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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the quarterly period ended June 30, 2001.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ____________ to _______________.
Commission file number 1-13669
TAG-IT PACIFIC, INC.
(Exact Name of Issuer as Specified in its Charter)
DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
21900 BURBANK BOULEVARD, SUITE 270
WOODLAND HILLS, CALIFORNIA 91367
(Address of Principal Executive Offices)
(818) 444-4100
(Issuer's Telephone Number)
Indicate by check whether the issuer: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes X No __
State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common Stock, par value $0.001
per share, 8,003,244 shares issued and outstanding as of August 13, 2001.
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TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q
PART I FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements...................................3
Consolidated Balance Sheets as of
June 30, 2001 (unaudited) and December 31, 2000.....................3
Consolidated Statements of Operations (unaudited) for the
Three Months and the Six Months Ended June 30, 2001 and 2000........4
Consolidated Statements of Cash Flows (unaudited) for
the Six Months Ended June 30, 2001 and 2000.........................5
Notes to the Consolidated Financial Statements......................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................9
Item 3 Quantitative and Qualitative Disclosures About Market Risk.........22
PART II OTHER INFORMATION
Item 1. Legal Proceedings..................................................22
Item 4. Submission of Matters to a Vote of Security Holders................22
Item 6. Exhibits and Reports on Form 8-K...................................22
Page 2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
Consolidated Balance Sheets
June 30, December
2001 31, 2000
--------------- -------------
Assets (unaudited)
Current Assets:
Cash and cash equivalents......................................... $ 197,625 $ 128,093
Due from factor................................................... 123,359 25,140
Trade accounts receivable, net.................................... 3,857,311 3,466,314
Trade accounts receivable, related parties........................ 10,522,058 9,041,752
Due from related parties.......................................... 821,043 513,614
Inventories....................................................... 19,107,663 19,868,160
Prepaid expenses and other current assets......................... 740,282 738,735
-------------- -------------
Total current assets.......................................... 35,369,341 $ 33,781,808
Property and Equipment, net of accumulated depreciation and
amortization...................................................... 2,997,845 3,755,127
Other assets........................................................ 2,422,704 1,562,539
-------------- -------------
Total assets........................................................ $ 40,789,890 $ 39,099,474
============== =============
Liabilities and Stockholders' Equity
Current Liabilities:
Bank overdraft.................................................... $ - $ 584,831
Line of credit.................................................... 10,990,257 9,956,436
Accounts payable.................................................. 8,828,061 8,228,677
Accrued expenses.................................................. 1,611,768 1,484,765
Accrued restructuring charges..................................... 386,678 -
Income taxes payable.............................................. - 66,942
Notes payable..................................................... 25,200 25,200
Subordinated notes payable to related parties..................... 3,618,458 882,970
Current portion of capital lease obligations...................... 307,716 250,403
-------------- -------------
Total current liabilities................................... 25,768,138 21,480,224
Capital lease obligations, less current portion..................... 15,729 113,046
Deferred income tax liability....................................... 113,335 113,335
Subordinated notes payable to related parties....................... - 2,601,470
-------------- -------------
Total liabilities........................................... 25,897,202 24,308,075
-------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, Series A $0.001 par value; 2,500,000 shares
authorized, no shares issued or outstanding................... - -
Convertible preferred stock Series B, $0.001 par value; 850,000
shares authorized; 850,000 shares issued and outstanding...... 1,400,000 1,400,000
Common stock, $0.001 par value, 30,000,000 shares authorized;
8,003,244 shares issued and outstanding at June 30, 2001;
7,863,244 at December 31, 2000................................ 8,004 7,864
Additional paid-in capital........................................ 12,274,570 11,737,810
Retained earnings................................................. 1,210,114 1,645,725
-------------- -------------
Total stockholders' equity ......................................... 14,892,688 14,791,399
-------------- -------------
Total liabilities and stockholders' equity ......................... $ 40,789,890 $ 39,099,474
============== =============
See accompanying notes to consolidated financial statements
Page 3
TAG-IT PACIFIC, INC.
Consolidated Statements of Operations
(unaudited)
Three Months Ended June 30, Six Months Ended June 30,
------------------------------- -----------------------------
2001 2000 2001 2000
-------------- ------------- ------------- -------------
Net sales $ 14,619,136 $ 11,358,627 $ 24,757,715 $ 19,549,451
Cost of goods sold 10,615,402 8,065,229 17,910,453 13,747,899
-------------- ------------- ------------- -------------
Gross profit 4,003,734 3,293,398 6,847,262 5,801,552
Selling expenses 401,043 424,793 881,124 785,642
General and administrative expenses 2,369,550 2,268,172 4,408,070 3,979,268
Restructuring Charges (Note 4) - - 1,257,598 -
-------------- ------------- ------------- -------------
Total operating expenses 2,770,593 2,692,965 6,546,792 4,764,910
Income from operations 1,233,141 600,433 300,470 1,036,642
Interest expense, net 325,650 121,321 839,449 224,440
-------------- ------------- ------------- -------------
Income (loss) before income taxes 907,491 479,112 (538,979) 812,202
Provision (benefit) for income taxes 198,030 133,661 (103,368) 204,644
-------------- ------------- ------------- -------------
Net income (loss) $ 709,461 $ 345,451 $ (435,611) $ 607,558
============== ============= ============= =============
Basic earnings per share $ 0.09 $ 0.05 $ (0.05) $ 0.09
============== ============= ============= =============
Diluted earnings per share $ 0.09 $ 0.05 $ (0.05) $ 0.08
============== ============= ============= =============
Weighted average number of common
shares outstanding:
Basic 8,003,244 6,777,556 7,999,211 6,777,556
============== ============= ============= =============
Diluted 8,304,188 7,264,966 7,999,211 7,284,287
============== ============= ============= =============
See accompanying notes to consolidated financial statements.
Page 4
TAG-IT PACIFIC, INC.
