================================================================================
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 March 31, 2002.
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, 9,282,909 shares issued and outstanding as of May 3, 2002.
================================================================================
TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q
PART I FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements....................................3
Consolidated Balance Sheets as of
March 31, 2002 (unaudited) and December 31, 2001.....................3
Consolidated Statements of Operations (unaudited) for the
Three Months Ended March 31, 2002 and 2001...........................4
Consolidated Statements of Cash Flows (unaudited) for
the Three Months Ended March 31, 2002 and 2001.......................5
Notes to the Consolidated Financial Statements.......................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................10
Item 3 Quantitative and Qualitative Disclosures About Market Risk..........24
PART II OTHER INFORMATION
Item 1. Legal Proceedings...................................................25
Item 2. Change in Securities................................................25
Item 6. Exhibits and Reports on Form 8-K....................................25
Page 2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
Consolidated Balance Sheets
March 31, December
2002 31, 2001
------------- -------------
Assets (unaudited)
Current Assets:
Cash and cash equivalents.................................. $ 65,340 $ 46,948
Due from factor............................................ 134,356 105,749
Trade accounts receivable, net............................. 3,244,468 3,037,034
Trade accounts receivable, related parties................. 8,192,037 7,914,838
Refundable income taxes.................................... 259,605 259,605
Due from related parties................................... 827,339 814,219
Inventories................................................ 21,652,076 20,450,740
Prepaid expenses and other current assets.................. 443,973 408,146
Deferred income taxes...................................... 107,599 107,599
------------- -------------
Total current assets................................. 34,926,793 33,144,878
Property and Equipment, net of accumulated
depreciation and amortization............................ 2,415,375 2,592,965
Tradename.................................................. 4,110,750 4,110,750
Other assets............................................... 906,450 944,912
------------- -------------
Total assets............................................... $ 42,359,368 $ 40,793,505
============= =============
Liabilities, Convertible Redeemable Preferred Stock
and Stockholders' Equity
Current Liabilities:
Line of credit........................................... $ 9,628,741 $ 9,660,581
Accounts payable......................................... 5,806,945 5,176,436
Accrued expenses......................................... 1,808,437 1,609,378
Note payable............................................. 25,200 25,200
Subordinated notes payable to related parties............ 849,971 849,971
Current portion of capital lease obligations............. 104,438 180,142
Current portion of subordinated note payable............. 1,200,000 1,100,000
------------- -------------
Total current liabilities.......................... 19,423,732 18,601,708
Capital lease obligations, less current portion............ 58,443 69,030
Subordinated note payable, less current portion............ 3,500,000 3,800,000
------------- -------------
Total liabilities.................................. 22,982,175 22,470,738
------------- -------------
Convertible redeemable preferred stock Series C,
$0.001 par value; 759,494 shares authorized;
759,494 shares issued and outstanding at
March 31, 2002 and December 31, 2001
(stated value $3,000,000)................................ 2,895,001 2,895,001
Stockholders' equity:
Preferred stock, Series A $0.001 par value;
250,000 shares authorized,
no shares issued or outstanding........................ - -
Convertible preferred stock Series B,
$0.001 par value; 850,000 shares
authorized; no shares issued or outstanding............ - -
Common stock, $0.001 par value,
30,000,000 shares authorized;
9,126,409 shares issued and outstanding at
March 31, 2002; 8,769,910 at December 31, 2001......... 9,127 8,771
Additional paid-in capital............................... 16,094,029 15,048,971
Retained earnings........................................ 379,036 370,024
------------- -------------
Total stockholders' equity ................................ 16,482,192 15,427,766
------------- -------------
Total liabilities, convertible redeemable
preferred stock and stockholders' equity................... $ 42,359,368 $ 40,793,505
============= =============
See accompanying notes to consolidated financial statements
Page 3
TAG-IT PACIFIC, INC.
Consolidated Statements of Operations
(unaudited)
Three months Ended March 31,
--------------------------------
2002 2001
-------------- --------------
Net sales................................. $ 9,325,056 $ 10,138,579
Cost of goods sold........................ 6,690,713 7,295,051
-------------- --------------
Gross profit........................... 2,634,343 2,843,528
Selling expenses.......................... 394,867 480,081
General and administrative expenses....... 1,905,131 2,038,520
Restructuring charges (Note 3) ........... - 1,257,598
-------------- --------------
Total operating expenses............... 2,299,998 3,776,199
Income (loss) from operations............. 334,345 (932,671)
Interest expense, net..................... 261,743 513,799
-------------- --------------
Income (loss) before income taxes......... 72,602 (1,446,470)
Provision (benefit) for income taxes...... 18,590 (301,398)
-------------- --------------
Net income (loss) ..................... $ 54,012 $ (1,145,072)
============== ==============
Less: Preferred stock dividends.......... 45,000 -
-------------- --------------
Net income (loss) to common shareholders.. $ 9,012 $ (1,145,072)
============== ==============
Basic earnings (loss) per share........... $ 0.00 $ (0.14)
============== ==============
Diluted earnings (loss) per share......... $ 0.00 $ (0.14)
============== ==============
Weighted average number of common shares
outstanding:
Basic.................................. 9,013,511 7,995,133
============== ==============
Diluted................................ 9,327,641 7,995,133
============== ==============
See accompanying notes to consolidated financial statements.
Page 4
TAG-IT PACIFIC, INC.
