SFAS No. 142 beginning with the first
quarter of fiscal 2002. SFAS No. 142 requires that goodwill and intangible
assets that have indefinite useful lives not be amortized but, instead, tested
at least annually for impairment while intangible assets that have finite useful
lives continue to be amortized over their respective useful lives. Accordingly,
Innovo Group has not amortized goodwill.
SFAS No. 142 requires that goodwill and other intangibles be tested for
impairment using a two-step process. The first step is to determine the fair
value of the reporting unit, which may be calculated using a discounted cash
flow methodology, and compare this value to its carrying value. If the fair
value exceeds the carrying value, no further work is required and no impairment
loss would be recognized. The second step is an allocation of the fair value of
the reporting unit to all of the reporting unit's assets and liabilities under a
hypothetical purchase price allocation. Based on the evaluation performed by
Innovo Group, there is no impairment to be recorded at November 29, 2003.
Cash Equivalents
Innovo Group considers all highly liquid investments that are both readily
convertible into known amounts of cash and mature within 90 days from their date
of purchase to be cash equivalents.
Concentration of Credit Risk
Financial instruments that potentially subject Innovo Group to significant
concentrations of credit risk consist principally of cash, accounts receivable
and amounts due from factor. Innovo Group maintains cash and cash equivalents
with various financial institutions. Its policy is designed to limit exposure to
any one institution. Innovo Group performs periodic evaluations of the relative
credit rating of those financial institutions that are considered in Innovo
Group's investment strategy.
Concentrations of credit risk with respect to accounts receivable are limited
due to the number of customers comprising Innovo Group's customer base. However,
for the years ended November 29, 2003 and November 30, 2002, $1,301,000 and
$1,652,000, respectively of total non-factored accounts receivables, (or 37% and
60%) were due from three and four customers. Innovo Group does not require
collateral for trade accounts receivable, and, therefore, is at risk for up to
$3,388,000 and $2,813,000, respectively, if these customers fail to pay. Innovo
Group provides an allowance for estimated losses to be incurred in the
collection of accounts receivable based upon the ageing of outstanding balances
and other account monitoring analysis. Such losses have historically been within
management's expectations. Uncollectible accounts are written off once
collection efforts are deemed by management to have been exhausted.
During fiscal 2003, 2002 and 2001, sales to customers representing greater than
10 percent of sales are as follows:
2003 2002 2001
---- ---- ----
American Eagle Outfitters 38% * *
Target 12% * *
Wal-Mart Stores * * 27%
* Less than 10%
Manufacturing, Warehousing and Distribution
Innovo Group purchases a significant portion of finished goods and obtains
certain warehousing and distribution services from Commerce and its affiliates
and obtains credit terms which Innovo Group believes are favorable. The loss of
Commerce as a vendor, or material changes to the terms, could have an adverse
impact on the business. Commerce and its affiliates are controlled by two
significant stockholders of Innovo Group.
Innovo Group's products are manufactured by contractors located in Los Angeles,
Mexico and/or Asia, including, Hong Kong, China, Korea, Vietnam and India. The
products are then distributed out of Los Angeles or directly from the factory to
the customer. For the year ended 2003, 22% of its apparel and accessory products
were manufactured outside of North America. The rest of its accessory and
apparel products were manufactured in the United States (21%) and Mexico (57%).
All of its products manufactured in Mexico are manufactured by an affiliate of
Commerce, Azteca Productions International, Inc. (Azteca) or its affiliates.
F-9
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" (SFAS No. 123), encourages, but does not require, companies to
record compensation cost for stock-based employee compensation plans at fair
value. Innovo Group has chosen to continue to account for employee stock-based
compensation using the method prescribed in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Innovo Group has adopted the disclosure-only provisions of SFAS No. 123.
Accordingly, no compensation expense has been recorded in conjunction with
options issued to employees. Had compensation costs been determined based upon
the fair value of the options at the grant date and amortized over the option's
vesting period, consistent with the method prescribed by SFAS No. 123, Innovo
Group's net income (loss) would have been increased to the pro forma amounts
indicated below for the years ended November 29, 2003, November 30, 2003 and
December 1, 2001 (in thousands, except per share data):
Year Ended
(in thousands, except per share data)
-------------------------------------------
2003 2002 2001
-------------------------------------------
Net (loss) income as reported $ (8,317) $ 572 $ (618)
Add:
Stock based employee compensation
expense included in reported net income
net of related tax effects 101 91 86
Deduct:
Total stock based employee compensation
expense determined under fair market value
based method for all awards, net of related
tax effects 504 140 454
-------------------------------------------
Pro forma net (loss) income $ (8,720) $ 523 $ (986)
===========================================
Net (loss) income per share
As reported - basic $ (0.49) $ 0.04 $ (0.04)
As reported - diluted $ (0.49) $ 0.04 $ (0.04)
Pro forma - basic $ (0.51) $ 0.04 $ (0.07)
Pro forma - diluted $ (0.51) $ 0.03 $ (0.07)
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions used for
grants in 2003 and 2002:
2003 2002 2001
---- ---- ----
Estimated dividend yield......................... 0.0% 0.0% 0.0%
Expected stock price volatility.................. 48% 38% 68%
Risk-free interest rate.......................... 5.0% 6.0% 6.0%
Expected life of options......................... 4 yrs. 2-4 yrs. 2-4 yrs.
The Black-Scholes model was developed for use in estimating the fair value of
traded options, which have no vesting restrictions and are fully transferable.
In addition, option valuation models require the input of highly subjective
assumptions, including, the expected stock price volatility. Because Innovo
Group's employee stock options have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimates, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
Property, Plant and Equipment
Property, plant and equipment are stated at the lesser of cost or fair value in
the case of impaired assets. Depreciation is computed on a straight-line basis
over the estimated useful lives of the assets and includes capital lease
amortization. Leasehold improvements are amortized over the lives of the
respective leases or the estimated service lives of the improvements, whichever
is shorter. Routine maintenance and repairs are charged to expense as incurred.
On sale or retirement, the asset cost and related accumulated depreciation or
amortization is removed from the accounts, and any related gain or loss is
included in the determination of income.
Reclassifications
Certain reclassifications have been made to prior year consolidated financial
statements to conform to the current year presentation.
F-10
Recently Issued Financial Accounting Standard
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. This Statement is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003 and is not expected to have a material impact on Innovo
Groups' consolidated results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. In particular, SFAS No. 149 clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a derivative
and when a derivative contains a financing component that warrants special
reporting in the statement of cash flows. SFAS No. 149 is generally effective
for contracts entered into or modified after June 30, 2003 and is not expected
to have a material impact on Innovo Group's consolidated results of operations
or financial position.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities." FIN 46 requires companies to evaluate variable
interest entities to determine whether to apply the consolidation provisions of
FIN 46 to those entities. Companies must apply FIN 46 to entities created after
January 31, 2003, and to variable interest entities in which a company obtains
an interest after that date. It applies in the first fiscal year or interim
period endings after December 15, 2003, to variable interest entities in which a
company holds a variable interest that it acquired before February 1, 2003.
Adoption of FIN 46 is not expected to have a material impact on Innovo Group's
consolidated results of operations or financial position
3. Acquisitions
Blue Concept Division Acquisition
On July 17, 2003, IAA entered into an asset purchase agreement (APA), with
Azteca, Hubert Guez and Paul Guez, (the Sellers), whereby IAA acquired the
division known as the Blue Concept Division of Azteca (the Blue Concept
Division). The Blue Concept Division sells primarily denim jeans to American
Eagle Outfitters, Inc. (AEO), a national retailer. Pursuant to the terms of the
APA, IAA paid $21.8 million for the Blue Concept Division, subject to adjustment
as noted below. Pursuant to the APA, IAA employed all of the existing employees
of the Blue Concept Division but did not assume any of the Blue Concept
Division's or the Sellers' existing liabilities. In connection with the purchase
of the Blue Concept Division from the Sellers, IAA issued a seven-year
convertible promissory note for $21.8 million (the Blue Concept Note). The Blue
Concept Note bears interest at a rate of 6% and requires payment of interest
only during the first 24 months and then is fully amortizing over the remaining
five-year period. The terms of the transaction further allows Innovo Group, upon
stockholder approval, to convert a portion of the Blue Concept Note into equity
through the issuance of 3,125,000 shares of its common stock valued at the
greater of $4.00 per share or the market value of our common stock on the day
prior to the date of the stockholder meeting at which approval for this
conversion is sought (Conversion Price) and up to an additional 1,041,667 shares
upon the occurrence of certain future contingencies relating to Innovo Group's
stock price for the thirty day period ending March 6, 2005. Presently, a special
stockholder meeting is scheduled for March 5, 2004 to vote on the approval of
this conversion of the Blue Concept Note into equity. In the event stockholder
approval is obtained, the Blue Concept Note will be reduced by an amount equal
to the product of the Conversion Price and 3,125,000 shares, so long as the
principal amount of the Blue Concept Note is not reduced below $9.3 million. The
shares issued pursuant to the conversion will be subject to certain lock-up
periods.
