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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended September 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, 11,506,909 shares issued and outstanding as of November
14, 2003.
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TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Consolidated Financial Statements.....................................3
Consolidated Balance Sheets as of
September 30, 2003 (unaudited) and December 31, 2002..................3
Consolidated Statements of Operations (unaudited)
for the Three Months and Nine Months Ended
September 30, 2003 and 2002...........................................4
Consolidated Statements of Cash Flows (unaudited)
for the Nine Months Ended September 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 6. Exhibits and Reports on Form 8-K.....................................32
2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
Consolidated Balance Sheets
September 30, December 31,
2003 2002
----------- -----------
Assets (unaudited)
Current Assets:
Cash and cash equivalents ....................... $ 288,360 $ 285,464
Due from factor ................................. 17,606 43,730
Trade accounts receivable, net .................. 7,043,930 5,697,655
Trade accounts receivable, related parties ...... 15,977,758 14,770,466
Refundable income taxes ......................... -- 212,082
Inventories ..................................... 22,978,398 23,105,267
Prepaid expenses and other current assets ....... 1,624,760 599,543
Deferred income taxes ........................... 90,928 90,928
----------- -----------
Total current assets ......................... 48,021,740 44,805,135
Property and Equipment, net of accumulated
depreciation and amortization ................ 6,035,842 2,953,701
Tradename ....................................... 4,110,750 4,110,750
Goodwill ........................................ 450,000 450,000
License rights .................................. 428,750 490,875
Due from related parties ........................ 914,426 870,251
Other assets .................................... 207,057 374,106
----------- -----------
Total assets .................................... $60,168,565 $54,054,818
=========== ===========
Liabilities, Convertible Redeemable Preferred
Stock and Stockholders' Equity
Current Liabilities:
Line of credit .................................. $13,265,244 $15,934,257
Accounts payable and accrued expenses ........... 12,084,456 10,401,187
Deferred income ................................. 449,984 1,027,984
Subordinated notes payable to related parties ... 849,971 1,349,971
Current portion of capital lease obligations .... 562,330 71,928
Current portion of subordinated note payable .... 1,200,000 1,200,000
----------- -----------
Total current liabilities .................... 28,411,985 29,985,327
Capital lease obligations, less current portion .... 782,780 107,307
Subordinated note payable, less current portion .... 1,700,000 2,600,000
----------- -----------
Total liabilities ............................. 30,894,765 32,692,634
Convertible redeemable preferred stock Series C,
$0.001 par value; 759,494 shares authorized;
759,494 shares issued and outstanding at
September 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; 11,464,909 shares
issued and outstanding at September 30,
2003; 9,319,909 at December 31, 2002 ......... 11,466 9,321
Additional paid in capital ...................... 23,624,907 16,776,012
Retained earnings ............................... 2,742,426 1,681,850
----------- -----------
Total stockholders' equity ......................... 26,378,799 18,467,183
----------- -----------
Total liabilities, convertible redeemable
preferred stock and stockholders' equity ........ $60,168,565 $54,054,818
=========== ===========
See accompanying notes to consolidated financial statements.
3
TAG-IT PACIFIC, INC.
Consolidated Statements of Operations
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net sales ......................... $16,467,896 $16,349,906 $51,558,303 $45,468,306
Cost of goods sold ................ 12,237,757 12,424,257 37,564,067 33,931,051
----------- ----------- ----------- -----------
Gross profit .................. 4,230,139 3,925,257 13,994,236 11,537,255
Selling expenses .................. 967,688 472,680 3,042,601 1,445,598
General and administrative expenses 2,831,140 2,649,188 8,469,572 7,246,100
----------- ----------- ----------- -----------
Total operating expenses ...... 3,798,828 3,121,868 11,512,173 8,691,698
Income from operations ............ 431,311 803,781 2,482,063 2,845,557
Interest expense, net ............. 307,253 344,585 971,090 912,856
----------- ----------- ----------- -----------
Income before income taxes ........ 124,058 459,196 1,510,973 1,932,701
Provision for income taxes ........ 28,888 115,265 306,271 488,455
----------- ----------- ----------- -----------
Net income .................... $ 95,170 $ 343,931 $ 1,204,702 $ 1,444,246
=========== =========== =========== ===========
Less: Preferred stock dividends .. 49,926 47,100 144,126 137,100
----------- ----------- ----------- -----------
Net income to common stockholders . $ 45,244 $ 296,831 $ 1,060,576 $ 1,307,146
=========== =========== =========== ===========
Basic earnings per share .......... $ 0.00 $ 0.03 $ 0.10 $ 0.14
=========== =========== =========== ===========
Diluted earnings per share ........ $ 0.00 $ 0.03 $ 0.10 $ 0.14
=========== =========== =========== ===========
Weighted average number of common
shares outstanding:
Basic ......................... 11,436,702 9,310,099 10,363,755 9,203,078
=========== =========== =========== ===========
Diluted ....................... 12,245,083 9,615,355 10,809,895 9,499,855
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
4
TAG-IT PACIFIC, INC.
