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, 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) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 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, 18,144,351 shares issued and outstanding as of November
15, 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 September 30, 2004
(unaudited) and December 31, 2003...............................3
Consolidated Statements of Operations (unaudited)
For the Three and Nine Months
Ended September 30, 2004 and 2003...............................4
Consolidated Statements of Cash Flows (unaudited) for the
Nine Months Ended September 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..............................................28
Item 4. Controls and Procedures...........................................29
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................30
Item 6. Exhibits..........................................................30
2
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2004 2003
------------ ------------
Assets (unaudited)
Current Assets:
Cash and cash equivalents .................. $ 1,566,027 $ 14,442,769
Due from factor ............................ 8,003 9,743
Trade accounts receivable, net ............. 22,511,020 7,531,079
Trade accounts receivable, related
parties ................................. 5,431,885 11,721,465
Inventories ................................ 16,483,353 17,096,879
Prepaid expenses and other current
assets .................................. 3,845,050 2,124,366
Deferred income taxes ...................... 2,800,000 2,800,000
------------ ------------
Total current assets ..................... 52,645,338 55,726,301
Property and equipment, net of accumulated
depreciation and amortization ............... 7,396,746 6,144,863
Tradename ..................................... 4,110,750 4,110,750
Goodwill ...................................... 450,000 450,000
License rights ................................ 306,250 375,375
Due from related parties ...................... 802,484 762,076
Other assets .................................. 698,464 200,949
------------ ------------
Total assets .................................. $ 66,410,032 67,770,314
============ ============
Liabilities, Convertible Redeemable Preferred
Stock and Stockholders' Equity
Current Liabilities:
Line of credit ............................. $ 4,597,480 $ 7,095,514
Accounts payable and accrued expenses ...... 9,051,494 9,552,196
Subordinated notes payable to
related parties ......................... 849,971 849,971
Current portion of capital lease
obligations ............................. 806,134 562,742
Current portion of mortgage note
payable ................................. 20,137 --
Current portion of subordinated
note payable ............................ 1,700,000 1,200,000
------------ ------------
Total current liabilities ................ 17,025,216 19,260,423
Capital lease obligations, less
current portion ............................ 1,281,949 651,191
Mortgage note payable, less current
portion .................................... 744,863 --
Subordinated note payable, less
current portion ............................ -- 1,400,000
------------ ------------
Total liabilities ......................... 19,052,028 21,311,614
------------ ------------
Convertible redeemable preferred stock
Series C, $0.001 par value; 759,494
shares authorized; no shares
issued and outstanding at September
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 September 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;
18,144,351 shares issued and
outstanding at September 30, 2004;
11,508,201 at December 31, 2003 .......... 18,146 11,510
Additional paid-in capital ................. 50,797,929 23,890,356
Accumulated deficit ........................ (3,458,071) (3,256,860)
------------ ------------
Total stockholders' equity .................... 47,358,004 43,563,699
------------ ------------
Total liabilities, convertible
redeemable preferred stock and
stockholders equity ........................ $ 66,410,032 $ 67,770,314
============ ============
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,
--------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net sales ........................................... $ 17,004,775 $ 16,467,896 $ 42,088,194 $ 51,558,303
Cost of goods sold .................................. 12,658,879 12,237,757 30,857,994 37,564,067
------------ ------------ ------------ ------------
Gross profit ..................................... 4,345,896 4,230,139 11,230,200 13,994,236
Selling expenses .................................... 646,000 967,688 2,120,598 3,042,601
General and administrative expenses ................. 3,226,995 2,831,140 8,875,344 8,469,572
------------ ------------ ------------ ------------
Total operating expenses ......................... 3,872,995 3,798,828 10,995,942 11,512,173
Income from operations .............................. 472,901 431,311 234,258 2,482,063
Interest expense, net ............................... 161,828 307,253 492,902 971,090
------------ ------------ ------------ ------------
Income (loss) before income taxes ................... 311,073 124,058 (258,644) 1,510,973
Provision (benefit) for income taxes ................ 100,069 28,888 (87,938) 306,271