In the event that sales of the Blue Concept Division fall below $70 million
during the first 17 month period, (Period I), following the closing of the
acquisition, or $65 million during the 12 month period (Period II) following
Period I, certain terms of the APA allow for a reduction in the purchase price
through a decrease in the principal balance of the Blue Concept Note and/or the
return of certain locked-up shares of Innovo Group's common stock. In the event
the Blue Concept Note is reduced during Period I and the sales of the Blue
Concept Division in Period II are greater than $65 million, the Blue Concept
Note shall be increased by half of the amount greater than $65 million, but in
no event shall the Blue Concept Note be increased by an amount greater than the
decrease in Period I.
In the event the principal amount of the Blue Concept Note needs to be reduced
beyond the outstanding principal balance, then an amount of the locked-up shares
equal to the balance of the required reduction shall be returned to Innovo
Group. For these purposes, the locked-up shares shall be valued at $4.00 per
share. Additionally, if during the 12 month period following the closing, AEO is
no longer a customer of IAA, the locked-up shares will be returned to Innovo
Group, and any amount remaining on the balance of the Blue Concept Note will be
forgiven.
In the event the revenues of the Blue Concept Division decrease to $35 million
or less during Period I or Period II, IAA shall have the right to sell the
purchased assets back to the Sellers, and the Sellers shall have the right to
buy back the purchased assets for the
F-11
remaining balance of the Blue Concept Note and any and all Locked Up Shares
shall be returned.
As part of the transaction, IAA and AZT International SA de CV (AZT), a Mexico
corporation and wholly-owned subsidiary of Azteca entered into a two-year,
renewable, non-exclusive supply agreement (Supply Agreement) for products to be
sold by the Blue Concept Division. In addition to the customary obligations, the
Supply Agreement requires that AZT will receive payment immediately upon receipt
of invoices for purchase orders and that AZT will charge a per unit price such
that IAA will have a guaranteed profit margin of 15 percent on a "per unit"
basis. In addition, AZT is responsible for all quality defects in merchandise
manufactured.
The acquisition of the Blue Concept Division was accounted for under the
purchase method of accounting. Of the $21.8 million purchase price, $13.2
million was recorded as an intangible asset representing the value of the
customer relationship, $361,000 was recorded as an intangible asset representing
the fair value of the existing purchase orders at the closing of the acquisition
and the balance of the purchase price of $8.32 million was recorded as goodwill.
The purchase price allocation was based upon a third party valuation. The
results of operations of the Blue Concept Division are included in Innovo
Group's consolidated results of operations beginning July 17, 2003.
The value assigned to the existing purchase orders was amortized during 2003 at
the time the goods were shipped and the value of the customer list is being
amortized over 10 years. The goodwill is expected to be amortizable for income
tax purposes. The acquisition was consummated to enable Innovo Group to expand
its private label operations.
The following table presents the unaudited pro forma consolidated results of
operations for the years ended 2003 and 2002 assuming the Blue Concept Division
had been acquired as of December 2, 2001.
Year Ended
(in thousands, except per share data)
--------------------------------------
2003 2002
--------- ---------
Net sales $ 130,720 $ 105,496
Net income (loss) (4,343) 4,681
Earnings (loss) per share:
Basic $ (0.22) $ 0.26
Diluted $ (0.22) $ 0.24
The pro forma operating results do not reflect any anticipated operating
efficiencies or synergies and are not necessarily indicative of the actual
results which might have occurred had the operations and management of the
companies been combined for the fiscal years included above.
Azteca Production International, Inc. Knit Division
On August 24, 2001, Innovo Group through its subsidiary, IAA, completed the
first phase of a two phase acquisition of Azteca knit apparel division (Knit
Division or Knit Acquisition). As discussed previously, Azteca is an affiliate
of Commerce. Pursuant to the terms of the first phase closing, Innovo Group
purchased the Knit Division's customer list, the right to manufacture and market
all of the Knit Division's current products and entered into certain non-compete
and non-solicitation agreements and other intangible assets associated with the
Knit Division (Phase I Assets). As consideration for the Phase I Assets, Innovo
Group issued to Azteca, 700,000 shares of its common stock valued at $1.27 per
share based upon the closing price of the common stock on August 24, 2001, and
promissory notes in the amount of $3.6 million.
The second phase of the Knit Acquisition called for Innovo Group to purchase for
cash the inventory of the Knit Division prior to November 30, 2001, with the
consideration not to exceed $3 million. The acquisition of the inventory was
subject to Innovo Group obtaining adequate financing. Upon the mutual agreement
of both parties, Innovo Group did not complete the second phase of the
acquisition prior to the expiration date due to Innovo Group's inability to
obtain the necessary funding.
The Knit Acquisition was accounted for under the purchase method of accounting
for business combinations pursuant to FAS 141. Accordingly, the accompanying
consolidated financial statements include the results of operations and other
information for the Knit Division for the period from August 24, 2001 through
December 1, 2001. The Acquisition was consummated to allow Innovo Group to
continue its expansion into various segments of the apparel industry.
Of the aggregate purchase price of $4,521,000, including acquisition costs of
$36,000, $250,000 has been allocated to the non-compete agreement and the
remaining amount of $4,271,000 has been allocated to goodwill. The non-compete
agreement was amortized over two years, based upon the term of the agreement.
The total amount of the goodwill is expected to be deductible for income tax
purposes.
F-12
The following table shows Innovo Group's unaudited pro forma consolidated
results of operations for the fiscal year ended December 1, 2001, assuming the
Knit Acquisition had occurred at the beginning of the year:
Year Ended
(in thousands,
except per share data)
----------------------
2001
----------------------
Net sales $17,243
Loss before extraordinary item (406)
Net Loss (406)
Loss per share:
Basic ($0.03)
Diluted ($0.03)
Joe's Jeans License
On February 7, 2001, Innovo Group acquired the license rights to the Joe's Jeans
label from JD Design, LLC (JD Design), along with the right to market the
previously designed product line and existing sales orders, in exchange for
500,000 shares of Innovo Group's common stock and, if certain sales and gross
margin objectives are reached, a warrant with a four year term granting JD
Design the right to purchase 250,000 shares of Innovo Group's common stock at a
price of $1.00 per share. As of November 29, 2003, the sales and gross margin
objectives had not been reached.
Additionally, Joe Dahan, the designer of the Joe's Jeans line joined Innovo
Group as President of its newly formed and wholly owned subsidiary, Joe's Jeans,
Inc. and received an option, with a four-year term, to purchase 250,000 shares
of Innovo Group's common stock at $1.00 per share, vesting over 24 months. These
options were granted pursuant to the employment agreement between Innovo Group
and Joe Dahan. These options vest over the term of employment. Under the terms
of the license, Innovo Group is required to pay a royalty of 3% of net sales,
with additional royalty amounts due in the event Innovo Group exceeds certain
minimum sales and gross profit thresholds. Innovo Group recorded $339,000,
$277,000 and $46,000 in royalty expense for the license in the years ended 2003,
2002 and 2001, respectively.
The purchase price for the Joe's Jeans license of $480,000 was determined based
upon the fair value of the 500,000 shares issued in connection with the
acquisition using the average of the quoted market price of $0.96 for a period
of 5 days prior to and 5 days after the commitment date. No value was assigned
to the warrant for 250,000 shares of common stock because the warrant only vests
in the event that Joe's Jeans meets certain sales and gross profit targets. The
remaining sales target for 2004 is $15 million, provided, that the sales have a
minimum gross profit of 55%. In the event that both the net sales and gross
margin target is achieved, JD Design will receive a warrant for 250,000 shares
of Innovo Group common stock with an exercise price of $1.00 per share, with a
4-year term and equal-monthly vesting over the first 24 months. The entire
purchase price was allocated to license rights that are being amortized over the
10-year term of the license.