Consolidated Statements of Cash Flows
(unaudited)
Nine Months Ended September 30,
-----------------------------
2003 2002
------------ ------------
Increase (decrease) in cash and cash
equivalents
Cash flows from operating activities:
Net income .............................. $ 1,204,702 $ 1,444,246
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization ........... 956,742 869,586
Increase in allowance for
doubtful accounts ..................... 238,440 72,096
Changes in operating assets and
Liabilities:
Receivables, including related
parties and due from factor ....... (2,765,882) (10,438,350)
Inventories .......................... 126,869 (3,879,117)
Other assets ......................... (6,050) (66,680)
Prepaid expenses and other
current assets .................... (1,025,217) (160,481)
Accounts payable and accrued
expenses .......................... 782,998 4,347,340
Deferred revenue ..................... -- 1,250,000
Income taxes payable ................. 504,291 483,807
------------ ------------
Net cash provided by (used in)
operating activities ...................... 16,893 (6,077,553)
------------ ------------
Cash flows from investing activities:
Acquisition of property and equipment ... (2,329,606) (437,823)
------------ ------------
Cash flows from financing activities:
(Repayment) proceeds from bank line
of credit, net ....................... (2,669,013) 6,378,886
Proceeds from private placement
transactions ......................... 6,395,300 1,029,997
Proceeds from exercise of stock
options .............................. 297,500 57,850
Repayment of capital leases ............. (308,178) (56,310)
Repayment of notes payable .............. (1,400,000) (700,000)
------------ ------------
Net cash provided by financing activities .... 2,315,609 6,710,423
------------ ------------
Net increase in cash ......................... 2,896 195,047
Cash at beginning of period .................. 285,464 46,948
------------ ------------
Cash at end of period ........................ $ 288,360 $ 241,995
============ ============
Supplemental disclosures of cash flow
information:
Cash paid (received) during the
period for:
Interest ............................. $ 953,732 $ 829,725
Income taxes paid .................... $ 13,208 $ 5,280
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:
THREE MONTHS ENDED SEPTEMBER 30, 2003: PER SHARE
INCOME SHARES AMOUNT
--------- ---------- --------
Basic earnings per share:
Income available to common stockholders .... $ 45,244 11,436,702 $ 0.00
Effect of Dilutive Securities:
Options .................................... 684,740
Warrants ................................... 123,641
--------- ---------- --------
Income available to common stockholders .... $ 45,244 12,245,083 $ 0.00
========= ========== ========
THREE MONTHS ENDED SEPTEMBER 30, 2002:
Basic earnings per share:
Income available to common stockholders .... $ 296,831 9,310,099 $ 0.03
Effect of Dilutive Securities:
Options .................................... 250,271
Warrants ................................... 54,985
--------- ---------- --------
Income available to common stockholders .... $ 296,831 9,615,355 $ 0.03
========= ========== ========
6
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2003: PER SHARE
INCOME SHARES AMOUNT
---------- ---------- --------
Basic earnings per share:
Income available to common stockholders ... $1,060,576 10,363,755 $ 0.10
Effect of Dilutive Securities:
Options ................................... 44,609
Warrants .................................. 401,531
---------- ---------- --------
Income available to common stockholders ... $1,060,576 10,809,895 $ 0.10
========== ========== ========
NINE MONTHS ENDED SEPTEMBER 30, 2002:
Basic earnings per share:
Income available to common stockholders ... $1,307,146 9,203,078 $ 0.14
Effect of Dilutive Securities:
Options ................................... 242,252
Warrants .................................. 54,525
---------- ---------- --------
Income available to common stockholders ... $1,307,146 9,499,855 $ 0.14
========== ========== ========
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 September 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 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 nine months ended September 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 nine months ended September 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 nine months ended September 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 nine months
ended September 30, 2003 and 2002 would have amounted to the pro forma amounts
presented below:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net Income, as reported................... $ 95,170 $ 343,931 $ 1,204,702 $ 1,444,246
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 methods for all
awards, net of related tax effects.... (44,838) (30,268) (94,948) (90,804)
----------- ----------- ----------- -----------
Pro forma net income...................... $ 50,332 $ 313,663 $ 1,109,754 $ 1,353,442
