================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended June 30, 2003.
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
(Registrant's Telephone Number, including area code)
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 [_]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes [_] No [X]
Indicate 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, 11,451,909 shares issued and outstanding as of August
14, 2003.
================================================================================
TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q
PART I FINANCIAL INFORMATION PAGE
----
Item 1. Consolidated Financial Statements..................................3
Consolidated Balance Sheets as of
June 30, 2003 (unaudited) and December 31, 2002....................3
Consolidated Statements of Operations (unaudited)
for the Three Months and Six Months Ended
June 30, 2003 and 2002.............................................4
Consolidated Statements of Cash Flows (unaudited)
for the Six Months Ended June 30, 2003 and 2002....................5
Notes to the Consolidated Financial Statements.....................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................13
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.......................................................31
Item 4. Controls and Procedures...........................................31
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................32
Item 2. Changes in Securities and Use of Proceeds.........................32
Item 4. Submission of Matters to a Vote of Security Holders...............32
Item 6. Exhibits and Reports on Form 8-K..................................33
2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
Consolidated Balance Sheets
June 30, December 31,
2003 2002
----------- -----------
Assets (unaudited)
Current Assets:
Cash and cash equivalents ....................... $ 1,376,892 $ 285,464
Due from factor ................................. 26,517 532,672
Trade accounts receivable, net .................. 8,036,297 5,456,517
Trade accounts receivable, related parties ...... 17,043,719 14,770,466
Refundable income taxes ......................... -- 212,082
Inventories ..................................... 24,586,332 23,105,267
Prepaid expenses and other current assets ....... 1,557,273 599,543
Deferred income taxes ........................... 90,928 90,928
----------- -----------
Total current assets .......................... 52,717,958 45,052,939
Property and Equipment, net of accumulated
depreciation and amortization ................... 4,937,066 2,953,701
Tradename .......................................... 4,110,750 4,110,750
Goodwill ........................................... 450,000 450,000
License rights ..................................... 459,375 490,875
Due from related parties ........................... 899,256 870,251
Other assets ....................................... 264,078 374,106
----------- -----------
Total assets ....................................... $63,838,483 $54,302,622
=========== ===========
Liabilities, Convertible Redeemable
Preferred Stock and Stockholders' Equity
Current Liabilities:
Line of credit .................................. $15,495,637 $16,182,061
Accounts payable and accrued expenses ........... 12,785,951 10,401,187
Deferred income ................................. 1,027,984 1,027,984
Subordinated notes payable to related parties ... 849,971 1,349,971
Current portion of capital lease obligations .... 561,933 71,928
Current portion of subordinated note payable .... 1,200,000 1,200,000
----------- -----------
Total current liabilities ..................... 31,921,476 30,233,131
Capital lease obligations, less current portion .... 920,991 107,307
Subordinated note payable, less current portion .... 2,000,000 2,600,000
----------- -----------
Total liabilities ............................. 34,842,467 32,940,438
----------- -----------
Convertible redeemable preferred stock
Series C, $0.001 par value; 759,494
shares authorized; 759,494 shares issued
and outstanding at June 30, 2003 and
December 31, 2002 (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; 11,394,909 shares
issued and outstanding at June 30, 2003;
9,319,909 at December 31, 2002 ................ 11,396 9,321
Additional paid-in capital ...................... 23,392,437 16,776,012
Retained earnings ............................... 2,697,182 1,681,850
----------- -----------
Total stockholders' equity ......................... 26,101,015 18,467,183
----------- -----------
Total liabilities, convertible redeemable
preferred stock and stockholders' equity ........ $63,838,483 $54,302,622
=========== ===========
See accompanying notes to consolidated financial statements.
3
TAG-IT PACIFIC, INC.
Consolidated Statements of Operations
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net sales ................... $20,731,573 $19,793,344 $35,090,407 $29,118,400
Cost of goods sold .......... 15,267,058 14,816,081 25,326,310 21,506,794
----------- ----------- ----------- -----------
Gross profit ............. 5,464,515 4,977,263 9,764,097 7,611,606
Selling expenses ............ 1,245,769 578,051 2,074,913 972,918
General and administrative
expenses ................. 2,939,927 2,691,781 5,638,432 4,596,912
----------- ----------- ----------- -----------
Total operating expenses . 4,185,696 3,269,832 7,713,345 5,569,830
Income from operations ...... 1,278,819 1,707,431 2,050,752 2,041,776
Interest expense, net ....... 342,989 306,528 663,837 568,271
----------- ----------- ----------- -----------
Income before income taxes .. 935,830 1,400,903 1,386,915 1,473,505
Provision for income taxes .. 187,166 354,600 277,383 373,190
----------- ----------- ----------- -----------
Net income ............... $ 748,664 $ 1,046,303 $ 1,109,532 $ 1,100,315
=========== =========== =========== ===========
Less: Preferred stock
dividends ................ 47,100 45,000 94,200 90,000
----------- ----------- ----------- -----------
Net income to common
shareholders ............. $ 701,564 $ 1,001,303 $ 1,015,332 $ 1,010,315
=========== =========== =========== ===========
Basic earnings per share .... $ 0.07 $ 0.11 $ 0.10 $ 0.11
=========== =========== =========== ===========
Diluted earnings per share .. $ 0.07 $ 0.10 $ 0.10 $ 0.11
=========== =========== =========== ===========
Weighted average number of
common shares outstanding:
Basic .................... 10,209,195 9,282,365 9,818,390 9,148,681
=========== =========== =========== ===========
Diluted .................. 10,737,427 9,591,984 10,169,168 9,448,223
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
4
TAG-IT PACIFIC, INC.
Consolidated Statements of Cash Flows
(unaudited)
Six Months Ended June 30,
----------------------------
2003 2002
----------- -----------
Increase (decrease) in cash and cash
equivalents
Cash flows from operating activities:
Net income ............................... $ 1,109,532 $ 1,100,315
Adjustments to reconcile net income
to net cash used in operating
activities:
Depreciation and amortization ............. 617,925 575,006
Increase in allowance for doubtful
accounts ................................ 163,489 23,315
Changes in operating assets and
liabilities:
Receivables, including related
parties and due from factor .......... (4,660,629) (9,841,998)
Inventories ............................ (1,481,065) (3,145,898)
Other assets ........................... (5,663) (46,439)
Prepaid expenses and other
current assets ....................... (957,730) (227,113)
Accounts payable and accrued
expenses ............................. 2,035,362 5,336,688
Income taxes payable ................... 479,479 369,008
----------- -----------
Net cash used in operating activities ........ (2,699,300) (5,857,116)
----------- -----------
Cash flows from investing activities:
Acquisition of property and
equipment .............................. (980,046) (140,835)
----------- -----------
Cash flows from financing activities:
(Repayment) proceeds from bank
line of credit, net .................... (536,162) 5,587,977
Proceeds from private placement
transactions ........................... 6,395,300 1,029,997
Proceeds from exercise of stock
options ................................ 182,000 49,400
Repayment of capital leases .............. (170,364) (155,339)
Repayment of notes payable ............... (1,100,000) (500,000)
----------- -----------
Net cash provided by financing
activities ................................. 4,770,774 6,012,035
----------- -----------
Net increase in cash ......................... 1,091,428 14,084
Cash at beginning of period .................. 285,464 46,948
----------- -----------
Cash at end of period ........................ $ 1,376,892 $ 61,032
=========== ===========
Supplemental disclosures of cash flow
information:
Cash paid (received) during the
period for:
Interest ............................... $ 637,930 $ 519,156
Income taxes paid ...................... $ 9,131 $ 4,814
Income taxes received .................. $ (212,082) $ --
Non-cash financing activity:
Common stock issued in acquisition
of license rights .................... $ -- $ 577,500
Capital lease obligation ............... $ 1,474,053 $ --
See accompanying notes to consolidated financial statements.