Consolidated Statements of Cash Flows
(unaudited)
Six months Ended June 30,
------------------------------
2001 2000
--------------- -------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income............................................. $ (435,611) $ 607,558
Adjustments to reconcile net (loss) income to net cash (used)
provided by operating activities:
Depreciation and amortization................................. 716,710 458,328
Increase in allowance for doubtful accounts................... 148,852 156,122
Loss (gain) on sale of assets................................. 312,418 (14,584 )
Changes in operating assets and liabilities:
Receivables, including related parties...................... (2,118,374) (2,560,027 )
Inventories................................................. 760,497 (1,317,157 )
Other assets................................................ (455,165) 41,682
Prepaid expenses and other current assets................... (1,547) 138,055
Accounts payable............................................ 599,384 2,683,505
Accrued restructuring charges............................... 386,678 -
Accrued expenses............................................ 196,944 393,896
Income taxes payable........................................ (119,484) (37,543 )
--------------- -------------
Net cash (used) provided by operating activities................. (8,698) 549,835
--------------- -------------
Cash flows from investing activities:
Additional loans to related parties........................... (307,429) (282,475 )
Acquisition of property and equipment......................... (206,608) (951,555 )
Proceeds from sale of fixed assets............................ 118,880 17,000
--------------- -------------
Net cash used in investing activities............................ (395,157) (1,217,030 )
--------------- -------------
Cash flows from financing activities:
Bank overdraft................................................ (584,831) -
Proceeds from bank line of credit, net........................ 1,033,821 1,246,703
Proceeds from exercise of stock options....................... 19,500 -
Proceeds from capital leases.................................. 87,556 -
Repayment of capital leases................................... (127,559) (116,920 )
Proceeds from subordinated notes payable to related parties... 180,000 -
Repayment of subordinated notes payable to related parties.... (135,100) (69,266 )
--------------- -------------
Net cash used in financing activities............................ 473,387 1,060,517
--------------- -------------
Net increase in cash............................................. 69,532 393,322
Cash at beginning of period...................................... 128,093 100,798
--------------- -------------
Cash at end of period............................................ $ 197,625 $ 494,120
=============== =============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest.................................................... $ 839,449 $ 246,468
Income taxes................................................ $ 2,430 $ 223,017
Non-cash financing activity:
Preferred stock issued in exchange for distribution rights.. $ - $ 1,400,000
Common stock issued in acquisition of assets................ $ 500,000 $ -
See accompanying notes to consolidated financial statements.
Page 5
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
1. PRESENTATION OF INTERIM INFORMATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and in accordance with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles in the United States for complete financial statements.
The accompanying unaudited consolidated financial statements reflect all
adjustments that, in the opinion of the management of Tag-It Pacific, Inc. and
Subsidiaries (collectively, the "Company"), are considered necessary for a fair
presentation of the financial position, results of operations, and cash flows
for the periods presented. The results of operations for such periods are not
necessarily indicative of the results expected for the full fiscal year or for
any future period. The accompanying financial statements should be read in
conjunction with the audited consolidated financial statements of the Company
included in the Company's Form 10-K for the year ended December 31, 2000.
2. EARNINGS PER SHARE
The Company has adopted Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share."
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:
THREE MONTHS ENDED JUNE 30, 2001: INCOME SHARES PER SHARE
- ---------------------------------------- ------------ ------------ -------------
BASIC EARNINGS PER SHARE:
Income available to common stockholders $ 709,461 $ 8,003,244 $ 0.09
EFFECT OF DILUTIVE SECURITIES:
Options 248,086
Warrants 52,858
------------ ------------- ------------
Income available to common stockholders $ 709,461 8,304,188 $ 0.09
============ ============= ============
THREE MONTHS ENDED JUNE 30, 2000:
- ----------------------------------------
BASIC EARNINGS PER SHARE:
Income available to common stockholders $ 345,451 6,777,556 $ 0.05
EFFECT OF DILUTIVE SECURITIES:
Options 429,894
Warrants 57,516
------------ ------------- ------------
Income available to common stockholders $ 345,451 7,264,966 $ 0.05
============ ============= ============
Page 6
SIX MONTHS ENDED JUNE 30, 2001: INCOME SHARES PER SHARE
- ---------------------------------------- ------------ ------------- ------------
BASIC EARNINGS PER SHARE:
Loss available to common stockholders $ (435,611) 7,999,211 $ (0.05)
EFFECT OF DILUTIVE SECURITIES:
Options -
Warrants -
------------ ------------- ------------
Loss available to common stockholders $ (435,611) 7,999,211 $ (0.05)
============ ============= ============
SIX MONTHS ENDED JUNE 30, 2000:
- ----------------------------------------
BASIC EARNINGS PER SHARE:
Income available to common stockholders $ 607,558 6,777,556 $ 0.09
EFFECT OF DILUTIVE SECURITIES:
Options 446,400
Warrants 60,331
------------ ------------- ------------
Income available to common stockholders $ 607,558 7,284,287 $ 0.08
============ ============= ============
Warrants to purchase 80,000 and 110,000 shares of common stock at $6.00
and $4.80, options to purchase 1,002,500 shares of common stock at between $3.75
and $4.63, convertible debt of $500,000 convertible at $4.50 per share and
850,000 shares of preferred Series B stock convertible when the average trading
price of the Company's stock for a 30-day consecutive period is equal to or
greater than $8.00 per share were outstanding for the three months ended June
30, 2001, but were not included in the computation of diluted earnings per share
because exercise or conversion would have an antidilutive effect on earnings per
share.
Warrants to purchase 80,000, 110,000, 39,235 and 35,555 shares of common
stock at $6.00, $4.80, $0.71 and $1.50, options to purchase 1,384,500 shares of
common stock at between $1.30 and $4.63, convertible debt of $500,000
convertible at $4.50 per share and 850,000 shares of preferred Series B stock
convertible when the average trading price of the Company's stock for a 30-day
consecutive period is equal to or greater than $8.00 per share were outstanding
for the six months ended June 30, 2001, but were not included in the computation
of diluted earnings per share because exercise or conversion would have an
antidilutive effect on earnings per share.
Warrants to purchase 80,000 and 110,000 shares of common stock at $6.00
and $4.80, respectively, were outstanding for the three months ended June 30,
2000 but were not included in the computations of diluted earnings per share
because exercise would have an antidilutive effect on earnings per share.
Warrants to purchase 80,000 shares of common stock at $6.00 were
outstanding for the six months ended June 30, 2000 but were not included in the
computations of diluted earnings per share because exercise would have an
antidilutive effect on earnings per share.
3. ACQUISITION OF ASSETS
Effective January 2, 2001, the Company entered into an asset purchase
agreement with Arzee Holdings, Inc., a Florida based corporation. The agreement
provided for the acquisition of certain assets of Arzee Holdings, Inc.,
including customer lists, fixed assets, general intangibles, among others, in
exchange for 125,000 shares of the Company's common stock. The stock was issued
at the market value of the Company's common stock on the closing date of the
transaction.
Page 7
4. RESTRUCTURING CHARGES
During the first quarter of 2001, the Company implemented a plan to
restructure certain business operations. In accordance with the restructuring
plan, the Company closed one of its Tijuana, Mexico, facilities and relocated
its TALON brand operations to Medley, Florida. In addition, the Company incurred
costs related to the reduction of its Hong Kong operations, the relocation of
its corporate headquarters from Los Angeles, California, to Woodland Hills,
California, and the downsizing of its corporate operations by eliminating
certain corporate expenses related to sales and marketing, customer service and
general and administrative expenses. Total restructuring charges for the first
quarter of 2001 amounted to $1,257,598.
5. REFINANCING OF WORKING CAPITAL LINE OF CREDIT
On May 30, 2001, the Company entered into a loan and security agreement
with UPS Capital Global Trade Finance Corporation, providing for a working
capital credit facility with a maximum available amount of $20,000,000. The
initial term of the Agreement is three years and the facility is secured by all
assets of the Company. The interest rate for the credit facility is at the prime
rate plus 2%. The new credit facility requires the compliance with certain
financial covenants including net worth, fixed charge coverage ratio and capital
expenditures. Availability under the UPS Capital credit facility is determined
based on a defined formula related to eligible accounts receivable and
inventory.