=========== =========== =========== ===========
Earnings per share:
Basic - as reported................... $ 0.00 $ 0.03 $ 0.10 $ 0.14
Basic - pro forma..................... $ 0.00 $ 0.03 $ 0.09 $ 0.13
Diluted - as reported................. $ 0.00 $ 0.03 $ 0.10 $ 0.14
Diluted - pro forma................... $ 0.00 $ 0.03 $ 0.09 $ 0.13
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 (three months)........................................ $ 141,220
2004....................................................... 564,880
2005....................................................... 466,756
2006....................................................... 152,117
-------------
Total payments............................................. 1,324,973
Less amount representing interest.......................... (105,187)
-------------
Balance at September 30, 2003.............................. 1,219,786
Less current Portion....................................... 499,726
-------------
Long-term portion.......................................... $ 720,060
=============
6. 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)
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.
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
11
TAG-IT PACIFIC, INC.
Notes to the Consolidated Financial Statements
(unaudited)
Activities. SFAS 149 is generally effective for contracts entered into or
modified after September 30, 2003 and for hedging relationships designated after
September 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 September
15, 2003 for public companies. The Company adopted SFAS 150 on July 1, 2003 and
the adoption of this statement had no material impact on its financial
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 nine months ended September 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.
13
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 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(TM) 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
14
leverage our position as a single source supplier of trim items as well as our
extensive expertise in the field of trim distribution and procurement to more
efficiently manage the trim assembly process resulting in faster delivery times
and fewer production delays for our manufacturing customers. Our MANAGED TRIM
SOLUTION(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 supplier
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
15
zipper for the jeans industry and is a specified zipper brand for manufacturers
in the sportswear and outerwear markets. The TALON acquisition is an important
step in our strategy to offer a complete high quality trim package to apparel
manufacturers. Our transition from a distributor to an owner of the TALON brand
name better positions us to revitalize the TALON brand name and capture
increased market share in the industry. As the owner of the TALON brand name, we
believe we will be able to more effectively respond to customer needs and better
maintain the quality and value of the TALON products.
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 43.7%
of our total sales for the nine months ended September 30, 2003. We will
continue to rely on these two customers for a significant amount of our sales
for the year ending December 2004. Sales under these exclusive supply agreements
as a percentage of total sales for the year ending December 2004 are anticipated
to be lower than the year ending December 30, 2003 due to an increase in sales
to other customers and a decrease in sales to these major customers as part of
our plan to further diversify our customer base. Our results of operations will
depend to a significant extent upon the
16
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 September 30, 2003, is approximately $16.0
million due from Tarrant Apparel Group and Azteca Production International.
Included in inventories at September 30, 2003 are inventories of
approximately $9.2 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 nine months ended September
30, 2003, we sold approximately $2.4 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 ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ----------------
2003 2002 2003 2002
------- ------- ------- -------
Net sales ............................. 100.0% 100.0% 100.0% 100.0%
Cost of goods sold .................... 74.3 76.0 72.9 74.6
------- ------- ------- -------
Gross profit ....................... 25.7 24.0 27.1 25.4
Selling expenses ...................... 5.9 2.9 5.9 3.2
General and administrative expenses ... 17.2 16.2 16.4 15.9
------- ------- ------- -------
Operating Income ................... 2.6% 4.9% 4.8% 6.3%
======= ======= ======= =======
Net sales increased approximately $118,000, or 0.7%, to $16,468,000 for
the three months ended September 30, 2003 from $16,350,000 for the three months
ended September 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 September 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.
