================================================================================ 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 June 30, 2004. 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, 18,085,116 shares issued and outstanding as of August 16, 2004. ================================================================================ TAG-IT PACIFIC, INC. INDEX TO FORM 10-Q PART I FINANCIAL INFORMATION PAGE ---- Item 1. Consolidated Financial Statements..................................3 Consolidated Balance Sheets as of June 30, 2004 (unaudited) and December 31, 2003..............................................3 Consolidated Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2004 and 2003.......................................4 Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2004 and 2003....................5 Notes to the Consolidated Financial Statements.....................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.....................11 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................................26 Item 4. Controls and Procedures...........................................26 PART II OTHER INFORMATION Item 1. Legal Proceedings.................................................27 Item 4. Submission of Matters to a Vote of Security Holders...............27 Item 6. Exhibits and Reports on Form 8-K..................................27 2 PART I FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS. TAG-IT PACIFIC, INC. CONSOLIDATED BALANCE SHEETS June 30, December 31, 2004 2003 ------------ ------------ Assets (unaudited) Current Assets: Cash and cash equivalents ................... $ 5,353,375 $ 14,442,769 Due from factor ............................. 8,297 9,743 Trade accounts receivable, net .............. 20,396,222 7,531,079 Trade accounts receivable, related parties .. 5,488,123 11,721,465 Inventories ................................. 19,004,055 17,096,879 Prepaid expenses and other current assets ... 1,194,951 2,124,366 Deferred income taxes ....................... 2,800,000 2,800,000 ------------ ------------ Total current assets ...................... 54,245,023 55,726,301 Property and equipment, net of accumulated depreciation and amortization ............... 6,047,142 6,144,863 Tradename ...................................... 4,110,750 4,110,750 Goodwill ....................................... 450,000 450,000 License rights ................................. 336,875 375,375 Due from related parties ....................... 788,758 762,076 Other assets ................................... 430,372 200,949 ------------ ------------ Total assets ................................... $ 66,408,920 $ 67,770,314 ============ ============ Liabilities, Convertible Redeemable Preferred Stock and Stockholders' Equity Current Liabilities: Line of credit .............................. $ 5,935,362 $ 7,095,514 Accounts payable and accrued expenses ....... 9,394,972 9,552,196 Subordinated notes payable to related parties .................................. 849,971 849,971 Current portion of capital lease obligations .............................. 570,980 562,742 Current portion of subordinated note payable .................................. 1,800,000 1,200,000 ------------ ------------ Total current liabilities ................. 18,551,285 19,260,423 Capital lease obligations, less current portion ..................................... 592,994 651,191 Subordinated note payable, less current portion ..................................... 200,000 1,400,000 ------------ ------------ Total liabilities .......................... 19,344,279 21,311,614 ------------ ------------ Convertible redeemable preferred stock Series C, $0.001 par value; 759,494 authorized; no shares issued and outstanding at June 30, 2004; 759,494 shares issued and outstanding at December 31, 2003 (stated value $3,000,000) ................................. -- 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 D, $0.001 par value; 572,818 shares authorized; no shares issued or outstanding at June 30, 2004; 572,818 shares issued and outstanding at December 31, 2003 .................................. -- 22,918,693 Common stock, $0.001 par value, 30,000,000 shares authorized; 18,085,116 shares issued and outstanding at June 30, 2004; 11,508,201 at December 31, 2003 ........... 18,087 11,510 Additional paid-in capital .................. 50,715,629 23,890,356 Accumulated deficit ......................... (3,669,075) (3,256,860) ------------ ------------ Total stockholders' equity ..................... 47,064,641 43,563,699 ------------ ------------ Total liabilities, convertible redeemable preferred stock and stockholders' equity .... $ 66,408,920 $ 67,770,314 ============ ============ See accompanying notes to consolidated financial statements. 3 TAG-IT PACIFIC, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended June 30, Six Months Ended June 30, --------------------------- ---------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Net sales .......................... $ 14,923,121 $ 20,731,573 $ 25,083,419 $ 35,090,407 Cost of goods sold ................. 11,030,867 15,267,058 18,199,115 25,326,310 ------------ ------------ ------------ ------------ Gross profit .................... 3,892,254 5,464,515 6,884,304 9,764,097 Selling expenses ................... 702,482 1,245,769 1,474,598 2,074,913 General and administrative expenses 2,791,209 2,939,927 5,648,349 5,638,432 ------------ ------------ ------------ ------------ Total operating expenses ........ 3,493,691 4,185,696 7,122,947 7,713,345 Income (loss) from operations ...... 398,563 1,278,819 (238,643) 2,050,752 Interest expense, net .............. 144,355 342,989 331,074 663,837 ------------ ------------ ------------ ------------ Income (loss) before income taxes .. 254,208 935,830 (569,717) 1,386,915 Provision (benefit) for income taxes 83,889 187,166 (188,007) 277,383 ------------ ------------ ------------ ------------ Net income (loss) ............... $ 170,319 $ 748,664 $ (381,710) $ 1,109,532 ============ ============ ============ ============ Less: Preferred stock dividends ... -- 47,100 30,505 94,200 ------------ ------------ ------------ ------------ Net income (loss) to common shareholders .................... $ 170,319 $ 701,564 $ (412,215) 1,015,332 ============ ============ ============ ============ Basic earnings (loss) per share .... $ 0.01 $ 0.07 $ (0.02) $ 0.10 ============ ============ ============ ============ Diluted earnings (loss) per share .. $ 0.01 $ 0.07 $ (0.02) $ 0.10 ============ ============ ============ ============ Weighted average number of common shares outstanding: Basic ........................... 18,061,778 10,209,195 16,491,684 9,818,390 ============ ============ ============ ============ Diluted ......................... 18,779,239 10,737,427 16,491,684 10,169,168 ============ ============ ============ ============ See accompanying notes to consolidated financial statements. 4 TAG-IT PACIFIC, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30, ----------------------------- 2004 2003 ------------- ------------- Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net (loss) income ..................................... $ (381,710) $ 1,109,532 Adjustments to reconcile net (loss) income to net cash used by operating activities: Depreciation and amortization ......................... 730,153 617,925 Increase in allowance for doubtful accounts ........... 147,282 163,489 Common stock issued for services ...................... 74,825 -- Changes in operating assets and liabilities: Receivables, including related parties .............. (6,777,637) (4,660,629) Inventories ......................................... (1,907,176) (1,481,065) Other assets ........................................ (236,854) (5,663) Prepaid expenses and other current assets ........... 929,415 (957,730) Accounts payable and accrued expenses ............... 739,019 2,035,362 Income taxes payable ................................ (434,901) 479,479 ------------ ------------ Net cash used by operating activities ..................... (7,117,584) (2,699,300) ------------ ------------ Cash flows from investing activities: Acquisition of property and equipment ................. (337,082) (980,046) ------------ ------------ Cash flows from financing activities: Repayment of bank line of credit, net ................. (1,160,152) (536,162) Proceeds from private placement transactions .......... -- 6,395,300 Proceeds from exercise of stock options and warrants .. 