6. CONTINGENCIES
The Company is subject to certain legal proceedings and claims arising
in connection with its business. In the opinion of management, there are
currently no claims that will have a material adverse effect on the Company's
consolidated financial position, results of operation or cash flows.
Page 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read together with the
Consolidated Financial Statements of Tag-It Pacific, Inc. and the notes to the
Consolidated Financial Statements included elsewhere in this Form 10-Q.
THIS DISCUSSION SUMMARIZES THE SIGNIFICANT FACTORS AFFECTING THE
CONSOLIDATED OPERATING RESULTS, FINANCIAL CONDITION AND LIQUIDITY AND CASH FLOWS
OF TAG-IT PACIFIC, INC. FOR THE THREE MONTHS AND THE SIX MONTHS ENDED JUNE 30,
2001 AND JUNE 30, 2000. EXCEPT FOR HISTORICAL INFORMATION, THE MATTERS DISCUSSED
IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS ARE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES AND ARE BASED UPON JUDGMENTS CONCERNING VARIOUS FACTORS THAT ARE
BEYOND OUR CONTROL. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED
IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF, AMONG OTHER THINGS; THE
FACTORS DESCRIBED BELOW UNDER THE CAPTION "CAUTIONARY STATEMENTS AND RISK
FACTORS."
OVERVIEW
We specialize in the distribution of trim items to manufacturers of
fashion apparel, licensed consumer products, specialty retailers and mass
merchandisers. We act as an outsourced trim management department for
manufacturers of fashion apparel such as Tarrant Apparel Group and Azteca
Production International. We also serve as a supplier of trim items to specific
brands, brand licensees and retailers, including Tommy Hilfiger, A/X Armani
Exchange, Express, The Limited, Lerner and Swank, among others.
We have positioned ourselves as a fully integrated single-source
supplier of a full range of trim items for manufacturers of fashion apparel. Our
business focus is on servicing all of the trim requirements of our customers at
the manufacturing and retail brand name level of the fashion apparel industry.
We offer customers complete management of ordering, production, inventory
management and just-in-time distribution of their trim and packaging
requirements. We provide our customers with a full range of trim items including
thread, zippers, labels, buttons, rivets, printed marketing material, polybags,
packing cartons and hangers. We also provide customers with printed marketing
materials including hang tags, bar-coded hang tags, pocket flashers, waistband
tickets and size stickers that are attached to products to identify and promote
the products, permit automated data collection, provide brand identification and
communicate consumer information such as a product's retail price, size, fabric
content and care instructions.
During 2000, we worked to further refine our proprietary
business-to-business e-commerce system. Renamed our MANAGED TRIM SOLUTION
(formerly called our TAG-IT TURNKEY SYSTEM), this solution allows us to provide
our customers with a customized, comprehensive system for the management of
various aspects of their trim programs. Our MANAGED TRIM SOLUTION provides
customers with assistance in their ordering, production, inventory management
and just-in-time distribution of their trim and packaging requirements.
We also serve as a specified supplier for a variety of major brand and
private label oriented companies. In each case, we seek to expand our services
as a supplier of select lines of trim items for such customers to being a
preferred or single source provider of all of such brand customer's authorized
trim requirements.
On April 3, 2000, we entered into a ten-year exclusive license and
distribution agreement with Talon, Inc. TALON is a leading brand of zippers with
an eighty-year history. These exclusive license and distribution rights give us
the right to distribute zippers and trim products under the TALON brand name in
the United States, Mexico, Canada and the Pacific Rim. In exchange for these
exclusive distribution rights, we issued 850,000 shares of our Series B
convertible preferred stock to Grupo Industrial Cierres Ideal, S.A. de C.V., or
GICISA. We began shipping products under the TALON brand name in July 2000.
On December 22, 2000, we entered into an exclusive supply agreement with
Hubert Guez, Paul Guez, Azteca Production International, Inc., AZT International
SA D RL, and Commerce Investment
Page 9
Group, LLC. Pursuant to this supply agreement we will provide all trim-related
products for certain programs manufactured by Azteca Production International.
The agreement provides for a minimum aggregate total of $10,000,000 in annual
purchases by Azteca Production International and its affiliates during each year
of the three-year term of the agreement, if and to the extent, we are able to
provide trim products on a basis that is competitive in terms of price and
quality. Azteca Production International has been a significant customer of the
Company for many years. This agreement is structured in a manner that is well
suited to allow us to utilize our MANAGED TRIM SOLUTION system to supply Azteca
Production International with its future trim program requirements. We expanded
our facilities in Tlaxcala, Mexico, to service Azteca Production International's
trim requirements.
On January 2, 2001, we purchased assets including customer lists of
Arzee Holdings, Inc., a Florida-based distributor of trim products in the
apparel industry. As an element in our strategy to expand in the Caribbean basin
and Central America, we are developing Arzee Holdings' former customer base in
this region, including converting selected customers to complete trim packages
via our MANAGED TRIM SOLUTION program.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, selected
statements of operations data shown as a percentage of net sales.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- -------------------
2001 2000 2001 2000
------- -------- -------- --------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 72.6 71.0 72.3 70.3
------- -------- -------- --------
Gross profit 27.4 29.0 27.7 29.7
Selling expenses 2.7 3.7 3.6 4.0
General and administrative expenses 16.2 20.0 17.8 20.4
Restructuring Charges - - 5.1 -
------- -------- -------- --------
Operating Income 8.5% 5.3% 1.2% 5.3%
------- -------- -------- --------
RESTRUCTURING PLAN
During the first quarter of 2001, we implemented a plan to restructure
certain of our business operations. In accordance with the restructuring plan,
we closed one of our Tijuana, Mexico, facilities and relocated our TALON brand
operations to Medley, Florida. In addition, we incurred costs related to the
reduction of our Hong Kong operations, the relocation of our corporate
headquarters from Los Angeles, California, to Woodland Hills, California, and
the downsizing of our corporate operations by eliminating certain corporate
expenses related to sales and marketing, customer service and general and
administrative expenses. Total restructuring charges amounted to $1,257,598 and
were charged to operations in the first quarter of 2001. We believe these
restructuring measures will significantly reduce our overhead, sales and
marketing and general and administrative expenses in the future.
Page 10
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000
NET SALES. Net sales increased approximately $3,260,000 or 28.7% to
$14,619,000 for the three months ended June 30, 2001 from $11,359,000 for the
three months ended June 30, 2000. The increase in net sales was due to an
increase in trim-related sales under our exclusive license and distribution
agreement of TALON products, which began in July 2000, as well as to an increase
in trim-related sales from our Tlaxcala, Mexico operations to our largest
customers, Tarrant Apparel Group and Azteca Production International. The
increase in net sales was also attributable to our January 2001 acquisition of
Arzee Holdings, a Florida-based distributor of trim products in the apparel
industry.