------------ ------------ ------------ ------------
Net income (loss) ................................ $ 211,004 $ 95,170 $ (170,706) $ 1,204,702
============ ============ ============ ============
Less: Preferred stock dividends .................... -- 49,926 30,505 144,126
------------ ------------ ------------ ------------
Net income (loss) to common shareholders ............ $ 211,004 $ 45,244 $ (201,211) $ 1,060,576
============ ============ ============ ============
Basic earnings (loss) per share ..................... $ 0.01 $ 0.00 $ (0.01) $ 0.10
============ ============ ============ ============
Diluted earnings (loss) per share ................... $ 0.01 $ 0.00 $ (0.01) $ 0.10
============ ============ ============ ============
Weighted average number of common shares outstanding:
Basic ............................................ 18,112,802 11,436,702 17,036,001 10,363,755
============ ============ ============ ============
Diluted .......................................... 18,269,005 12,245,083 17,036,001 10,809,895
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months
Ended September 30,
----------------------------
2004 2003
------------ ------------
Increase (decrease) in cash and cash
equivalents
Cash flows from operating activities:
Net (loss) income .......................... $ (170,706) $ 1,204,702
Adjustments to reconcile net (loss)
income to net cash (used in)
provided by operating activities:
Depreciation and amortization ............... 1,100,886 956,742
Increase in allowance for doubtful accounts . 421,943 238,440
Common stock issued for services ............ 74,825 --
Warrants issued for services ................ 10,906 --
Changes in operating assets and liabilities:
Receivables, including related parties ... (9,110,564) (2,765,882)
Inventories .............................. 613,526 126,869
Other assets ............................. (504,946) (6,050)
Prepaid expenses and other current assets (1,720,684) (1,025,217)
Accounts payable and accrued expenses .... 377,567 782,998
Income taxes payable ..................... (413,212) 504,291
------------ ------------
Net cash (used in) provided by operating
activities .................................. (9,320,459) 16,893
------------ ------------
Cash flows from investing activities:
Acquisition of property and equipment ...... (1,261,795) (2,329,606)
------------ ------------
Cash flows from financing activities:
Repayment of bank line of credit, net ...... (2,498,034) (2,669,013)
Proceeds from private placement transactions -- 6,395,300
Proceeds from exercise of stock options and
warrants ................................ 478,814 297,500
Repayment of capital leases ................ (325,268) (308,178)
Proceeds from capital lease ................ 950,000 --
Repayment of notes payable ................. (900,000) (1,400,000)
------------ ------------
Net cash (used in) provided by financing
activities .................................. (2,294,488) 2,315,609
------------ ------------
Net (decrease) increase in cash ................ (12,876,742) 2,896
Cash at beginning of period .................... 14,442,769 285,464
------------ ------------
Cash at end of period .......................... $ 1,566,027 $ 288,360
============ ============
Supplemental disclosures of cash flow
information:
Cash received (paid) during the period for:
Interest paid ............................ $ (474,619) $ (953,732)
Income taxes paid ........................ $ (340,119) $ (13,208)
Income taxes received .................... $ 2,585 $ 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
Mortgage note payable ...................... $ 765,000 $ --
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 SEPTEMBER 30, 2004:
Basic earnings per share:
Income available to common stockholders $ 211,004 18,112,802 $ 0.01
Effect of Dilutive Securities:
Options ............................... -- 156,203 --
Warrants .............................. -- -- --
---------- ---------- ----------
Income available to common stockholders $ 211,004 18,269,005 $ 0.01
========== ========== ==========
THREE MONTHS ENDED SEPTEMBER 30, 2003:
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
========== ========== ==========
6
(LOSS)
INCOME SHARES PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, 2004: ---------- ---------- ----------
Basic loss per share:
Loss available to common stockholders $ (201,211) 17,036,001 $ (0.01)
Effect of Dilutive Securities:
Options -- -- --
Warrants -- -- --
---------- ---------- ----------
Loss available to common stockholders $ (201,221) 17,036,001 $ (0.01)
========== ========== ==========
NINE MONTHS ENDED SEPTEMBER 30, 2003:
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 10,806,895 $ 0.10
========== ========== ==========
Warrants to purchase 1,191,984 shares of common stock at between $4.29
and $5.06, options to purchase 1,270,200 shares of common stock at between $3.63
and $4.63, and convertible debt of $500,000 convertible at $4.50 per share, were
outstanding for the three months ended September 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 1,191,984 shares of common stock at between $4.29
and $5.06, options to purchase 1,790,200 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 nine months ended September 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.