424,801 182,000 Repayment of capital leases ........................... (299,377) (170,364) Repayment of notes payable ............................ (600,000) (1,100,000) ------------ ------------ Net cash used (provided) by financing activities .......... (1,634,728) 4,770,774 ------------ ------------ Net (decrease) increase in cash ........................... (9,089,394) 1,091,428 Cash at beginning of period ............................... 14,442,769 285,464 ------------ ------------ Cash at end of period ..................................... $ 5,353,375 $ 1,376,892 ============ ============ Supplemental disclosures of cash flow information: Cash received (paid) during the period for: Interest paid ....................................... $ (324,292) $ (637,930) Income taxes paid ................................... $ (255,067) $ (9,131) Income taxes received ............................... $ -- $ 212,082 Non-cash financing activities: Preferred Series D stock converted to common stock .... $ 22,918,693 $ -- Preferred Series C stock converted to common stock .... $ 2,895,001 $ -- Accrued dividends converted to common stock ........... $ 458,707 $ -- Capital lease obligation .............................. $ 249,418 $ 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 accounting principles generally accepted 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, 2003. 2. EARNINGS PER SHARE The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations: INCOME SHARES PER SHARE ---------- ---------- ---------- THREE MONTHS ENDED JUNE 30, 2004: Basic earnings per share: Income available to common stockholders $ 170,319 18,061,778 $ 0.01 Effect of Dilutive Securities: Options ............................... -- 584,415 -- Warrants .............................. -- 133,046 -- ---------- ---------- ---------- Income available to common stockholders $ 170,319 18,779,239 $ 0.01 ========== ========== ========== THREE MONTHS ENDED JUNE 30, 2003: Basic earnings per share: Income available to common stockholders $ 701,564 10,209,195 $ 0.07 Effect of Dilutive Securities: Options -- 482,937 -- Warrants -- 45,295 -- ---------- ---------- ---------- Income available to common stockholders $ 701,564 10,737,427 $ 0.07 ========== ========== ========== 6 (LOSS) INCOME SHARES PER SHARE SIX MONTHS ENDED JUNE 30, 2004: ---------- ---------- ---------- Basic loss per share: Loss available to common stockholders $ (412,215) 16,491,684 $ (0.02) Effect of Dilutive Securities: Options -- -- -- Warrants -- -- -- ---------- ---------- ---------- Loss available to common stockholders $ (412,215) 16,491,684 $ (0.02) ========== ========== ========== SIX MONTHS ENDED JUNE 30, 2003: Basic earnings per share: Income available to common stockholders $1,015,332 9,818,390 $ 0.10 Effect of Dilutive Securities: Options -- 33,488 -- Warrants -- 317,290 -- ---------- ---------- ---------- Income available to common stockholders $1,015,332 10,169,168 $ 0.10 ========== ========== ========== Convertible debt of $500,000, convertible at $4.50 per common share, was outstanding for the three months ended June 30, 2004, but was not included in the computation of diluted earnings per share because the effect of conversion would have an antidilutive effect on earnings per share. Warrants to purchase 1,236,219 shares of common stock at between $0.71 and $5.06, options to purchase 1,875,200 shares of common stock at between $1.30 and $4.63 and convertible debt of $500,000 convertible at $4.50 per share were outstanding for the six months ended June 30, 2004, 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 three months ended June 30, 2003, but were not included in the computation of diluted earnings per share because exercise or conversion would have an antidilutive effect on earnings per share. Warrants to purchase 655,832 shares of common stock at between $4.34 and $5.06, options to purchase 568,000 shares of common stock at between $4.25 and $4.63, convertible debt of $500,000 convertible at $4.50 per share and 759,494 shares of preferred Series C stock convertible at $4.94 per share were outstanding for the six months ended June 30, 2003, but were not included in the computation of diluted earnings per share because exercise or conversion would have an antidilutive effect on earnings per share. 7 3. STOCK BASED COMPENSATION All stock options issued to employees had an exercise price not less than the fair market value of the Company's Common Stock on the date of grant, and in accounting for such options utilizing the intrinsic value method there is no related compensation expense recorded in the Company's financial statements for the three and six months ended June 30, 2004 and 2003. 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 (loss) and earnings (loss) per share for the three and six months ended June 30, 2004 and 2003 would have amounted to the pro forma amounts presented below: Three Months Six Months Ended June 30, Ended June 30, --------------------------- -------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Net income, as reported........................ $ 170,319 $ 748,664 $ (381,710) $ 1,109,532 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects ...................... -- -- -- -- Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects .................................. (5,224) (44,838) (44,780) (50,120) ----------- ----------- ----------- ----------- Pro forma net income........................... $ 165,095 $ 703,826 $ (426,490) $ 1,059,412 =========== =========== =========== =========== Earnings per share: Basic - as reported....................... $ 0.01 $ 0.07 $ (0.02) $ 0.10 Basic - pro forma......................... $ 0.01 $ 0.06 $ (0.03) $ 0.10 Diluted - as reported..................... $ 0.01 $ 0.07 $ (0.02) $ 0.10 Diluted - pro forma....................... $ 0.01 $ 0.06 $ (0.03) $ 0.10 4. SERIES D PREFERRED STOCK On December 18, 2003, the Company sold an aggregate of 572,818 shares of non-voting Series D Convertible Preferred Stock, at a price of $44.00 per share, to institutional investors and individual accredited investors in a private placement transaction. The Company received net proceeds of $23,083,693 after commissions and other offering expenses. The Series D Convertible Preferred Stock was convertible after approval at a special meeting of stockholders at a rate of 10 common shares for each share of Series D Convertible Preferred Stock. Except as required by law, the Preferred Shares had no voting rights. The Preferred Shares would have accrued dividends, commencing on June 1, 2004, at an annual rate of 5% of the initial stated value of $44.00 per share, payable quarterly. In the event of a liquidation, dissolution or winding-up of the Company, the holders of the Preferred Shares would have been entitled to receive, prior to any distribution on the common stock, a distribution equal to the initial stated value of the Preferred Shares plus all accrued and unpaid dividends. At a special meeting of stockholders held on February 11, 2004, the stockholders of the Company approved the issuance of 5,728,180 shares of common stock upon conversion of the Series D Preferred 8 Stock. At the conclusion of the meeting, all of the shares of the Series D Convertible Preferred Stock automatically converted into common shares. The Company has registered the common shares issued upon conversion of the Series D Convertible Preferred Stock with the Securities and Exchange Commission for resale by the investors. In conjunction with the private placement transaction, the Company issued a warrant to purchase 572,818 common shares to the placement agent. The warrant is exercisable beginning June 18, 2004 through December 18, 2008. The fair value of the warrant was estimated at approximately $165,000 utilizing the Black-Scholes option-pricing model. 5. SERIES C PREFERRED STOCK On February 25, 2004, the holders of the Series C Preferred Stock converted all 759,494 shares of Series C Preferred Stock, plus $458,707 of accrued dividends, into 700,144 shares of common stock. 