SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the quarterly period ended September 30, 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 November 14, 2001.
TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q
PART I FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements..................................3
Consolidated Balance Sheets as of
September 30, 2001 (unaudited) and December 31, 2000...............3
Consolidated Statements of Operations (unaudited) for
the Three Months and the Nine Months Ended
September 30, 2001 and 2000........................................4
Consolidated Statements of Cash Flows (unaudited) for
the Nine Months Ended September 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........21
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................22
Item 2. Change in Securities..............................................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
September December
30, 2001 31, 2000
------------- -------------
Assets (unaudited)
Current Assets:
Cash and cash equivalents.................................. $ 138,673 $ 128,093
Due from factor............................................ 29,992 25,140
Trade accounts receivable, net............................. 4,174,934 3,466,314
Trade accounts receivable, related parties................. 9,597,761 9,041,752
Due from related parties................................... 802,078 513,614
Inventories................................................ 20,449,571 19,868,160
Prepaid expenses and other current assets.................. 640,795 738,735
------------- -------------
Total current assets................................. 35,833,804 $ 33,781,808
Property and Equipment, net of accumulated
depreciation and amortization............................ 2,935,913 3,755,127
Other assets............................................... 2,423,758 1,562,539
------------- -------------
Total assets............................................... $ 41,193,475 $ 39,099,474
============= =============
Liabilities and Stockholders' Equity
Current Liabilities:
Bank overdraft........................................... $ - $ 584,831
Line of credit........................................... 10,409,585 9,956,436
Accounts payable......................................... 6,786,242 8,228,677
Accrued expenses......................................... 1,873,664 1,484,765
Accrued restructuring charges............................ 335,000 -
Income taxes payable..................................... - 66,942
Notes payable............................................ 25,200 25,200
Subordinated notes payable to related parties............ 3,619,911 882,970
Current portion of capital lease obligations............. 241,785 250,403
------------- -------------
Total current liabilities.......................... 23,291,387 21,480,224
Capital lease obligations, less current portion............ 94,488 113,046
Deferred income tax liability.............................. 113,335 113,335
Subordinated notes payable to related parties.............. - 2,601,470
------------- -------------
Total liabilities.................................. 23,499,210 24,308,075
------------- -------------
Convertible redeemable preferred stock Series C,
$0.001 par value; 759,494 shares shares authorized;
759,494 shares issued and outstanding.................... 3,000,001 -
Stockholders' equity:
Preferred stock, Series A $0.001 par value;
250,000 shares authorized, no shares
issued or outstanding.................................. - -
Convertible preferred stock Series B,
$0.001 par value; 850,000 shares authorized;
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 September 30, 2001; 7,863,244
at December 31, 2000................................... 8,004 7,864
Additional paid-in capital............................... 12,279,740 11,737,810
Retained earnings........................................ 1,006,520 1,645,725
------------- -------------
Total stockholders' equity ................................ 14,694,264 14,791,399
------------- -------------
Total liabilities and stockholders' equity ................ $ 41,193,475 $ 39,099,474
============= =============
See accompanying notes to consolidated financial statements
Page 3
TAG-IT PACIFIC, INC.
Consolidated Statements of Operations
(unaudited)
Three Months Ended Nine months Ended
September 30, September 30,
------------------------------- ------------------------------
2001 2000 2001 2000
-------------- ------------- ------------- -------------
Net sales $ 11,039,211 $ 17,514,988 $ 35,796,926 $ 37,064,439
Cost of goods sold 8,173,816 13,329,945 26,084,269 27,077,844
-------------- ------------- ------------- -------------
Gross profit 2,865,395 4,185,043 9,712,657 9,986,595
Selling expenses 367,266 741,312 1,248,390 1,526,954
General and administrative expenses 2,439,587 2,497,979 6,847,656 6,477,247
Restructuring Charges (Note 4) - - 1,257,598 -
-------------- ------------- ------------- -------------
Total operating expenses 2,806,853 3,239,291 9,353,644 8,004,201
Income from operations 58,542 945,752 359,013 1,982,394
Interest expense, net 308,426 187,710 1,147,875 412,150
-------------- ------------- ------------- -------------
Income (loss) before income taxes (249,884) 758,042 (788,862) 1,570,244
Provision (benefit) for income taxes (51,240) 211,981 (154,607) 416,625
-------------- ------------- ------------- -------------
Net income (loss) $ (198,644) 546,061 $ (634,255) $ 1,153,619
============== ============= ============= =============
Less: Preferred stock dividends (4,950) - (4,950) -
-------------- ------------- ------------- -------------
Net income (loss) to common shareholders $ (203,594) $ 546,061 $ (639,205) $ 1,153,619
============== ============= ============= =============
Basic earnings (loss) per share $ (0.03) $ 0.08 $ (0.08) $ 0.17
============== ============= ============= =============
Diluted earnings (loss) per share $ (0.03) $ 0.08 $ (0.08) $ 0.16
============== ============= ============= =============
Weighted average number of
common shares outstanding:
Basic 8,003,244 6,781,904 8,000,570 6,779,016
============== ============= ============= =============
Diluted 8,003,244 7,202,436 8,000,570 7,259,067
============== ============= ============= =============
See accompanying notes to consolidated financial statements.