4. Inventories
Inventories are stated at the lower of cost, as determined by the first-in,
first-out method, or market. Inventories consisted of the following (in
thousands):
2003 2002
--------------------------
Finished goods $ 10,189 $ 5,741
Work in progress 199 --
Raw materials 1,329 74
--------------------------
$ 11,717 $ 5,815
Less allowance for obsolescence and
slow moving items (4,193) (105)
--------------------------
$ 7,524 $ 5,710
==========================
F-13
5. Real Estate Transactions
In April 2002, Innovo Group's wholly-owned subsidiary IRI acquired a 30% limited
partnership interest in each of 22 separate partnerships. These partnerships
simultaneously acquired 28 apartment complexes at various locations throughout
the United States consisting of approximately 4,000 apartment units (the
Properties). A portion of the aggregate $98,080,000 purchase price was paid
through the transfer of 195,295 shares of our $100, 8% Series A Redeemable
Cumulative Preferred Stock (the Series A Preferred Shares) to the sellers of the
Properties. The balance of the purchase price was paid by Metra Capital, LLC
(Metra Capital) in the amount of $5,924,000 (the Metra Capital Contribution) and
through proceeds from a Bank of America loan, in the amount $72,625,000.
Innovo Group had originally issued the Series A Preferred Shares to IRI in
exchange for all shares of its common stock. IRI then acquired a 30% limited
partnership interest in each of the 22 separate limited partnerships in exchange
for the Series A Preferred Stock, which then transferred the Series A Preferred
Shares to the sellers of the Properties.
Each of Messrs. Hubert Guez and Simon Mizrachi and their affiliates have
invested in each of the 22 separate partnerships. Each of Messrs. Guez and
Mizrachi, together with their respective affiliates, own 50% of the membership
interests of Third Millennium. Third Millennium is the managing member of Metra
Capital, which owns 100% of the membership interest in each of the 22 separate
limited liability companies collectively the General Partners and together with
Metra Capital, the Metra Partners, that hold a 1% general partnership interest
in each of the 22 separate limited partnerships that own the Properties. Metra
Capital also owns 69% of the limited partnership interest in each of the 22
separate limited partnerships. At the time of the transaction, Messrs. Guez and
Mizrachi and their affiliates owned more than 5 percent of Innovo Group's
outstanding shares.
Pursuant to each of the limited partnership agreements, the Metra Partners
receive at least quarterly (either from cash flow and/or property sale proceeds)
an amount sufficient to provide the Metra Partners (1) a 15% cumulative compound
annual rate of return on the outstanding amount of the Metra Capital
Contribution that has not been previously returned to them through prior
distributions of cash flow and/or property sale proceeds and (2) a cumulative
annual amount of .50% of the average outstanding balance of the average
outstanding balance of the mortgage indebtedness secured by any of the
Properties. In addition, in the event of a distribution solely due to a property
sale proceeds after the above distributions have been made to the Metra
Partners, Metra Partners also receive an amount equal to 125% of the amount of
the Metra Capital Contribution allocated to the Property sold until the Metra
Partners have received from all previous cash flow or property sale
distributions an amount equal to its Metra Capital Contribution.
Third Millenium receives on a quarterly basis from cash flows and/or property
sale proceeds an amount equal to $63,000 until it receives an aggregate of
$252,000.
After the above distributions have been made, and if any cash is available for
distribution, IRI. is to receive at least quarterly in the case of cash flow
distributions and at the time of property sale distributions an amount
sufficient for it to pay the 8% coupon on the Series A Preferred Shares and then
any remaining amounts left for distribution to redeem a portion or all of the
Series A Preferred Shares.
After all of the Series A Preferred Shares have been redeemed ($19.5 million),
future distributions are split between Metra Partners and IRI, with Metra
Partners receiving 70% of such distribution and Innovo Realty, Inc. receiving
the balance. In addition, IRI. receives a quarterly sub-asset management fee of
$85,000.
IRI may also be liable to the holders of the Series A Preferred Shares for the
breach of certain covenants, including, but not limited to, failure (i) to
deposit distributions from the partnerships into a sinking fund which funds are
to be distributed to the holders of the Preferred Shares as a dividend or
redemption of Series A Preferred Shares or (ii) to enforce its rights to receive
distributions from the partnerships.
Innovo Group has not given accounting recognition to the value of its investment
in the Limited Partnerships, because Innovo Group has determined that the asset
is contingent and will only have value to the extent that cash flows from the
operations of the properties or from the sale of underlying assets is in excess
of the 8% coupon and redemption of the Series A Preferred Shares. Innovo Group
is obligated to pay the 8% coupon and redeem the Series A Preferred Shares from
its partnership distributions, prior to Innovo Group being able to recover the
underlying value of its investment. Additionally, Innovo Group has determined
that the Series A Preferred Shares will not be accounted for as a component of
equity as the shares are redeemable outside of Innovo Group's control. No value
has been ascribed to the Series A Preferred Shares for financial reporting
purposes as Innovo Group is obligated to pay the 8% coupon or redeem the shares
only if Innovo Group receives cash flow from the Limited Partnerships adequate
to make the payments. Innovo Group has included the quarterly management fee
paid to IRI in other income using the accrual basis of accounting. During 2002
and 2003, IRI recorded $329,000 and $173,000, respectively, as management fee
income. As of November 29, 2003, $175,000 was due to Innovo Group representing
unpaid sub-management fees.
194,000 shares of the Series A Preferred Shares remain outstanding and
redeemable at November 29, 2003 and the cumulative amount of the unpaid 8%
coupon aggregated $822,000. Such amount has not been recorded as an obligation
by Innovo Group as the funds had not been received by IRI from the Limited
Partnerships.
F-14
6. Accounts Receivable
Accounts receivable consist of the following (in thousands):
2003 2002
-----------------------
Nonrecourse receivables assigned to factor, net of
advances $ 453 $ 307
Nonfactored accounts receivable 3,388 2,813
Allowance for customer credits and doubtful accounts (2,158) (383)
-----------------------
$ 1,683 $ 2,737
=======================
As of November 29, 2003, there were $600,000 of client recourse receivables
assigned to factor for which Innovo Group bears collection risk in the event of
non-payment by the customers.
CIT Commercial Services
On June 1, 2001, Innovo Group's subsidiaries, Innovo and Joe's, entered into
accounts receivable factoring agreements with CIT Commercial Services, a unit of
CIT Group, Inc. (CIT) which may be terminated with 60 days notice by CIT, or on
the anniversary date, by Innovo or Joe's. Under the terms of the agreements,
Innovo or Joe's has the option to factor receivables with CIT on a non-recourse
basis, provided that CIT approves the receivable in advance. Innovo or Joe's
may, at their option, also factor non-approved receivables on a recourse basis.
Innovo or Joe's continue to be obligated in the event of product defects and
other disputes, unrelated to the credit worthiness of the customer. Innovo or
Joe's has the ability to obtain advances against factored receivables up to 85%
of the face amount of the factored receivables. The agreement calls for a 0.8%
factoring fee on invoices factored with CIT and a per annum rate equal to the
greater of the Chase prime rate plus 0.25% or 6.5% on funds borrowed against the
factored receivables. On September 10, 2001, IAA entered into a similar
factoring agreement with CIT upon the same terms.
On or about August 20, 2002, Innovo Group's Innovo and Joe's subsidiaries each
entered into certain amendments to their respective factoring agreements, which
included inventory security agreements, to permit the subsidiaries to obtain
advances of up to 50% of the eligible inventory up to $400,000 each. According
to the terms of the agreements, amounts loaned against inventory are to bear an
interest rate equal to the greater of the bank's prime rate plus 0.75% or 6.5%
per annum.