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, 2002.
2. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:
PER
THREE MONTHS ENDED JUNE 30, 2003: INCOME SHARES SHARE
---------- ---------- --------
Basic earnings per share:
Income available to common
stockholders ................... $ 701,564 10,209,195 $ 0.07
Effect of Dilutive Securities:
Options .......................... 482,937
Warrants ......................... 45,295
---------- ---------- --------
Income available to common
stockholders ................... $ 701,564 10,737,427 $ 0.07
========== ========== ========
THREE MONTHS ENDED JUNE 30, 2002:
Basic earnings per share:
Income available to common
stockholders ................... $1,001,303 9,282,365 $ 0.11
Effect of Dilutive Securities:
Options .......................... 254,634
Warrants ......................... 54,985
---------- ---------- --------
Income available to common
stockholders ................... $1,001,303 9,591,984 $ 0.10
========== ========== ========
6
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
PER
SIX MONTHS ENDED JUNE 30, 2003: INCOME SHARES SHARE
---------- ---------- --------
Basic earnings per share:
Income available to common
stockholders ................... $1,015,332 9,818,390 $ 0.10
Effect of Dilutive Securities:
Options .......................... 33,488
Warrants ......................... 317,290
---------- ---------- --------
Income available to common
stockholders ................... $1,015,332 10,169,168 $ 0.10
========== ========== ========
SIX MONTHS ENDED JUNE 30, 2002:
Basic earnings per share:
Income available to common
stockholders ................... $1,010,315 9,148,681 $ 0.11
Effect of Dilutive Securities:
Options .......................... 245,101
Warrants ......................... 54,441
---------- ---------- --------
Income available to common
stockholders ................... $1,010,315 9,448,223 $ 0.11
========== ========== ========
Warrants to purchase 426,666 shares of common stock at between $4.57
and $5.06, options to purchase 105,000 shares of common stock at $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 June 30, 2003, 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 655,832 shares of common stock at between $4.34
and $5.06, options to purchase 568,000 shares of common stock at between $4.25
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 six months ended June 30, 2003, 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 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 and six months ended June 30, 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.
7
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
3. STOCK BASED COMPENSATION
All stock options issued to employees had an exercise price not less
than the fair market value of the Company's Common Stock on the date of grant,
and in accounting for such options utilizing the intrinsic value method there is
no related compensation expense recorded in the Company's financial statements
for the three and six months ended June 30, 2003 and 2002. If compensation cost
for stock-based compensation had been determined based on the fair market value
of the stock options on their dates of grant in accordance with SFAS 123, the
Company's net income and earnings per share for the three and six months ended
June 30, 2003 and 2002 would have amounted to the pro forma amounts presented
below:
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
----------- ------------- ------------- -------------
Net income, as reported ................. $ 748,664 $ 1,046,303 $ 1,109,532 $ 1,100,315
Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects . -- -- -- --
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects ............................ (44,838) (30,268) (50,120) (60,536)
----------- ------------- ------------- -------------
Pro forma net income .................... $ 703,826 $ 1,016,035 $ 1,059,412 $ 1,039,779
=========== ============= ============= =============
Earnings per share:
Basic - as reported .............. $ 0.07 $ 0.11 $ 0.10 $ 0.11
Basic - pro forma ................ $ 0.06 $ 0.11 $ 0.10 $ 0.10
Diluted - as reported ............ $ 0.07 $ 0.10 $ 0.10 $ 0.11
Diluted - pro forma .............. $ 0.06 $ 0.10 $ 0.10 $ 0.10
8
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
4. PRIVATE PLACEMENTS
On May 30, 2003, the Company raised approximately $6,037,500 in a
private placement transaction with five institutional investors. Pursuant to a
securities purchase agreement with these institutional investors, the Company
sold 1,725,000 shares of its common stock at a price per share of $3.50. After
commissions and expenses, the Company received net proceeds of approximately
$5.5 million. The Company has agreed to register the shares issued in the
private placement with the Securities and Exchange Commission for resale by the
investors. In conjunction with the private placement transaction, the Company
issued 172,500 warrants to the placement agent. The warrants are exercisable
beginning August 30, 2003 through May 30, 2008 and have a per share exercise
price of $5.06.
In a series of sales on December 28, 2001, January 7, 2002 and January
8, 2002, the Company entered into Stock and Warrant Purchase Agreements with
three private investors, including Mark Dyne, the chairman of the Company's
board of directors. Pursuant to the Stock and Warrant Purchase Agreements, the
Company issued an aggregate of 516,665 shares of common stock at a price per
share of $3.00 for aggregate proceeds of $1,549,995. The Stock and Warrant
Purchase Agreements also included a commitment by one of the two non-related
investors to purchase an additional 400,000 shares of common stock at a price
per share of $3.00 at a second closing (subject of certain conditions) on or
prior to March 1, 2003, as amended, for additional proceeds of $1,200,000.
Pursuant to the Stock and Warrant purchase agreements, 258,332 warrants to
purchase common stock were issued at the first closing of the transactions and
200,000 warrants were 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.
In March 2002 and February 2003, one of the non-related investors
purchased an additional 100,000 and 300,000 shares, respectively, of common
stock at a price per share of $3.00 pursuant to the second closing provisions of
the related agreement for total proceeds of $1,200,000. Pursuant to the second
closing provisions of the Stock and Warrant Purchase Agreement, 50,000 and
150,000 warrants were issued to the investor in March 2002 and February 2003,
respectively. There are no remaining commitments due under the stock and warrant
purchase agreements.