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.
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 nine months ended September 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
nine months ended September 30, 2004 and 2003 would have amounted to the pro
forma amounts presented below:
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income (loss), as reported................. $ 211,004 $ 95,170 $ (170,706) $ 1,204,702
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) (50,004) (94,948)
----------- ----------- ----------- -----------
Pro forma net income (loss) ................... $ 205,780 $ 50,332 $ (220,710) $ 1,109,754
=========== =========== =========== ===========
Earnings per share:
Basic - as reported....................... $ 0.01 $ 0.00 $ (0.01) $ 0.10
Basic - pro forma......................... $ 0.01 $ 0.00 $ (0.01) $ 0.09
Diluted - as reported..................... $ 0.01 $ 0.00 $ (0.01) $ 0.10
Diluted - pro forma....................... $ 0.01 $ 0.00 $ (0.01) $ 0.09
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.
8
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 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. EXCLUSIVE SUPPLY AGREEMENT
On July 16, 2004, we amended our exclusive supply agreement with Levi
Strauss & Co. ("Levi") 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. SUBSEQUENT EVENTS
REFINANCING OF WORKING CAPITAL CREDIT FACILITY
On November 10, 2004, the Company raised $12.5 million from the sale of
Secured Convertible Notes Payable (the "Notes") to existing shareholders. The
Notes are convertible into common stock at a price of $3.65 per share, bear
interest at 6% payable quarterly, are due November 9, 2007 and are secured by
the TALON trademarks. The Notes are convertible at the option of the holder at
any time after closing. The Company may repay the Notes at any time after one
year from the closing date with a 15% prepayment penalty. At maturity, the
Company may repay the Notes in cash or require conversion if certain conditions
are met. In connection with the issuance of the Notes, 171,235 warrants were
issued to the Note holders. The warrants have a term of five years, an exercise
price of $3.65 and vest 30 days after closing. The Company is required to
register the shares issuable upon conversion of the options and exercise of the
warrants. In connection with this financing, the Company paid the placement
agent $704,000 in cash, and issued the placement agent a warrant to purchase
215,754 common shares at an exercise price of $3.65 per share. The warrant is
exercisable beginning May 10, 2004 through November 10, 2009.
A portion of the proceeds from the Secured Convertible Notes Payable
was used to pay off all existing indebtedness under our credit facility with UPS
Capital Global Trade Finance Corporation.
9
FRANCHISE AGREEMENTS
On October 21, 2004, the Company entered into a franchise agreement for
the sale of TALON zippers in Central Asia. The agreement provides for minimum
purchases from the Company of $9.5 million of TALON zipper products to be
received over a term beginning October 21, 2004 through April 21, 2008.
On November 10, 2004, the Company entered into a second franchise
agreement for the sale of TALON zippers in South East Asia. The agreement
provides for minimum purchases from the Company of $10.5 million of TALON zipper
products to be received over a term beginning November 10, 2004 through May 10,
2008.
8. 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.
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.
10
9. NEW ACCOUNTING PRONOUNCEMENT
In March 2004, the Financial Accounting Standards Board ("FASB")
published an Exposure Draft, "Share-Based Payment, an Amendment of FASB
Statements No. 123 and 95." The proposed change in accounting would replace
existing requirements under SFAS No. 123 and APB Opinion No. 25. The proposed
statement would require public companies to recognize the cost of employee
services received in exchange for equity instruments, based on the grant-date
fair value of those instruments, with limited exceptions. The proposed statement
would also affect the pattern in which compensation costs would be recognized,
the accounting for employee share purchase plans, and the accounting for income
tax effects of share-based payment transactions. The Exposure Draft also notes
that the use of a lattice model, such as the binomial model, to determine the
fair value of employee stock options, is preferable. The Company currently uses
the Black-Scholes pricing model to determine the fair value of its employee
stock options. Use of a lattice model to determine the fair value of employee
stock options may result in compensation costs materially different from those
pro forma costs disclosed in Note 3 to the consolidated financial information.