Consolidated Statements of Cash Flows
(unaudited)
Three months Ended March 31,
3131,31,
------------------------------
2002 2001
-------------- -------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net income (loss)............................................. $ 54,012 $ (1,145,072)
Adjustments to reconcile net income (loss) to
net cash provided (used) by operating activities:
Depreciation and amortization................................. 274,505 356,879
Increase in allowance for doubtful accounts................... - 67,218
Loss on sale of assets........................................ - 27,141
Changes in operating assets and liabilities:
Receivables, including related parties...................... (513,240) 900,607
Inventories................................................. (1,201,336) (524,960)
Other assets................................................ (9,323) 4,225
Prepaid expenses and other current assets................... (35,826) 47,096
Accounts payable............................................ 630,509 111,254
Accrued restructuring charges............................... (114,554) 808,703
Accrued expenses............................................ 256,797 432,089
Income taxes payable........................................ 18,782 (303,829)
-------------- -------------
Net cash provided (used) by operating activities................. (639,674) 781,351
-------------- -------------
Cash flows from investing activities:
Additional loans to related parties........................... (13,120) (118,167)
Acquisition of property and equipment......................... (49,129) (146,097)
Proceeds from sale of fixed assets............................ - 118,880
-------------- -------------
Net cash used in investing activities............................ (62,249) (145,384)
-------------- -------------
Cash flows from financing activities:
Bank overdraft................................................ - (584,831)
Repayment of bank line of credit, net......................... (31,840) (279,009)
Proceeds from private placement transactions.................. 1,029,996 -
Proceeds from exercise of stock options....................... 8,450 19,500
Proceeds from capital leases.................................. - 87,556
Repayment of capital leases................................... (86,291) (91,333)
Proceeds from notes payable................................... - 180,000
Repayment of notes payable.................................... (200,000) (70,846)
-------------- -------------
Net cash provided (used) by financing activities................. 720,315 (738,963)
-------------- -------------
Net increase (decrease) in cash.................................. 18,392 (102,996)
Cash at beginning of period...................................... 46,948 128,093
-------------- -------------
Cash at end of period............................................ $ 65,340 $ 25,097
============== =============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest paid............................................... $ 221,834 $ 513,799
Income taxes paid........................................... $ 439 $ 2,430
Non-cash financing activity:
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, 2001.
2. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
INCOME PER SHARE
THREE MONTHS ENDED MARCH 31, 2002: (LOSS) SHARES AMOUNT
------------- ------------ -----------
Basic earnings per share:
Income available to common stockholders $ 9,012 9,013,511 $ 0.00
Effect of Dilutive Securities:
Options 260,253
Warrants 53,877
------------- ------------ -----------
Income available to common stockholders $ 9,012 9,327,641 $ 0.00
============= ============ ===========
THREE MONTHS ENDED MARCH 31, 2001:
Basic earnings per share:
Loss available to common stockholders $ (1,145,072) 7,995,133 $ (0.14)
Effect of Dilutive Securities:
Options -
Warrants -
------------- ------------ -----------
Loss available to common stockholders $ (1,145,072) 7,995,133 $ (0.14)
============= ============ ===========
Warrants to purchase 523,332 shares of common stock at between $4.34 and
$6.00, options to purchase 646,000 shares of common stock at between $4.00 and
$4.63, convertible debt of $500,000 convertible at $4.50 per share and 759,494
shares of preferred Series C stock convertible at $4.94 per share were
outstanding for the three months ended March 31, 2002, 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.
Page 6
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 1,262,500 shares of
common stock at between $1.30 and $4.63 and convertible debt of $500,000
convertible at $4.50 per share were outstanding for the three months ended March
31, 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. For the three months ended March 31, 2001, 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
not included in the computation of diluted earnings per share because the
conversion contingency related to these preferred shares was not met.
3. 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 its Tijuana, Mexico, facilities and relocated its TALON
brand operations to Miami, 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
and fourth quarters of 2001 amounted to $1,257,598 and $304,025, including
$355,769 of benefits paid to terminated employees. Included in accrued expenses
at December 31, 2001 was $114,554 of accrued restructuring charges consisting of
future payments to former employees paid in the first quarter of 2002.
4. PRIVATE PLACEMENTS
In a series of sales on December 28, 2001, January 7, 2002 and January 8,
2002, the Company entered into Stock and Warrant Purchase Agreements with three
private investors, including Mark Dyne, the chairman of the Company's board of
directors. Pursuant to the Stock and Warrant Purchase Agreements, the Company
issued an aggregate of 516,665 shares of common stock at a price per share of
$3.00 for aggregate proceeds of $1,549,995. The Stock and Warrant Purchase
Agreements also include a commitment by one of the private investors to purchase
an additional 400,000 shares of common stock at a price per share of $3.00 at
second closings (subject of certain conditions) on or prior to October 1, 2002
for additional proceeds of $1,200,000. Pursuant to the Stock and Warrant
purchase agreements, 258,332 warrants to purchase common stock were issued at
the first closing of the transactions and 200,000 warrants are to be issued at
the second closings. The warrants are exercisable immediately after closing, one
half of the warrants at an exercise price of 110% and the second half at an
exercise price of 120% of the market value of the Company's common stock on the
date of closing. The exercise price for the warrants shall be adjusted upward by
25% of the amount, if any, that the market price of our common stock on the
exercise date exceeds the initial exercise price (as adjusted) up to a maximum
exercise price of $5.25. The warrants have a term of four years. The shares
contain restrictions related to the sale or transfer of the shares, registration
and voting rights. Total shares and warrants issued during the year ended
December 31, 2001 amount to 266,666 and 133,332. Total shares and warrants
issued in January 2002 amounted to 249,999 and 125,000.
In March 2002, one of the private investors purchased an additional 100,000
shares of common stock at a price per share of $3.00 pursuant to the second
closing provisions of the related agreement for total proceeds of $300,000. The
remaining commitment under this agreement is for an additional 300,000 shares
with aggregate proceeds of $900,000. Pursuant to the second closing provisions
of the Stock and Warrant Purchase Agreement, 50,000 warrants were issued to the
investor.