9
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
5. CAPITAL LEASE OBLIGATION
On April 3, 2003, the Company entered into a financing agreement for
the purchase and implementation of computer equipment and software. The capital
lease obligation bears interest at 6% and expires in March 2006. Future minimum
annual payments under the capital lease obligation are as follows:
Years ending December 31, Amount
-----------
2003 (six months) ....................................... $ 282,440
2004 .................................................... 564,880
2005 .................................................... 466,756
2006 .................................................... 152,117
-----------
Total payments .......................................... 1,466,193
Less amount representing interest ....................... (126,278)
-----------
Balance at June 30, 2003 ................................ 1,339,995
Less current portion .................................... 491,982
-----------
Long-term portion ....................................... $ 847,933
===========
6. GUARANTEES AND CONTINGENCIES
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of the Company's
agreements that it has determined are within the scope of FIN 45:
In accordance with the bylaws of the Company, officers and directors
are indemnified for certain events or occurrences arising as a result of the
officer or director's serving in such capacity. The term of the indemnification
period is for the lifetime of the officer or director. The maximum potential
amount of future payments the Company could be required to make under the
indemnification provisions of its bylaws is unlimited. However, the Company has
a director and officer liability insurance policy that reduces its exposure and
enables it to recover a portion of any future amounts paid. As a result of its
insurance policy coverage, the Company believes the estimated fair value of the
indemnification provisions of its bylaws is minimal and therefore, the Company
has not recorded any related liabilities.
The Company enters into indemnification provisions under its agreements
with investors and its agreements with other parties in the normal course of
business, typically with suppliers, customers and landlords. Under these
provisions, the Company generally indemnifies and holds harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
the Company's activities or, in some cases, as a result of the indemnified
party's activities under the agreement. These indemnification provisions often
include indemnifications relating to representations made by the Company with
regard to intellectual property rights. These indemnification provisions
generally survive termination of the underlying agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is unlimited. The Company has not incurred material
costs to defend lawsuits or settle claims related to these indemnification
agreements. As a result, the Company believes the estimated fair value of these
agreements is minimal. Accordingly, the Company has not recorded any related
liabilities.
10
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
As of June 30, 2003, the Company indirectly guaranteed the indebtedness
of one of its suppliers through the issuance by a related party of letters of
credit to purchase goods totaling $528,000. Financing costs due to the related
party amounted to approximately $43,000. The letters of credit expire on various
dates thru July 2003.
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 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
September 15, 2002. The Company believes the adoption of this Statement will
have no material impact on its financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This statement eliminates the current requirement that gains and
losses on debt extinguishment must be classified as extraordinary items in the
income statement. Instead, such gains and losses will be classified as
extraordinary items only if they are deemed to be unusual and infrequent, in
accordance with the current GAAP criteria for extraordinary classification. In
addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring
that modifications of capital leases that result in reclassification as
operating leases be accounted for consistent with sale-leaseback accounting
rules. The statement also contains other nonsubstantive corrections to
authoritative accounting literature. The changes related to debt extinguishment
will be effective for fiscal years beginning after May 15, 2002, and the changes
related to lease accounting will be effective for transactions occurring after
May 15, 2002. Adoption of this standard will not have any immediate effect on
the Company's consolidated financial statements.
In September 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The
Company will adopt the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of a company's commitment to an exit plan. SFAS No. 146
also establishes that the liability should initially be measured and recorded at
fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing
future restructuring costs as well as the amount recognized.
In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, an interpretation of Accounting
Research Bulletins ("ARB") No. 51, Consolidated Financial Statements ("FIN 46").
FIN 46 clarifies the application of ARB No. 51 to certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
The Company does not believe the adoption of FIN 46 will have a material impact
on its financial position and results of operations.
11
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities," ("SFAS 149"). SFAS No.
149 amends and clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for the hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS 149 is generally effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. The adoption of SFAS 149 is not expected to have a material
effect on the Company's financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Instruments with Characteristics of Both Liabilities and Equity," ("SFAS 150")
which establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires that an issuer classify a financial instrument that is within
its scope, which may have previously been reported as equity, as a liability (or
an asset in some circumstances). This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003 for public companies. The Company does not believe the adoption of SFAS 150
will have a material impact on its fiancial statements.
12
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 and six months ended June 30, 2003 and
2002. 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.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to our valuation of inventory and our allowance for uncollectable
accounts receivable. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
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. A substantial portion of our
total inventories is subject to buyback arrangements with our
customers. The buyback arrangements contain provisions related
to the inventory we purchase and warehouse on behalf of our
customers. In the event that inventories remain with us in
excess of six to nine months from our receipt of the goods
from our vendors or the termination of production of a
customer's product line related to the inventories, the
customer is required to purchase the inventories from us under
normal invoice and selling terms. If the financial condition
of a customer were to deteriorate, resulting in an impairment
of its ability to purchase inventories, an additional
adjustment may be required. These buyback arrangements are
considered in management's estimate of future market value of
inventories.
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 its ability to make payments, an additional
allowance may be required. Allowance adjustments are charged
to operations in the period in which the facts that give rise
to the adjustments become known.
o We record valuation allowances to reduce our deferred tax
assets to an amount that we believe is more likely than not to
be realized. We consider estimated future taxable
13
income and ongoing prudent and feasible tax planning
strategies in accessing the need for a valuation allowance. If
we determine that we will not realize all or part of our
deferred tax assets in the future, we would make an adjustment
to the carrying value of the deferred tax asset, which would
be reflected as an income tax expense. Conversely, if we
determine that we will realize a deferred tax asset, which
currently has a valuation allowance, we would be required to
reverse the valuation allowance, which would be reflected as
an income tax benefit.
o Intangible assets are evaluated on a continual basis and
impairment adjustments are made based on management's
valuation of identified reporting units related to goodwill,
the valuation of intangible assets with indefinite lives and
the reassessment of the useful lives related to other
intangible assets with definite useful lives. Impairment
adjustments are made for the difference between the carrying
value of the intangible asset and the estimated valuation and
charged to operations in the period in which the facts that
give rise to the adjustments become known.
o Sales are recorded at the time of shipment, at which point
title transfers to the customer, and when collection is
reasonably assured.
BUSINESS OVERVIEW AND RECENT DEVELOPMENTS
Tag-It Pacific, Inc. is an apparel company that specializes in the
distribution of trim items to manufacturers of fashion apparel and licensed
consumer products, and 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 specified supplier of trim items to owners of specific brands,
brand licensees and retailers, including Abercrombie & Fitch, The Limited,
Express, Lerner and Miller's Outpost, among others. We also distribute zippers
under our TALON brand name to owners of apparel brands and apparel manufacturers
such as Levi Strauss & Co., VF Corporation and Tropical Sportswear, among
others. In 2002, we created a new division under the TEKFIT brand name. This
division develops and sells apparel components that utilize the patented Pro-Fit
technology, including a stretch waistband. We market these products to the same
customers targeted by our MANAGED TRIM SOLUTION and TALON zipper divisions.
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(TM), 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 manufacturers 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(TM) 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
14
TRIM SOLUTION(TM) also helps to eliminate a manufacturer's need to maintain a
trim purchasing and logistics department.