Net sales increased approximately $6,090,000, or 13.4%, to $51,558,000
for the nine months ended September 30, 2003 from $45,468,000 for the nine
months ended September 30, 2002. The increase in net sales was primarily due to
the addition of sales under our TEKFIT stretch waistband
17
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 partially 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 $304,000, or 7.7%, to $4,230,000
for the three months ended September 30, 2003 from $3,926,000 for the three
months ended September 30, 2002. Gross margin as a percentage of net sales
increased to approximately 25.7% for the three months ended September 30, 2003
as compared to 24.0% for the three months ended September 30, 2002. The increase
in gross profit as a percentage of net sales for the three months ended
September 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 $2,457,000, or 21.3%, to
$13,994,000 for the nine months ended September 30, 2003 from $11,537,000 for
the nine months ended September 30, 2002. Gross margin as a percentage of net
sales increased to approximately 27.1% for the nine months ended September 30,
2003 as compared to 25.4% for the nine months ended September 30, 2002. The
increase in gross profit as a percentage of net sales for the nine months ended
September 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 $495,000, or 104.7%, to
$968,000 for the three months ended September 30, 2003 from $473,000 for the
three months ended September 30, 2002. As a percentage of net sales, these
expenses increased to 5.9% for the three months ended September 30, 2003
compared to 2.9% for the three months ended September 30, 2002. The increase in
selling expenses during the quarter was due primarily to royalty and other
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(TM) system. We are in the
process of completing an update of our MANAGED TRIM SOLUTION(TM) system which
will enable us to further sell complete trim packages to new locations on a
global basis. Royalty expense related to our exclusive license and intellectual
property rights agreement with Pro-Fit Holdings Limited amounted to
approximately $199,000 for the three months ended September 30, 2003. We pay
royalties of 6% on related sales of up to $10 million, 4% of related sales from
$10-20 million and 3% on related sales in excess of $20 million. There were no
royalties incurred for the three months ended September 30, 2002.
Selling expenses increased approximately $1,597,000, or 110.4%, to
$3,043,000 for the nine months ended September 30, 2003 from $1,446,000 for the
nine months ended September 30, 2002. As a percentage of net sales, these
expenses increased to 5.9% for the nine months ended September 30, 2003 compared
to 3.2% for the nine months ended September 30, 2002. The increase in selling
expenses during the period was due primarily to royalty and other 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 in our Hong Kong facility and for our TEKFIT division. Royalty
expense related to our exclusive license and intellectual property rights
agreement with Pro-Fit Holdings Limited amounted to approximately $705,000 for
the nine months ended September 30, 2003. There were no royalties incurred for
the nine months ended September 30, 2002.
18
General and administrative expenses increased approximately $182,000,
or 6.9%, to $2,831,000 for the three months ended September 30, 2003 from
$2,649,000 for the three months ended September 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. In addition, we incurred approximately $156,000 of non-recurring
severance costs during the three months ended September 30, 2003 related to the
reduction of our workforce in certain divisions. As a percentage of net sales,
these expenses increased to 17.2% for the three months ended September 30, 2003
compared to 16.2% for the three months ended September 30, 2002, because the
rate of increase in net sales did not exceed that of general and administrative
expenses.
General and administrative expenses increased approximately $1,224,000,
or 16.9%, to $8,470,000 for the nine months ended September 30, 2003 from
$7,246,000 for the nine months ended September 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 year. In addition, we
incurred approximately $249,000 of non-recurring severance costs during the
three months ended September 30, 2003 related to the reduction of our workforce
in certain divisions. As a percentage of net sales, these expenses increased to
16.4% for the nine months ended September 30, 2003 compared to 15.9% for the
nine months ended September 30, 2002, because the rate of increase in net sales
did not exceed that of general and administrative expenses.
Interest expense decreased approximately $38,000, or 11.0%, to $307,000
for the three months ended September 30, 2003 from $345,000 for the three months
ended September 30, 2002. Borrowings under our UPS Capital credit facility
decreased during the quarter ended September 30, 2003 due to proceeds received
from our private placement transaction in which we raised approximately $6
million from the sale of common stock.
Interest expense increased approximately $58,000, or 6.4%, to $971,000
for the nine months ended September 30, 2003 from $913,000 for the nine months
ended September 30, 2002. Borrowings under our UPS Capital credit facility
increased during the period ended September 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 September 30,
2003 amounted to approximately $29,000 compared to $115,000 for the three months
ended September 30, 2002. Income taxes decreased for the three months ended
September 30, 2003 primarily due to decreased taxable income.