COST OF GOODS SOLD. Cost of goods sold increased approximately
$2,550,000 or 31.6% to $10,615,000 for the three months ended June 30, 2001 from
$8,065,000 for the three months ended June 30, 2000. Cost of goods sold as a
percentage of net sales increased to approximately 72.6% for the three months
ended June 30, 2001 compared to 71.0% for the three months ended June 30, 2000.
The increase in cost of sales for the three months ended June 30, 2001 was in
proportion to the increase in net sales for the period.
GROSS PROFIT. Gross profit increased approximately $711,000 or 21.6% to
$4,004,000 for the three months ended June 30, 2001 from $3,293,000 for the
three months ended June 30, 2000. Gross margin as a percentage of net sales
decreased to approximately 27.4% for the three months ended June 30, 2001 as
compared to 29.0% for the three months ended June 30, 2000. The reduction in
gross profit as a percentage of net sales for the three months ended June 30,
2001 was primarily due to an increase in the proportion of sales of trim
products with lower gross margins that were included within the complete trim
package we offered to our customers through our MANAGED TRIM SOLUTION. Since
full package sales under our MANAGED TRIM SOLUTION have a lower margin than
single trim item sales, the shift in product mix from single trim item sales to
full package sales under our MANAGED TRIM SOLUTION resulted in a reduction of
gross margin. The reduction in gross margin for the three months ended June 30,
2001was offset by a decrease in manufacturing and facility costs which was a
direct result of the implementation of our restructuring plan that was
implemented in the first quarter of 2001.
SELLING EXPENSES. Selling expenses decreased approximately $24,000 or
5.6% to $401,000 for the three months ended June 30, 2001 from $425,000 for the
three months ended June 30, 2000. As a percentage of net sales, these expenses
decreased to 2.7% for the three months ended June 30, 2001 compared to 3.7% for
the three months ended June 30, 2000. This decrease was due to a reduction of
our sales force which was part of our restructuring plan that was implemented in
the first quarter of 2001.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased approximately $102,000 or 4.5% to $2,370,000 for the three months
ended June 30, 2001 from $2,268,000 for the three months ended June 30, 2000.
The increase in these expenses was due to additional staffing and other expenses
related to our new Florida operation, offset by the reduction of general and
administrative expenses in accordance with the implementation of our first
quarter 2001 restructuring plan. As a percentage of net sales, these expenses
decreased to 16.2% for the three months ended June 30, 2001 compared to 20.0%
for the three months ended June 30, 2000, as the rate of increase in net sales
exceeded that of general and administrative expenses.
INTEREST EXPENSE. Interest expense increased approximately $205,000 or
169.4% to $326,000 for the three months ended June 30, 2001 from $121,000 for
the three months ended June 30, 2000. Due to expanded operations, we have had to
increase our borrowing under our working capital credit facility, which
contributed to the increased interest expense for the three months ended June
30, 2001 as compared to the three months ended June 30, 2000. On May 30, 2001,
we replaced our credit facility with Sanwa Bank with a new facility with UPS
Capital Global Trade Finance Corporation which provides for increased borrowing
availability of up to $20,000,000 and a more favorable interest rate. Our
interest rate under the former Sanwa facility ranged from prime plus 2% to prime
plus 6.5%. The new UPS Capital credit facility provides for interest at the rate
of prime plus 2%.
Page 11
PROVISION FOR INCOME TAXES. The income tax provision for the three
months ended June 30, 2001 amounted to approximately $198,000 compared to a
provision for income taxes of $134,000 for the three months ended June 30, 2000.
Income taxes increased for the three months ended June 30, 2001 primarily due to
increased taxable income. The Company was able to utilize net operating loss
carry forwards from its subsidiary, AGS Stationery, Inc., of approximately
$430,000 to offset taxable income during 2001 and 2000, a portion of which was
utilized during the three months ended June 30, 2001 and 2000.
NET INCOME. Net income was approximately $709,000 for the three months
ended June 30, 2000 as compared to net income of $345,000 for the three months
ended June 30, 2000, due to the factors set forth above.
SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000
NET SALES. Net sales increased approximately $5,209,000 or 26.6% to
$24,758,000 for the six months ended June 30, 2001 from $19,549,000 for the six
months ended June 30, 2000. The increase in net sales was due to an increase in
trim-related sales under our exclusive license and distribution agreement of
TALON products, which began in July 2000, as well as to an increase in
trim-related sales from our Tlaxcala, Mexico operations to our largest
customers, Tarrant Apparel Group and Azteca Production International. The
increase in net sales was also attributable to our January 2001 acquisition of
Arzee Holdings, a Florida-based distributor of trim products in the apparel
industry.
COST OF GOODS SOLD. Cost of goods sold increased approximately
$4,162,000 or 30.3% to $17,910,000 for the six months ended June 30, 2001 from
$13,748,000 for the six months ended June 30, 2000. Cost of goods sold as a
percentage of net sales increased to approximately 72.3% for the six months
ended June 30, 2001 compared to 70.3% for the six months ended June 30, 2000.
The increase in cost of goods sold for the six months ended June 30, 2001 was in
proportion to the increase in net sales for the period.
GROSS PROFIT. Gross profit increased approximately $1,045,000 or 18.0%
to $6,847,000 for the six months ended June 30, 2001 from $5,802,000 for the six
months ended June 30, 2000. Gross margin as a percentage of net sales decreased
to approximately 27.7% for the six months ended June 30, 2001 as compared to
29.7% for the six months ended June 30, 2000. The reduction in gross profit for
the six months ended June 30, 2001 was primarily due to an increase in the
proportion of sales of trim products with lower gross margins that were included
within the complete trim package we offered to our customers through our MANAGED
TRIM SOLUTION. In addition, sales of TALON products, with lower gross margins,
accounted for a portion of net sales for the six months ended June 30, 2001. We
began shipping TALON products in July 2000.
SELLING EXPENSES. Selling expenses increased approximately $95,000 or
12.1% to $881,000 for the six months ended June 30, 2001 from $786,000 for the
six months ended June 30, 2000. As a percentage of net sales, these expenses
decreased to 3.6% for the six months ended June 30, 2001 compared to 4.0% for
the six months ended June 30, 2000. The decrease in selling expenses as a
percentage of net sales for the six months ended June 30, 2001 compared to the
six months ended June 30, 2000 was due to a reduction of our sales force which
was part of our restructuring plan that was implemented in the first quarter of
2001.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased approximately $429,000 or 10.8% to $4,408,000 for the six months ended
June 30, 2001 from $3,979,000 for the six months ended June 30, 2000. The
increase in these expenses was due to additional staffing and other expenses
related to our new Florida operation, offset by the reduction of general and
administrative expenses in accordance with the implementation of our first
quarter 2001 restructuring plan. As a percentage of net sales, these expenses
decreased to 17.8% for the six months ended June 30, 2001 compared to 20.4% for
the six months ended June 30, 2000, as the rate of increase in net sales
exceeded that of general and administrative expenses.