6. SUBSEQUENT EVENT On July 16, 2004, we amended our exclusive supply agreement with Levi Strauss & Co. to provide for an additional two-year term through November 2006. In accordance with the supply agreement, Levi is to purchase waistbands for specific product categories over the term of the agreement. Certain proprietary products, equipment and technological know-how will be supplied to Levi on an exclusive basis for specific product categories during the extended period. 7. GUARANTEES AND CONTINGENCIES In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34." The following is a summary of the Company's agreements that it has determined are within the scope of FIN 45: In accordance with the bylaws of the Company, officers and directors are indemnified for certain events or occurrences arising as a result of the officer or director's serving in such capacity. The term of the indemnification period is for the lifetime of the officer or director. The maximum potential amount of future payments the Company could be required to make under the indemnification provisions of its bylaws is unlimited. However, the Company has a director and officer liability insurance policy that reduces its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of the indemnification provisions of its bylaws is minimal and therefore, the Company has not recorded any related liabilities. The Company enters into indemnification provisions under its agreements with investors and its agreements with other parties in the normal course of business, typically with suppliers, customers and landlords. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities or, in some cases, as a result of the indemnified party's activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights. These indemnification provisions generally survive termination of the underlying agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has not recorded any related liabilities. 9 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. 8. NEW ACCOUNTING PRONOUNCEMENTS In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (SAB No. 104), "REVENUE RECOGNITION," which codifies, revises and rescinds certain sections of SAB No. 101, "REVENUE RECOGNITION," in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our consolidated results of operations, consolidated financial position or consolidated cash flows. In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 150, ACCOUNTING FOR CERTAIN INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("FAS 150"), which establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. FAS 150 requires an issuer to classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability. This Statement is effective at the beginning of the first interim period beginning after June 15, 2003 for public companies. The Company adopted this Statement as of July 1, 2003 and it had no material impact on its financial statements. In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("FAS No. 149"). FAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." FAS No. 149 also amends certain other existing pronouncements, which will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. This Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The Company adopted this Statement as of July 1, 2003 and it had no material impact on its financial statements. 10 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 six months ended June 30, 2004 and 2003. 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. OVERVIEW Tag-It Pacific, Inc. is an apparel company that specializes in the distribution of trim items to manufacturers of fashion apparel, specialty retailers and mass merchandisers. We act as a full service outsourced trim management department for manufacturers, a specified supplier of trim items to owners of specific brands, brand licensees and retailers, a manufacturer and distributor of zippers under our TALON brand name and a distributor of stretch waistbands that utilize licensed patented technology under our TEKFIT brand name. The global apparel industry served by our company continues to undergo dramatic change within its traditional supply chain. Large retail brands such as Levi Strauss & Co. and other major brands have largely moved away from owning their manufacturing operations and have increasingly embraced an outsourced production model. These brands today are primarily focused on design, marketing and sourcing. As sourcing has gained prominence in these organizations, they have become increasingly adept at responding to changing market conditions with respect to labor costs, trade policies and other areas, and are more capable of shifting production to new geographic areas. As the separation of the retail brands and apparel production has grown, the disintermediation of the retail brands and the underlying suppliers of apparel component products such as trim has become substantially more pronounced. The management of trim procurement, including ordering, production, inventory management and just-in-time distribution to a brand's manufacturers, has become an increasingly cumbersome task given (i) the proliferation of brands, styles and divisions within the major retail brands and (ii) the growing pace of globalization within the apparel manufacturing industry. While the global apparel industry is in the midst of restructuring its supply chain, the trim product industry has not evolved and remains highly fragmented, with no single player providing the global scope, integrated product set or service focus required for the broader industry evolution to succeed. We believe these trends present an attractive opportunity for a fully-integrated single source supplier of trim products to successfully interface between the retail brands, their manufacturing partners and other underlying trim component suppliers. Our objective is to provide the global apparel industry with innovative products and distribution solutions that improve both the quality of fashion apparel and the efficiency of the industry itself. The launch of TRIMNET, our Oracle based e-sourcing system will allow us to seamlessly supply complete trim packages to apparel brands, retailers and manufacturers around the world, greatly expanding upon our success in offering complete trim packages to customers in Mexico over the past several years. TRIMNET is an upgrade of our MANAGED TRIM SOLUTION software and will allow us to provide additional services to customers on a global platform. 11 On July 16, 2004, we amended our exclusive supply agreement with Levi Strauss & Co. to provide for an additional two-year term through November 2006. In accordance with the supply agreement, Levi is to purchase waistbands for specific product categories over the term of the agreement. Certain proprietary products, equipment and technological know-how will be supplied to Levi on an exclusive basis for specific product categories during the extended period. 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, if lower, and charged to operations in the period in which the facts that give rise to the adjustments become known. A substantial portion of our total inventories is subject to buyback arrangements with our customers. The buyback arrangements contain provisions related to the inventory we purchase and warehouse on behalf of our customers. In the event that inventories remain with us in excess of six to nine months from our receipt of the goods from our vendors or the termination of production of a customer's product line related to the inventories, the customer is required to purchase the inventories from us under normal invoice and selling terms. If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to purchase inventories, an additional adjustment may be required. These buyback arrangements are considered in management's estimate of future market value of inventories. o Accounts receivable balances are evaluated on a continual basis and allowances are provided for potentially uncollectable accounts based on management's estimate of the collectability of customer accounts. If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments, an additional allowance may be required. Allowance adjustments are charged to operations in the period in which the facts that give rise to the adjustments become known. o We record valuation allowances to reduce our deferred tax assets to an amount that we believe is more likely than not to be realized. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing 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 12 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. RESULTS OF OPERATIONS The following table sets forth for the periods indicated, selected statements of operations data shown as a percentage of net sales: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------- ----------------- 2004 2003 2004 2003 ----- ----- ----- ----- Net sales ......................... 100.0% 100.0% 100.0% 100.0% Cost of goods sold ................ 73.9 73.6 72.6 72.2 ----- ----- ----- ----- Gross profit ...................... 26.1 26.4 27.4 27.8 Selling expenses .................. 4.7 6.0 5.9 5.9 General and administrative expenses ....................... 18.7 14.2 22.5 16.1 ----- ----- ----- ----- Operating Income (loss) ........... 2.7% 6.2% (1.0)% 5.8% ===== ===== ===== ===== The following table sets forth for the periods indicated revenues attributed to geographical regions based on the location of the customer as a percentage of net sales: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------- ---------------- 2004 2003 2004 2003 ----- ----- ----- ----- United States ...................... 7.7% 16.6% 8.2% 16.3% Asia ............................... 24.3 13.8 24.1 12.3 Mexico ............................. 39.1 38.6 37.1 42.6 Dominican Republic ................. 19.7 23.0 19.7 22.7 Central and South America .......... 8.7 5.5 10.5 4.5 Other .............................. 0.5 2.5 0.4 1.6 ----- ----- ----- ----- 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== 13 Net sales decreased approximately $5,809,000, or 28.0%, to $14,923,000 for the three months ended June 30, 2004 from $20,732,000 for the three months ended June 30, 2003. The decrease in net sales for the three months ended June 30, 2004 was primarily due to a decrease in trim-related sales of approximately $8.3 million from our Tlaxcala, Mexico, operations under our MANAGED TRIM SOLUTION(TM) trim package program. During the fourth quarter of 2003, we implemented a plan to restructure certain business operations, including the reduction of our reliance on two significant customers in Mexico, Tarrant Apparel Group and Azteca Production International, which contributed approximately $8.9 million or 43.2% of revenues in the second quarter of 2003. These customers contributed approximately $600,000 or 3.9% of revenues in the second quarter of 2004. This plan was accelerated when Tarrant Apparel Group unexpectedly exited its Mexico operations. We were able to replace approximately 22% of the lost revenue during the three months ended June 30, 2004. The reduction of our operations in Mexico was also in response to our efforts to decrease our reliance on our larger Mexico customers, and our difficulty obtaining financing in Mexico due to the location of assets in Mexico and customer concentration and other limits imposed by financial institutions. Fiscal 2004 continues to be a transitional year as we experience the effects of diversifying our customer base. We are no longer reliant on Tarrant Apparel Group and Azteca Production International for a significant portion of our sales. The decrease in net sales was also offset by an increase in sales from our Hong Kong subsidiary for TRIMNET programs related to major U.S. retailers and an increase in zipper sales under our TALON brand name in Asia. Net sales decreased approximately $10,007,000, or 28.5%, to $25,083,000 for the six months ended June 30, 2004 from $35,090,000 for the six months ended June 30, 2003. The decrease in net sales for the six months ended June 30, 2004 was primarily due to a decrease in trim-related sales of approximately $15.4 million from our Tlaxcala, Mexico operations, as discussed above. Our previous reliance on two significant customers in Mexico, Tarrant Apparel Group and Azteca Production International, during the six months ended June 30, 2003 contributed approximately $16.6 million or 47.3% of revenues compared to approximately $1.2 million or 4.8% of revenues for the six months ended June 30, 2004. We were able to replace approximately 29% of lost revenue during the six months ended June 30, 2004. The decrease in net sales was also offset by an increase in sales from our Hong Kong subsidiary for TRIMNET programs related to major U.S. retailers and an increase in zipper sales under our TALON brand name in Asia. Gross profit decreased approximately $1,573,000, or 28.8%, to $3,892,000 for the three months ended June 30, 2004 from $5,465,000 for the three months ended June 30, 2003. Gross margin as a percentage of net sales decreased to approximately 26.1% for the three months ended June 30, 2004 as compared to 26.4% for the three months ended June 30, 2003. The decrease in gross profit as a percentage of net sales for the three months ended June 30, 2004 was due to a change in our product mix during the current quarter. Gross profit decreased approximately $2,880,000, or 29.5%, to $6,884,000 for the six months ended June 30, 2004 from $9,764,000 for the six months ended June 30, 2003. Gross margin as a percentage of net sales decreased to approximately 27.4% for the six months ended June 30, 2004 as compared to 27.8% for the six months ended June 30, 2003. The decrease in gross profit as a percentage of net sales for the six months ended June 30, 2004 was due to a change in our product mix during the current period. Selling expenses decreased approximately $544,000, or 43.7%, to $702,000 for the three months ended June 30, 2004 from $1,246,000 for the three months ended June 30, 2003. As a percentage of net sales, these expenses decreased to 4.7% for the three months ended June 30, 2004 compared to 6.0% for the three months ended June 30, 2003. The decrease in selling expenses during the period was due in part to a decrease in the royalty rate related to our exclusive license and intellectual property rights agreement with Pro-Fit Holdings Limited. We incurred royalties related to this agreement of approximately 14 $110,000 for the three months ended June 30, 2004 compared to $346,000 for the three months ended June 30, 2003. Over the life of the contract, 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. Selling expenses also decreased due to the implementation of our restructuring plan in the fourth quarter of 2003. Selling expenses decreased approximately $600,000, or 28.9%, to $1,475,000 for the six months ended June 30, 2004 from $2,075,000 for the six months ended June 30, 2003. As a percentage of net sales, these expenses remained consistent at 5.9% for the six months ended June 30, 2004 and the six months ended June 30, 2003. The decrease in selling expenses during the period was due in part to a decrease in the royalty rate related to our exclusive license and intellectual property rights agreement with Pro-Fit Holdings Limited. We incurred royalties related to this agreement of approximately $225,000 for the six months ended June 30, 2004 compared to $501,000 for the six months ended June 30, 2003. Selling expenses also decreased due to the implementation of our restructuring plan in the fourth quarter of 2003. General and administrative expenses decreased approximately $149,000, or 5.1%, to $2,791,000 for the three months ended June 30, 2004 from $2,940,000 for the three months ended June 30, 2003. The decrease in these expenses was due primarily to a reduction in salaries and related benefits and other costs associated with our restructuring plan implemented in the fourth quarter of 2003. As a percentage of net sales, these expenses increased to 18.7% for the three months ended June 30, 2004 compared to 14.2% for the three months ended June 30, 2003, due to the decrease in net sales. General and administrative expenses increased approximately $10,000, or 0.2%, to $5,648,000 for the six months ended June 30, 2004 from $5,638,000 for the six months ended June 30, 2003. The increase in these expenses was due primarily to a one-time charge of approximately $400,000 in the first quarter of 2004 