We also serve as a specified supplier for a variety of major retail
brand and private label oriented companies. A specified supplier is a suppler
that has been approved for quality and service by a major retail brand or
private label company. 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 May 30, 2003, we raised approximately $6,037,500 in a private
placement transaction with five institutional investors. Pursuant to a
securities purchase agreement with these institutional investors, we sold
1,725,000 shares of our common stock at a price per share of $3.50. After
commissions and expenses, we received net proceeds of approximately $5.5
million. We have agreed to register the shares issued in the private placement
with the Securities and Exchange Commission for resale by the investors. In
conjunction with the private placement transaction, we issued 172,500 warrants
to the placement agent. The warrants are exercisable beginning August 30, 2003
through May 30, 2008 and have a per share exercise price of $5.06.
On July 12, 2002, we entered into an exclusive supply agreement with
Levi Strauss & Co. In accordance with the supply agreement, Levi is to purchase
a minimum of $10 million of waistbands, various trim products, garment
components and services over the two-year term of the agreement. Certain
proprietary products, equipment and technological know-how will be supplied to
Levi on an exclusive basis during this period. The supply agreement also
appoints TALON as an approved zipper supplier to Levi. As an addendum to the
supply agreement, we have also been granted approval as a specified vendor of
woven labels and printed tags by Levi Strauss & Co.
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. 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
15
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.
RELATED PARTY SUPPLY AGREEMENTS
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(TM) 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(TM) 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(TM) 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.
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. 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(TM) system to
supply Azteca Production International with all of its trim program
requirements. We have 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(TM) system since 1998. The exclusive supply
agreement with Tarrant Apparel Group has an indefinite term.
Sales under our exclusive supply agreements with Azteca Production
International and Tarrant Apparel Group amounted to approximately 69.7% and
63.0% of our total sales for the years ended December 2002 and 2001, and 47.3%
of our total sales for the six months ended June 30, 2003. We will continue to
rely on these two customers for a significant amount of our sales for the year
ended December 2003. Sales under these exclusive supply agreements as a
percentage of total sales for the year ended December 2003 are anticipated to be
lower than the year ended December 2002 due mainly to an increase in sales to
other customers. 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. Included in trade accounts
receivable, related parties at June
16
30, 2003, is approximately $17.0 million due from Tarrant Apparel Group and
Azteca Production International.
Included in inventories at June 30, 2003 are inventories of
approximately $10.5 million that are subject to buyback arrangements with Levi
Strauss & Co., Tarrant Apparel Group, Azteca Production International and other
customers. The buyback arrangements contain provisions related to the inventory
purchased on behalf of these customers. In the event that inventories remain
with us in excess of six to nine months from our receipt of the goods from our
vendors or the termination of production of a customer's product line related to
the inventories, the customer is required to purchase the inventories from us
under normal invoice and selling terms. During the six months ended June 30,
2003, we sold approximately $1.3 million in inventory to Tarrant Apparel Group
and Azteca Production International pursuant to these buyback arrangements. If
the financial condition of Tarrant Apparel Group and Azteca Production
International were to deteriorate, resulting in an impairment of their ability
to purchase inventories or pay receivables, it may have an adverse affect on our
results of operations.
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 SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
-------------- --------------
2003 2002 2003 2002
----- ----- ----- -----
Net sales ............................... 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ...................... 73.6 74.9 72.2 73.9
----- ----- ----- -----
Gross profit ............................ 26.4 25.1 27.8 26.1
Selling expenses ........................ 6.0 2.9 5.9 3.3
General and administrative expenses ..... 14.2 13.6 16.1 15.8
----- ----- ----- -----
Operating Income ........................ 6.2% 8.6% 5.8% 7.0%
===== ===== ===== =====
Net sales increased approximately $939,000, or 4.7%, to $20,732,000 for
the three months ended June 30, 2003 from $19,793,000 for the three months ended
June 30, 2002. The increase in net sales was primarily due to the addition of
sales under our TEKFIT stretch waistband division, for which there were no sales
in the three months ended June 30, 2002. In late 2002, we created a new division
under the TEKFIT brand name. This division develops and sells apparel components
that utilize the patented Pro-Fit technology, including a stretch waistband sold
under our exclusive supply agreement with Levi Strauss & Co. The increase in net
sales was also attributable to an increase in sales from our Hong Kong
subsidiary for programs related to major U.S. retailers and an increase in
zipper sales under our TALON brand name to our MANAGED TRIM SOLUTION(TM)
customers in Mexico and our other Talon customers in Mexico and Asia. The
increase in net sales was offset by a decrease in trim-related sales from our
Tlaxcala, Mexico operations under our MANAGED TRIM SOLUTION(TM) trim package
program. This decrease is due in part to our efforts to decrease our reliance on
our major customers and to further diversify our customer base.
17
Net sales increased approximately $5,972,000, or 20.5%, to $35,090,000
for the six months ended June 30, 2003 from $29,118,000 for the six months ended
June 30, 2002. The increase in net sales was primarily due to the addition of
sales under our TEKFIT stretch waistband division, as discussed above. The
increase in net sales was also attributable to an increase in sales from our
Hong Kong subsidiary for programs related to major U.S. retailers and an
increase in zipper sales under our TALON brand name to our MANAGED TRIM
SOLUTION(TM) customers in Mexico and our other Talon customers in Mexico and
Asia. The increase in net sales was offset by a decrease in trim-related sales
from our Tlaxcala, Mexico operations under our MANAGED TRIM SOLUTION(TM) trim
package program. This decrease is due in part to our efforts to decrease our
reliance on our major customers and to further diversify our customer base.
Gross profit increased approximately $488,000, or 9.8%, to $5,465,000
for the three months ended June 30, 2003 from $4,977,000 for the three months
ended June 30, 2002. Gross margin as a percentage of net sales increased to
approximately 26.4% for the three months ended June 30, 2003 as compared to
25.1% for the three months ended June 30, 2002. The increase in gross profit as
a percentage of net sales for the three months ended June 30, 2003 was due to a
change in our product mix during the current quarter, resulting in an increase
in sales of products with higher gross margins.
Gross profit increased approximately $2,152,000, or 28.3%, to
$9,764,000 for the six months ended June 30, 2003 from $7,612,000 for the six
months ended June 30, 2002. Gross margin as a percentage of net sales increased
to approximately 27.8% for the six months ended June 30, 2003 as compared to
26.1% for the six months ended June 30, 2002. The increase in gross profit as a
percentage of net sales for the six months ended June 30, 2003 was due to a
change in our product mix during the period, resulting in an increase in sales
of products with higher gross margins.
Selling expenses increased approximately $668,000, or 115.6%, to
$1,246,000 for the three months ended June 30, 2003 from $578,000 for the three
months ended June 30, 2002. As a percentage of net sales, these expenses
increased to 6.0% for the three months ended June 30, 2003 compared to 2.9% for
the three months ended June 30, 2002. The increase in selling expenses during
the quarter was due primarily to royalty expenses related to our exclusive
license and intellectual property rights agreement with Pro-Fit Holdings Limited
incurred during the period, the addition of sales personnel in our Hong Kong
facility and increased marketing efforts to promote our updated Oracle-based
MANAGED TRIM SOLUTION system. We are in the process of completing an update of
our MANAGED TRIM SOLUTION system which will enable us to further sell complete
trim packages to new locations on a global basis.