Page 4
TAG-IT PACIFIC, INC.
Consolidated Statements of Cash Flows
(unaudited)
Nine months Ended September
30, 3131,31,
----------------------------
2001 2000
------------- -------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income............................................. $ (634,255) $ 1,153,619
Adjustments to reconcile net (loss) income to net cash used
by operating activities:
Depreciation and amortization................................. 1,126,766 738,352
Increase in allowance for doubtful accounts................... 291,518 470,444
Loss (gain) on sale of assets................................. 312,418 (14,927)
Warrants and common stock issued for services................. 5,170 32,813
Changes in operating assets and liabilities:
Receivables, including related parties...................... (1,560,999) (10,557,342)
Inventories................................................. (581,411) (3,161,138)
Other assets................................................ (567,431) 60,955
Prepaid expenses and other current assets................... 97,940 79,118
Accounts payable............................................ (1,442,435) 7,438,227
Accrued restructuring charges............................... 335,000 -
Accrued expenses............................................ 503,293 1,150,994
Income taxes payable........................................ (168,887) 160,553
------------- ------------
Net cash used by operating activities............................ (2,283,313) (2,448,332)
------------- ------------
Cash flows from investing activities:
Additional loans to related parties........................... (288,464) (353,611)
Acquisition of property and equipment......................... (397,821) (1,598,716)
Proceeds from sale of fixed assets............................ 118,880 19,260
------------- ------------
Net cash used in investing activities............................ (567,405) (1,933,067)
------------- ------------
Cash flows from financing activities:
Bank overdraft................................................ (584,831) 770,133
Proceeds from bank line of credit, net........................ 453,149 3,821,587
Proceeds from exercise of stock options....................... 19,500 -
Proceeds from stock issuance.................................. 3,000,001 3,900
Proceeds from capital leases.................................. 207,240 -
Repayment of capital leases................................... (234,415) (174,871)
Proceeds from subordinated notes payable to related parties... 180,000 -
Repayment of subordinated notes payable to related parties.... (179,346) (140,148)
------------- ------------
Net cash provided by financing activities........................ 2,861,298 4,280,601
------------- ------------
Net increase (decrease) in cash.................................. 10,580 (100,798)
Cash at beginning of period...................................... 128,093 100,798
------------- ------------
Cash at end of period............................................ $ 138,673 $ -
============= ============
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest paid............................................... $ 1,110,794 $ 472,430
Interest received........................................... $ (2,430) $ (12,220)
Income taxes paid........................................... $ - $ 223,224
Non-cash financing activity:
Preferred stock issued in exchange for distribution rights.. $ - $ 1,400,000
Note payable to related party issued in exchange for
inventory................................................. $ - $ 2,558,024
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:
INCOME (LOSS) SHARES PER SHARE
THREE MONTHS ENDED SEPTEMBER 30, 2001: (NUMERATOR) (DENOMINATOR) AMOUNT
------------- ------------- ----------
BASIC EARNINGS PER SHARE:
Loss available to common stockholders $ (203,594) 8,003,244 $ (0.03)
EFFECT OF DILUTIVE SECURITIES:
Options -
Warrants -
------------- ------------- ----------
Income available to common stockholders $ (203,594) 8,003,244 $ (0.03)
============= ============= ==========
THREE MONTHS ENDED SEPTEMBER 30, 2000:
BASIC EARNINGS PER SHARE:
Income available to common stockholders $ 546,061 6,781,904 $ 0.08