The Company is currently determining what impact the proposed statement would
have on its results of operations or financial position.
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 nine months ended September 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.
11
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.
On November 10, 2004, we refinanced our working capital credit facility
with UPS Capital Global Trade Finance Corporation with a portion of the proceeds
received from a private placement of $12.5 million Secured Convertible Notes
Payable. See further discussion under the LIQUIDITY AND CAPITAL RESOURCES
section of this document.
We have developed, and are now implementing, what were refer to as our
TALON franchise strategy, whereby we locate suitable candidates in various
geographic international regions to finish and sell zippers under the TALON
brand name. Our designated franchisees purchase and install locally equipment
for producing finished zippers, thus minimizing our capital outlay. The
franchisee will then purchase from us large zippers rolls and produce finished
zippers locally, according to their customers' specifications, in markets around
the world, becoming in essence a local marketer and distributor of the TALON
brand. The benefits of this strategy are profound, as we expect to dramatically
expand the geographic footprint of our TALON division without the need to build
factories, commit significant capital resources and hire sales people in the
markets we target.
On October 21, 2004, we entered into a franchise agreement for the sale
of TALON zippers in Central Asia. The agreement provides for minimum purchases
from us of $9.5 million in TALON zipper products to be received over a term
beginning October 21, 2004 through April 21, 2008.
On November 10, 2004, we entered into our second franchise agreement
for the sale of TALON zippers in South East Asia. The agreement provides for
minimum purchases from us of $10.5 million in TALON zipper products to be
received over a term beginning November 10, 2004 through May 10, 2008.
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.
12
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 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
13
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ---------------------
2004 2003 2004 2003
--------- ---------- ---------- ---------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 74.4 74.3 73.3 72.9
--------- ---------- ---------- ---------
Gross profit 25.6 25.7 26.7 27.1
Selling expenses 3.8 5.9 5.0 5.9
General and administrative
expenses 19.0 17.2 21.1 16.4
--------- ---------- ---------- ---------
Operating Income 2.8% 2.6% 0.6% 4.8%
========= ========== ========== =========
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2004 2003 2004 2003
--------- ---------- ---------- ---------
United States................. 9.7% 5.4% 8.7% 12.9%
Asia 19.3 15.9 22.2 13.6
Mexico........................ 44.9 43.0 40.2 42.3
Dominican Republic............ 15.8 22.1 18.2 22.5
Central and South America..... 7.4 8.6 9.3 5.9
Other......................... 2.9 5.0 1.4 2.8
--------- ---------- ---------- ---------
100.0% 100.0% 100.0% 100.0%
========= ========== ========== =========
14
Net sales increased approximately $537,000, or 3.3%, to $17,005,000 for
the three months ended September 30, 2004 from $16,468,000 for the three months
ended September 30, 2003. The increase in net sales for the three months ended
September 30, 2004 was primarily due to an increase in sales from our TRIMNET
programs related to major U.S. retailers in our Hong Kong and Mexico facilities
and an increase in zipper sales under our TALON brand name in Asia. The increase
in net sales was offset by a decrease in trim-related sales of approximately
$3.0 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 $6.0 million or 36.2% of revenues in the third quarter of 2003.
These customers contributed approximately $3.0 million or 17.9% of revenues in
the third quarter of 2004. This plan was accelerated when Tarrant Apparel Group
unexpectedly exited its Mexico operations. We were able to replace in excess of
100% of the lost revenue during the three months ended September 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. Fiscal 2004 continues to
be a transitional year as we experience the effects of diversifying our customer
base.