Selling expenses increased approximately $1,102,000, or 113.3%, to
$2,075,000 for the six months ended June 30, 2003 from $973,000 for the six
months ended June 30, 2002. As a percentage of net sales, these expenses
increased to 5.9% for the six months ended June 30, 2003 compared to 3.3% for
the six months ended June 30, 2002. The increase in selling expenses during the
period was due primarily to royalty expenses related to our exclusive license
and intellectual property rights agreement with Pro-Fit Holdings Limited
incurred during the period and additional sales personnel hired for our TEKFIT
division.
General and administrative expenses increased approximately $248,000,
or 9.2%, to $2,940,000 for the three months ended June 30, 2003 from $2,692,000
for the three months ended June 30, 2002. The increase in these expenses was due
primarily to expenses incurred related to our exclusive waistband license
agreement and the amortization of intangible assets incurred as a result of the
exclusive waistband technology license rights we acquired in April 2002. As a
percentage of net sales, these expenses increased to 14.2% for the three months
ended June 30, 2003 compared to 13.6% for the three months ended June 30, 2002,
because the rate of increase in net sales did not exceed that of general and
administrative expenses.
18
General and administrative expenses increased approximately $1,041,000,
or 22.6%, to $5,638,000 for the six months ended June 30, 2003 from $4,597,000
for the six months ended June 30, 2002. The increase in these expenses was due
primarily to expenses incurred related to our exclusive waistband license
agreement, the amortization of intangible assets incurred as a result of the
exclusive waistband technology license rights we acquired in April 2002 and the
relocation of our Hong Kong office during the period. As a percentage of net
sales, these expenses increased to 16.1% for the six months ended June 30, 2003
compared to 15.8% for the six months ended June 30, 2002, because the rate of
increase in net sales did not exceed that of general and administrative
expenses.
Interest expense increased approximately $36,000, or 11.7%, to $343,000
for the three months ended June 30, 2003 from $307,000 for the three months
ended June 30, 2002. Borrowings under our UPS Capital credit facility increased
during the quarter ended June 30, 2003 due to increased sales and expanded
operations in Mexico, the Dominican Republic and Asia. The additional borrowings
during the quarter were offset by the application of the proceeds from our
private placement transaction in which we raised approximately $6 million from
the sale of common stock.
Interest expense increased approximately $96,000, or 16.9%, to $664,000
for the six months ended June 30, 2003 from $568,000 for the six months ended
June 30, 2002. Borrowings under our UPS Capital credit facility increased during
the period ended June 30, 2003 due to increased sales and expanded operations in
Mexico, the Dominican Republic and Asia. The additional borrowings during the
period were offset by the application of the proceeds from our private placement
transaction in which we raised approximately $6 million in May 2003.
The provision for income taxes for the three months ended June 30, 2003
amounted to approximately $187,000 compared to $355,000 for the three months
ended June 30, 2002. Income taxes decreased for the three months ended June 30,
2003 primarily due to decreased taxable income.
The provision for income taxes for the six months ended June 30, 2003
amounted to approximately $277,000 compared to an income tax benefit of $373,000
for the six months ended June 30, 2002. Income taxes decreased for the six
months ended June 30, 2003 primarily due to decreased taxable income.
Net income was approximately $749,000 for the three months ended June
30, 2003 as compared to net income of $1,046,000 for the three months ended June
30, 2002, due primarily to an increase in net sales and gross margin, offset by
increases in selling and general and administrative expenses, as discussed
above.
Net income was approximately $1,110,000 for the six months ended June
30, 2003 as compared to net income of $1,100,000 for the six months ended June
30, 2002, due primarily to an increase in net sales and gross margin, offset by
increases in selling and general and administrative expenses, as discussed
above.
Preferred stock dividends amounted to $47,100 for the three months
ended June 30, 2003 as compared to $45,000 for the three months ended June 30,
2002. Preferred stock dividends represent earned dividends at 6% of the stated
value per annum of the Series C convertible redeemable preferred stock. Net
income available to common shareholders amounted to $702,000 for the three
months ended June 30, 2003 compared to $1,001,000 for the three months ended
June 30, 2002. Basic and diluted earnings per share were $0.07 for the three
months ended June 30, 2003. Basic and diluted earnings per share were $0.11 and
$0.10 for the three months ended June 30, 2002.
Preferred stock dividends amounted to $94,200 for the six months ended
June 30, 2003 as compared to $90,000 for the six months ended June 30, 2002.
Preferred stock dividends represent earned dividends at 6% of the stated value
per annum of the Series C convertible redeemable preferred stock.
19
Net income available to common shareholders amounted to $1,015,000 for the six
months ended June 30, 2003 compared to $1,010,000 for the six months ended June
30, 2002 and basic and diluted earnings per share were $0.10 and $0.11 for the
six months ended June 30, 2003 and 2002.
LIQUIDITY AND CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS
Cash and cash equivalents increased to $1,377,000 at June 30, 2003 from
$285,000 at December 31, 2002. The increase resulted from $4,771,000 of cash
provided by financing activities, offset by $2,699,000 and $980,000 of cash used
in operating and investing activities, respectively.
Net cash used in operating activities was approximately $2,699,000 and
$5,857,000 for the six months ended June 30, 2003 and 2002, respectively. Cash
used in operating activities for the six months ended June 30, 2003 resulted
primarily from increases in inventories and receivables, which was partially
offset by increases in accounts payable and accrued expenses and net income. The
increase in inventories during the period was due to increased customer orders
for future sales. The increase in accounts receivable during the period was due
primarily to increased sales during 2003 and slower collections from related
parties. Cash used in operating activities for the six months ended June 30,
2002 resulted primarily from increases in inventories and accounts receivable,
which was partially offset by increases in accounts payable and accrued expenses
and net income.
Net cash used in investing activities was approximately $980,000 and
$141,000 for the six months ended June 30, 2003 and 2002, respectively. Net cash
used in investing activities for the six months ended June 30, 2003 consisted
primarily of capital expenditures for equipment related to the exclusive supply
agreement we entered into with Levi Strauss & Co. During the period, we also
purchased computer equipment and software for the implementation of a new
Oracle-based computer system. This purchase was treated as a non-cash capital
lease obligation. Net cash used in investing activities for the six months ended
June 30, 2002 consisted primarily of capital expenditures for computer equipment
and upgrades
Net cash provided by financing activities was approximately $4,771,000
and $6,012,000 for the six months ended June 30, 2003 and 2002, respectively.
Net cash provided by financing activities for the six months ended June 30, 2003
primarily reflects funds raised from private placement transactions, offset by
the repayment of notes payable and decreased borrowings under our credit
facility. Net cash provided by financing activities for the six months ended
June 30, 2002 primarily reflects increased borrowings under our credit facility
and funds raised from private placement transactions, offset by the repayment of
notes payable.