Page 7
5. EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY RIGHTS AGREEMENT
On April 2, 2002, the Company entered into an Exclusive License and
Intellectual Property Rights Agreement (the "Agreement") with Pro-Fit Holdings
Limited ("Pro-Fit"). The Agreement gives the Company the exclusive rights to
sell or sublicense waistbands manufactured under patented technology developed
by Pro-Fit for garments manufactured anywhere in the world for the United States
market and all United States brands. In accordance with the Agreement, the
Company issued 150,000 shares of its common stock at the market value of the
stock on the date of the Agreement. The shares contain restrictions related to
the transfer of the shares and registration rights. The Agreement has an
indefinite term that extends for the duration of the trade secrets licensed
under the agreement.
Future minimum annual royalty payments due under the Agreement are as
follows:
YEARS ENDING DECEMBER 31, Amount
-----------
2002......................................... $ 150,000
2003......................................... 75,000
2004......................................... 200,000
2005......................................... 400,000
2006......................................... 225,000
----------
Total minimum royalties...................... $1,050,000
===========
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 operations or cash flows.
7. NEW ACCOUNTING PRONOUNCEMENTS
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.
The Company has adopted SFAS 141 and 142 effective January 1, 2002. The
Company's previous business combinations were accounted for using the purchase
method and there are no intangible assets acquired in connection with the
business combinations that are required to be recognized separately from
goodwill. The Company ceased amortization of goodwill effective as of January 1,
2002. As provided by SFAS 142, the initial testing of goodwill for possible
impairment will be completed within the first six months of 2002 and final
testing, if possible impairment has been identified, by the end of the year. As
of March 31, 2002, the net carrying amount of goodwill is $450,000.
Page 8
Another intangible asset, totaling $4,110,750 at January 1, 2002, consists
of the Talon tradename and trademarks acquired on December 21, 2001 under an
asset purchase agreement with Talon, Inc. and Grupo Industrial Cierres Ideal,
S.A. de C.V. The Company has determined that this intangible asset has an
indefinite life and therefore, ceased amortization in accordance with SFAS 142
beginning January 1, 2002. The impairment test was completed as of January 1,
2002 and did not result in an impairment charge.
In accordance with SFAS 142, prior period amounts were not restated. The
March 31, 2001 net loss adjusted for the exclusion of amortization of goodwill
would have been $12,500 less than reported and there would have been no
difference in basic or diluted earnings per share.
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 adoption of this Statement had no material impact on the
Company's financial statements.
Page 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read together with the
Consolidated Financial Statements of Tag-It Pacific, Inc. and the notes to the
Consolidated Financial Statements included elsewhere in this Form 10-Q.
This discussion summarizes the significant factors affecting the
consolidated operating results, financial condition and liquidity and cash flows
of Tag-It Pacific, Inc. for the three months ended March 31, 2002 and 2001.
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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to our valuation of inventory and our allowance for uncollectable
accounts receivable. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o Inventory is evaluated on a continual basis and reserve adjustments
are made based on management's estimate of future sales value, if any,
of specific inventory items. Reserve adjustments are made for the
difference between the cost of the inventory and the estimated market
value and charged to operations in the period in which the facts that
give rise to the adjustments become known. Certain inventories 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 our
vendors, the customer is required to purchase the inventories from us
under normal invoice and selling terms. These buyback agreements are
considered in management's estimate of future market value of
inventories.
o Accounts receivable balances are evaluated on a continual basis and
allowances are provided for potentially uncollectable accounts based
on management's estimate of the collectability of customer accounts.
If the financial condition of a customer were to deteriorate,
resulting in an impairment of their ability to make payments, an
additional allowance may be required. Allowance adjustments are
charged to operations in the period in which the facts that give rise
to the adjustments become known.
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 a full service 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 Abercrombie & Fitch, A/X Armani
Exchange, Express, The Limited, Lerner and Swank, among others. In addition, we
distribute zippers under our TALON brand name to apparel brands and
manufacturers such as VF Corporation, Savane International and Tropical
Sportswear, among others.
Page 10
We have positioned ourselves as a fully integrated single-source supplier
of a full range of trim items for manufacturers of fashion apparel. Our business
focuses on servicing all of the trim requirements of our customers at the
manufacturing and retail brand level of the fashion apparel industry. Trim items
include thread, zippers, labels, buttons, rivets, printed marketing material,
polybags, packing cartons, and hangers. Trim items comprise a relatively small
part of the cost of most apparel products but comprise the vast majority of
components necessary to fabricate a typical apparel product. We offer customers
what we call our MANAGED TRIM SOLUTION, which is an Internet-based supply-chain
management system covering the complete management of development, ordering,
production, inventory management and just-in-time distribution of their trim and
packaging requirements. Traditionally, manufacturers of apparel products have
been required to operate their own apparel trim departments, requiring the
manufacturer to maintain a significant amount of infrastructure to coordinate
the buying of trim products from a large number of vendors. By acting as a
single source provider of a full range of trim items, we allow manufacturers
using our MANAGED TRIM SOLUTION to eliminate the added infrastructure, trim
inventory positions, overhead costs and inefficiencies created by in-house trim
departments that deal with a large number of vendors for the procurement of trim
items. We also seek to leverage our position as a single source supplier of trim
items as well as our extensive expertise in the field of trim distribution and
procurement to more efficiently manage the trim assembly process resulting in
faster delivery times and fewer production delays for our manufacturing
customers. Our MANAGED TRIM SOLUTION also helps to eliminate a manufacturer's
need to maintain a trim purchasing and logistics department.
We also serve as specified supplier for a variety of major retail brand and
private label oriented companies. We seek to expand our services as a vendor of
select lines of trim items for such customers to being a preferred or single
source provider of all of such brand customer's authorized trim requirements.