On or about June 10, 2003, the existing financing facilities with CIT for these
subsidiaries were amended, to be effective as of April 11, 2003, primarily to
remove the fixed aggregate cap of $800,000 on their inventory security agreement
to allow for Innovo and Joe's to borrow up to 50% of the value of certain
eligible inventory calculated on the basis of the lower of cost or market, with
cost calculated on a first-in-first out basis. In connection with these
amendments, IAA, entered into an inventory security agreement with CIT based on
the same terms as Joe's and Innovo. IAA did not previously have an inventory
security agreement with CIT. Under the factoring arrangements, Innovo Group
through its subsidiaries may borrow up to 85% of the value of eligible factored
receivables outstanding. The factoring rate that Innovo Group pays to CIT to
factor accounts, on which CIT bears some or all of the credit risk, was lowered
to 0.4% and the interest rate associated with borrowings under the inventory
lines and factoring facility were reduced to the bank's prime rate. Innovo Group
has also established a letter of credit facility with CIT whereby Innovo Group
can open letters of credit, for 0.125% of the face value, with international and
domestic suppliers provided Innovo Group has availability on its inventory line
of credit. In addition, Innovo Group also may elect to factor with CIT its
receivables by utilizing an adjustment of the interest rate as set on a
case-by-case basis, whereby certain allocation of risk would be borne by Innovo
Group, depending upon the interest rate adjustment. Innovo Group records its
accounts receivables on the balance sheet net of receivables factored with CIT,
since the factoring of receivables is non-recourse to Innovo Group. Further, in
the event Innovo Group's loan balance with CIT exceeds the face value of the
receivables factored with CIT, Innovo Group records the difference between the
face value of the factored receivables and the outstanding loan balance as a
liability on Innovo Group's balance sheet as "Due to Factor". At November 29,
2003, Innovo Group's loan balance with CIT was $8,786,000 and Innovo Group had
$8,536,000 of factored receivables with CIT. At November 29, 2003, an aggregate
amount of $2,149,000 of unused letters of credit were outstanding. Cross
guarantees were executed by and among the subsidiaries, Innovo, Joe's, and IAA
and Innovo Group entered into a guarantee for its subsidiaries' obligations in
connection with the amendments to the existing credit facilities.
In connection with the agreements with CIT, receivables and inventory are
pledged to CIT.
F-15
7. Property, Plant and Equipment
Property, plant and equipment consisted of the following (in thousands):
Useful Lives
(years) 2003 2002
-----------------------------------------------------------
Building, land and improvements 8-38 $ 1,679 $ 1,582
Machinery and equipment 5-10 394 258
Furniture and fixtures 3-8 760 212
Transportation equipment 5 13 13
Leasehold improvements 5-8 116 14
---------------------------
2,962 2,079
Less accumulated depreciation and amortization (895) (660)
---------------------------
Net property, plant and equipment $ 2,067 $ 1,419
===========================
Depreciation expense aggregated $232,000, $86,000 and $88,000 for the years
ended 2003, 2002 and 2001, respectively.
8. Intangible Assets
Identifiable intangible assets resulting from acquisitions consist of the
following (in thousands):
2003 2002
-------------------
License rights, net of $136 and $88 accumulated
amortization for 2003 and 2002, respectively $ 344 $392
Covenant not to compete, net of $250 and $155
accumulated amortization for 2003 and 2002, respectively -- 95
Customer relationship, net of $486 and $0 accumulated
amortization for 2003 and 2002, respectively 12,714 --
-------------------
$13,058 $487
===================
Amortization expense related to the license rights, covenant not to compete,
customer relationships and acquired purchase orders total $991,000 $168,000 and
$75,000 for the years ended 2003, 2002 and 2001, respectively. Aggregate
amortization expense will be approximately $1,368,000, $1,368,000, $1,368,000,
$1,368,000, $1,368,000 and $6,218,000 for fiscal years ending November 29, 2004
through November 30, 2008 and thereafter, respectively.
9. Long-Term Debt
Long-term debt consists of the following (in thousands):
2003 2002
---------------------
First mortgage loan on Springfield property $ 476 $ 558
Promissory note to Azteca (Blue Concepts) 21,800 --
Promissory note to Azteca (Knit Div. Note 1) 68 786
Promissory note to Azteca (Knit Div. Note 2) -- 2,043
---------------------
Total long-term debt $22,344 $3,387
Less current maturities 168 756
---------------------
Total long-term debt $22,176 $2,631
=====================
First Mortgage Loan on Springfield, Tennessee property
The first mortgage loan is collateralized by a first deed of trust on real
property in Springfield, Tennessee (with a carrying value of $1.2 million at
November 29, 2003), and by an assignment of key-man life insurance on the
President of Innovo in the amount of $1 million. The loan bears interest at
2.75% over the lender's prime rate per annum (which was 6.75% at November 29,
2003 and 7.50% at November 30, 2002) and requires monthly principal and interest
payments of $9,900 through February 2008. The loan is also guaranteed by the
Small Business Administration (SBA). In exchange for the SBA guarantee, Innovo
Group and certain subsidiaries and the
F-16
President of Innovo have also agreed to act as guarantors for the obligations
under the loan agreement.
Promissory Note to Azteca in connection with Blue Concept Division Acquisition
In connection with the purchase of the Blue Concept Division from Azteca, IAA
issued a seven-year unsecured, convertible promissory note for $21.8 million.
The Blue Concept Note bears interest at a rate of 6% and requires payment of
interest only during the first 24 months and then is fully amortized over the
remaining five-year period. The terms of the transaction further allow Innovo
Group, upon shareholder approval, to convert a portion of the Blue Concept Note
into equity through the issuance of 3,125,000 shares of common stock valued at
the greater of $4.00 per share or the market value of Innovo Group's common
stock on the day prior to the date of the shareholder meeting at which approval
for this conversion is sought and up to an additional 1,041,667 shares upon the
occurrence of certain future contingencies relating to Innovo Group's stock
price for the thirty day period ending March 6, 2005. Presently, a special
stockholder meeting is scheduled for March 5, 2004 to vote on the approval of
this conversion of the Blue Concept Note into equity. In the event shareholder
approval is obtained, the Blue Concept Note will be reduced by an amount equal
to the product of the Conversion Price and 3,125,000, so long as the principal
amount of the Blue Concept Note is not reduced below $9.3 million and the shares
issued pursuant to the conversion will be subject to certain lock-up periods.
The Blue Concept Note is subject to further reduction as a result of other
events. See Note 3.
Promissory Notes to Azteca in connection with acquisition of Knit Division
In connection with the acquisition of the Knit Division from Azteca (see Note
3), Innovo Group issued promissory notes in the face amounts of $1.0 million and
$2.6 million, which bear interest at 8.0% per annum and require monthly payments
of $20,000 and $53,000, respectively. The notes have a five-year term and are
unsecured.
At the election of Azteca, the balance of the promissory notes may be offset
against monies payable by Azteca or its affiliates to Innovo Group for the
exercise of issued and outstanding stock warrants that are owned by Azteca or
its affiliates, including Commerce. During 2003, Azteca offset $2.1 million in
face amount of the notes in connection with the exercise of 1 million warrants
for Innovo Group common stock.
Principal maturities of long-term debt, assuming none of the Blue Concept Note
is converted into equity, as of November 29, 2003 are as follows (in thousands):
2004 $ 168
2005 1,355
2006 4,035
2007 4,284
2008 4,500
Thereafter 8,002
--------
Total $ 22,344
========
F-17
10. Income Taxes
The provision (credit) for domestic and foreign income taxes is as follows:
(in thousands)
---------------------------------------------------------
2003 2002 2001
---------------- ----------------- ----------------
Current:
Federal $ -- $ -- $ --
State 27 94 89
Foreign 17 46 --
---------------- ----------------- ----------------
44 140 89
Deferred:
Federal -- -- --
State -- -- --
Foreign -- -- --
---------------- ----------------- ----------------
-- -- --
---------------- ----------------- ----------------
Total $ 44 $ 140 $ 89
================ ================= ================
The source of income (loss) before the provision for taxes is as follows:
Year Ended
(in thousands)
-------------------------------------------
2003 2002 2001
------- ---- -----
Federal $(7,259) $599 $(529)
Foreign (1,014) 113 --
------- ---- -----
Total $(8,273) $712 $(529)
======= ==== =====
Net deferred tax assets result from the following temporary differences between
the book and tax bases of assets and liabilities at (in thousands):
2003 2002
------------------------
Deferred tax assets:
Allowance for doubtful accounts $ -- $ 102
Inventory 234 310
Benefit of net operating loss carryforwards 7,411 13,129
Capital loss carryfowards 280 280
Amortization of intangibles (9) (77)
Other 282 174
------------------------
Gross deferred tax assets 8,198 13,918
Valuation allowance (8,198) (13,918)
------------------------
Net deferred tax assets $ -- $ --
========================
F-18
The reconciliation of the effective income tax rate to the federal statutory
rate for the years ended is as follows:
Year Ended
(in thousands)
-------------------------------------
2003 2002 2001
----------- --------- --------
Computed tax provision (benefit) at the statutory rate (34%) (34%) (34%)
State income tax -- 13 18
Foreign taxes in excess of statutory rate -- 2 --
Utilization of unbenefitted net operating loss carryforwards -- 45 --
Change in valuation allowance 34 16 34
-------------------------------------
0% 20% 18%
=====================================
Innovo Group has consolidated net operating loss carryforwards of approximately
$20.8 million expiring through 2023. Such net operating loss carryforwards have
been reduced as a result of "changes in control" as defined in Section 382 of
the Internal Revenue Code. Such limitation has had the effect of limiting annual
usage of the carryforwards in future years. Additional changes in control in
future periods could result in further limitations of Innovo Groups's ability to
offset taxable income. Management has determined that realization of the net
deferred tax assets does not meet the more likely than not criteria. As a
result, a valuation allowance has been provided for.