related to the final residual costs associated with our restructuring plan implemented in the fourth quarter of 2003. This one-time charge was offset by a decrease in salaries and related benefits and other costs as a result of the implementation of our restructuring plan in the fourth quarter of 2003. As a percentage of net sales, these expenses increased to 22.5% for the six months ended June 30, 2004 compared to 16.1% for the six months ended June 30, 2003, due to the decrease in net sales. Interest expense decreased approximately $199,000, or 58.0%, to $144,000 for the three months ended June 30, 2004 from $343,000 for the three months ended June 30, 2003. Borrowings under our UPS Capital credit facility decreased during the period ended June 30, 2004 due to proceeds received from our private placement transactions in May and December 2003 in which we raised approximately $29 million from the sale of common and convertible preferred stock. Interest expense decreased approximately $333,000, or 50.2%, to $331,000 for the six months ended June 30, 2004 from $664,000 for the six months ended June 30, 2003. Borrowings under our UPS Capital credit facility decreased during the period ended June 30, 2004 due to proceeds received from our private placement transactions in May and December 2003 in which we raised approximately $29 million from the sale of common and convertible preferred stock. The provision for income taxes for the three months ended June 30, 2004 amounted to approximately $84,000 compared to $187,000 for the three months ended June 30, 2003. Income taxes decreased for the three months ended June 30, 2004 primarily due to decreased taxable income. The income tax benefit for the six months ended June 30, 2004 amounted to approximately $188,000 compared to a provision for income taxes of $277,000 for the six months ended June 30, 2003. Income taxes decreased for the six months ended June 30, 2004 primarily due to decreased taxable income. 15 Net income was approximately $170,000 for the three months ended June 30, 2004 as compared to $749,000 for the three months ended June 30, 2003, due primarily to a decrease in net sales offset by decreases in selling, general and administrative and interest expenses, as discussed above. Net loss was approximately $382,000 for the six months ended June 30, 2004 as compared to net income of $1,110,000 for the six months ended June 30, 2003, due primarily to a decrease in net sales offset by decreases in selling and interest expenses, as discussed above. There were no preferred stock dividends for the three months ended June 30, 2004 as compared to $47,000 for the three months ended June 30, 2003. Preferred stock dividends represent earned dividends at 6% of the stated value per annum of the Series C convertible redeemable preferred stock. In February 2004, the holders of the Series C convertible redeemable preferred stock converted all 759,494 shares of the Series C Preferred Stock, plus $458,707 of accrued dividends, into 700,144 shares of our common stock. Net income available to common shareholders amounted to $170,000 for the three months ended June 30, 2004 compared to $702,000 for the three months ended June 30, 2003. Basic and diluted earnings per share were $0.01 for the three months ended June 30, 2004 and $0.07 for the three months ended June 30, 2003. Preferred stock dividends amounted to $31,000 for the six months ended June 30, 2004 as compared to $94,000 for the six months ended June 30, 2003. Preferred stock dividends represent earned dividends at 6% of the stated value per annum of the Series C convertible redeemable preferred stock. In February 2004, the holders of the Series C convertible redeemable preferred stock converted all 759,494 shares of the Series C Preferred Stock, plus $458,707 of accrued dividends, into 700,144 shares of our common stock. Net loss available to common shareholders amounted to $412,000 for the six months ended June 30, 2004 compared to net income available to common shareholders of $1,015,000 for the six months ended June 30, 2003. Basic and diluted loss per share was $0.02 for the six months ended June 30, 2004 and basic and diluted earnings per share was $0.10 for the six months ended June 30, 2003. LIQUIDITY AND CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS Cash and cash equivalents decreased to $5,353,000 at June 30, 2004 from $14,443,000 at December 31, 2003. The decrease resulted from approximately $7,118,000 of cash used by operating activities, $337,000 of cash used in investing activities and $1,635,000 of cash used in financing activities. Net cash used in operating activities was approximately $7,118,000 for the six months ended June 30, 2004 and approximately $2,699,000 for the six months ended June 30, 2003. Cash used in operating activities for the six months ended June 30, 2004 resulted primarily from increased accounts receivable and inventories. The increase in inventories during the period was due primarily to increased customer orders for future sales. The increase in accounts receivable during the period was due primarily to slower customer collections of non-related party receivables during the months of May and June 2004. Cash used in operating activities for the six months ended June 30, 2003 resulted primarily from increases in inventories and receivables, which was partially offset by increases in accounts payable and accrued expenses and net income. Net cash used in investing activities was approximately $337,000 and $980,000 for the six months ended June 30, 2004 and 2003, respectively. Net cash used in investing activities for the six months ended June 30, 2004 consisted primarily of capital expenditures for computer equipment and the purchase of additional TALON zipper equipment. Net cash used in investing activities for the six months ended June 30, 2003 consisted primarily of capital expenditures for equipment related to the exclusive supply agreement we entered into with Levi Strauss & Co. We also purchased computer equipment and 16 software for the implementation of a new Oracle-based computer system during the six months ended June 30, 2003. This purchase was treated as a non-cash capital lease obligation. Net cash used in financing activities was approximately $1,635,000 for the six months ended June 30, 2004 compared to net cash provided by financing activities of $4,771,000 for the six months ended June 30, 2003. Net cash used in financing activities for the six months ended June 30, 2004 primarily reflects the repayment of borrowings under our credit facility and subordinated notes payable, offset by funds raised from the exercise of stock options and warrants. Net cash provided by financing activities for the six months ended June 30, 2003 primarily reflects funds raised from private placement transactions, offset by the repayment of notes payable and decreased borrowings under our credit facility. We currently satisfy our working capital requirements primarily through cash flows generated from operations, sales of equity securities and borrowings under our credit facility with UPS Capital. Our maximum availability under the credit facility is $7 million. At June 30, 2004 and 2003, outstanding borrowings under our UPS Capital credit facility, including amounts borrowed under our foreign factoring agreement, amounted to approximately $5,935,000 and $15,495,000, respectively. Open letters of credit under our UPS Capital credit facility amounted to approximately $481,000 at June 30, 2004. There were no open letters of credit at June 30, 2003. The initial term of our agreement with UPS Capital was three years, expiring May 30, 2004, 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% on advances and the prime rate plus 4% on the term loan. On November 17, 2003, the credit facility was amended to provide for a term loan of $6 million in addition to the revolving credit facility with a maximum availability of $7 million. The term loan provided for monthly payments beginning December 15, 2003 through March 1, 2004 and has been paid in full as of June 30, 2004. On May 14, 2004, the credit facility was further amended to provide for an additional term expiring August 28, 2004 and an increased interest rate of prime plus 2.75% on advances. We are currently pursuing alternative working capital credit arrangements to replace the UPS Capital credit facility upon its expiration. The credit facility requires that we comply with certain financial covenants including net worth, fixed charge ratio and capital expenditures. We were not in compliance with one of the financial covenants at June 30, 2004. The non-compliance was subsequently waived by the bank. 