INTEREST EXPENSE. Interest expense increased approximately $615,000 or
274.6% to $839,000 for the six months ended June 30, 2001 from $224,000 for the
six months ended June 30, 2000. Due to expanded operations, we have had to
increase our borrowing under our credit facility with Sanwa Bank, which
contributed to the increased interest expense for the six months ended June 30,
2001 as compared to the six months ended June 30, 2000. On May 30, 2001, we
replaced our credit facility with Sanwa
Page 12
Bank with a new facility with UPS Capital Global Trade Finance Corporation which
provides for increased borrowing availability of up to $20,000,000 and a more
favorable interest rate. We incurred other financing charges of approximately
$150,000 in the first quarter of 2001 related to our efforts to replace our
existing Sanwa credit facility. Subsequent to May 30, 2001, we will be
amortizing other expenses and fees related to the replacement of our credit
facility. As our borrowings under the new UPS Capital credit facility increase
due to expanding operations, we anticipate that our interest expense will
increase in future periods.
PROVISION (BENEFIT) FOR INCOME TAXES. The income tax benefit for the six
months ended June 30, 2001 amounted to approximately $103,000 compared to a
provision for income taxes of $205,000 for the six months ended June 30, 2001.
Income taxes decreased for the six months ended June 30, 2001 primarily due to
decreased taxable income as a result of the net loss incurred for the six months
ended June 30, 2001.
NET INCOME (LOSS). Net loss was approximately $436,000 for the six
months ended June 30, 2000 as compared to net income of $608,000 for the six
months ended June 30, 2000, due to restructuring charges that were incurred in
the first quarter of 2001.
LIQUIDITY AND CAPITAL RESOURCES
We currently satisfy our working capital requirements primarily through cash
flows generated from operations and borrowings under our credit facility with
UPS Capital Global Trade Finance Corporation. On May 30, 2001, we replaced our
Sanwa Bank credit facility with a new facility with UPS Capital which provides
for increased borrowing availability of up to $20,000,000 and interest at prime
plus 2%. Availability under the UPS Capital credit facility is determined based
on a defined formula related to eligible accounts receivable and inventory. The
credit facility expires on May 30, 2004.
At June 30, 2001, outstanding borrowings under the UPS Capital credit
facility amounted to $10,990,000. At June 30, 2000, outstanding borrowings under
the Sanwa Bank facility amounted to $6,314,000. There were no open letters of
credit at June 30, 2001 or 2000.
The UPS Capital credit facility contains customary covenants restricting
our activities as well as those of our subsidiaries, including limitations on
certain transactions related to the disposition of assets; mergers; entering
into operating leases or capital leases; entering into transactions involving
subsidiaries and related parties outside of the ordinary course of business;
incurring indebtedness or granting liens or negative pledges on our assets;
making loans or other investments; paying dividends or repurchasing stock or
other securities; guarantying third party obligations; repaying subordinated
debt; and making changes in our corporate structure. The UPS credit facility
further requires the compliance with certain financial covenants including net
worth, fixed charge coverage ratio and capital expenditures. As of June 30,
2001, we were in compliance with these covenants.
Inventories at June 30, 2001 and 2000 include goods that are subject to
buyback agreements with our customers. The buyback agreements contain provisions
related to the inventory purchased on behalf of our customers. In the event that
inventories remain with us in excess of six months from our receipt of the goods
from suppliers, the customer is required to purchase the inventories from us
under normal invoice and selling terms. The majority of the inventories at June
30, 2001 are subject to these buyback agreements.
Pursuant to the terms of a factoring agreement for our Hong Kong
subsidiary, Tag-It Pacific Limited, the factor purchases our eligible accounts
receivable and assumes the credit risk with respect to those accounts for which
the factor has given its prior approval. As of June 30, 2001, the amount
factored without recourse was approximately $123,000. If the factor does not
assume the credit risk for a receivable, the collection risk associated with the
receivable remains with us. If the factor determines, at its discretion, to
advance against the receivable, the customer's payment obligation is recorded as
our receivable and the advance from the factor is recorded as a current
liability. There were no outstanding advances from the factor as of June 30,
2001 and June 30, 2000.
Page 13
In October 2000, in connection with the amendment of our former line of
credit agreement with Sanwa Bank, we borrowed $500,000 from Mark Dyne, our
chairman, in the form of a convertible secured subordinated promissory note. The
note bears interest at 11.0% per annum, is due on demand and is convertible at
any time into our common stock at the market price of the stock on the date of
the agreement. The note is secured by substantially all of our assets and is
subordinate to all of our other obligations, including our pledge of
substantially all of our assets under the credit facility with UPS Capital.
As of June 30, 2001, we had outstanding related-party debt, including
the $500,000 convertible note mentioned above, of $3,618,458 at a weighted
average interest rate of between 0% and 11% and additional non-related-party
debt of $25,200 at an interest rate of 10.0%. All of the related-party debt at
June 30, 2001 is subordinate to the security interests of UPS Capital. The
majority of related-party debt is due and payable on April 1, 2002, with the
remainder due on the fifteenth day following the date of delivery of written
demand for payment. As of June 30, 2000, we had outstanding related-party debt
of $336,000 at a weighted average interest rate of 8.2% and additional
non-related-party debt of $25,200 at an interest rate of 10.0%.
Our trade receivables increased to approximately $14,503,000 at June 30,
2001 from $8,171,000 at June 30, 2000. This increase was due primarily to
increased sales, increased related-party trade receivables and receivables from
TALON product sales.
Net cash used in operating activities was approximately $9,000 for the
six months ended June 30, 2001 and net cash provided by operating activities was
$550,000 for the six months ended June 30, 2000. The decrease in cash provided
by operations for the six months ended June 30, 2001 resulted primarily from
increases in trade accounts receivable and net losses, which were offset by
decreases in inventories and increases in accounts payable and accrued expenses.
Cash provided by operations for the six months ended June 30, 2000 resulted
primarily from increases in trade accounts receivables and inventories, offset
by increases in accounts payable, accrued expenses and net income.
Net cash used in investing activities was approximately $395,000 for the
six months ended June 30, 2001 and $1,217,000 for the six months ended June 30,
2000. Net cash used in investing activities for the six months ended June 30,
2001 and 2000 consisted primarily of additional loans to related parties and
capital expenditures.
Net cash provided by financing activities was approximately $473,000 for
the six months ended June 30, 2001 and $1,061,000 for the six months ended June
30, 2000. Net cash provided by financing activities for the six months ended
June 30, 2001 primarily reflects increased borrowing under our credit facility,
offset by the repayment of a bank overdraft. Net cash provided by financing
activities for the six months ended June 30, 2000 primarily reflects increased
borrowing under our credit facility, offset by the repayment on capital lease
obligations.
Our need for additional financing includes the integration and expansion
of our operations to exploit our rights under our exclusive license and
distribution agreement with GICISA for TALON products and the expansion of our
operations in the Caribbean and Central America markets.