Our ability to offer brand name and private label oriented customers a full
range of trim products is attractive because it enables our customers to address
their quality and supply needs for all of their trim requirements from a single
source, avoiding the time and expense necessary to monitor quality and supply
from multiple vendors and manufacturer sources. In addition, by becoming a
specified supplier to brand customers, we have an opportunity to become the
preferred or sole vendor of trim items for all contract manufacturers of apparel
under that brand name.
On April 2, 2002, we entered into an exclusive license and intellectual
property rights agreement with Pro-Fit Holdings Limited. This agreement gives us
the exclusive rights to sell or sublicense waistbands manufactured under
patented technology developed by Pro-Fit Holdings for garments manufactured
anywhere in the world for the United States market and for all United States
brands. The new technology allows pant manufacturers to build a stretch factor
into standard waistbands that does not alter the appearance of the garment, but
allows the waist to stretch out and back by as much as two waist sizes. Through
our trim package business, and our TALON line of zippers, we are already focused
on the North American bottoms market. This product compliments our existing
product line and we intend to integrate the production of the waistbands into
our existing infrastructure. We will also target our existing customer base as a
ready-made market for this product. The exclusive license and intellectual
property rights agreement has an indefinite term that extends for the duration
of the trade secrets licensed under the agreement.
On December 21, 2001, we entered into an asset purchase agreement with
Talon, Inc. and Grupo Industrial Cierres Ideal, S.A. de C.V. whereby we
purchased certain TALON zipper assets, including the TALON(R) zipper brand name,
trademarks, patents, technical field equipment and inventory. Since July 2000,
we have been the exclusive distributor of TALON brand zippers. TALON is an
American brand with significant name recognition and brand equity. TALON was the
original pioneer of the formed wire metal zipper for the jeans industry and is a
specified zipper brand for manufacturers in the sportswear and outerwear
markets. The TALON acquisition is an important step in our strategy to offer a
complete high quality trim package to apparel manufacturers. Our transition from
a distributor to an owner of the TALON brand name better positions us to
revitalize the TALON brand name and capture increased market share in the
industry. As the owner of the TALON brand name, we believe we will be able to
more effectively respond to customer needs and better maintain the quality and
value of the TALON products.
Page 11
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 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, we
received a cash investment of $3 million from Coats North America Consolidated
in exchange for 759,494 shares of series C convertible redeemable preferred
stock. London-based Coats, plc is the world's largest manufacturer of industrial
thread and textile-related craft products. Coats has operations in 65 countries
and has a North American presence in the United States, Canada, Mexico, Central
America and the Caribbean.
On January 2, 2001, we purchased assets including customer lists of 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 our customer base in this region, including converting selected
customers to complete trim packages via our MANAGED TRIM SOLUTION program.
We have entered into an exclusive supply agreement with Azteca Production
International, Inc., AZT International SA D RL and Commerce Investment Group,
LLC. Pursuant to this supply agreement, we provide all trim-related products for
certain programs manufactured by Azteca Production International. The agreement
provides for a minimum aggregate total of $10 million 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. The
first contract year used to compute the minimum sales requirement is for a
period of eighteen months. Azteca Production International has been a
significant customer of ours for many years. This agreement is structured in a
manner that has allowed us to utilize our MANAGED TRIM SOLUTION system to supply
Azteca Production International with all of its trim program requirements. We
expanded our facilities in Tlaxcala, Mexico, to service Azteca Production
International's trim requirements.
We also have an exclusive supply agreement with Tarrant Apparel Group and
have been supplying Tarrant Apparel Group with all of its trim requirements
under our MANAGED TRIM SOLUTION system since 1998.
Sales under our exclusive supply agreements with Azteca Production
International and Tarrant Apparel Group amounted to approximately 63% of our
total sales for the year ended December 2001. We will continue to rely on these
two customers for a significant amount of our sales for the year ended December
2002. 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 of operations.
Page 12
The following table sets forth for the periods indicated, selected
statements of operations data shown as a percentage of net sales.
THREE MONTHS ENDED
MARCH 31,
------------------------
2002 2001
--------- ---------
Net sales 100.0 % 100.0 %
Cost of goods sold 71.7 72.0
--------- ---------
Gross profit 28.3 28.0
Selling expenses 4.2 4.7
General and administrative expenses 20.4 20.1
Restructuring charges - 12.4
--------- ---------
Operating income (loss) 3.7 % (9.2)%
========= =========
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 our Tijuana, Mexico, facilities and relocated our TALON brand
operations to Miami, 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 for the first and fourth
quarters of 2001 amounted to $1,257,598 and $304,025, including $355,769 of
benefits paid to terminated employees. We believe these restructuring measures
will reduce our overhead, sales and marketing and general and administrative
expenses in the future.
RESULTS OF OPERATIONS
Net sales decreased approximately $814,000, or 8.0%, to $9,325,000 for the
three months ended March 31, 2002 from $10,139,000 for the three months ended
March 31, 2001. 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. In addition, our purchase
of the TALON brand name and trademarks in December 2001 will enable us to better
control products offerings, selling prices and profit margins to our customers.
The decrease in net sales for the quarter was offset by an increase in
trim-related sales from our Tlaxcala, Mexico operations under our MANAGED TRIM
SOLUTION program. The overall decrease in sales compared to the prior year is
due to a general slow down of the economy and consumer spending. Management
estimates, based on current customer orders, that there will be a rebound in our
net sales through fiscal 2002 and we estimate that we will exceed 2001 sales
levels.