F-19
11. Stockholders' Equity
Private Placements and Stock Issuances
In fiscal 2003, Innovo Group consummated five private placements of its common
stock resulting in net proceeds of approximately $17,540,000, after deducting
commissions. During its first private placement completed on March 19, 2003,
Innovo Group issued 165,000 shares of common stock to 17 accredited investors at
$2.65 per share, raising net proceeds of approximately $407,000. During its
second private placement completed on March 26, 2003, Innovo Group issued 63,500
shares of common stock to 5 accredited investors at $2.65 per share, raising net
proceeds of approximately $156,000. During its third private placement completed
on July 1, 2003, Innovo Group issued 2,835,000 shares to 34 accredited investors
at $3.33 per share, raising net proceeds of approximately $8,751,000. As part of
this private placement, and in addition to commissions paid, warrants to
purchase 300,000 shares of common stock at $4.50 per share were issued to the
placement agent, Sanders Morris Harris, Inc. During its fourth private placement
completed on August 29, 2003, Innovo Group issued 175,000 shares of common stock
to 5 accredited investors at $3.62 per share, raising net proceeds of
approximately $592,000. As part of this private placement, and in addition to
commissions paid, warrants to purchase 17,500 shares of common stock at $3.62
per share were issued to the placement agent, Pacific Summit Securities. During
its fifth private placement funded on or before November 29, 2003, but completed
on December 1, 2003, Innovo Group issued 2,997,000 shares of common stock to 14
accredited investors at $3.00 per share and warrants to purchase an additional
599,333 shares of common stock at $4.00 per share to certain of these investors,
raising net proceeds of approximately $10,704,000.
During fiscal 2002, Innovo Group did not issue any shares of common stock.
During fiscal 2002, Innovo Group issued preferred shares in association with the
purchase of limited partnerships in certain real estate properties. See Note 5.
During fiscal 2001, in connection with the Acquisition of the Knit Division from
Azteca (see Note 3), Innovo Group issued 700,000 shares of its common stock, and
in connection with the acquisition of the Joe's Jeans license from JD Design,
Innovo Group issued 500,000 shares of its common stock and a warrant to purchase
250,000 shares of its common stock at a price of $1.00 per share, provided
certain sales and gross margin targets are met.
F-20
Warrants
Innovo Group has issued warrants in conjunction with various private placements
of its common stock, debt to equity conversions, acquisitions and in exchange
for services. All warrants are currently exercisable. As of November 29, 2003,
outstanding common stock warrants are as follows:
Exercise Price Shares Issued Expiration
- ------------------------------------------------------------------------------
$2.10 300,000 October 2000 October 2005
$1.50 100,000 March 2001 March 2004
$2.00 100,000 March 2001 March 2004
$2.50 50,000 March 2001 March 2004
$0.90 20,000 December 2001 December 2005
$2.75 100,000 May 2002 May 2004
$2.50 75,000 June 2002 May 2004
$3.00 75,000 June 2002 May 2004
$4.50 300,000 June 2003 June 2008
$3.62 17,500 August 2003 August 2008
$4.00 599,333 November 2003 November 2008
-------------
1,736,833
=============
During fiscal 2000, Innovo Group issued 1,787,365 shares of common stock and
warrants to purchase an additional 1,500,000 shares of common stock at $2.10 per
share to the Sam Furrow and Jay Furrow (collectively, the Furrow Group) in
exchange for the Furrow Group's assumption of $1,000,000 of Innovo Group's debt
and the cancellation of $1,000,000 of indebtedness owed to members of the Furrow
Group. The issuance of the shares of common stock and warrants resulted in a
$1,095,000 charge for the extinguishment of debt. During fiscal 2003, the
warrants issued to the Furrow Group to purchase an additional 1,500,000 shares
were exercised pursuant to a cashless exercise provision contained in the
warrants and the members of the Furrow Group were issued an aggregate of
1,061,892 shares of common stock.
During fiscal 2000, Innovo Group issued warrants to purchase an additional
102,040 shares at $1.75 per share to private investors for $179,000. Commerce
received warrants to purchase an additional 3,300,000 shares of common stock
with warrants for 3,000,000 shares of common stock exercisable over a three-year
period at $2.10 per share and the remaining warrants for 300,000 shares of
common stock subject to a two-year vesting period and exercisable over a
five-year period at $2.10 per share. The proceeds from the sale of these
warrants were used to purchase inventory and services from Commerce and its
affiliates and to repay certain outstanding debt.
In October and November 2000, Innovo Group issued warrants to purchase an
additional 1,700,000 shares of common stock in private placements to JAML, LLC,
Innovation, LLC and Third Millennium Properties, Inc. (collectively, the
Mizrachi Group) for $1,700,000 in cash. During fiscal 2003, prior to the
scheduled expiration date, the warrants issued to the Mizrachi Group to purchase
an additional 1,696,875 shares were exercised pursuant to cashless exercise
provision contained in the warrants and the members of the Mizrachi Group were
issued an aggregate of 1,195,380 shares of common stock.
During fiscal 2001, Innovo Group issued a warrant related to the Joe's License
to purchase 250,000 shares of common stock at a price of $1.00 per share, in the
event that certain future sales and gross margin performance criteria are met.
The sales targets are $2 million, $4 million, $8 million and $15 million for
each of the years ended December 31, 2001, 2002, 2003, and 2004, respectively,
provided, that the sales have a minimum gross profit of 55%. In the event that
both net sales and gross margin targets are achieved in any one of the scheduled
years, JD Design will receive a warrants for 250,000 shares of Innovo Group
common stock with an exercise price of $1.00 per share, with a 4-year term and
equal-monthly vesting over the first 24 months. When a revenue target is
achieved, the warrants will be issued immediately following the year end of the
year in which the Net Sales Target is achieved and the vesting period and term
will commence immediately upon issuance. JD Designs will not be entitled to any
additional warrants if the Net Sales Targets are reached in more than one of the
scheduled years. This warrant has not been included in the table above as the
performance criteria has not been met.
During fiscal 2001, Innovo Group also issued warrants to a company in exchange
for certain services. Warrants to purchase 20,000, 100,000, 100,000 and 50,000,
shares exercisable at $0.90, $1.50, $2.00 and $2.50 per share, respectively,
which were vested on the date of issuance and have a term of three years, were
issued in exchange for services which are to be rendered over a four-year term.
During fiscal 2002, Innovo Group issued warrants to companies in exchange for
certain services. Warrants to purchase 100,000, 75,000 and 75,000 shares
exercisable at $2.75, $2.50 and $3.00 per share, respectively, which were vested
on the date of issuance and have a
F-21
term of two years, were issued in exchange for services to be rendered over
three, four and four year terms, respectively.
During fiscal 2003, Innovo Group issued warrants to its placement agents as
compensation pursuant to a private placement in August 2003 and other certain
investors on or before November 29, 2003. Innovo Group issued warrants to
purchase 300,000 shares of common stock at $4.50 per share, warrants to purchase
17,500 shares of common stock at $3.62 per share and warrants to purchase
599,333 shares at $4.00 per share.
During fiscal 2003, warrants to purchase an aggregate of 5,298,915 shares were
exercised pursuant to cashless exercise provisions contained in the warrants and
an aggregate of 3,597,938 shares of common stock was issued in fiscal 2003.
During fiscal 2003, Commerce elected to exercise warrants to purchase 1,000,000
shares and in lieu of payment therefore, Commerce elected to offset $2.1 million
in debt due from Innovo Group pursuant to certain promissory notes.
As of November 29, 2003, 4,500,000 shares of common stock of Innovo Group were
reserved for the exercise of warrants, options, conversion of debt.
Stock Based Compensation
In March 2000, Innovo Group adopted the 2000 Employee Stock Option Plan ("2000
Employee Plan"). In May, 2003, the 2000 Employee Plan was amended to provide for
incentive and nonqualified options for up to 3,000,000 shares of common stock
that may be granted to employees, officers, directors and consultants. The 2000
Employee Plan limits the number of shares that can be granted to any employee in
one year to 1,250,000 and the total market value of common stock that becomes
exercisable for the first time by any grantee during a calendar year. Exercise
price for incentive options may not be less than the fair market value of Innovo
Group's common stock on the date of grant and the exercise period may not exceed
ten years. Vesting periods and option terms are determined by the Board of
Directors. The 2000 Employee Plan will expire in March 2010.