We currently satisfy our working capital requirements primarily through
cash flows generated from operations and borrowings under our credit facility
with UPS Capital. Our maximum availability under the credit facility is $20
million, although historically we have been unable to borrow up to this maximum
amount due to borrowing restrictions under our credit facility. At June 30, 2003
and 2002, outstanding borrowings under our UPS Capital credit facility,
including amounts borrowed under the foreign factoring agreement, amounted to
approximately $15,314,000 and $15,249,000, respectively. There were no open
letters of credit under our UPS Capital credit facility at June 30, 2003. Open
letters of credit amounted to approximately $287,000 at June 30, 2002.
The initial term of our agreement with UPS Capital 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
that we comply with certain financial covenants including net worth, fixed
charge ratio and capital expenditures. We were in compliance with all financial
covenants at June 30, 2003. The amount we can borrow under the credit facility
is determined based on a defined borrowing base formula related to eligible
accounts receivable and inventories. Our borrowing base availability ranged from
20
approximately $14,801,000 to $18,829,000 from July 1, 2002 to June 30, 2003. A
significant decrease in eligible accounts receivable and inventories due to
customer concentration levels and the aging of inventories, among other factors,
can have an adverse effect on our borrowing capabilities under our credit
facility, which thereafter, may not be adequate to satisfy our working capital
requirements. Eligible accounts receivable are reduced if our accounts
receivable customer balances are concentrated with a particular customer in
excess of the percentages allowed under our agreement with UPS Capital. In
addition, we have typically 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 decreases in eligible accounts
receivables generated from our sales. As a result of our concentration of
business with Tarrant Apparel Group and Azteca Production International, our
eligible receivables have been limited under the UPS Capital facility over the
past year. If our business becomes further dependant on one or a limited number
of customers or if we experience future significant seasonal reductions in
receivables, our availability under the UPS Capital credit facility would be
correspondingly reduced. If this were to occur, we would be required to seek
additional financing which may not be available on attractive terms and, if such
financing is unavailable, we may be unable to meet our working capital
requirements.
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.
Pursuant to the terms of a foreign factoring agreement under our UPS
Capital credit facility, UPS Capital purchases our eligible accounts receivable
and assumes the credit risk with respect to those foreign accounts for which UPS
Capital has given its prior approval. If UPS Capital 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 85% of
eligible accounts receivable under our credit facility. Included in due from
factor as of June 30, 2003 and 2002, are trade accounts receivable factored
without recourse of approximately $177,000 and $501,000, respectively. Included
in due from factor are outstanding advances due to UPS Capital under this
factoring arrangement amounting to approximately $150,000 and $426,000 at June
30, 2003 and 2002, respectively.
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 June 30, 2003 and 2002, the amount factored with
recourse and included in trade accounts receivable was approximately $542,000
and $203,000. Outstanding advances as of June 30, 2003 and 2002 amounted to
approximately $332,000 and $59,000, respectively, and are included in the line
of credit balance.
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 included
a commitment by one of the private investors to
21
purchase an additional 400,000 shares of common stock at a price per share of
$3.00 at second closings on or prior to March 1, 2003, as amended, for
additional proceeds of $1,200,000. In March 2002 and February 2003, this private
investor purchased 100,000 and 300,000 shares, respectively, of common stock at
a price per share of $3.00 pursuant to the second closing provisions of the
stock and warrant purchase agreement for total proceeds of $1,200,000. Pursuant
to the second closing provisions of the stock and warrant purchase agreement,
50,000 and 150,000 warrants were issued to the investor in March 2002 and
February 2003, respectively. There are no remaining commitments due under the
stock and warrant purchase agreements.
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 $4.94 per share. 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 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.
As of June 30, 2003 and 2002, we had outstanding related-party debt of
approximately $850,000 at interest rates ranging from 7% to 11%, 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. On
October 4, 2002, we entered into a note payable agreement with a related party
in the amount of $500,000 to fund additional working capital requirements. The
note payable was unsecured, due on demand, accrued interest at 4% and was
subordinated to UPS Capital. This note was re-paid on February 28, 2003.
Our receivables increased to $25,080,000 at June 30, 2003 from
$20,172,000 at June 30, 2002. This increase was due primarily to increased
non-related trade receivables of approximately $4.2 million resulting from
increased sales to non-related parties during the period.
In October 1998, we entered into a supply agreement with Tarrant
Apparel Group. In October 1998, we also issued 2,390,000 shares of our common
stock to KG Investment, LLC. 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. Pricing and terms are consistent
with competitive vendors.
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. In
accordance with the supply agreement, we issued 1,000,000 shares of our common
stock to Commerce Investment Group, LLC. Commencing in December 2000, we began
to provide trim products to Azteca Production International, Inc for its
operations in Mexico. Pricing and terms are consistent with competitive vendors.
22
Included in inventories at June 30, 2003 are inventories of
approximately $10.5 million that are subject to buyback arrangements with Levi
Strauss & Co., Tarrant Apparel Group, Azteca Production International and other
customers. The buyback arrangements contain provisions related to the inventory
purchased on behalf of these customers. In the event that inventories remain
with us in excess of six to nine months from our receipt of the goods from our
vendors or the termination of production of a customer's product line related to
the inventories, the customer is required to purchase the inventories from us
under normal invoice and selling terms. During the six months ended June 30,
2003, we sold approximately $1.3 million in inventory to Tarrant Apparel Group
and Azteca Production International pursuant to these buyback arrangements. If
the financial condition of Tarrant Apparel Group and Azteca Production
International were to deteriorate, resulting in an impairment of their ability
to purchase inventories or pay receivables, it may have an adverse affect on our
results of operations.
We believe that our existing cash and cash equivalents and anticipated
cash flows from our operating activities and available financing will be
sufficient to fund our minimum working capital and capital expenditure needs for
the next twelve months. In May 2003, we raised approximately $6 million in a
private placement transaction with five institutional investors. Net proceeds
received from the private placement amounted to approximately $5.5 million. As
of June 30, 2003, we have applied approximately $4.25 million of the proceeds
against vendor payables, equipment purchases and other working capital
requirements. We expect to receive quarterly cash payments of a minimum of $1.25
million under our supply agreement with Levi Strauss & Co. through August 2004.
We also received additional funds of $900,000 in February 2003 pursuant to the
remaining commitment due under the stock warrant and purchase agreement we
entered into with a related party private investor. We used a portion of these
funds to repay a subordinated note payable to this related party private
investor of $500,000 in February 2003. The extent of our future capital
requirements will depend on many factors, including our results of operations,
future demand for our products, the size and timing of future acquisitions, our
borrowing base availability limitations related to eligible accounts receivable
and inventories and our expansion into foreign markets. 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. 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, the expansion of our operations in the Asian and Caribbean markets and the
further development of our waistband technology.