EFFECT OF DILUTIVE SECURITIES:
Options 364,556
Warrants 55,976
------------- ------------- ----------
Income available to common stockholders $ 546,061 7,202,436 $ 0.08
============= ============= ==========
Page 6
INCOME (LOSS) SHARES PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, 2001: (NUMERATOR) (DENOMINATOR) AMOUNT
------------- ------------- ----------
BASIC EARNINGS PER SHARE:
Loss available to common stockholders $ (639,205) 8,000,570 $ (0.08)
EFFECT OF DILUTIVE SECURITIES:
Options -
Warrants -
------------- ------------- ----------
Loss available to common stockholders $ (639,205) 8,000,570 $ (0.08)
============= ============= ==========
NINE MONTHS ENDED SEPTEMBER 30, 2000:
BASIC EARNINGS PER SHARE:
Income available to common stockholders $ 1,153,619 6,779,016 $ 0.17
EFFECT OF DILUTIVE SECURITIES:
Options 422,547
Warrants 57,504
------------- ------------- ----------
Income available to common stockholders $ 1,153,619 7,259,067 $ 0.16
============= ============= ==========
Warrants to purchase 299,790 shares of common stock at between $0.71 and
$6.00, options to purchase 1,384,500 shares of common stock at between $1.30 and
$4.63, convertible debt of $500,000 convertible at $4.50 per share, 759,494
shares of preferred Series C stock convertible at $4.94 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 and nine months ended September
30, 2001, but were not included in the computation of diluted earnings per share
because exercise or conversion would have an antidilutive effect on earnings per
share.
Warrants to purchase 80,000 and 110,000 shares of common stock at $6.00 and
$4.80 and options to purchase 143,000 shares of common stock at $4.63 were
outstanding for the three months ended September 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 and 110,000 shares of common stock at $6.00 and
$4.80 were outstanding for the nine months ended September 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.
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.
Page 7
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. SERIES C PREFERRED STOCK PURCHASE AGREEMENT AND SUPPLY AGREEMENT
In accordance with the Series C Preferred Stock Purchase Agreement entered
into by the Company and Coats North America Consolidated, Inc. ("Coats") on
September 20, 2001, the Company issued 759,494 shares of Series C Convertible
Redeemable Preferred Stock (the "Shares") to Coats North America Consolidated,
Inc. in exchange for an equity investment from Coats of $3,000,000 cash. The
Shares are convertible at the option of the holder after one year at the rate of
the closing price muliplied by 125% of the ten-day average closing price prior
to closing. The Shares are redeemable at the option of the holder after four
years. If the holders elect to redeem the Shares, the Company has the option to
redeem for cash at the stated value of $3,000,000 or in the form of the
Company's common stock at 85% of the market price of the Company's common stock
on the date of redemption. If the market price of the Company's common stock on
the date of redemption is less than $2.75 per share, the Company must redeem for
cash at the stated value of the Shares. The Company can elect to redeem the
Shares at any time for cash at the stated value. The Preferred Stock Purchase
Agreement provides for cumulative dividends at a rate of 6% of the stated value
per annum, payable in cash or the Company's common stock. Each Preferred Share
has the right to vote for each of the Company's common shares that the Shares
could then be converted into on the record date.
In connection with the Series C Preferred Stock Purchase Agreement, the
Company also entered into a 10-year Co-Marketing and Supply Agreement with
Coats. The Co-Marketing and Supply Agreement provides for selected introductions
into Coats' customer base and the Company's trim packages will exclusively offer
thread manufactured by Coats.
7. 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 NINE MONTHS ENDED SEPTEMBER
30, 2001 AND SEPTEMBER 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
and Lerner, 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.