In September 2000, Innovo Group adopted the 2000 Director Stock Incentive Plan
("2000 Director Plan"), under which nonqualified options for up to 500,000
shares of common stock may be granted. At the first annual meeting of
stockholders following appointment to the board and annually thereafter during
their term, each director will receive options for common stock with aggregate
fair value of $10,000. These options are exercisable beginning one year from the
date of grant and expire in ten years. Exercise price is set at 50% of the fair
market value of the common stock on the date of grant. The discount is lieu of
cash director fees. The 2000 Director Plan will expire in September 2010.
The following summarizes option grants to members of the Board of Directors for
the fiscal years 2001 through 2003:
Number of
Options Exercise Price
------- --------------
2001 102,564 $0.39
2002 40,000 $1.00
2003 30,768 $1.30
F-22
Stock option activity, including grants to members of the Board of Directors,
during the periods indicated is as follows:
2003 2002 2001
------------------------- -------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
---------- ---------- ---------- ---------- ---------- ----------
Outstanding at beginning of
year 1,257,981 $ 2.07 1,517,981 $ 2.33 685,417 $ 3.89
Granted 1,330,768 2.74 40,000 1.00 832,564 1.06
Exercised 50,000 1.64 -- -- -- --
Forfeited (185,417) (3.93) (300,000) (3.28) -- --
---------- ---------- ---------- ---------- ---------- ----------
Outstanding at end of year 2,353,332 $ 2.31 1,257,981 $ 2.07 1,517,981 $ 2.33
Exercisable at end of year 1,686,665 1,220,452 1,305,443
Weighted average per option
fair value of options granted
during the year $ 1.21 $ 1.26 $ 0.59
Weighted average contractual
life remaining 6.1 years 3.7 years 3.4 years
Exercise prices for options outstanding as of November 29, 2003 are as follows:
Number of
Options Exercise Price
-----------------------------------
102,564 $0.39
290,000 $1.00
480,768 $1.25 - $1.30
280,000 $2.40 - $2.60
1,000,000 $2.86
200,000 $4.75
-----------
2,353,332
===========
F-23
Earnings (Loss) Per Share
Earnings (loss) per share are computed using weighted average common shares and
dilutive common equivalent shares outstanding. Potentially dilutive securities
consist of outstanding options and warrants. A reconciliation of the numerator
and denominator of basic earnings per share and diluted earnings per share is as
follows:
Year Ended
(in thousands, except per share data)
----------------------------------------
2003 2002 2001
-------- ------- --------
Basic EPS Computation:
Numerator $ (8,317) $ 572 $ (618)
Denominator:
Weighted average common shares
outstanding 17,009 14,856 14,315
-------- ------- --------
Total shares 17,009 14,856 14,315
-------- ------- --------
Basic EPS $ (0.49) $ 0.04 $ (0.04)
======== ======= ========
Diluted EPS Calculation:
Numerator $ (8,317) $ 572 $ (618)
Denominator:
Weighted average common shares
outstanding 17,009 14,856 14,315
Incremental shares outstanding from
assumed exercise of options and
warrants -- 1,253 --
-------- ------- --------
Total shares 17,009 16,109 14,315
-------- ------- --------
Diluted EPS $ (0.49) $ 0.04 $ (0.04)
======== ======= ========
Potentially dilutive options and warrants in the aggregate of 4,090,000 and
8,397,000 in fiscal 2003 and fiscal 2001, respectively, have been excluded from
the calculation of the diluted loss per share as their effect would have been
anti-dilutive.
12. Commitments and Contingencies
Leases
Innovo Group leases certain properties, buildings, office spaces, showrooms and
equipment. Certain leases contain provisions for renewals and escalations.
Rental expense for the years ended November 29, 2003, November 30, 2002, and
December 1, 2001 was approximately $367,000, $136,000, and $107,000,
respectively. During September 2000, Innovo Group entered into a lease agreement
with a related party, which is owned by Innovo Group's Chairman, Sam Furrow, to
lease office space in Knoxville, Tennessee. The lease rate is $3,500 per month
for approximately 5,000 square feet of office space, has a ten-year term and is
cancelable with six months written notice.
Innovo Group also utilizes office space and office equipment under a cost
sharing arrangement with Commerce and its affiliates. Under the terms of the
verbal arrangement, Innovo Group is allocated a portion of costs incurred by
Commerce and its affiliates for rent, insurance, office supplies, certain
employees' wages and benefits, security and utilities.
Expenses for the years ended 2003, 2002 and 2001 under this arrangement were
$343,000, $25,000, and $25,000, respectively.
F-24
12. Commitments and Contingencies (continued)
The future minimum rental commitments under operating leases as of November 29,
2003 are as follows (in thousands):
2004 $ 616
2005 568
2006 500
2007 411
2008 401
Thereafter 316
-----------
Total future minimum lease payments $ 2,812
-----------
License Agreements
Joe's Jeans
On February 7, 2001, in connection with the acquisition of the Joe's Jeans
license rights, Innovo Group entered into a ten- year license agreement that
requires the payment of a royalty based upon 3% of net sales, subject to
additional royalty amounts in the event certain sales and gross profit
thresholds are met on an annual basis.
Bongo(R).
On March 26, 2001, Innovo Group entered into a license agreement with IP
Holdings LLC, the licensor of the Bongo(R) mark, pursuant to which Innovo Group
obtained the right to design, manufacture and distribute bags, belts and small
leather/pvc goods bearing the Bongo(R) trademark. The agreement was amended on
July 26, 2002 that extended the term of the license agreement commencing as of
April 1, 2003 and continuing through March 31, 2007, unless the Bongo(R) brand
is sold in its entirety, in which case the license agreement would terminate
immediately. Innovo Group pays a 5% royalty and a 2% advertising fee on the net
sales of Innovo Group's goods bearing the Bongo(R) trademark.
Mattel, Inc.
In fiscal 2002, IAA entered into a five-year license agreement with Mattel, Inc.
to produce Hot Wheels(R) branded adult apparel and accessories in the United
States, Canada and Puerto Rico. Under the terms of the license agreement, IAA
may produce apparel and accessory products targeted to men and women in the
junior and contemporary markets. The products lines may include active wear,
sweatshirts and pants, outerwear, t-shirts, "baby tees" for women, headwear,
bags, backpacks and totes, which will be emblazoned with the Hot Wheels(R) flame
logo.
IAA may terminate the agreement in any year by paying the remaining balance of
that years minimum royalty guarantees plus the subsequent years minimum royalty
guarantees. Royalties paid by IAA earned in excess of the minimum royalty
requirements for any one given year, may be credited towards the shortfall
amount of the minimum required royalties in any subsequent period during the
term of the license agreement.
According to the terms of the agreement, IAA has the right to sublicense the
accessory product's category to Innovo. The agreement calls for a royalty rate
of seven percent and a two percent advertising fee on the net sales of goods
bearing the Hot Wheels(R) trademark. In the event IAA defaults upon any material
terms of the agreement, the licensor shall have the right to terminate the
agreement. As of November 29, 2003, Innovo Group had not yet commenced sales of
the Hot Wheels(R) apparel and accessory products. Innovo Group has accrued for
the minimum royalties under the terms of the agreement.
Bow Wow
On August 1, 2002, IAA entered into an exclusive 42-month worldwide agreement
for the Bow Wow license, granting IAA the right to produce and market products
bearing the mark and likeness of the popular stage and screen performer. The IAA
division has created and market a wide range of apparel and coordinating
accessories for boys and plans on creating and marketing a wide range of apparel
and coordinating accessories for girls. The license agreement between IAA,
Bravado International Group, the agency with the master license rights to Bow
Wow, and LBW Entertainment, Inc. calls for the performer to make at least one
public appearance every six months during the term of the agreement to promote
the Bow Wow products, as well as use his best efforts to promote and market
these products on a daily basis.
Additional terms of the license agreement allows IAA to market boys and girls
products bearing the Bow Wow brand to all distribution channels, the right of
first refusal on all other Bow Wow related product categories during the term of
the license agreement, and the
F-25
right of first of refusal on proposed transactions by the licensor with third
parties upon the expiration of the agreement. The agreement calls for IAA to pay
an eight percent royalty on the nets sales of goods bearing Bow Wow related
marks. In the event IAA defaults upon any material terms of the agreement, the
licensor shall have the right to terminate the agreement. Furthermore, IAA has
the right to sublicense the accessory product's category to Innovo.