The provision for income taxes for the nine months ended September 30,
2003 amounted to approximately $306,000 compared to $488,000 for the nine months
ended September 30, 2002. Income taxes decreased for the nine months ended
September 30, 2003 primarily due to decreased taxable income.
Net income was approximately $95,000 for the three months ended
September 30, 2003 as compared to net income of $344,000 for the three months
ended September 30, 2002, due primarily to increases in selling and general and
administrative expenses, offset by an increase in net sales and gross margin, as
discussed above.
19
Net income was approximately $1,205,000 for the nine months ended
September 30, 2003 as compared to net income of $1,444,000 for the nine months
ended September 30, 2002, due primarily to increases in selling and general and
administrative expenses, offset by an increase in net sales and gross margin, as
discussed above.
Preferred stock dividends amounted to approximately $50,000 for the
three months ended September 30, 2003 as compared to $47,000 for the three
months ended September 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 stockholders amounted
to $45,000 for the three months ended September 30, 2003 compared to $297,000
for the three months ended September 30, 2002. Basic and diluted earnings per
share were $0.00 for the three months ended September 30, 2003. Basic and
diluted earnings per share were $0.03 for the three months ended September 30,
2002.
Preferred stock dividends amounted to approximately $144,000 for the
nine months ended September 30, 2003 as compared to $137,100 for the nine months
ended September 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 stockholders amounted to
$1,061,000 for the nine months ended September 30, 2003 compared to $1,307,000
for the nine months ended September 30, 2002 and basic and diluted earnings per
share were $0.10 for the nine months ended September 30, 2003. Basic and diluted
earnings per share were $0.14 for the nine months ended September 30, 2002.
LIQUIDITY AND CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS
Cash and cash equivalents increased to $288,000 at September 30, 2003
from $285,000 at December 31, 2002. The increase resulted from $17,000 and
$2,316,000 of cash provided by operating and financing activities, respectively,
offset by $2,330,000 of cash used in investing activities.
Net cash provided by operating activities was approximately $17,000 for
the nine months ended September 30, 2003 and net cash used in operating
activities was $6,078,000 for the nine months ended September 30, 2002. Cash
provided by operating activities for the nine months ended September 30, 2003
resulted primarily from increases in accounts payable and accrued expenses,
income taxes payable and net income, which was offset primarily by increases in
receivables and prepaid expenses. The increase in accounts receivable during the
period was due primarily to increased sales during 2003 and slower customer
collections. Cash used in operating activities for the nine months ended
September 30, 2002 resulted primarily from increases in inventories and accounts
receivable, which was partially offset by increases in accounts payable and
accrued expenses, deferred revenue and net income.
Net cash used in investing activities was approximately $2,330,000 and
$438,000 for the nine months ended September 30, 2003 and 2002, respectively.
Net cash used in investing activities for the nine months ended September 30,
2003 consisted primarily of capital expenditures for equipment related to the
exclusive supply agreement we entered into with Levi Strauss & Co. and the
purchase of additional TALON zipper equipment. 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 nine months
ended September 30, 2002 consisted primarily of capital expenditures for
machinery and equipment.
Net cash provided by financing activities was approximately $2,316,000
and $6,710,000 for the nine months ended September 30, 2003 and 2002,
respectively. Net cash provided by financing activities for the nine months
ended September 30, 2003 primarily reflects funds raised from private placement
20
transactions, offset by the repayment of notes payable and decreased borrowings
under our credit facility. Net cash provided by financing activities for the
nine months ended September 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 September 30,
2003 and 2002, outstanding borrowings under our UPS Capital credit facility,
including amounts borrowed under the foreign factoring agreement, amounted to
approximately $13,265,000 and $15,688,000, respectively. There were no open
letters of credit under our UPS Capital credit facility at September 30, 2003.
Open letters of credit amounted to approximately $1,080,000 at September 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 September 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 approximately $14,801,000 to $18,829,000 from October 1, 2002 to
September 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. From time to time, we may be in an overadvance position due to
borrowing base constraints under our credit facility related to customer
concentration levels and other reductions in eligible collateral. We were in an
overadvance position as of the date of this report. UPS Capital has accommodated
us in these periods of overadvance. There can be no assurance, however, that UPS
Capital will continue to accommodate us in the future. 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.