We believe that our existing cash and cash equivalents and anticipated
cash flows from our operating activities and available financing will be
sufficient to fund our minimum working capital and capital expenditure needs
through fiscal 2002. If our cash from operations is less than anticipated or our
working capital requirements and capital expenditures are greater than we
expect, we will need to raise additional debt or equity financing in order to
provide for our operations. We are continually evaluating various financing
strategies to be used to expand our business and fund future growth or
acquisitions. The extent of our future capital requirements will depend,
however, on many factors, including our results of operations and the size and
timing of future acquisitions. There can be no assurance that additional debt or
equity financing will be available on acceptable terms or at all.
NEW ACCOUNTING PRONOUNCEMENTS
In October 2000, we adopted Financial Accounting Standards Board SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards requiring every
derivative instrument, including derivative instruments embedded in other
Page 14
contracts, to be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement also requires changes in the
derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. The adoption of SFAS 133 did not have a material
impact on the consolidated financial statements.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin, or SAB, No. 101, "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation and
disclosure of revenue in the financial statements filed with the SEC.
Subsequently, the SEC released SAB 101B, which delayed the implementation date
of SAB 101 for registrants with fiscal years that begin between December 16,
1999 and March 15, 2000. We were required to be in conformity with the
provisions of SAB 101, as amended by SAB 101B, no later than October 1, 2000. We
believe the adoption of SAB 101, as amended by SAB 101B, has not had a material
effect on our financial position, results of operations or cash flows for the
six months ended June 30, 2001.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation, the Interpretation of APB
Opinion No. 25" (FIN 44). The Interpretation is intended to clarify certain
problems that have arisen in practice since the issuance of APB No. 25,
"Accounting for Stock Issued to Employees." The effective date of the
Interpretation was July 1, 2000. The provisions of the Interpretation apply
prospectively, but they will also cover certain events occurring after December
15, 1998 and after January 12, 2000. The adoption of FIN 44 did not have a
material adverse affect on the current and historical consolidated financial
statements.
In June 2001, the Financial Accounting Standards Board finalized FASB
Statements No. 141, BUSINESS COMBINATIONS (SFAS 141), and No. 142, GOODWILL AND
OTHER INTANGIBLE ASSETS (SFAS 142). SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The Company's previous business combinations were accounted for using
the purchase method. As of June 30, 2001, the net carrying amount of goodwill is
$475,000 and other intangible assets is $1,225,000. Amortization expense during
the six-month period ended June 30, 2001 was $95,000. Currently, the Company is
assessing but has not yet determined how the adoption of SFAS 141 and SFAS 142
will impact its financial position and results of operations.
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In addition to other information contained in this report, readers should
carefully consider the following cautionary statements and risk factors.
Page 15
IF WE LOSE OUR LARGEST CUSTOMERS OR THEY FAIL TO PURCHASE AT ANTICIPATED LEVELS,
OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED.
Our largest customer, Tarrant Apparel Group, accounted for approximately 47.9%
and 48.1% of our net sales, on a consolidated basis, for the years ended
December 31, 1999 and 2000. In December 2000, we entered into an exclusive
supply agreement with Hubert Guez, Paul Guez, Azteca Production International,
AZT International SA D RL, and Commerce Investment Group, LLC that provides for
a minimum of $10,000,000 in total annual purchases by Azteca Production
International and its affiliates during each year of the three-year term of the
agreement. Azteca Production International is required to purchase from us only
if we are able to provide trim products on a competitive basis in terms of price
and quality.
Our results of operations will depend to a significant extent upon the
commercial success of Azteca Production International and Tarrant Apparel Group.
If Azteca Production International and Tarrant Apparel Group fail to purchase
our trim products at anticipated levels, or our relationship with Azteca
Production International or Tarrant Apparel Group terminates, it may have an
adverse affect on our results because:
o We will lose a primary source of revenue if either of Tarrant
Apparel Group or Azteca Production International choose not to
purchase our products or services;
o We may not be able to reduce fixed costs incurred in developing
the relationship with Azteca Production International and
Tarrant Apparel Group in a timely manner;
o We may not be able to recoup setup and inventory costs;
o We may be left holding inventory that cannot be sold to other
customers; and
o We may not be able to collect our receivables from them.
CONCENTRATION OF RECEIVABLES FROM OUR LARGEST CUSTOMERS MAKES RECEIVABLE BASED
FINANCING DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGEST CUSTOMERS FAIL TO
PAY US, OUR CASH FLOW WOULD BE SEVERELY AFFECTED.
Our business relies heavily on a relatively small number of customers, including
Tarrant Apparel Group and Azteca Production International. This concentration of
our business adversely affects our ability to obtain receivable based financing
due to customer concentration limitations customarily applied by financial
institutions, including UPS Capital, and factors. Given the nature of our
business, we do not expect our customer concentration to improve significantly
in the near future. Further, if we are unable to collect any large receivables
due us, our cash flow would be severely impacted.
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS CONTINUE TO WORSEN.
Our revenues are dependent on the health of the economy and the growth of our
customers and potential future customers. When economic conditions weaken,
certain apparel manufacturers and retailers, including some of our customers,
have experienced in the past, and may experience in the future, financial
difficulties which increase the risk of extending credit to such customers.
Customers adversely affected by economic conditions have also attempted to
improve their own operating efficiencies by concentrating their purchasing power
among a narrowing group of vendors. There can be no assurance that we will
remain a preferred vendor to our existing customers. A decrease in business from
or loss of a major customer could have a material adverse effect on the
Company's results of operations. Further, if the economic conditions in the
United States worsen or if a wider or global economic slowdown occurs, we may
experience a material adverse impact on our business, operating results, and
financial condition.
WE MAY RAISE FUNDS THROUGH ADDITIONAL EQUITY FINANCINGS, WHICH WOULD DILUTE OUR
STOCKHOLDERS' OWNERSHIP.
We anticipate that we may need to raise additional funds through equity
financings during the next twelve months. Such additional funds are expected to
assist us in expanding our borrowing base under our credit
Page 16
facility and by supplementing financing available under our credit facility. We
cannot guarantee that additional equity financing will be available, or that if
available, we can obtain it on terms that we deem favorable. Our stockholders'
ownership may be diluted if we raise additional funds through the sale of our
stock.
IF WE ARE NOT ABLE TO MANAGE OUR RAPID EXPANSION AND GROWTH, WE COULD INCUR
UNFORESEEN COSTS OR DELAYS AND OUR REPUTATION AND RELIABILITY IN THE MARKETPLACE
AND OUR REVENUES WILL BE ADVERSELY AFFECTED.
The growth of our operations and activities has placed and will continue to
place a significant strain on our management, operational, financial and
accounting resources. If we cannot implement and improve our financial and
management information and reporting systems, we will not be able to implement
our growth strategies successfully and our revenues will be adversely affected.
In addition, if we cannot hire, train, motivate and manage new employees,
including management and operating personnel in sufficient numbers, and
integrate them into our overall operations and culture, our ability to manage
future growth, increase production levels and effectively market and distribute
our products will be significantly impaired.
WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS IN
OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND STOCK
PRICE VOLATILITY.