Fetish(TM)
On February 13, 2003, IAA entered into a 44 month exclusive license agreement
for the United States, its territories and possessions with the recording artist
and entertainer Eve for the license of the Fetish(TM) trademark for use with the
production and distribution of apparel and accessory products. IAA has
guaranteed minimum net sales obligations of $8,000,000 in the first 18 months of
the agreement, $10,000,000 in the following 12 month period and $12,000,000 in
the 12 month period following thereafter. According to the terms of the
agreement, IAA is required to pay an 8% royalty and a 2% advertising fee on the
net sales of products bearing the Fetish(TM) logo. In the event IAA does not
meet the minimum guaranteed sales, IAA will be obligated to make royalty and
advertising payments equal to the minimum guaranteed sales multiplied by the
royalty rate of 8% and the advertising fee of 2%. IAA also has the right of
first refusal with respect to the license rights for the Fetish(TM) trademark in
the apparel and accessories category upon the expiration of the agreement,
subject to meeting certain sales performance targets during the term of the
agreement. Additionally, IAA has the right of first refusal for the apparel and
accessory categories in territories in which it does not currently have the
license rights for the Fetish(TM) trademark.
In connection with the launch and subsequent promotion of the Fetish(TM) brand,
IAA incurrent certain advertising and promotion expenses in excess of the
required 2% advertising royalty, which the licensor has agreed represent a
prepayment against future advertising royalties under the license. Accordingly,
Innovo Group has recorded approximately $985,000 of advertising expenses as
prepaid royalties in the accompanying balance sheet.
Innovo Group displays names and logos on its products under license agreements
that require royalties ranging from 3% to 8% of sales and required annual
advance payments (included in prepaid expenses) and certain annual minimum
payments. Royalty expense was $1,338,000, $463,000, and $132,000 for the years
ending 2003, 2002, and 2001, respectively.
The future minimum royalty commitments under royalty agreements as of November
29, 2003 are as follows (in thousands):
2004 $ 832
2005 1,188
2006 885
2007 417
-----------
Total future minimum royalty payments $ 3,322
-----------
Litigation
Innovo Group is involved from time to time in routine legal matters incidental
to its business. In the opinion of Innovo Group's management, resolution of such
matters will not have a material effect on its financial position or results of
operations.
13. Segment Disclosures
Current Operating Segments
During fiscal 2003, Innovo Group operated in two segments, accessories and
apparel. The Accessories segment represents Innovo Group's historical line of
business as conducted by Innovo Group. The apparel segment is comprised of the
operations of Joe's and IAA, both of which began in fiscal 2001, as a result of
acquisitions. Innovo Group's real estate operations and real estate transactions
of Innovo Group's Leasall and IRI subsidiaries do not require substantial
management oversight and have therefore been treated as "other" for purposes of
segment reporting. The operating segments have been classified based upon the
nature of their respective operations, customer base and the nature of the
products sold.
Innovo Group evaluates performance and allocates resources based on gross
profits, and profit or loss from operations before interest and income taxes.
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies.
F-26
Information for each reportable segment during the three years ended November
29, 2003, is as follows (in thousands):
November 29, 2003 Accessories Apparel Other (A) Total
-----------------------------------------------------
(in thousands)
Net Sales $14,026 $69,103 $ -- $83,129
Gross Profit 3,095 9,881 -- 12,976
Depreciation & Amortization 39 1,087 101 1,227
Interest Expense 214 946 56 1,216
Segment Assets 4,218 33,571 8,576 46,365
Expenditures for Segment Assets 186 563 146 895
(A) Other includes corporate expenses and assets and expenses related to real
estate transactions.
November 30, 2002 Accessories Apparel Other (A) Total
-----------------------------------------------------
(in thousands)
Net Sales $12,072 $17,537 $ -- $29,609
Gross Profit 3,393 6,144 -- 9,537
Depreciation & Amortization 21 183 52 256
Interest Expense 140 339 59 538
Segment Assets 3,820 9,343 1,980 15,143
Expenditures for Segment Assets 70 97 455 622
(A) Other includes corporate expenses and assets and expenses related to real
estate transactions.
December 1, 2001 Accessories Apparel Other (A) Total
-----------------------------------------------------
(in thousands)
Net Sales $ 5,642 $ 3,650 $ -- $ 9,292
Gross Profit 1,749 1,208 -- 2,957
Depreciation & Amortization 45 35 87 167
Interest Expense 32 79 100 211
Segment Assets 2,705 6,658 884 10,247
Expenditures for Segment Assets 32 -- 29 61
(A) Other includes corporate expenses and assets and expenses related to real
estate transactions.
F-27
Operations by Geographic Areas
Information about Innovo Group's operations in the United States and Asia is
presented below (in thousands). Inter- company revenues and assets have been
eliminated to arrive at the consolidated amounts.
Adjustments &
United States Asia Eliminations Total
------------- -------- ------------- --------
(in thousands)
Novmeber 29, 2003
Sales $ 80,111 $ 3,018 $ -- $ 83,129
Intercompany sales 959 -- (959) --
-------- -------- -------- --------
Total sales $ 81,070 $ 3,018 $ (959) $ 83,129
======== ======== ======== ========
Income from operations $ (6,964) $ (1,093) $ 541 $ (7,516)
======== ======== ======== ========
Total assets $ 48,386 $ (743) $ (1,278) $ 46,365
======== ======== ======== ========
Novmeber 30, 2002
Sales $ 27,707 $ 1,902 $ -- $ 29,609
Intercompany sales 2,228 -- (2,228) --
-------- -------- -------- --------
Total sales $ 29,935 1,902 $ (2,228) $ 29,609
======== ======== ======== ========
Income from operations $ 1,558 $ 115 $ (484) $ 1,189
======== ======== ======== ========
Total assets $ 13,693 $ 1,974 $ (524) $ 15,143
======== ======== ======== ========
December 1, 2001
Sales $ 9,292 $ -- $ -- $ 9,292
Intercompany sales -- -- -- --
-------- -------- -------- --------
Total sales $ 9,292 $ -- $ -- $ 9,292
======== ======== ======== ========
Income from operations $ (399) $ -- $ -- $ (399)
======== ======== ======== ========
Total assets $ 10,247 $ -- $ -- $ 10,247
======== ======== ======== ========
14. Related Party Transactions
Innovo Group has adopted a policy requiring that any material transaction
between Innovo Group and persons or entities affiliated with officers, directors
or principal stockholders of Innovo Group be on terms no less favorable to
Innovo Group than reasonably could have been obtained in arms' length
transactions with independent third parties.
Anderson Stock Purchase Agreement
Pursuant to a Stock Purchase Right Award granted in February 1997, Innovo
Group's president purchased 250,000 shares of common stock (the Award Shares)
with payment made by the execution of a non-recourse note (the Note) for the
exercise price of $2.81 per share ($703,125 in the aggregate). The Note was due,
without interest, on April 30, 2002, and was collateralized by the 1997 Award
Shares. The Note may be paid or prepaid (without penalty) by (i) cash, or (ii)
the delivery of Innovo Group's common stock (other than the Award Shares) held
for a period of at least six months, which shares would be credited against the
Note on the basis of the closing bid price for the common stock on the date of
delivery.
On July 18, 2002, the Board of Directors voted in favor of extending the term of
Note until April 30, 2005. The remaining provisions of the Note remained the
same. As of November 29, 2003, $703,125 remains outstanding under this
promissory note.
Crossman Loan
On February 7, 2003 and on February 13, 2003, Innovo Group entered into a loan
agreement with Marc Crossman, then a member of our Board of Directors and now
also our Chief Financial Officer. The loan was funded in two phases of $250,000
each on February 7, 2003 and February 13, 2003 for an aggregate loan value of
$500,000. In the event of default, each loan is collateralized by 125,000 shares
of Innovo Group common stock as well as a general unsecured claim on the assets
of Innovo Group, subordinate to existing lenders. Each loan matures six months
and one day from the date of its respective funding, at which point the
principal amount loaned and any unpaid accrued interest is due and payable in
full without demand. The loan carries an 8% annualized interest rate with
interest payable in equal monthly installments. The loan may be repaid by us at
any time during the term of the loan without penalty. Further, prior to the
maturity of the loan and the original due dates, Innovo Group elected, at its
sole option, to extend the term of the loan for an additional period of six
months and one day. Innovo Group's disinterested directors approved the loan
from Mr. Crossman. Subsequent to the year ended November 29, 2003 and prior to
the maturity of the loans in February 2004, the parties agreed to extend the
term of the loan for an additional period of ninety days. Further, pursuant to
the extension of the loan, the loan was amended to provide Mr. Crossman with the
F-28
sole and exclusive option to continue to extend the term of the loan for three
additional ninety day periods by giving notice of such extension on or before
the due date of the loan.