Net sales decreased approximately $9,470,000, or 18.4%, to $42,088,000
for the nine months ended September 30, 2004 from $51,558,000 for the nine
months ended September 30, 2003. The decrease in net sales for the nine months
ended September 30, 2004 was primarily due to a decrease in trim-related sales
of approximately $18.3 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 nine
months ended September 30, 2003 contributed approximately $22.5 million or 43.7%
of revenues compared to approximately $4.2 million or 10.1% of revenues for the
nine months ended September 30, 2004. We were able to replace approximately 48%
of lost revenue during the nine months ended September 30, 2004. The decrease in
net sales was offset by an increase in sales from our TRIMNET programs related
to major U.S. retailers in our Hong Kong and Mexico facilities and an increase
in zipper sales under our TALON brand name in Asia.
Gross profit increased approximately $116,000, or 2.7%, to $4,346,000
for the three months ended September 30, 2004 from $4,230,000 for the three
months ended September 30, 2003. Gross margin as a percentage of net sales
decreased to approximately 25.6% for the three months ended September 30, 2004
as compared to 25.7% for the three months ended September 30, 2003. The decrease
in gross profit as a percentage of net sales for the three months ended
September 30, 2004 was due to a change in our product mix during the quarter.
Gross profit decreased approximately $2,764,000, or 19.8%, to
$11,230,000 for the nine months ended September 30, 2004 from $13,994,000 for
the nine months ended September 30, 2003. Gross margin as a percentage of net
sales decreased to approximately 26.7% for the nine months ended September 30,
2004 as compared to 27.1% for the nine months ended September 30, 2003. The
decrease in gross profit as a percentage of net sales for the nine months ended
September 30, 2004 was due to a change in our product mix during the period.
15
Selling expenses decreased approximately $322,000, or 33.3%, to
$646,000 for the three months ended September 30, 2004 from $968,000 for the
three months ended September 30, 2003. As a percentage of net sales, these
expenses decreased to 3.8% for the three months ended September 30, 2004
compared to 5.9% for the three months ended September 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 $85,000 for the three months ended September 30, 2004 compared
to $199,000 for the three months ended September 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 $922,000, or 30.3%, to
$2,121,000 for the nine months ended September 30, 2004 from $3,043,000 for the
nine months ended September 30, 2003. As a percentage of net sales, these
expenses decreased to 5.0% for the nine months ended September 30, 2004 compared
to $5.9% for the nine months ended September 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 $312,000 for the nine months ended September 30, 2004 compared to
$705,000 for the nine months ended September 30, 2003. Selling expenses also
decreased due to the implementation of our restructuring plan in the fourth
quarter of 2003.
General and administrative expenses increased approximately $396,000,
or 14.0%, to $3,227,000 for the three months ended September 30, 2004 from
$2,831,000 for the three months ended September 30, 2003. The increase in
general and administrative expenses was due primarily to the hiring of
additional employees related to the expansion of our Asian operations, including
our TALON franchising strategy. Additional administrative employees were also
hired for our new TALON manufacturing facility in North Carolina. This facility
is estimated to begin production in December 2004. As a percentage of net sales,
these expenses increased to 19.0% for the three months ended September 30, 2004
compared to 17.2% for the three months ended September 30, 2003, as the rate of
increase in general and administrative expenses exceeded the rate of increase in
net sales.
General and administrative expenses increased approximately $405,000,
or 4.8%, to $8,875,000 for the nine months ended September 30, 2004 from
$8,470,000 for the nine months ended September 30, 2003. The increase in general
and administrative expenses was due primarily to the hiring of additional
employees related to the expansion of our Asian operations, including our TALON
franchising strategy. Additional administrative employees were also hired for
our new TALON manufacturing facility in North Carolina. This facility is
estimated to begin production in December 2004. The increase in these expenses
was also due 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 21.1% for the nine months
ended September 30, 2004 compared to 16.4% for the nine months ended September
30, 2003, due to the decrease in net sales.
Interest expense decreased approximately $145,000, or 47.2%, to
$162,000 for the three months ended September 30, 2004 from $307,000 for the
three months ended September 30, 2003. Borrowings under our UPS Capital credit
facility decreased during the period ended September 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.