We offer apparel manufacturers a proprietary business-to-business
e-commerce system. Renamed our MANAGED TRIM SOLUTION (formerly called our TAG-IT
TURNKEY SYSTEM), this system 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 September 20, 2001, we entered into a ten-year Co-Marketing and Supply
Agreement with Coats American, Inc., an affiliate of Coats plc, as well as a
Preferred Stock Purchase Agreement with Coats North America Consolidated, Inc.,
also an affiliate of Coats plc. The Co-Marketing and Supply agreement provides
for selected introductions into Coats' customer base and has the potential to
accelerate our growth plans and to introduce our MANAGED TRIM SOLUTION to
apparel manufacturers on a broader basis. Pursuant to the terms of the
Co-Marketing and Supply Agreement, our trim packages will exclusively offer
thread manufactured by Coats. Coats was selected for its quality, service, brand
recognition and global reach. Prior to entering into the Co-Marketing and Supply
Agreement, we were a long-time customer of Coats, distributing their thread to
sewing operations under our MANAGED TRIM SOLUTION program. This exclusive
agreement will allow Coats to offer its customer
Page 9
base of contractors in Mexico, Central America and the Caribbean full-service
trim management under our MANAGED TRIM SOLUTION program.
Pursuant to the terms of the Preferred Stock Purchase Agreement entered
into by the Company and Coats, Coats invested $3,000,000 cash into the Company
in exchange for 759,494 shares of Series C Convertible Redeemable preferred
stock.
London-based Coats is the world's largest manufacturer of industrial thread
and textile-related craft products. Coats has operations in 65 countries and a
North American presence in the U.S., Canada, Mexico, Central America and the
Caribbean.
We distribute TALON zippers under 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.
We have entered into an exclusive supply agreement with Hubert Guez, Paul
Guez, Azteca Production International, Inc., AZT International SA D RL, and
Commerce Investment Group, LLC. Pursuant to this supply agreement, we provide
all trim-related products for certain programs manufactured by Azteca Production
International. The agreement provides for a minimum aggregate total of
$10,000,000 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2001 2000 2001 2000
-------- -------- --------- --------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 74.0 76.1 72.9 73.1
------- -------- --------- --------
Gross profit 26.0 23.9 27.1 26.9
Selling expenses 3.3 4.2 3.5 4.1
General and administrative expenses 22.1 14.3 19.1 17.5
Restructuring Charges - - 3.5 -
------- -------- --------- --------
Operating Income 0.6% 5.4% 1.0% 5.3%
------- -------- --------- --------
Page 10
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.
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2000
NET SALES. Net sales decreased approximately $6,476,000 or 37.0% to
$11,039,000 for the three months ended September 30, 2001 from $17,515,000 for
the three months ended September 30, 2000. The decrease in net sales was
primarily due to a decrease in zipper sales under our exclusive license and
distribution agreement of TALON products, which began in July 2000. Our
exclusive vendor of TALON products discontinued manufacturing these products in
December 2000. We have successfully negotiated with alternative vendors for
TALON products and do not anticipate any further reductions of TALON sales from
present levels. The decrease in net sales for the quarter was also due to a
decrease in trim-related sales from our Tlaxcala, Mexico operations. We
experienced significant sales growth during the second quarter of 2001 due to an
acceleration of orders from our Tlaxcala, Mexico operations of approximately
$3.9 million. This resulted in a corresponding decrease in sales during the
third quarter of 2001 of approximately $1.6 million. The decrease in net sales
for the quarter was partially offset by an increase in sales as a result of our
January 2001 acquisition of Arzee Holdings, a Florida-based distributor of trim
products in the apparel industry.
GROSS PROFIT. Gross profit decreased approximately $1,320,000 or 31.5% to
$2,865,000 for the three months ended September 30, 2001 from $4,185,000 for the
three months ended September 30, 2000. Gross margin as a percentage of net sales
increased to approximately 26.0% for the three months ended September 30, 2001
as compared to 23.9% for the three months ended September 30, 2000. The increase
in gross profit as a percentage of net sales for the three months ended
September 30, 2001 was primarily due to a decrease in net sales of TALON
products during the quarter. TALON products have a lower gross margin than
products included within the complete trim packages we offer to our customers
through our MANAGED TRIM SOLUTION. The increase in gross margin for the three
months ended September 30, 2001 was also attributable to a decrease in
manufacturing and facility costs which was a direct result of the implementation
of our restructuring plan in the first quarter of 2001.