Gross profit decreased approximately $210,000, or 7.4%, to $2,634,000 for
the three months ended March 31, 2002 from $2,844,000 for the three months ended
March 31, 2001. Gross margin as a percentage of net sales increased to
approximately 28.3% for the three months ended March 31, 2002 as compared to
28.0% for the three months ended March 31, 2001. The increase in gross profit as
a percentage of net sales for the three months ended March 31, 2002 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 March 31, 2002
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.
Page 13
Selling expenses decreased approximately $85,000, or 17.7%, to $395,000 for
the three months ended March 31, 2002 from $480,000 for the three months ended
March 31, 2001. As a percentage of net sales, these expenses decreased to 4.2%
for the three months ended March 31, 2002 compared to 4.7% for the three months
ended March 31, 2001. 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 decreased approximately $134,000, or
6.6%, to $1,905,000 for the three months ended March 31, 2002 from $2,039,000
for the three months ended March 31, 2001. 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 20.4% for the three months ended March
31, 2002 compared to 20.1% for the three months ended March 31, 2001, because
the rate of increase in net sales did not exceed that of general and
administrative expenses.
Interest expense decreased approximately $252,000, or 49.0%, to $262,000
for the three months ended March 31, 2002 from $514,000 for the three months
ended March 31, 2001. On May 30, 2001, we replaced our credit facility 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 of prime plus 2%. We incurred financing charges of approximately
$570,000, including legal, consulting and closing costs, in the first two
quarters of 2001 related to our efforts to replace our existing 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. This increase in interest expense will be offset by decreases in
the prime rate from prior periods.
The provision for income taxes for the three months ended March 31, 2002
amounted to approximately $19,000 compared to an income tax benefit of $301,000
for the three months ended March 31, 2001. Income taxes increased for the three
months ended March 31, 2002 primarily due to increased taxable income.
Net income was approximately $54,000 for the three months ended March 31,
2002 as compared to a net loss of $1,145,000 for the three months ended March
31, 2001, due primarily to the restructuring charges incurred during the first
quarter of 2001 of approximately $1.3 million and the reduction of sales from
the prior quarter, as discussed above.
LIQUIDITY AND CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS
Cash and cash equivalents increased to $65,000 at March 31, 2002 from
$47,000 at December 31, 2001. The increase resulted from $640,000 and $62,000 of
cash used by operating and investing activities, offset by $720,000 of cash
provided by financing activities.
Net cash used by operating activities was approximately $640,000 and for
the three months ended March 31, 2002 and net cash provided by operating
activities was approximately $781,000 for the three months ended March 31, 2001.
The decrease in cash provided by operating activities for the three months ended
March 31, 2002 resulted primarily from increases in inventories and receivables,
which was offset by increases in accounts payable and accrued expenses. Cash
provided by operating activities for the three months ended March 31, 2001
resulted primarily from decreased accounts receivable and increased accounts
payable and accrued expenses, which was offset by increased inventories and net
losses.
Net cash used in investing activities was approximately $62,000 and
$145,000 for the three months ended March 31, 2002 and 2001, respectively. Net
cash used in investing activities for the three months ended March 31, 2002 and
2001 consisted primarily of capital expenditures for computer equipment and
upgrades.
Net cash provided by financing activities was approximately $720,000 for
the three months ended March 31, 2002 and net cash used in financing activities
for the three months ended March 31, 2001 was approximately $739,000. Net cash
provided by financing activities for the three months ended March 31, 2002
primarily reflects funds raised from private placement transactions, offset by
the repayment of subordinated notes payable. Net cash used in financing
activities for the three months ended March 31, 2001 primarily reflects the
repayment of a bank overdraft and decreased borrowings under our credit
facility.
Page 14
On May 30, 2001, we replaced our credit facility with a new facility with
UPS Capital Global Trade Finance Corporation which provides for increased
borrowing availability of up to $20,000,000. The initial term of the agreement
is three years and the facility is secured by substantially all of our assets.
The interest rate of the credit facility is at the prime rate plus 2%. The
credit facility requires the compliance with certain financial covenants
including net worth, fixed charge 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. Eligible accounts
receivable are reduced if our accounts receivable customer balances are
concentrated in excess of the percentages allowed under our agreement with UPS
Capital. If our business becomes further dependant on one or a limited number of
customers, increases in concentration levels of our receivables may limit the
receivables deemed eligible under our credit facility which could
correspondingly reduce our availability under the UPS Capital credit facility.
At March 31, 2002, outstanding borrowings under our UPS Capital credit facility
amounted to approximately $9,629,000. At March 31, 2001, outstanding borrowings
under our former facility amounted to approximately $9,677,000. Open letters of
credit amounted to approximately $50,000 at March 31, 2002. There were no open
letters of credit at March 31, 2001.
We currently satisfy our working capital requirements primarily through
cash flow generated from operations and borrowings under our credit facility
with UPS Capital. Our maximum availability under the credit facility is $20
million. Our borrowing base availability, calculated based on a defined formula
related to eligible accounts receivable and inventory, ranged from approximately
$9,900,000 to $13,300,000 from May 30, 2001 to March 31, 2002. A significant
decrease in eligible accounts receivable and inventory due to customer
concentration levels and the aging of inventory, among other factors, can have
an effect on our borrowing capabilities under our credit facility and may not be
adequate to satisfy our working capital requirements.
Historically, we have experienced seasonal fluctuations in sales volume.
These seasonal fluctuations result in sales volume decreases in the first and
fourth quarters of each year due to the seasonal fluctuations experienced by the
majority of our customers. During these quarters, borrowing availability under
our credit facility may decrease as a result of any decreases in eligible
accounts receivables generated from our sales. The decrease in borrowing
availability under our credit facility may result in our inability to meet our
working capital requirements during the first and fourth quarters of each year.
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 March 31,
2002, we were in compliance with these covenants.