We operate in an industry that is subject to significant fluctuations in
operating results from quarter to quarter, which may lead to unexpected
reductions in revenues and stock price volatility. Factors that may influence
our quarterly operating results include:
o The volume and timing of customer orders received during the
quarter;
o The timing and magnitude of customers' marketing campaigns;
o The loss or addition of a major customer;
o The availability and pricing of materials for our products;
o The increased expenses incurred in connection with the
introduction of new products;
o Currency fluctuations;
o Delays caused by third parties; and
o Changes in our product mix or in the relative contribution to
sales of our subsidiaries.
Due to these factors, particularly in light of our customer concentration, it is
possible that in some quarters our operating results may be below our
stockholders' expectations and those of public market analysts. If this occurs,
the price of our common stock would likely be adversely affected.
OUR CUSTOMERS HAVE CYCLICAL BUYING PATTERNS WHICH MAY CAUSE US TO HAVE PERIODS
OF LOW SALES VOLUME.
Most of our customers are in the apparel industry. The apparel industry
historically has been subject to substantial cyclical variations. Our business
has experienced, and we expect our business to continue to experience,
significant cyclical fluctuations due, in part, to customer buying patterns,
which may result in periods of low sales usually in the first and fourth
quarters of our financial year. A recession in the general economy or
uncertainties regarding future economic prospects that affect consumer-spending
habits could also reduce our sales.
Page 17
OUR BUSINESS MODEL IS DEPENDENT ON INTEGRATION OF INFORMATION SYSTEMS ON A
GLOBAL BASIS AND, TO THE EXTENT THAT WE FAIL TO MAINTAIN AND SUPPORT OUR
INFORMATION SYSTEMS, IT CAN RESULT IN LOST REVENUES.
We must consolidate and centralize the management of our subsidiaries and
significantly expand and improve our financial and operating controls.
Additionally, we must effectively integrate the information systems of our
Mexico, Central America and Caribbean facilities with the information systems of
our principal offices in California and Florida. Our failure to do so could
result in lost revenues, delay financial reporting or adversely affect
availability of funds under our credit facilities.
BECAUSE WE GENERALLY DO NOT ENTER INTO LONG-TERM SALES CONTRACTS WITH ALL OF OUR
CUSTOMERS, OUR SALES MAY DECLINE IF OUR EXISTING CUSTOMERS CHOOSE NOT TO BUY OUR
PRODUCTS OR SERVICES.
Very few of our customers are required to purchase our products on a long-term
basis. We usually document sales by a purchase order or similar documentation
limited to the specific sale. As a result, a customer from whom we generate
substantial revenue in one period may not be a substantial source of revenue in
a future period. In addition, our customers generally have the right to
terminate their relationships with us without penalty and with little or no
notice. Without long-term contracts with the majority of our customers, we
cannot be certain that our customers will continue to purchase our products or
that we will be able to maintain a consistent level of sales.
THE LOSS OF KEY MANAGEMENT, DESIGN AND SALES PERSONNEL COULD ADVERSELY AFFECT
OUR BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE
SALES.
Our success has and will continue to depend to a significant extent upon key
management and design and sales personnel, many of whom would be difficult to
replace, particularly Colin Dyne, our Chief Executive Officer. Colin Dyne is not
bound by an employment agreement nor is he the subject of key man insurance. The
loss of the services of Colin Dyne or the services of other key employees could
have a material adverse effect on our business, including our ability to
establish and maintain client relationships. Our future success will depend in
large part upon our ability to attract and retain personnel with a variety of
design, sales, operating and managerial skills.
IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN PRODUCTION FACILITIES, WE
WILL NOT BE ABLE TO MEET OUR PRODUCTION OBLIGATIONS AND MAY LOSE SALES AND
CUSTOMERS.
We assemble or finish some of our products at our foreign assembly facilities.
Currently, we do not operate duplicate facilities in different geographic areas.
Therefore, in the event of a regional disruption where we maintain one or more
of our facilities, it is unlikely that we could shift manufacturing operations
to a different geographic region and we may have to cease or curtail our
assembly or finishing operations. This may cause us to lose sales and customers.
The types of disruptions that may occur include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention; and
o Natural disasters.
BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, WE MAY NOT ALWAYS BE ABLE TO
OBTAIN MATERIALS WHEN WE NEED THEM AND WE MAY LOSE SALES AND CUSTOMERS.
Generally, we do not have long-term agreements with our key sources of supply.
Lead times for materials we order can vary significantly and depend on many
factors, including the specific supplier, the contract terms and the demand for
particular materials at a given time. Some of our suppliers are also
Page 18
competitors and may, for competitive reasons, elect to cease supplying us with
their products. From time to time, we experience fluctuations in the prices and
disruptions in the supply of materials. Shortages or disruptions in the supply
of materials, or our inability to procure materials from alternate sources at
acceptable prices in a timely manner, could lead us to miss deadlines for orders
and lose revenue and customers.
INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY EXPERIENCE
DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS.
Our MANAGED TRIM SOLUTION is an Internet-based business-to-business e-commerce
system. To the extent that we fail to adequately continue to update and maintain
the hardware and software implementing the MANAGED TRIM SOLUTION, our customers
may experience interruptions in service due to defects in our hardware or our
source code. In addition, since our MANAGED TRIM SOLUTION is Internet-based,
interruptions in Internet service generally can negatively impact our customers'
ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects
of their trim needs. Such defects or interruptions could result in lost revenues
and lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND SERVICES WE
SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL BE ADVERSELY
AFFECTED.
We compete in highly competitive and fragmented industries with numerous local
and regional companies that provide some or all of the products and services we
offer. We compete with national and international design companies, distributors
and manufacturers of tags, packaging products and trims. Some of our
competitors, including Paxar Corporation, YKK, Universal Button, Inc., Avery
Dennison Corporation and Scovill Fasteners, Inc., have greater name recognition,
longer operating histories and, in many cases, substantially greater financial
and other resources than we do.
PRODUCT RETURNS THAT EXCEED OUR ANTICIPATED RESERVES COULD RESULT IN WORSE THAN
EXPECTED OPERATING RESULTS.
We incur expenses when customers return our products. Product returns or price
protection concessions that exceed our reserves could result in worse than
expected operating results. Generally, returned items have limited or no value
and we are forced to bear the cost of their return. Product returns also could
result in lost revenue, delays in market acceptance, diversion of development
resources, increased service and warranty costs and damage to our reputation.
Products are returned for a number of reasons, including as a result of:
o Defective goods;
o Inadequate performance relative to customer expectations;
o Shipping errors; and
o Other causes which are outside of our control.
IF CUSTOMERS DEFAULT ON BUYBACK AGREEMENTS WITH US, WE WILL BE LEFT HOLDING
UNSALABLE INVENTORY.
The majority of our inventories are subject to buyback agreements with our
customers. Under these buyback agreements, the customer must purchase the
inventories from us under normal invoice and selling terms, if any inventory
which we purchase on their behalf remains in our hands longer than six months
after the time we received the goods from our vendors. If any customer defaults
on these buyback provisions, we may incur a charge in connection with our
holding significant amounts of unsalable inventory.