SELLING EXPENSES. Selling expenses decreased approximately $374,000 or
50.5% to $367,000 for the three months ended September 30, 2001 from $741,000
for the three months ended September 30, 2000. As a percentage of net sales,
these expenses decreased to 3.3% for the three months ended September 30, 2001
compared to 4.2% for the three months ended September 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
decreased approximately $58,000 or 2.3% to $2,440,000 for the three months ended
September 30, 2001 from $2,498,000 for the three months ended September 30,
2000. The decrease in these expenses was due to 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
increased to 22.1% for the three months ended September 30, 2001 compared to
14.3% for the three months ended September 30, 2000, as the rate of increase in
net sales did not exceed that of general and administrative expenses.
INTEREST EXPENSE. Interest expense increased approximately $120,000 or
63.8% to $308,000 for the three months ended September 30, 2001 from $188,000
for the three months ended September 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
September
Page 11
30, 2001 as compared to the three months ended September 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%.
PROVISION (BENEFIT) FOR INCOME TAXES. The income tax benefit for the three
months ended September 30, 2001 amounted to approximately $51,000 compared to a
provision for income taxes of $212,000 for the three months ended September 30,
2000. Income taxes decreased for the three months ended September 30, 2001
primarily due to decreased 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 September 30, 2001 and 2000.
NET INCOME (LOSS). Net loss was approximately $199,000 for the three months
ended September 30, 2001 as compared to net income of $546,000 for the three
months ended September 30, 2000, due to the factors set forth above.
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2000
NET SALES. Net sales decreased approximately $1,267,000 or 3.4% to
$35,797,000 for the nine months ended September 30, 2001 from $37,064,000 for
the nine months ended September 30, 2000. The decrease in net sales was
primarily a result of a reduction of sales from our Hong Kong operations. Our
restructuring plan implemented in the first quarter of 2001, included the
reduction of our sales force and operations in our Hong Kong facility in order
to increase profitability and also included the reduction of small dollar volume
customers with lower gross margins. Because we did not begin shipping products
under the TALON brand name until July 2000, the decrease in net sales for the
three months ended September 30, 2001 compared to the three months ended
September 30, 2000 resulted in a consistent amount of sales for the nine months
ended September 30, 2001 compared to September 30, 2000. The decrease in net
sales for the nine-month period was partially offset by an increase in sales as
a result of our January 2001 acquisition of Arzee Holdings, a Florida-based
distributor of trim products in the apparel industry.
GROSS PROFIT. Gross profit decreased approximately $274,000 or 2.7% to
$9,713,000 for the nine months ended September 30, 2001 from $9,987,000 for the
nine months ended September 30, 2000. Gross margin as a percentage of net sales
increased to approximately 27.1% for the nine months ended September 30, 2001 as
compared to 26.9% for the nine months ended September 30, 2000. The increase in
gross profit for the nine months ended September 30, 2001 was primarily due to a
decrease in sales with lower gross margins from our operations in Hong Kong.
These operations were restructured in the first quarter of 2001. The increase in
gross margin for the nine months ended September 30, 2001was also attributable
to decreased manufacturing and facility costs in our other locations which were
a direct result of the implementation of our restructuring plan in the first
quarter of 2001.
SELLING EXPENSES. Selling expenses decreased approximately $279,000 or
18.3% to $1,248,000 for the nine months ended September 30, 2001 from $1,527,000
for the nine months ended September 30, 2000. As a percentage of net sales,
these expenses decreased to 3.5% for the nine months ended September 30, 2001
compared to 4.1% for the nine months ended September 30, 2000. The decrease in
selling expenses as a percentage of net sales for the nine months ended
September 30, 2001 compared to the nine months ended September 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 $371,000 or 5.7% to $6,848,000 for the nine months ended
September 30, 2001 from $6,477,000 for the nine months ended September 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
increased to 19.1% for the nine months ended September 30, 2001 compared to
17.5% for the nine months ended September 30, 2000, as the rate of increase in
net sales did not exceed that of general and administrative expenses.
Page 12
INTEREST EXPENSE. Interest expense increased approximately $736,000 or
178.6% to $1,148,000 for the nine months ended September 30, 2001 from $412,000
for the nine months ended September 30, 2000. Due to expanded operations, we
increased our borrowing under our credit facility with Sanwa Bank, which
contributed to the increased interest expense for the nine months ended
September 30, 2001 as compared to the nine months ended September 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. 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. On May 30, 2001, we began 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 nine
months ended September 30, 2001 amounted to approximately $155,000 compared to a
provision for income taxes of $417,000 for the nine months ended September 30,
2001. Income taxes decreased for the nine months ended September 30, 2001
primarily due to decreased taxable income as a result of the net loss incurred
for the nine months ended September 30, 2001.