In a series of sales on December 28, 2001, January 7, 2002 and January 8,
2002, we entered into stock and warrant purchase agreements with three private
investors, including Mark Dyne, the chairman of our board of directors. Pursuant
to the stock and warrant purchase agreements, we issued an aggregate of 516,665
shares of common stock at a price per share of $3.00 for aggregate proceeds of
$1,549,995. The stock and warrant purchase agreements also include a commitment
by one of the private investors to purchase an additional 400,000 shares of
common stock at a price per share of $3.00 at second closings (subject of
certain conditions) on or prior to October 1, 2002 for additional proceeds of
$1,200,000. In March 2002, this private investor purchased 100,000 shares of
common stock at a price per share of $3.00 pursuant to the second closing
provisions of the stock and warrant purchase agreement for total proceeds of
$300,000. The remaining commitment under the stock and warrant purchase
agreement is for an additional 300,000 shares with aggregate proceeds of
$900,000. Pursuant to the second closing provisions of the stock and warrant
purchase agreement, 50,000 warrants were issued to the investor.
Page 15
In accordance with the series C preferred stock purchase agreement entered
into by us and 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 North America Consolidated of $3 million cash. The series C preferred
shares 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 series C preferred shares are redeemable at the option of the
holder after four years. If the holders elect to redeem the series C preferred
shares, we have the option to redeem for cash at the stated value of $3 million
or in the form of the 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 shares. We can elect to redeem the series
C preferred 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 our common stock. Each holder of the
series C preferred shares has the right to vote with our common stock based on
the number of our common shares that the series C preferred shares could then be
converted into on the record date.
Pursuant to the terms of a factoring agreement for our Hong Kong
subsidiary, Tag-It Pacific Limited, the factor purchases our eligible accounts
receivable and assumes the credit risk with respect to those accounts for which
the factor has given its prior approval. If the factor does not assume the
credit risk for a receivable, the collection risk associated with the receivable
remains with us. We pay a fixed commission rate and may borrow up to 80% of
eligible accounts receivable. Interest is charged at 1.5% over the Hong Kong
Dollar prime rate. As of March 31, 2002 and 2001, the amount factored without
recourse was approximately $134,000 and $35,000 and the amount due from the
factor and recorded as a current asset was approximately $134,000 and $35,000.
There were no outstanding advances from the factor as of March 31, 2002 and
2001.
As of March 31, 2002, we had outstanding related-party debt of
approximately $850,000 at a weighted average interest rate of 10.5%, and
additional non-related-party debt of $25,200 at an interest rate of 10%. The
majority of related-party debt is due on demand, with the remainder due and
payable on the fifteenth day following the date of delivery of written demand
for payment. As of March 31, 2001, we had outstanding related-party debt, of
approximately $997,000 and $2,600,000 at a weighted average interest rate of
10.5% and 10%, and additional non-related-party debt of $25,200 at an interest
rate of 10%. The majority of related-party debt was cancelled in connection with
the TALON trademark purchase agreement dated December 21, 2001, with the
remainder due on the fifteenth day following the date of delivery of written
demand for payment.
Our receivables increased from $12,197,000 at March 31, 2001 to $12,398,000
at March 31, 2002. This increase was due primarily to increased related-party
trade receivables, partially offset by a decrease in trade accounts receivable.
In October 1998, we sold 2,390,000 shares of our common stock at a purchase
price per share of $1.125 to KG Investment, LLC. We used the $2,688,750 raised
in the private placement to fund a portion of our business growth plans and
operations. KG Investment is owned by Gerard Guez and Todd Kay, executive
officers and significant shareholders of Tarrant Apparel Group. Commencing in
December 1998, we began to provide trim products to Tarrant Apparel Group for
its operations in Mexico. In connection therewith, we purchased $2.25 million of
Tarrant's existing inventory in December 1998 for resale to Tarrant. Total sales
to Tarrant Apparel Group for the year ended December 31, 2001 amounted to
approximately $18,438,000. Pricing is consistent with competitive vendors and
terms are net 60 days.
On December 22, 2000, we entered into a supply agreement with Azteca
Production International, Inc., AZT International SA D RL and Commerce
Investment Group, LLC. The term of the supply agreement is three years, with
automatic renewals of consecutive three-year terms, and provides for a minimum
of $10 million in sales for each contract year beginning April 1, 2001. The
first contract year used to compute the minimum sales requirement is for a
period of eighteen months. In accordance with the agreement, we purchased
existing inventory from Azteca Production International in exchange for
1,000,000 shares of our common stock. Commencing in December 2000, we began to
provide trim products to Azteca Production International, Inc for its operations
in Mexico. In connection therewith, we
Page 16
purchased Azteca Production International's existing trim inventory in December
2000 for resale to Azteca Production International. Total sales to Azteca
Production International for the year ended December 31, 2001 amounted to
approximately $9,016,000. Pricing is consistent with competitive vendors and
terms are net 60 days.
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, future demand for our products, the size
and timing of future acquisitions, our borrowing base availability limitations
related to eligible accounts receivable and inventory and our expansion into
foreign markets. There can be no assurance that additional debt or equity
financing will be available on acceptable terms or at all. If we are unable to
secure additional financing, we may not be able to execute our plans for
expansion, including expansion into foreign markets to promote our TALON brand
tradename, and we may need to implement additional cost savings initiatives.