Purchases of Goods and Services
The Innovo, Joe's and IAA subsidiaries purchased goods and distribution and
operational services from Commerce and its affiliates in fiscal 2003, fiscal
2002 and fiscal 2001. The services purchased included but were not limited to
accounts receivable collections, certain general accounting functions, inventory
management and distribution logistics. The following schedule represents
Innovo's, Joe's and IAA's purchases from Commerce and its affiliates during
fiscal 2003, fiscal 2002 and fiscal 2001 (in thousands):
Innovo
-----------------------------------------
Year Ended
(in thousands)
-----------------------------------------
2003 2002 2001
-----------------------------------------
Goods $ 2,898 $ 3,317 $ 2,320
Distribution Services 615 644 362
Operational Services 228 203 112
-----------------------------------------
Total $ 3,741 $ 4,164 $ 2,794
=========================================
Joe's IAA
---------------------------------- -----------------------------------
Year Ended Year Ended
(in thousands) (in thousands)
---------------------------------- -----------------------------------
2003 2002 2001 2003 2002 2001
---------------------------------- -----------------------------------
Goods $2,195 $6,102 $1,102 $41,798 $6,171 $1,794
Distribution Services 127 107 20 -- -- --
---------------------------------- -----------------------------------
Total $2,322 $6,209 $1,122 $41,798 $6,171 $1,794
================================== ===================================
Additionally, Innovo Group is charged an allocation expense from Commerce for
expenses associated with Innovo Group occupying space in Commerce's Commerce,
California facility and the use of general business machines and communication
services. These expenses totaled approximately $343,000 for fiscal 2003 and
$25,000 for fiscal 2002 and fiscal 2001. Innovo Group also utilizes office space
and office equipment under a cost sharing arrangement with Commerce and its
affiliates.
Innovo Group believes that all the transactions conducted between Innovo Group
and Commerce were completed on terms that were competitive and at market rates.
Included in due to related parties is $390,000 and $4,159,000 at November 29,
2003 and November 30, 2002, respectively, relating to amounts due to Commerce
and affiliated entities for goods and services described above.
Azteca Production International, Inc.
In the third quarter of fiscal 2001, Innovo Group acquired Azteca Productions
International, Inc.'s Knit Division and formed the subsidiary Innovo Azteca
Apparel, Inc. Pursuant to equity transactions completed in fiscal 2000, the
principals of Azteca Production International, Inc. became affiliates of Innovo
Group. Innovo Group purchased the Division's customer list, the right to
manufacture and market all of the Knit Division's current products and entered
into certain non-compete and non- solicitation agreements and other intangible
assets associated with the Knit Division. As consideration, Innovo Group issued
to Azteca, 700,000 shares of Company's common stock valued at $1.27 per share
based upon the closing price of the common stock on August 24, 2001, and
promissory notes in the amount of $3.6 million.
As part of the acquisition of the Blue Concept Division from Azteca in July
2003, IAA and AZT entered into a two-year, renewable, non-exclusive Supply
Agreement for products to be sold by the Blue Concept Division. In addition to
the customary obligations, the Supply Agreement requires that AZT will receive
payment immediately upon receipt of invoices for our purchase orders and that
AZT will charge a per unit price such that IAA will have a guaranteed profit
margin of 15 percent on a "per unit" basis. In addition, AZT is responsible for
all quality defects in merchandise manufactured.
IAA also utilizes AZT to distribute goods manufactured under the Supply
Agreement, and temporarily has AZT invoice and collect payments from AEO, for
goods manufactured in Mexico, until such time that we can establish a Mexican
subsidiary to invoice and collect payments from AEO.
F-29
JD Design, LLC
Pursuant to the license agreement entered into with JD Design, LLC under which
Innovo Group obtained the license rights to Joe's Jeans, Joe's is obligated to
pay a 3% royalty on the net sales of all products bearing the Joe's Jeans or JD
trademark or logo. For fiscal 2003, fiscal 2002 and fiscal 2001, this amount
totaled $339,000, $277,000 and $46,000, respectively. Included in due to related
parties on our balance sheet are accrued royalties of $189,000 and $91,000 for
fiscal 2003 and fiscal 2002, respectively.
15. Quarterly Results of Operations (Unaudited)
The following is a summary of the quarterly results of operations for the three
years ended November 29, 2003, November 30, 2002 and December 1, 2001,
respectively: (in thousands, except per share amounts)
2003 Quarter Ended
(in thousands, except per share data)
------------------------------------------------------------
March 1 May 31 August 30 November 29
-------- -------- --------- -----------
Net Sales $ 11,915 $ 12,013 $ 21,906 $ 37,295
Gross Profit 3,310 3,456 3,893 2,317
Income (Loss) before Income Taxes 345 (503) (2,288) (5,827)
Net Income (Loss) 282 (493) (2,312) (5,794)
Net Income (Loss) per Share:
Basic $ 0.02 $ (0.03) $ (0.14) $ (0.34)
Diluted $ 0.02 $ (0.03) $ (0.14) $ (0.34)
2002 Quarter Ended
(in thousands, except per share data)
------------------------------------------------------------
March 2 June 1 August 31 November 30
-------- -------- --------- -----------
Net Sales $ 3,201 $ 6,802 $ 10,148 $ 9,458
Gross Profit 912 2,345 3,357 3,156
Income (Loss) before Income Taxes (475) 223 932 32
Net Income (Loss) (496) 207 820 41
Net Income (Loss) per Share:
Basic $ (0.03) $ 0.01 $ 0.06 $ 0.00
Diluted $ (0.03) $ 0.01 $ 0.05 $ 0.00
16. Employee Benefit Plans
On December 1, 2002, Innovo Group established a tax qualified defined
contribution 401(k) Profit Sharing Plan (the "Plan"). All employees who have
worked for Innovo Group for 30 consecutive days may participate in the Plan and
may contribute up to 100% of their salary to the plan. Innovo Group's
contributions may be made on a discretionary basis. All employees who have
worked 500 hours qualify for profit sharing in the event at the end of each year
Innovo Group decides to do so. Costs of the plan charged to operations were
$20,000 for the year ended November 29, 2003.
F-30
17. Other Income and Expense.
Other income and expense consist of the following:
Year Ended
(in thousands)
---------------------------
2003 2002 2001
---- ---- ----
Rental, real estate, and management fee income $366 $217 $71
Unrealized gain on foreign currency 154 -- --
Other items 6 18 13
---- ---- ----
Total other income $526 $235 $84
==== ==== ====
Rental expense $ 58 $ 43 $--
Unrealized loss on foreign currency -- 41 --
Other items 10 90 3
---- ---- ----
Total other expense $ 68 $174 $ 3
==== ==== ====
F-31
ITEM 16.2
Innovo Group Inc. and Subsidiaries
Schedule II
Valuation of Qualifying Accounts
Additions
Balance at Charged to
Beginning of Costs & Charged to Balance at End
Description Period Expenses Other Accounts Deductions of Period
- ------------------------------------------------------------------------------------------------------------------------------------
Allowance for customer credits and allowances:
Year ended November 29, 2003 $ 383,000 $ 1,775,000 $ -- $ -- $ 2,158,000
Year ended November 30, 2002 164,000 56,000 163,000 (A) -- 383,000
Year ended December 1, 2001 36,000 128,000 -- -- 164,000
Allowances for inventories:
Year ended November 29, 2003 105,000 4,088,000 -- -- 4,193,000
Year ended November 30, 2002 125,000 19,000 -- (39,000) 105,000
Year ended December 1, 2001 78,000 47,000 -- -- 125,000
Allowance for deferred taxes:
Year ended November 29, 2003 13,918,000 (5,720,000) -- -- 8,198,000
Year ended November 30, 2002 7,316,000 6,602,000 -- -- 13,918,000
Year ended December 1, 2001 6,032,000 1,284,000 -- -- 7,316,000
(A) Uncollected receivables written off, net of recoveries
End of Filing
F-32