21
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 September 30, 2003 and 2002, are trade accounts receivable factored
without recourse of approximately $117,000 and $552,000, respectively. Included
in due from factor are outstanding advances due to UPS Capital under this
factoring arrangement amounting to approximately $100,000 and $469,000 at
September 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 September 30, 2003 and 2002, the amount factored with
recourse and included in trade accounts receivable was approximately $260,000
and $223,000. Outstanding advances as of September 30, 2003 and 2002 amounted to
approximately $213,000 and $118,000, 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 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.
22
As of September 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 $23,022,000 at September 30, 2003 from
$20,872,000 at September 30, 2002. This increase was due to increased
non-related trade receivables of approximately $2.1 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.
Included in inventories at September 30, 2003 are inventories of
approximately $9.2 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 nine months ended September
30, 2003, we sold approximately $2.4 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 September 30, 2003, we have applied 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
23
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.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at September 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 notes payable $ 2,900,000 $ 1,200,000 $ 1,700,000 $ -- $ --
Capital lease obligations $ 1,345,110 $ 562,330 $ 782,780 $ -- $ --
Subordinated notes payable
to related parties(1) $ 849,971 $ 849,971 $ -- $ -- $ --
Operating leases ......... $ 1,251,565 $ 534,542 $ 714,661 $ 2,362 $ --
Line of credit ........... $13,265,244 $13,265,244 $ -- $ -- $ --
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>
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
24
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 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 September 30, 2003 and for hedging relationships designated
after September 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 September
15, 2003 for public companies. The Company adopted SFAS 150 on July 1, 2003 and
the adoption of this statement had no material impact on its financial
statements.
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In addition to other information contained in this report, readers should
carefully consider the following cautionary statements and risk factors.
25
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 22.5% of our total sales for the nine months
ended September 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. In addition, Gerard Guez, the founder,
Chairman and Chief Executive Officer, and a significant stockholder of Tarrant
Apparel Group and Hubert Guez, the founder, Chief Executive Officer and
President, and a significant stockholder of Azteca Production International, are
brothers. This relationship between our two largest customers further
concentrates our receivables risk significantly among this family group.
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.
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
26
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 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.
27
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(TM) MAY
EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our
Managed Trim Solution(TM) 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(TM), our
customers mAY experience interruptions in service due to defects in our hardware
or our source code. In addition, since our Managed Trim Solution(TM) is
Internet-based, interruptions in Internet service generally can negatively
impact our customers' ability to use the Managed Trim Solution(TM) to monitor
and manage various aspects of their trim needs. Such defects or interruptions
could result in lost revenues aND lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors,
including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison
Corporation and Scovill Fasteners, Inc., have greater name recognition, longer
operating histories and, in many cases, substantially greater financial and
other resources than we do.
IF CUSTOMERS DEFAULT ON BUYBACK AGREEMENTS WITH US, WE WILL BE LEFT
HOLDING UNSALABLE INVENTORY. Inventories include goods that are subject to
buyback agreements with our customers. Under these buyback agreements, the
customer must purchase the inventories from us under normal invoice and selling
terms, if any inventory which we purchase on their behalf remains in our hands
longer than agreed by the customer from the time we received the goods from our
vendors. If any customer defaults on these buyback provisions, we may incur a
charge in connection with our holding significant amounts of unsalable
inventory.
28
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.
29
WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS.
We may consider strategic acquisitions as opportunities arise, subject to the
obtaining of any necessary financing. Acquisitions involve numerous risks,
including diversion of our management's attention away from our operating
activities. We cannot assure our stockholders that we will not encounter
unanticipated problems or liabilities relating to the integration of an acquired
company's operations, nor can we assure our stockholders that we will realize
the anticipated benefits of any future acquisitions.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue
additional shares of preferred stock and some provisions of our certificate of
incorporation and bylaws and of Delaware law could make it more difficult for a
third party to make an unsolicited takeover attempt of us. These anti-takeover
measures may depress the price of our common stock by making it more difficult
for third parties to acquire us by offering to purchase shares of our stock at a
premium to its market price.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD
LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As
of December 31, 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.
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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 September 30, 2003, we had approximately $17.0
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 September 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.
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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 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, reporting Items 7 and 12, as filed
on August 18, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2003 TAG-IT PACIFIC, INC.
/S/ RONDA SALLMEN
-----------------------------------
By: Ronda Sallmen
Its: Chief Financial Officer
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