16
Interest expense decreased approximately $478,000, or 49.2%, to
$493,000 for the nine months ended September 30, 2004 from $971,000 for the nine
months ended September 30, 2003. Borrowings under our UPS Capital credit
facility decreased during the period ended September 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 September 30,
2004 amounted to approximately $100,000 compared to $29,000 for the three months
ended September 30, 2003. Income taxes increased for the three months ended
September 30, 2004 primarily due to increased taxable income.
The income tax benefit for the nine months ended September 30, 2004
amounted to approximately $88,000 compared to a provision for income taxes of
$306,000 for the nine months ended September 30, 2003. Income taxes decreased
for the nine months ended September 30, 2004 primarily due to decreased taxable
income.
Net income was approximately $211,000 for the three months ended
September 30, 2004 as compared to $95,000 for the three months ended September
30, 2003, due primarily to an increase in net sales, decreases in selling and
interest expenses, offset by an increase in general and administrative, as
discussed above.
Net loss was approximately $171,000 for the nine months ended September
30, 2004 as compared to net income of $1,205,000 for the nine months ended
September 30, 2003, due primarily to a decrease in net sales and an increase in
general and administrative expenses, offset by decreases in selling and interest
expenses, as discussed above.
There were no preferred stock dividends for the three months ended
September 30, 2004 as compared to $50,000 for the three months ended September
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 $211,000 for the three
months ended September 30, 2004 compared to $45,000 for the three months ended
September 30, 2003. Basic and diluted earnings per share were $0.01 for the
three months ended September 30, 2004 and $0.00 for the three months ended
September 30, 2003.
Preferred stock dividends amounted to $31,000 for the nine months ended
September 30, 2004 as compared to $144,000 for the nine months ended September
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 $201,000 for the nine months ended
September 30, 2004 compared to net income available to common shareholders of
$1,061,000 for the nine months ended September 30, 2003. Basic and diluted loss
per share was $0.01 for the nine months ended September 30, 2004 and basic and
diluted earnings per share was $0.10 for the nine months ended September 30,
2003.
17
LIQUIDITY AND CAPITAL RESOURCES AND RELATED PARTY TRANSACTIONS
Cash and cash equivalents decreased to $1,566,000 at September 30, 2004
from $14,443,000 at December 31, 2003. The decrease resulted from approximately
$9,320,000 of cash used by operating activities, $1,262,000 of cash used in
investing activities and $2,294,000 of cash used in financing activities.
Net cash used in operating activities was approximately $9,320,000 for
the nine months ended September 30, 2004 and cash provided by operations was
approximately $17,000 for the nine months ended September 30, 2003. Cash used in
operating activities for the nine months ended September 30, 2004 resulted
primarily from increased accounts receivable and prepaid and other current
assets. The increase in accounts receivable during the period was due primarily
to slower customer collections of non-related party receivables during the
nine-month period. Non-related party trade receivables increased by an
additional $5.4 million due to the inclusion of receivables that were previously
classified as related party trade receivables. 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.
Net cash used in investing activities was approximately $1,262,000 and
$2,330,000 for the nine months ended September 30, 2004 and 2003, respectively.
Net cash used in investing activities for the nine months ended September 30,
2004 consisted primarily of capital expenditures for computer equipment, the
purchase of additional TALON zipper equipment and leasehold improvements related
to our new TALON manufacturing facility. During the quarter, we also purchased a
building and land in North Carolina for the manufacturing of TALON zippers. This
purchase was treated as a non-cash financing transaction. 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 financing activities was approximately $2,294,000 for
the nine months ended September 30, 2004 compared to net cash provided by
financing activities of $2,316,000 for the nine months ended September 30, 2003.
Net cash used in financing activities for the nine months ended September 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 and proceeds from a capital lease obligation. Net
cash provided by financing activities for the nine months ended September 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
from institutional investors and individual accredited investors. On November
10, 2004, we refinanced our working capital credit facility with UPS Capital
Global Trade Finance Corporation with a portion of the proceeds received from a
private placement of $12.5 million of Secured Convertible Promissory Notes. The
Secured Convertible Promissory Notes are convertible into common stock at a
price of $3.65 per share, bear interest at 6% payable quarterly, are due
November 9, 2007 and are secured by the TALON trademarks. The Notes are
convertible at the option of the holder at any time after closing. We may repay
the Notes at any time after one year from the closing date with a 15% prepayment
penalty. At maturity, we may repay the Notes in
18
cash or require conversion if certain conditions are met. In connection with the
issuance of the Notes, 171,235 warrants were issued to the Note holders. The
warrants have a term of five years, an exercise price of $3.65 and vest 30 days
after closing. We are required to register the shares issuable upon conversion
of the options and exercise of the warrants.