NET INCOME (LOSS). Net loss was approximately $634,000 for the nine months
ended September 30, 2001 as compared to net income of $1,154,000 for the nine
months ended September 30, 2000, due primarily 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 September 30, 2001, outstanding borrowings under the UPS Capital credit
facility amounted to $10,410,000. At September 30, 2000, outstanding borrowings
under the Sanwa Bank facility amounted to $8,889,000. There were no open letters
of credit at September 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 September 30,
2001, we were in compliance with these covenants.
Inventories at September 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 nine 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 September 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 September 30, 2001, the amount
factored without recourse was approximately $30,000. 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
Page 13
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 September 30, 2001 and September 30, 2000.
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 September 30, 2001, we had outstanding related-party debt, including
the $500,000 convertible note mentioned above, of $3,620,000 at a weighted
average interest rate of between 0% and 11% and additional non-related-party
debt of $25,200 at an interest rate of 10.0%. All of the related-party debt at
September 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 September 30, 2000, we had outstanding related-party
debt of $2,823,000 at a weighted average interest rate of between 0% and 8.2%
and additional non-related-party debt of $25,200 at an interest rate of 10.0%.
Our trade receivables decreased to approximately $13,773,000 at September
30, 2001 from $15,852,000 at September 30, 2000. This decrease was due primarily
to decreased sales and decreased receivables from TALON product sales.
Net cash used in operating activities was approximately $2,283,000 for the
nine months ended September 30, 2001 and $2,448,000 for the nine months ended
September 30, 2000. The decrease in cash used by operations for the nine months
ended September 30, 2001 resulted primarily from increases in trade accounts
receivable, inventories and net losses and decreases in accounts payable, offset
by depreciation and amortization. Cash used by operations for the nine months
ended September 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 $567,000 for the
nine months ended September 30, 2001 and $1,933,000 for the nine months ended
September 30, 2000. Net cash used in investing activities for the nine months
ended September 30, 2001 and 2000 consisted primarily of additional loans to
related parties and capital expenditures.
Net cash provided by financing activities was approximately $2,861,000 for
the nine months ended September 30, 2001 and $4,281,000 for the nine months
ended September 30, 2000. Net cash provided by financing activities for the nine
months ended September 30, 2001 primarily reflects proceeds from the issuance of
Series C Convertible Redeemable preferred stock, offset by the repayment of a
bank overdraft. Net cash provided by financing activities for the nine months
ended September 30, 2000 primarily reflects increased borrowing under our credit
facility and increased bank overdraft, 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.
Page 14
NEW ACCOUNTING PRONOUNCEMENTS
In September 2001, the Financial Accounting Standards Board finalized FASB
Statements No. 141, BUSINESS COMBINATIONS (SFAS 141), and No. 142, GOODWILL AND
OTHER INTANGIBLE ASSETS (SFAS 142). SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after September 30, 2001. SFAS
141 also requires that the Company recognize acquired intangible assets apart
from goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after September 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful 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 nine 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 September 30, 2001, the net carrying amount of goodwill
is $462,500 and other intangible assets is $1,190,000. Amortization expense
during the nine-month period ended September 30, 2001 was $142,500. 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.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The
Company believes the adoption of this Statement will have no material impact on
its financial statements.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFASB 144 requires that those long-lived assets
be measured at the lower of carrying amount or fair value less cost to sell,
whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable
value or include amounts for operating losses that have not yet occurred. SFASB
144 is effective for financial statements issued for fiscal years beginning
after December 15, 2001 and, generally, are to be applied prospectively. The
Company believes the adoption of this Statement will have no material impact on
its financial statements.
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
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.
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.
WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED SECURITY
MEASURES IN RESPONSE TO TERRORISM.
Our business depends on the free flow of products and services through the
channels of commerce. Recently, in response to terrorists' activities and
threats aimed at the United States, transportation, mail,
Page 16
financial and other services have been slowed or stopped altogether. Further
delays or stoppages in transportation, mail, financial or other services could
have a material adverse effect on our business, results of operations and
financial condition. Furthermore, we may experience an increase in operating
costs, such as costs for transportation, insurance and security as a result of
the activities and potential activities. We may also experience delays in
receiving payments from payers that have been affected by the terrorist
activities and potential activities. The U.S. economy in general is being
adversely affected by the terrorist activities and potential activities and any
economic downturn could adversely impact our results of operations, impair our
ability to raise capital or otherwise adversely affect our ability to grow our
business.