23
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at June 30, 2003
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 note payable $ 3,200,000 $ 1,200,000 $ 2,000,000 $ -- $ --
Capital lease obligations $ 1,482,924 $ 561,933 $ 920,991 $ -- $ --
Subordinated notes payable
to related parties (1) ... $ 849,971 $ 849,971 $ -- $ -- $ --
Operating leases ......... $ 1,357,346 $ 571,733 $ 780,890 $ 4,723 $ --
Line of credit ........... $15,495,637 $15,495,637 $ -- $ -- $ --
Note payable ............. $ 25,200 $ 25,200 $ -- $ -- $ --
Royalty Payments ......... $ 453,460 $ -- $ 453,460 $ -- $ --
<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>
As of June 30, 2003, we indirectly guaranteed the indebtedness of one
of our suppliers through the issuance by a related party of letters of credit to
purchase goods totaling $528,000. Financing costs due to the related party
amounted to approximately $43,000. The letters of credit expire on various dates
thru July 2003.
NEW ACCOUNTING PRONOUNCEMENTS
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
September 15, 2002. We believe the adoption of this Statement will have no
material impact on our financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This statement eliminates the current requirement that gains and
losses on debt extinguishment must be classified as extraordinary items in the
income statement. Instead, such gains and losses will be classified as
extraordinary items only if they are deemed to be unusual and infrequent, in
accordance with the current GAAP criteria for extraordinary classification. In
addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring
that modifications of capital leases that result in reclassification as
operating leases be accounted for consistent with sale-leaseback accounting
rules. The statement also contains other nonsubstantive corrections to
authoritative accounting literature. The changes related to debt extinguishment
will be effective for fiscal years beginning after May 15, 2002, and the changes
related to lease accounting will be effective for transactions occurring after
May 15, 2002. Adoption of this standard will not have any immediate effect on
our consolidated financial statements.
In September 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The
Company will adopt the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal
24
activity be recognized when the liability is incurred. Under EITF No. 94-3, a
liability for an exit cost was recognized at the date of a company's commitment
to an exit plan. SFAS No. 146 also establishes that the liability should
initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may
affect the timing of recognizing future restructuring costs as well as the
amount recognized.
In January 2003, the FASB issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, an interpretation of Accounting
Research Bulletins ("ARB") No. 51, Consolidated Financial Statements ("FIN 46").
FIN 46 clarifies the application of ARB No. 51 to certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
We do not believe the adoption of FIN 46 will have a material impact on our
financial position and results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities," ("SFAS 149"). SFAS No.
149 amends and clarifies the accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and for the hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." SFAS 149 is generally effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. The adoption of SFAS 149 is not expected to have a material
effect on the Company's financial position, results of operations or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Instruments with Characteristics of Both Liabilities and Equity," ("SFAS 150")
which establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires that an issuer classify a financial instrument that is within
its scope, which may have previously been reported as equity, as a liability (or
an asset in some circumstances). This statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003 for public companies. The Company does not believe the adoption of SFAS 150
will have a material impact on its fiancial statements.
25
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 41.5%
and 42.3% of our net sales, on a consolidated basis, for the years ended
December 31, 2002 and 2001, and 24.1% of our total sales for the six months
ended June 30, 2003. 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 and Tarrant fail to purchase our trim products at anticipated levels,
or our relationship with Azteca or Tarrant terminates, it may have an adverse
affect on our results because:
o We will lose a primary source of revenue if either of Tarrant
or Azteca 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 and Tarrant 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 Levi Strauss
& Co., Tarrant Apparel Group and Azteca Production International. This
concentration of our business reduces the amount we can borrow from our lenders
under receivables based financing agreements. Under our credit agreement with
UPS Capital, for instance, if accounts receivable due us from a particular
customer exceed a specified percentage of the total eligible accounts receivable
against which we can borrower, UPS Capital will not lend against the receivables
that exceed the specified percentage. Further, if we are unable to collect any
large receivables due us, our cash flow would be severely impacted.
BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, WE MAY NOT BE ABLE
TO ALWAYS OBTAIN MATERIALS WHEN WE NEED THEM AND WE MAY LOSE SALES AND
CUSTOMERS. Lead times for materials we order can vary significantly and depend
on many factors, including the specific supplier, the contract terms and the
demand for particular materials at a given time. From time to time, we may
experience fluctuations in the prices, and disruptions in the supply, of
materials. Shortages or disruptions in the supply of materials, or our inability
to procure materials from alternate sources at acceptable prices in a timely
manner, could lead us to miss deadlines for orders and lose sales and customers.
26
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS WORSEN. Our
revenues depend on the health of the economy and the growth of our customers and
potential future customers. When economic conditions weaken, certain apparel
manufacturers and retailers, including some of our customers, have experienced
in the past, and may experience in the future, financial difficulties which
increase the risk of extending credit to such customers. Customers adversely
affected by economic conditions have also attempted to improve their own
operating efficiencies by concentrating their purchasing power among a narrowing
group of vendors. There can be no assurance that we will remain a preferred
vendor to our existing customers. A decrease in business from or loss of a major
customer could have a material adverse effect on our results of operations.
Further, if the economic conditions in the United States worsen or if a wider or
global economic slowdown occurs, we may experience a material adverse impact on
our business, operating results, and financial condition.
IF WE ARE NOT ABLE TO MANAGE OUR RAPID EXPANSION AND GROWTH, WE COULD
INCUR UNFORESEEN COSTS OR DELAYS AND OUR REPUTATION AND RELIABILITY IN THE
MARKETPLACE AND OUR REVENUES WILL BE ADVERSELY AFFECTED. The growth of our
operations and activities has placed and will continue to place a significant
strain on our management, operational, financial and accounting resources. If we
cannot implement and improve our financial and management information and
reporting systems, we may not be able to implement our growth strategies
successfully and our revenues will be adversely affected. In addition, if we
cannot hire, train, motivate and manage new employees, including management and
operating personnel in sufficient numbers, and integrate them into our overall
operations and culture, our ability to manage future growth, increase production
levels and effectively market and distribute our products may be significantly
impaired.
WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS
IN OPERATING RESULTS FROM QUARTER TO QUARTER, THAT MAY RESULT IN UNEXPECTED
REDUCTIONS IN REVENUE 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
27
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.
THE LOSS OF KEY MANAGEMENT AND SALES PERSONNEL COULD ADVERSELY AFFECT
OUR BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE
SALES. Our success has and will continue to depend to a significant extent upon
key management and sales personnel, many of whom would be difficult to replace,
particularly Colin Dyne, our Chief Executive Officer. Colin Dyne is not bound by
an employment agreement. The loss of the services of Colin Dyne or the services
of other key employees could have a material adverse effect on our business,
including our ability to establish and maintain client relationships. Our future
success will depend in large part upon our ability to attract and retain
personnel with a variety of sales, operating and managerial skills.
IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL
NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently,
we do not operate duplicate facilities in different geographic areas. Therefore,
in the event of a regional disruption where we maintain one or more of our
facilities, it is unlikely that we could shift our operations to a different
geographic region and we may have to cease or curtail our operations. This may
cause us to lose sales and customers. The types of disruptions that may occur
include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention; and
o Natural disasters.
INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY
EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our
MANAGED TRIM SOLUTION is an Internet-based business-to-business e-commerce
system. To the extent that we fail to adequately continue to update and maintain
the hardware and software implementing the MANAGED TRIM SOLUTION, our customers
may experience interruptions in service due to defects in our hardware or our
source code. In addition, since our MANAGED TRIM SOLUTION is Internet-based,
interruptions in Internet service generally can negatively impact our customers'
ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects
of their trim needs. Such defects or interruptions could result in lost revenues
and lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors,
including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison
Corporation and Scovill Fasteners, Inc., have greater name recognition, longer
operating histories and, in many cases, substantially greater financial and
other resources than we do.
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
28
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.
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
29
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, 2002, our officers and directors and their affiliates owned
approximately 36.2% 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 41.1% 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 10.7% of the
outstanding shares of common stock at December 31, 2002. Gerard Guez and Todd
Kay, significant stockholders of Tarrant Apparel Group, each own approximately
12.8% of the outstanding shares of our common stock at December 31, 2002. As a
result, our officers and directors, the Dyne family and Messrs. Kay and Guez 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.
30
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 in which our products originate 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 on our
outstanding borrowings. At June 30, 2003, we had approximately $18.7 million of
indebtedness subject to interest rate fluctuations. These fluctuations may
increase our interest expense and decrease our cash flows from time to time. For
example, based on average bank borrowings of $10 million during a three-month
period, if the interest rate indices on which our bank borrowing rates are based
were to increase 100 basis points in the three-month period, interest incurred
would increase and cash flows would decrease by $25,000.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures, which we have designed
to ensure that material information related to Tag-it Pacific, Inc., including
our consolidated subsidiaries, is disclosed in our public filings on a regular
basis. In response to recent legislation and proposed regulations, we reviewed
our internal control structure and our disclosure controls and procedures. We
believe our pre-existing disclosure controls and procedures are adequate to
enable us to comply with our disclosure obligations.
As of June 30, 2003, the end of the period covered by this report,
members of the Company's management, including the Company's Chief Executive
Officer, Colin Dyne, and Chief Financial Officer, Ronda Sallmen, evaluated the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based upon that evaluation, Mr. Dyne and Ms. Sallmen concluded
that the Company's disclosure controls and procedures are effective in causing
material information to be recorded, processed, summarized and reported by
management of the Company on a timely basis and to ensure that the quality and
timeliness of the Company's public disclosures complies with its SEC disclosure
obligations.
CHANGES IN CONTROLS AND PROCEDURES
There were no significant changes in the Company's internal controls or
in other factors that could significantly affect these internal controls after
the date of our most recent evaluation.
31
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 AND USE OF PROCEEDS.
In May 2003, we entered into a securities purchase agreement, pursuant
to which we sold shares of our common stock, with the following investors: Neil
I Goldman, Prism Offshore Fund, Ltd, Prism Partners, LP, SF Capital Partners,
Ltd., MicroCapital Fund Limited Partner, MicroCapital LLC, Lagunitas Partners
LP, Gruber & McBaine International, Jon D. Gruber and Linda W. Gruber, and J.
Patterson McBaine. Pursuant to this securities purchase agreement, on June 2,
2003 we sold 1,725,000 shares of our common stock at a price per share of $3.50
for aggregate proceeds to us of $6,037,500. Roth Capital Partners LLC acted as
placement agent in connection with this private placement financing transaction.
For their services as placement agent, we paid Roth Capital Partners LLC a fee
equal to 8% of our gross proceeds from the financing ($483,000) and a $25,000
non-accountable expense allowance. In addition, we issued to Roth Capital
Partners LLC a warrant to purchase up to 172,500 shares of our common stock at
an exercise price of $5.06 per share. The warrants have a term of 5 years. These
warrants vest and become exercisable on August 30, 2003. Each of the investors
in the transaction represented to us, and we reasonably believed, that the
investor (i) was acquiring the securities for his or its own account with the
present intention of holding such securities for investment purposes only and
not with a view to, or for sale in connection with, any distribution of such
securities (other than a distribution in compliance with all applicable federal
and state securities laws); (ii) was an experienced and sophisticated investor
and has such knowledge and experience in financial and business matters that it
is capable of evaluating the relative merits and the risks of an investment in
the securities and of protecting his or its own interests in connection with the
transaction; (iii) was willing to bear and was capable of bearing the economic
risk of an investment in the securities; and (iv) was an "accredited investor"
as that term is defined under Rule 501(a)(8) of Regulation D promulgated by the
Commission under the Securities Act. Each of the certificates representing the
securities contained a customary legend restricting resale of the securities.
The issuance and sale of these securities was exempt from the registration and
prospectus delivery requirements of the Securities Act pursuant to Section 4(2)
of the Securities Act (in accordance with Rule 506 of Regulation D) as a
transaction not involving any public offering.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders held on June 14, 2003, our
stockholders (a) elected Colin Dyne, Mark Dyne and Donna Armstrong to serve as
Class III Directors on our Board of Directors for three years and until their
respective successors have been elected, and (b) approved an amendment to our
1997 Stock Plan to increase from 2,277,500 to 2,577,500 the maximum number of
shares of common stock that may be issued pursuant to awards granted under the
1997 Stock Plan. Each Class III Director was elected by a vote of 7,981,485
shares in favor, 44,700 shares voted against, and no shares were withheld from
voting for the directors. At the annual meeting, 7,974,835 shares were voted in
favor of, 51,350 shares were voted against, and no shares were withheld from
voting on the amendment to our 1997 Stock Plan. There were no broker non-votes
at the annual meeting. Immediately prior to and
32
following the meeting, the Board of Directors was comprised of Mark Dyne, Colin
Dyne, Donna Armstrong, Kevin Bermeister, Brent Cohen, Michael Katz and Jonathan
Burstein.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certificate of Chief Executive Officer pursuant to
Rule 13a-14(a) under the Securities and Exchange Act
of 1934, as amended
31.2 Certificate of Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities and Exchange Act
of 1934, as amended
32.1 Certificate of Chief Executive Officer and Chief
Financial Officer pursuant to Rule 13a-14(b) under
the Securities and Exchange Act of 1934, as amended.
(b) Reports on Form 8-K:
Current Report on Form 8-K dated May 15, 2003, reporting Items
7 and 9, as filed on May 15, 2003.
Current Report on Form 8-K dated May 30, 2003, reporting Items
5 and 7, as filed on June 4, 2003.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2003 TAG-IT PACIFIC, INC.
/s/ Ronda Sallmen
-----------------------------
By: Ronda Sallmen
Its: Chief Financial Officer
34