Our need for additional long-term financing includes the integration and
expansion of our operations to exploit our rights under our TALON trade name and
the expansion of our operations in the Asian, Caribbean and Central American
markets.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at March 31, 2002 and the
effects such obligations are expected to have on liquidity and cash flow in
future periods:
PAYMENTS DUE BY PERIOD
---------------------------------------------------------------
LESS THAN 1-3 4-5 AFTER
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
- -------------------------- ---------- ------------ ------------ ---------- ----------
Subordinated notes payable $4,700,000 $ 1,200,000 $ 3,500,000 $ - $ -
Capital lease obligations $ 162,881 $ 104,438 $ 58,443 $ - $ -
Subordinated notes
payable to related
parties (1) $ 849,971 $ 849,971 $ - $ - $ -
Operating leases $1,897,587 $ 630,807 $ 1,192,920 $ 73,860 $ -
Line of credit $9,628,741 $ 9,628,741 $ - $ - $ -
Note payable $ 25,200 $ 25,200 $ - $ - $ -
<FN>
- --------------------
(1) The majority of subordinated notes payable to related parties are due on
demand with the remainder due and payable on the fifteenth day following the
date of delivery of written demand for payment.
</FN>
Page 17
NEW ACCOUNTING PRONOUNCEMENT
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. We believe the adoption of this Statement will have no material
impact on our financial statements.
Page 18
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain forward-looking
statements that involve risks and uncertainties. Factors associated with the
forward-looking statements that could cause actual results to differ from those
projected or forecast are included in the statements below. In addition to other
information contained in this report, readers should carefully consider the
following cautionary statements and risk factors.
IF WE LOSE OUR 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 42.0% and 48.1% of
our net sales, on a consolidated basis, for the years ended December 31, 2001
and 2000. In December 2000, we entered into an exclusive supply agreement with
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 our results of operations. Further, if the economic conditions in the United
States worsen or if a wider or global economic slowdown occurs, we may
experience a material adverse impact on our business, operating results, and
financial condition.
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
Page 19
our financial and management information and reporting systems, we may not be
able to implement our growth strategies successfully and our revenues will be
adversely affected. In addition, if we cannot hire, train, motivate and manage
new employees, including management and operating personnel in sufficient
numbers, and integrate them into our overall operations and culture, our ability
to manage future growth, increase production levels and effectively market and
distribute our products may be significantly impaired.
WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS IN
OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND STOCK
PRICE VOLATILITY. We operate in an industry that is subject to significant
fluctuations in operating results from quarter to quarter, which may lead to
unexpected reductions in revenues and stock price volatility. Factors that may
influence our quarterly operating results include:
o The volume and timing of customer orders received during the quarter;
o The timing and magnitude of customers' marketing campaigns;
o The loss or addition of a major customer;
o The availability and pricing of materials for our products;
o The increased expenses incurred in connection with the introduction of
new products;
o Currency fluctuations;
o Delays caused by third parties; and
o Changes in our product mix or in the relative contribution to sales of
our subsidiaries.
Due to these factors, it is possible that in some quarters our operating
results may be below our stockholders' expectations and those of public market
analysts. If this occurs, the price of our common stock would likely be
adversely affected.
OUR CUSTOMERS HAVE CYCLICAL BUYING PATTERNS WHICH MAY CAUSE US TO HAVE
PERIODS OF LOW SALES VOLUME. Most of our customers are in the apparel industry.
The apparel industry historically has been subject to substantial cyclical
variations. Our business has experienced, and we expect our business to continue
to experience, significant cyclical fluctuations due, in part, to customer
buying patterns, which may result in periods of low sales usually in the first
and fourth quarters of our financial year.
OUR BUSINESS MODEL IS DEPENDENT ON INTEGRATION OF INFORMATION SYSTEMS ON A
GLOBAL BASIS AND, TO THE EXTENT THAT WE FAIL TO MAINTAIN AND SUPPORT OUR
INFORMATION SYSTEMS, IT CAN RESULT IN LOST REVENUES. We must consolidate and
centralize the management of our subsidiaries and significantly expand and
improve our financial and operating controls. Additionally, we must effectively
integrate the information systems of our Mexican 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
Page 20
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 FACILITIES, WE WILL NOT
BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently, we
do not operate duplicate facilities in different geographic areas. Therefore, in
the event of a regional disruption where we maintain one or more of our
facilities, it is unlikely that we could shift our operations to a different
geographic region and we may have to cease or curtail our operations. This may
cause us to lose sales and customers. The types of disruptions that may occur
include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention; and
o Natural disasters.
INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY EXPERIENCE
DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our MANAGED TRIM
SOLUTION is an Internet-based business-to-business e-commerce system. To the
extent that we fail to adequately continue to update and maintain the hardware
and software implementing the MANAGED TRIM SOLUTION, our customers may
experience interruptions in service due to defects in our hardware or our source
code. In addition, since our MANAGED TRIM SOLUTION is Internet-based,
interruptions in Internet service generally can negatively impact our customers'
ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects
of their trim needs. Such defects or interruptions could result in lost revenues
and lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors,
including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison
Corporation and Scovill Fasteners, Inc., have greater name recognition, longer
operating histories and, in many cases, substantially greater financial and
other resources than we do.
IF CUSTOMERS DEFAULT ON BUYBACK AGREEMENTS WITH US, WE WILL BE LEFT HOLDING
UNSALABLE INVENTORY. Inventories include goods that are subject to buyback
agreements with our customers. Under these buyback agreements, the customer must
purchase the inventories from us under normal invoice and selling terms, if any
inventory which we purchase on their behalf remains in our hands longer than
agreed by the customer from the time we received the goods from our vendors. If
any customer defaults on these buyback provisions, we may incur a charge in
connection with our holding significant amounts of unsalable inventory.
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
Page 21
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;
o Interest rates;
o Changes in accounting principles;
o Sales of common stock by existing shareholders or holders of options;
o Announcements of key developments by our competitors; and
o The reaction of markets and securities analysts to announcements and
developments involving our company.
IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may
include expansion through internal growth, by acquiring complementary businesses
or by establishing strategic relationships with targeted customers and
suppliers. In order to do so or to fund our other activities, we may issue
additional equity securities that could dilute our stockholders' stock
ownership. We may also assume additional debt and incur impairment losses
related to goodwill and other tangible assets if we acquire another company and
this could negatively impact our results of operations.
WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS. We
may consider strategic acquisitions as opportunities arise, subject to the
obtaining of any necessary financing. Acquisitions involve numerous risks,
including diversion of our management's attention away from our operating
activities. We cannot assure our stockholders that we will not encounter
unanticipated problems or liabilities relating to the integration of an acquired
company's operations, nor can we assure our stockholders that we will realize
the anticipated benefits of any future acquisitions.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue
additional shares of preferred stock and some provisions of our certificate of
incorporation and bylaws and of Delaware law could make it more difficult for a
third party to make an unsolicited takeover attempt of us. These anti-takeover
measures may depress the price of our common stock by making it more difficult
for third parties to acquire us by offering to purchase shares of our stock at a
premium to its market price.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT
OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As of
December 31, 2001, our officers and directors and their affiliates owned
approximately 42.4% 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
Page 22
Harold Dyne, beneficially owned approximately 40.4% 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 11.4% of the
outstanding shares of common stock at December 31, 2001. KG Investment, LLC, a
significant stockholder, owns approximately 27.2% of the outstanding shares of
our common stock at December 31, 2001. 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.
WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED
SECURITY MEASURES IN RESPONSE TO TERRORISM. Our business depends on the free
flow of products and services through the channels of commerce. Recently, in
response to terrorists' activities and threats aimed at the United States,
transportation, mail, financial and other services have been slowed or stopped
altogether. Further delays or stoppages in transportation, mail, financial or
other services could have a material adverse effect on our business, results of
operations and financial condition. Furthermore, we may experience an increase
in operating costs, such as costs for transportation, insurance and security as
a result of the activities and potential activities. We may also experience
delays in receiving payments from payers that have been affected by the
terrorist activities and potential activities. The United States economy in
general is being adversely affected by the terrorist activities and potential
activities and any economic downturn could adversely impact our results of
operations, impair our ability to raise capital or otherwise adversely affect
our ability to grow our business.
Page 23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of our sales are denominated in United States dollars or the currency of the
country 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 United States bank accounts and we do not believe we
have significant market risk exposure with regard to our investments.
We are also exposed to the impact of interest rate changes. 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.
Page 24
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We currently have pending claims, suits and complaints that arise in the
ordinary course of our business. We believe that we have meritorious defenses to
these claims and the claims are covered by insurance or, after taking into
account the insurance in place, would not have a material effect on our
consolidated financial condition if adversely determined against us.
ITEM 2. CHANGES IN SECURITIES
On April 2, 2002, we entered into an exclusive license and intellectual
property rights agreement with Pro-Fit Holdings Limited. The exclusive license
and intellectual property rights agreement gives us the exclusive rights to sell
or sublicense waistbands manufactured under patented technology developed by
Pro-Fit Holdings Limited for garments manufactured anywhere in the world for the
United States market and all United States brands. In accordance with the
exclusive license and intellectual property agreement, we issued 150,000 shares
of our common stock at the market value of the stock on the date of the
agreement in a private placement exempt from registration pursuant to Section
4(2) of the Securities Act of 1933. The shares contain restrictions related to
the transfer of the shares and registration rights. The agreement has an
indefinite term that extends for the duration of the trade secrets licensed
under the agreement.
In a series of sales on December 28, 2001, January 7, 2002 and January 8,
2002, we entered into stock and warrant purchase agreements with three private
investors, including Mark Dyne, the chairman of our board of directors. Pursuant
to the stock and warrant purchase agreements, we issued an aggregate of 516,665
shares of common stock at a price per share of $3.00 for aggregate proceeds of
$1,549,995 in private placements exempt from registration pursuant to Section
4(2) of the Securities Act of 1933. The stock and warrant purchase agreements
also include a commitment by one of the private investors to purchase an
additional 400,000 shares of common stock at a price per share of $3.00 at
second closings (subject of certain conditions) on or prior to October 1, 2002
for additional proceeds of $1,200,000. Pursuant to the stock and warrant
purchase agreements, 258,332 warrants to purchase common stock were issued at
the first closing of the transactions and 200,000 warrants are to be issued at
the second closing. The warrants are exercisable immediately after closing, one
half of the warrants at an exercise price of 110% and the second half at an
exercise price of 120% of the market value of the our common stock on the date
of closing. The exercise price for the warrants shall be adjusted upward by 25%
of the amount, if any, that the market price of our common stock on the exercise
date exceeds the initial exercise price (as adjusted) up to a maximum exercise
price of $5.25. The warrants have a term of four years. The shares contain
restrictions related to the sale or transfer of the shares, registration and
voting rights. Total shares and warrants issued during the year ended December
31, 2001 amount to 266,666 and 133,332. Total shares and warrants issued in
January 2002 amounted to 249,999 and 125,000.
In March 2002, one of the private investors purchased an additional 100,000
shares of common stock at a price per share of $3.00 pursuant to the second
closing provisions of the related agreement for total proceeds of $300,000. The
remaining commitment under this agreement is for an additional 300,000 shares
with aggregate proceeds of $900,000. Pursuant to the second closing provisions
of the stock and warrant purchase agreement, 50,000 warrants were issued to the
investor.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None.
(b) Report on Form 8-K.
Report on Form 8-K, Filed March 28, 2002, reporting under Item 5, our press
release for the fiscal year end 2001 operating results.
Page 25
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: May 3, 2002 TAG-IT PACIFIC, INC.
` /S/ RONDA SALLMEN
--------------------------------------
By: Ronda Sallmen
Its: Chief Financial Officer
Page 26