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 $3,434,000 to $6,442,000 from January 1, 2004 to June 30, 2004. A significant decrease in eligible accounts receivable and inventories due to customer concentration levels and the aging of inventories, among other factors, can have an adverse effect on our borrowing capabilities under our credit facility, which thereafter, may not be adequate to satisfy our working capital requirements. Eligible accounts receivable are reduced if our accounts receivable customer balances are concentrated with a particular customer in excess of the percentages allowed under our agreement with UPS Capital. In addition, we have typically experienced seasonal fluctuations in sales volume. These seasonal fluctuations result in sales volume decreases in the first and fourth quarters of each year due to the seasonal fluctuations experienced by the majority of our customers. During these quarters, borrowing availability under our credit facility may decrease as a result of decreases in eligible accounts receivables generated from our sales. If our business becomes dependent 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. 17 The UPS Capital credit facility contains customary covenants restricting our activities as well as those of our subsidiaries, including limitations on certain transactions related to the disposition of assets; mergers; entering into operating leases or capital leases; entering into transactions involving subsidiaries and related parties outside of the ordinary course of business; incurring indebtedness or granting liens or negative pledges on our assets; making loans or other investments; paying dividends or repurchasing stock or other securities; guarantying third party obligations; repaying subordinated debt; and making changes in our corporate structure. Pursuant to the terms of a foreign factoring agreement under our UPS Capital credit facility, UPS Capital purchases our eligible accounts receivable and assumes the credit risk with respect to those foreign accounts for which UPS Capital has given its prior approval. If UPS Capital does not assume the credit risk for a receivable, the collection risk associated with the receivable remains with us. We pay a fixed commission rate and may borrow up to 85% of eligible accounts receivable under our credit facility. Included in due from factor as of June 30, 2004 and 2003 are trade accounts receivable factored without recourse of approximately $55,000 and $177,000. Included in due from factor are outstanding advances due to UPS Capital under this factoring arrangement amounting to approximately $47,000 and $150,000 at June 30, 2004 and 2003. Pursuant to the terms of a factoring agreement for our Hong Kong subsidiary, Tag-It Pacific Limited, the factor purchases our eligible accounts receivable and assumes the credit risk with respect to those accounts for which the factor has given its prior approval. If the factor does not assume the credit risk for a receivable, the collection risk associated with the receivable remains with us. We pay a fixed commission rate and may borrow up to 80% of eligible accounts receivable. Interest is charged at 1.5% over the Hong Kong Dollar prime rate. As of June 30, 2004 and 2003, the amount factored with recourse and included in trade accounts receivable was approximately $883,000 and $542,000. Outstanding advances as of June 30, 2004 and 2003 amounted to approximately $215,000 and $332,000 and are included in the line of credit balance. As we continue to respond to the current industry trend of large retail brands to outsource apparel manufacturing to offshore locations, our foreign customers, though backed by U.S. brands and retailers, are increasing. This makes receivables based financing with traditional U.S. banks more difficult. Our current credit facility may not provide the level of financing we may need to expand into additional foreign markets. As a result, we are continuing to evaluate non-traditional financing of our foreign assets. Our trade receivables increased to $25,884,000 at June 30, 2004 from $25,080,000 at June 30, 2003. This increase was due primarily to increased non-related party receivables of approximately $9.1 million due to increased sales to non-related party customers and slower collections in the months of May and June 2004. Non-related party trade receivables increased by an additional $3.3 million due to the inclusion of receivables that were previously classified as related party trade receivables. As a result of the sale of its ownership in our common stock, Azteca Production International is no longer considered a related party customer. The increase in non-related party receivables was offset by a decrease in related party trade receivables of approximately $8.3 million resulting from decreased sales to related parties during the period, offset by slower collections. Our net deferred tax asset increased to $2,800,000 at June 30, 2004 from $91,000 at June 30, 2003. The increase in our net deferred tax asset results primarily from 2003 losses. At December 31, 2003, we had Federal and state net operating loss carryforwards of approximately $9.2 million and $5.1 million, respectively, available to offset future taxable income. 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 at least the next twelve months. 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. The extent of our future capital requirements will depend on many factors, including our 18 results of operations, future demand for our products, the size and timing of future acquisitions, our borrowing base availability limitations related to eligible accounts receivable and inventories and our expansion into foreign markets. 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, Central American, South America and Caribbean markets and the further development of our waistband technology. If our cash from operations is less than anticipated or our working capital requirements and capital expenditures are greater than we expect, we may 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. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS The following summarizes our contractual obligations at June 30, 2004 and the effects such obligations are expected to have on liquidity and cash flow in future periods: Payments Due by Period -------------------------------------------------------------- Less than 1-3 4-5 After Contractual Obligations Total 1 Year Years Years 5 Years - -------------------------- ---------- ---------- ---------- ---------- ---------- Subordinated note payable $2,000,000 $1,800,000 $ 200,000 $ -- $ -- Capital lease obligations $1,163,974 $ 570,980 $ 592,994 $ -- $ -- Subordinated notes payable to related parties (1) $ 849,971 $ 849,971 $ -- $ -- $ -- Operating leases ......... $1,339,022 $ 685,006 $ 649,293 $ 4,723 $ -- Line of credit ........... $5,935,362 $5,935,362 $ -- $ -- $ -- Notes payable ............ $ 25,200 $ 25,200 $ -- $ -- $ -- Royalty payments ......... $ 369,315 $ -- $ 369,315 $ -- $ -- - ---------- <FN> (1) The majority of subordinated notes payable to related parties are due on demand with the remainder due and payable on the fifteenth day following the date of delivery of written demand for payment. </FN> As of June 30, 2003, we indirectly guaranteed the indebtedness of two of our suppliers through the issuance by a related party of letters of credit to purchase goods and equipment totaling $528,000. Financing costs due to the related party amounted to approximately $43,000. The letters of credit expired on various dates through July 2003. There were no outstanding letters of credit at June 30, 2004. At June 30, 2004 and 2003, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. RELATED PARTY TRANSACTIONS We 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 supply agreement with Tarrant Apparel Group has an indefinite term. Pricing and terms are consistent with competitive vendors. At the time we entered into this supply agreement, we also sold 19 2,390,000 shares of our common stock to KG Investment, LLC, an entity then owned by Gerard Guez and Todd Kay, executive officers and significant shareholders of Tarrant Apparel Group. Sales under our supply agreements with Tarrant Apparel Group and Azteca Production International (a former related party), and their affiliates, amounted to approximately 40.2% and 69.7% of our total sales for the years ended December 2003 and 2002, respectively, and 4.8% and 47.3% of our total sales for the six months ended June 30, 2004 and 2003. Sales under these supply agreements as a percentage of total sales for the year ending December 2004 are anticipated to be significantly lower than the year ended December 2003. This decrease is due in part to our efforts to decrease our reliance on these customers and to further diversify our customer base. Our results of operations will depend, to a lesser extent than in prior periods, upon the commercial success of Azteca Production International and Tarrant Apparel Group. If 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 at June 30, 2004 and 2003 and December 31, 2003, is approximately $8.8, $17.0 and $11.7 million due from Tarrant Apparel Group and Azteca Production International, and their affiliates. Included in inventories at June 30, 2004 and 2003 are inventories of approximately $6.6 and $8.0 million that are subject to buyback arrangements with Tarrant Apparel Group and Azteca Production International. The buyback arrangements contain provisions related to the inventory purchased on behalf of these customers. In the event that inventories remain with us in excess of six to nine months from our receipt of the goods from our vendors or the termination of production of a customer's product line related to the inventories, the customer is required to purchase the inventories from us under normal invoice and selling terms. During the six months ended June 30, 2004 and 2003, we sold approximately $130,000 and $1,300,000 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. As of June 30, 2004 and 2003, 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. NEW ACCOUNTING PRONOUNCEMENTS In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (SAB No. 104), "REVENUE RECOGNITION," which codifies, revises and rescinds certain sections of SAB No. 101, "REVENUE RECOGNITION," in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our consolidated results of operations, consolidated financial position or consolidated cash flows. In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 150, ACCOUNTING FOR CERTAIN INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("FAS 150"), which establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. FAS 150 requires an issuer to classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability. This Statement is effective at the beginning of the first interim period beginning after June 15, 2003 for public companies. We adopted this Statement as of July 1, 2003 and it had no material impact on our financial statements. 20 In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("FAS No. 149"). FAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." FAS No. 149 also amends certain other existing pronouncements, which will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. This Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. We adopted this Statement as of July 1, 2003 and it had no material impact on our 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. IF WE LOSE OUR LARGER CUSTOMERS OR THEY FAIL TO PURCHASE AT ANTICIPATED LEVELS, OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED. Our results of operations will depend to a significant extent upon the commercial success of our larger customers. If these customers fail to purchase our trim products at anticipated levels, or our relationship with these customers terminates, it may have an adverse affect on our results because: o We will lose a primary source of revenue if these customers choose not to purchase our products or services; o We may not be able to reduce fixed costs incurred in developing the relationship with these customers 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 LARGER CUSTOMERS MAKES RECEIVABLE BASED FINANCING DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGER CUSTOMERS FAIL TO PAY US, OUR CASH FLOW WOULD BE SEVERELY AFFECTED. Our business relies heavily on a relatively small number of customers. 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. If we are unable to collect any large receivables due us, our cash flow would be severely impacted. OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY EFFECTED IF WE ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING OUR RIGHTS UNDER OUR EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY AGREEMENT ("AGREEMENT") WITH PRO-FIT HOLDINGS. Pursuant to our Agreement with Pro-Fit Holdings Limited, we have exclusive rights in certain geographic areas to Pro-Fit's stretch and rigid waistband technology. By letter dated April 6, 2004, Pro-Fit alleged various breaches of the Agreement which we dispute. To prevent Pro-Fit in the future from terminating the Agreement based on alleged breaches that we do not regard as meritorious, we filed a lawsuit against Pro-Fit in the U.S. District Court for the Central District of California, based on various contractual and tort claims seeking declaratory 21 relief, injunctive relief and damages. There has been no activity in the litigation pending the outcome of ongoing negotiations with Pro-Fit. We intend to proceed with the lawsuit if these negotiations are not concluded in a manner satisfactory to us. We derive a significant amount of revenues from the sale of products incorporating the stretch waistband technology. Our business, results of operations and financial condition could be materially adversely affected if we are unable to conclude our present negotiations in a manner acceptable to us and ensuing litigation is not resolved in a manner favorable to us. 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 or insists on markdowns, we may incur a charge in connection with our holding significant amounts of unsalable inventory and this would have a negative impact on the income of the company. OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS WORSEN. Our revenues depend on the health of the economy and the growth of our customers and potential future customers. When economic conditions weaken, certain apparel manufacturers and retailers, including some of our customers, have experienced in the past, and may experience in the future, financial difficulties which increase the risk of extending credit to such customers. Customers adversely affected by economic conditions have also attempted to improve their own operating efficiencies by concentrating their purchasing power among a narrowing group of vendors. There can be no assurance that we will remain a preferred vendor to our existing customers. A decrease in business from or loss of a major customer could have a material adverse effect on our results of operations. Further, if the economic conditions in the United States worsen or if a wider or global economic slowdown occurs, we may experience a material adverse impact on our business, operating results, and financial condition. 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. 