Page 19
BECAUSE WE CONDUCT A SUBSTANTIAL PORTION OF OUR BUSINESS OUTSIDE OF THE UNITED
STATES, WE ARE SUBJECT TO MANY RISKS RELATING TO INTERNATIONAL BUSINESS THAT MAY
ADVERSELY AFFECT OUR OPERATING RESULTS.
We sell, assemble or finish a substantial portion of our products outside of the
United States, principally in Hong Kong and Mexico. Our international business
is subject to numerous risks that could result in lost sales, increased costs
and worse than expected operating results, including:
o The need to comply with a wide variety of foreign and United
States export and import laws;
o Changes in export or import controls, tariffs and other
regulatory requirements;
o The imposition of governmental controls;
o Political and economic instability;
o Trade restrictions;
o The difficulty of administering business overseas; and
o The general economic conditions of the countries in which we do
business.
If any of the above risks were to render the conduct of business in a particular
country undesirable or impractical, we may not be able to deliver products to
our customers and our sales may be reduced.
UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR LITIGATION COSTS
AND ADVERSELY AFFECT OUR SALES.
We rely on trademark, trade secret and copyright laws to protect our designs and
other proprietary property worldwide. We cannot be certain that these laws will
be sufficient to protect our property. In particular, the laws of some countries
in which our products are distributed or may be distributed in the future may
not protect our products and intellectual rights to the same extent as the laws
of the United States. If litigation is necessary in the future to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others, such litigation could
result in substantial costs and diversion of resources. This could have a
material adverse effect on our operating results and financial condition.
Ultimately, we may be unable, for financial or other reasons, to enforce our
rights under intellectual property laws, which could result in lost sales.
IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY BE SUED
AND HAVE TO PAY LARGE LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR DISCONTINUE
SELLING OUR PRODUCTS.
From time to time in our industry, third parties allege infringement of their
proprietary rights. Any infringement claims, whether or not meritorious, could
result in costly litigation or require us to enter into royalty or licensing
agreements as a means of settlement. If we are found to have infringed the
proprietary rights of others, we could be required to pay damages, cease sales
of the infringing products and redesign the products or discontinue their sale.
Any of these outcomes, individually or collectively, could have a material
adverse effect on our operating results and financial condition.
OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS AND
CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES.
The following factors could cause the market price of our common stock to
decrease, perhaps substantially:
o The failure of our quarterly operating results to meet
expectations of investors or securities analysts;
o Adverse developments in the financial markets, the apparel
industry and the worldwide or regional economies;
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o Interest rates;
o Changes in accounting principles;
o Sales of common stock by existing shareholders or holders of
options;
o Announcements of key developments by our competitors; and
o The reaction of markets and securities analysts to announcements
and developments involving our company.
IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED.
Our business strategy may include expansion through internal growth, by
acquiring complementary businesses or by establishing strategic relationships
with targeted customers and suppliers. In order to do so or to fund our other
activities, we may issue additional equity securities that could dilute our
stockholders' stock ownership. We may also assume additional debt and amortize
expenses related to goodwill and other tangible assets if we acquire another
company and this could negatively impact our results of operations.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF
OUR COMMON STOCK.
Our stockholders' rights plan, our ability to issue additional shares of
preferred stock and some provisions of our certificate of incorporation and
bylaws and of Delaware law could make it more difficult for a third party to
make an unsolicited takeover attempt of us. These anti-takeover measures may
depress the price of our common stock by making it more difficult for third
parties to acquire us by offering to purchase shares of our stock at a premium
to its market price.
WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS.
We may consider strategic acquisitions as opportunities arise, subject to the
obtaining of any necessary financing. Acquisitions involve numerous risks,
including diversion of our management's attention away from our operating
activities. We cannot assure our stockholders that we will not encounter
unanticipated problems or liabilities relating to the integration of an acquired
company's operations, nor can we assure our stockholders that we will realize
the anticipated benefits of any future acquisitions.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR
STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS.
As of December 31, 2000, our officers and directors and their affiliates owned
approximately 44.7% of the outstanding shares of our common stock. The Dyne
family, which includes Mark Dyne, Colin Dyne, Larry Dyne, Jonathan Burstein and
the estate of Harold Dyne, beneficially owned approximately 41.7% of the
outstanding shares of our common stock. The number of shares beneficially owned
by the Dyne family includes the shares of common stock held by Azteca Production
International, which are voted by Colin Dyne pursuant to a voting agreement. The
Azteca Production International shares constitute approximately 12.7% of the
outstanding shares of common stock at December 31, 2000. KG Investment, LLC, a
significant stockholder, owns approximately 30.4% of the outstanding shares of
our common stock at December 31, 2000. As a result, our officers and directors,
the Dyne family and KG Investment, LLC are able to exert considerable influence
over the outcome of any matters submitted to a vote of the holders of our common
stock, including the election of our Board of Directors. The voting power of
these stockholders could also discourage others from seeking to acquire control
of us through the purchase of our common stock, which might depress the price of
our common stock.
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ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of our sales are denominated in U.S. dollars or the currency of the country
of origin and, accordingly, we do not enter into hedging transactions with
regard to any foreign currencies. Currency fluctuations can, however, increase
the price of our products to foreign customers which can adversely impact the
level of our export sales from time to time. The majority of our cash
equivalents are held in U.S. bank accounts and we do not believe we have
significant market risk exposure with regard to our investments.
We are also exposed to the impact of interest rate changes. For example, based
on average bank borrowings of $10 million during a three-month period, if the
interest rate indices on which our bank borrowing rates are based were to
increase 100 basis points in the three-month period, interest incurred would
increase and cash flows would decrease by $25,000.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We currently have pending a number of claims, suits and complaints that arise in
the ordinary course of our business. We believe that we have meritorious
defenses to these claims and the claims are covered by insurance or, after
taking into account the insurance in place, would not have a material effect on
our consolidated financial condition if adversely determined against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders held on June 15, 2001, our stockholders
(a) elected Kevin Bermeister and Brent Cohen to serve as Class I Directors of
Registrant for three years and until their respective successors have been
elected, and (b) approved an amendment to our 1997 Stock Plan to increase from
1,777,500 to 2,077,500 the maximum number of shares of common stock that may be
issued pursuant to awards granted under the Plan. Each Class I Director was
elected by a vote of 5,939,040 shares in favor, 1,800 shares voted against, and
no shares were withheld from voting for the directors. At the annual meeting,
5,937,586 shares were voted in favor of, 3,254 shares were voted against, and no
shares were withheld from voting on the amendment to our 1997 Stock Plan. There
were no broker non-votes at the annual meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None.
(b) Report on Form 8-K.
Report on Form 8-K, filed June 19, 2001, reporting under Item 5, our entering
into of a Loan and Security Agreement with UPS Capital.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 13, 2001 TAG-IT PACIFIC, INC.
` /S/ RONDA SALLMEN
------------------------------------
By: Ronda Sallmen
Its: Chief Financial Officer
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