At September 30, 2004 and 2003, outstanding borrowings under our UPS
Capital credit facility, including amounts borrowed under our foreign factoring
agreement, amounted to approximately $4,597,000 and $13,265,000, respectively.
Open letters of credit under our UPS Capital credit facility amounted to
approximately $96,000 at September 30, 2004. There were no open letters of
credit at September 30, 2003.
Pursuant to the terms of a foreign factoring agreement under our UPS
Capital credit facility, UPS Capital purchased our eligible accounts receivable
and assumed the credit risk with respect to those foreign accounts for which UPS
Capital had given its prior approval. If UPS Capital did not assume the credit
risk for a receivable, the collection risk associated with the receivable
remained with us. We paid a fixed commission rate and borrowed up to 85% of
eligible accounts receivable under our credit facility. Included in due from
factor as of September 30, 2004 and 2003 are trade accounts receivable factored
without recourse of approximately $53,000 and $117,000. Included in due from
factor are outstanding advances due to UPS Capital under this factoring
arrangement amounting to approximately $45,000 and $100,000 at September 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 September 30, 2004 and 2003, the amount factored with
recourse and included in trade accounts receivable was approximately $872,000
and $260,000. Outstanding advances as of September 30, 2004 and 2003 amounted to
approximately $512,000 and $213,000 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 borrowings 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 $27,943,000 at September 30, 2004
from $23,022,000 at September 30, 2003. This increase was due primarily to
increased non-related party receivables of approximately $10 million due to
increased sales to non-related party customers and slower collections.
Non-related party trade receivables increased by an additional $5.4 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 $10.5 million resulting from
decreased sales to related parties during the period, offset by slower
collections. We are currently in negotiations with the management of Tarrant
Apparel Group to resolve its outstanding accounts receivable position. We
believe we can come to an agreement and have recorded a reserve against
outstanding accounts receivable based on these negotiations. If Tarrant does not
execute against its commitments, we will be required to record a write-down of
all or a portion of the outstanding receivables due from Tarrant.
Our net deferred tax asset increased to $2,800,000 at September 30,
2004 from $91,000 at September 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.
19
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. The extent of our future capital requirements
will depend on many factors, including our results of operations, future demand
for our products, the size and timing of future acquisitions, our borrowing base
availability limitations related to eligible accounts receivable and inventories
and our expansion into foreign markets. 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 September 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 $1,700,000 $1,700,000 $ -- $ -- $ --
Capital lease obligations $2,088,083 $ 806,134 $1,049,608 $ 232,341 $ --
Subordinated notes payable
to related parties (1) $ 849,971 $ 849,971 $ -- $ -- $ --
Operating leases ......... $1,162,387 $ 662,385 $ 500,002 $ -- $ --
Line of credit ........... $4,597,480 $4,597,480 $ -- $ -- $ --
Notes payable ............ $ 25,200 $ 25,200 $ -- $ -- $ --
Mortgage note payments.... $ 765,000 $ 20,137 $ 44,411 $ 50,559 $ 649,893
Royalty payments ......... $ 119,947 $ -- $ 119,947 $ -- $ --
- ----------
<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>
At September 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.
20
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 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 10.1% and 43.7% of our total sales for
the nine months ended September 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 for 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 September 30, 2004 and 2003 and December 31,
2003, is approximately $10.8, $16.0 and $11.7 million due from Tarrant Apparel
Group and Azteca Production International, and their affiliates.
We are currently in negotiations with the management of Tarrant Apparel
Group to resolve its outstanding accounts receivable position. We believe we can
come to an agreement and have recorded a reserve against outstanding accounts
receivable based on these negotiations. If Tarrant does not execute against its
commitments, we will be required to record a write-down of all or a portion of
the outstanding receivables due from Tarrant.