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 THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND STOCK PRICE VOLATILITY. We operate in an industry that is subject to significant fluctuations in operating results from quarter to quarter, which may lead to unexpected reductions in revenues and stock price volatility. Factors that may influence our quarterly operating results include: 22 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 Hong Kong, Mexico and Caribbean facilities with the information systems of our principal offices in California. Our failure to do so could result in lost revenues, delay financial reporting or adversely affect availability of funds under our credit facilities. THE LOSS OF KEY MANAGEMENT AND SALES PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE SALES. Our success has and will continue to depend to a significant extent upon key management and sales personnel, many of whom would be difficult to replace, particularly Colin Dyne, our Chief Executive Officer. Colin Dyne is not bound by an employment agreement. The loss of the services of Colin Dyne or the services of other key employees could have a material adverse effect on our business, including our ability to establish and maintain client relationships. Our future success will depend in large part upon our ability to attract and retain personnel with a variety of sales, operating and managerial skills. IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently, we do not operate duplicate facilities in different geographic areas. Therefore, in the event of a regional disruption where we maintain one or more of our facilities, it is unlikely that we could shift our operations to a different geographic region and we may have to cease or curtail our operations. This may cause us to lose sales and customers. The types of disruptions that may occur include: o Foreign trade disruptions; o Import restrictions; o Labor disruptions; o Embargoes; o Government intervention; and o Natural disasters. 23 INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our MANAGED TRIM SOLUTION is an Internet-based business-to-business e-commerce system. To the extent that we fail to adequately continue to update and maintain the hardware and software implementing the MANAGED TRIM SOLUTION, our customers may experience interruptions in service due to defects in our hardware or our source code. In addition, since our MANAGED TRIM SOLUTION is Internet-based, interruptions in Internet service generally can negatively impact our customers' ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects of their trim needs. Such defects or interruptions could result in lost revenues and lost customers. THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented industries with numerous local and regional companies that provide some or all of the products and services we offer. We compete with national and international design companies, distributors and manufacturers of tags, packaging products, zippers and other trim items. Some of our competitors, including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison Corporation and Scovill Fasteners, Inc., have greater name recognition, longer operating histories and, in many cases, substantially greater financial and other resources than we do. 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. 24 IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may include expansion through internal growth, by acquiring complementary businesses or by establishing strategic relationships with targeted customers and suppliers. In order to do so or to fund our other activities, we may issue additional equity securities that could dilute our stockholders' stock ownership. We may also assume additional debt and incur impairment losses related to goodwill and other tangible assets if we acquire another company and this could negatively impact our results of operations. WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS. We may consider strategic acquisitions as opportunities arise, subject to the obtaining of any necessary financing. Acquisitions involve numerous risks, including diversion of our management's attention away from our operating activities. We cannot assure our stockholders that we will not encounter unanticipated problems or liabilities relating to the integration of an acquired company's operations, nor can we assure our stockholders that we will realize the anticipated benefits of any future acquisitions. WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue additional shares of preferred stock and some provisions of our certificate of incorporation and bylaws and of Delaware law could make it more difficult for a third party to make an unsolicited takeover attempt of us. These anti-takeover measures may depress the price of our common stock by making it more difficult for third parties to acquire us by offering to purchase shares of our stock at a premium to its market price. INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As of August 1, 2004, our officers and directors and their affiliates beneficially owned approximately 16.0% 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 18.2% of the outstanding shares of our common stock at August 1, 2004. Gerard Guez and Todd Kay, significant stockholders of Tarrant Apparel Group, own approximately 5.6% of the outstanding shares of our common stock at August 1, 2004. As a result, our officers and directors, the Dyne family, Gerard Guez and Todd Kay 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. 25 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. We are exposed to market risk for fluctuations in the foreign currency exchange rates for certain product purchases that are denominated in British Pounds. At June 30, 2004, we purchased forward exchange contracts for British Pounds to hedge the payments of product purchases through September 2004. These contracts have an aggregate notional amount of $360,000. The market value of these contracts approximated their carrying value at June 30, 2004. The Company intends to purchase additional contracts to hedge the British Pound exposure for future product purchases. Currency fluctuations can increase the price of our products to foreign customers which can adversely impact the level of our export sales from time to time. The majority of our cash equivalents are held in United States bank accounts and we do not believe we have significant market risk exposure with regard to our investments. We are also exposed to the impact of interest rate changes on our outstanding borrowings. At June 30 2004, we had approximately $7.9 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. Members of the Company's management, including the Company's Chief Executive Officer, Colin Dyne, and Chief Financial Officer, Ronda Ferguson, have evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of June 30, 2004, the end of the period covered by this report. Based upon that evaluation, Mr. Dyne and Ms. Ferguson 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 INTERNAL CONTROLS OVER FINANCIAL REPORTING There were no significant changes in the Company's internal controls over financial reporting or in other factors that could significantly affect these internal controls over financial reporting after the date of our most recent evaluation. 26 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. At our Annual Meeting of Stockholders held on May 12, 2004 our stockholders (a) elected Kevin Bermeister and Brent Cohen to serve as Class I Directors on our Board of Directors for three years and until their respective successors have been elected, and (b) approved an amendment to our 1997 Stock Plan to increase from 2,577,500 to 3,077,500 the maximum number of shares of common stock that may be issued pursuant to awards granted under the 1997 Stock Plan. Kevin Bermeister was elected by a vote of 15,193,784 shares in favor, 67,800 shares voted against, and no shares were withheld from voting for the directors. Brent Cohen was elected by a vote of 15,160,184 shares in favor, 101,400 shares voted against, and no shares were withheld from voting for the directors. At the annual meeting, 10,299,282 shares were voted in favor of, 326,863 shares were voted against, and 228,870 shares were withheld from voting on the amendment to our 1997 Stock Plan. There were 4,406,569 broker non-votes at the annual meeting. Immediately prior to and following the meeting, the Board of Directors was comprised of Mark Dyne, Colin Dyne, G. Maxwell Perks, Kevin Bermeister, Brent Cohen, Michael Katz and Jonathan Burstein. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 10.1 Tag-It Pacific, Inc. Amended and Restated 1997 Stock Plan 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, filed on May 18, 2004. 27 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. Dated: August 16, 2004 TAG-IT PACIFIC, INC. /S/ RONDA FERGUSON -------------------------------- By: Ronda Ferguson Its: Chief Financial Officer 28