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, 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.
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.
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
Page 18
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.
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 agreed by the
customer from the time we received the goods from our vendors. If any customer
defaults on these buyback provisions, we may incur a charge in connection with
our holding significant amounts of unsalable inventory.
UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR LITIGATION COSTS
AND ADVERSELY AFFECT OUR SALES.
We rely on trademark, trade secret and copyright laws to protect our designs and
other proprietary property worldwide. We cannot be certain that these laws will
be sufficient to protect our property. In particular, the laws of some countries
in which our products are distributed or may be distributed in the future may
not protect our products and intellectual rights to the same extent as the laws
of the United States. If litigation is necessary in the future to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others, such litigation could
result in substantial costs and diversion of resources. This could have a
material adverse effect on our operating results and financial condition.
Ultimately, we may be unable, for financial or other reasons, to enforce our
rights under intellectual property laws, which could result in lost sales.
IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY BE SUED
AND HAVE TO PAY LARGE LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR DISCONTINUE
SELLING OUR PRODUCTS.
From time to time in our industry, third parties allege infringement of their
proprietary rights. Any infringement claims, whether or not meritorious, could
result in costly litigation or require us to enter into royalty or licensing
agreements as a means of settlement. If we are found to have infringed the
proprietary rights of others, we could be required to pay damages, cease sales
of the infringing products and redesign the products or discontinue their sale.
Any of these outcomes, individually or collectively, could have a material
adverse effect on our operating results and financial condition.
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OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS AND
CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES.
The following factors could cause the market price of our common stock to
decrease, perhaps substantially:
o The failure of our quarterly operating results to meet
expectations of investors or securities analysts;
o Adverse developments in the financial markets, the apparel
industry and the worldwide or regional economies;
o Interest rates;
o Changes in accounting principles;
o Sales of common stock by existing shareholders or holders of
options;
o Announcements of key developments by our competitors; and
o The reaction of markets and securities analysts to announcements
and developments involving our company.
IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED.
Our business strategy may include expansion through internal growth, by
acquiring complementary businesses or by establishing strategic relationships
with targeted customers and suppliers. In order to do so or to fund our other
activities, we may issue additional equity securities that could dilute our
stockholders' stock ownership. We may also assume additional debt and 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
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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.
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.
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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 2. CHANGES IN SECURITIES
In accordance with the Series C Preferred Stock Purchase Agreement and the
Supply Agreement we entered into with Coats North America Consolidated, Inc. on
September 20, 2001, we issued 759,494 shares of Series C Convertible Redeemable
Preferred Stock to Coats North America Consolidated, Inc. in exchange for an
equity investment from Coats of $3,000,000 cash. The shares of Series C
Preferred Stock are convertible at the option of the holder after one year at
the rate of the closing price multiplied by 125% of the ten-day average closing
price prior to closing. The shares of Series C Preferred Stock are redeemable at
the option of the holder after four years. If the holders elect to redeem the
Series C Preferred Stock, we have the option to redeem for cash at the stated
value of $3,000,000 or in the form of our common stock at 85% of the market
price of our common stock on the date of redemption. If the market price of our
common stock on the date of redemption is less than $2.75 per share, we must
redeem for cash at the stated value of the Series C Preferred Stock. We can
elect to redeem the Series C Preferred Stock at any time for cash at the stated
value. The Series C Preferred Stock Purchase Agreement provides for cumulative
dividends at a rate of 6% of the stated value per annum, payable in cash or our
common stock. The holders of Series C Preferred Stock vote together with the
holders of the common stock on an as converted to common stock basis.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None.
(b) Report on Form 8-K.
Report on Form 8-K, filed October 15, 2001, reporting under Item 5, our entering
into of a Preferred Stock Purchase Agreement and Supply Agreement.
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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: November 14, 2001 TAG-IT PACIFIC, INC.
` /S/ RONDA SALLMEN
-----------------------------------
By: Ronda Sallmen
Its: Chief Financial Officer
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