Included in inventories at September 30, 2004 and 2003 are inventories
of approximately $5.1 and $8.4 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 nine months ended September 30, 2004 and 2003, we
sold approximately $1,735,000 and $2,400,000 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. Of the $5.1 million of buyback inventories
with Tarrant Apparel Group and Azteca Production International at September 30,
2004, approximately $3.9 million represent generic goods that can be sold to
other customers. We are in the process of selling these goods to other
customers.
As of September 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.
21
NEW ACCOUNTING PRONOUNCEMENT
In March 2004, the Financial Accounting Standards Board ("FASB")
published an Exposure Draft, "Share-Based Payment, an Amendment of FASB
Statements No. 123 and 95." The proposed change in accounting would replace
existing requirements under SFAS No. 123 and APB Opinion No. 25. The proposed
statement would require public companies to recognize the cost of employee
services received in exchange for equity instruments, based on the grant-date
fair value of those instruments, with limited exceptions. The proposed statement
would also affect the pattern in which compensation costs would be recognized,
the accounting for employee share purchase plans, and the accounting for income
tax effects of share-based payment transactions. The Exposure Draft also notes
that the use of a lattice model, such as the binomial model, to determine the
fair value of employee stock options, is preferable. We currently use the
Black-Scholes pricing model to determine the fair value of its employee stock
options. Use of a lattice model to determine the fair value of employee stock
options may result in compensation costs materially different from those pro
forma costs disclosed in Note 3 to the consolidated financial information. We
are currently determining what impact the proposed statement would have on its
results of operations or financial position.
22
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 relief, injunctive relief and
damages. Pro-Fit filed an answer denying the material allegations of the
complaint and filed a counterclaim alleging various contractual and tort claims
seeking injunctive relief and damages. We filed a reply denying the material
allegations of Pro-Fit's pleading. Discovery in this case has not yet commenced
and no date has been set for trial of this matter. There have been ongoing
negotiations with Pro-Fit to attempt to resolve these disputes. 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.
23
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.
24
WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS
IN OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND
STOCK PRICE VOLATILITY. We operate in an industry that is subject to significant
fluctuations in operating results from quarter to quarter, which may lead to
unexpected reductions in revenues and stock price volatility. Factors that may
influence our quarterly operating results include:
o The volume and timing of customer orders received during the
quarter;
o The timing and magnitude of customers' marketing campaigns;
o The loss or addition of a major customer;
o The availability and pricing of materials for our products;
o The increased expenses incurred in connection with the
introduction of new products;
o Currency fluctuations;
o Delays caused by third parties; and
o Changes in our product mix or in the relative contribution to
sales of our subsidiaries.
Due to these factors, it is possible that in some quarters our
operating results may be below our stockholders' expectations and those of
public market analysts. If this occurs, the price of our common stock would
likely be adversely affected.
OUR CUSTOMERS HAVE CYCLICAL BUYING PATTERNS WHICH MAY CAUSE US TO HAVE
PERIODS OF LOW SALES VOLUME. Most of our customers are in the apparel industry.
The apparel industry historically has been subject to substantial cyclical
variations. Our business has experienced, and we expect our business to continue
to experience, significant cyclical fluctuations due, in part, to customer
buying patterns, which may result in periods of low sales usually in the first
and fourth quarters of our financial year.
OUR BUSINESS MODEL IS DEPENDENT ON INTEGRATION OF INFORMATION SYSTEMS
ON A GLOBAL BASIS AND, TO THE EXTENT THAT WE FAIL TO MAINTAIN AND SUPPORT OUR
INFORMATION SYSTEMS, IT CAN RESULT IN LOST REVENUES. We must consolidate and
centralize the management of our subsidiaries and significantly expand and
improve our financial and operating controls. Additionally, we must effectively
integrate the information systems of our 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.
25
IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL
NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently,
we do not operate duplicate facilities in different geographic areas. Therefore,
in the event of a regional disruption where we maintain one or more of our
facilities, it is unlikely that we could shift our operations to a different
geographic region and we may have to cease or curtail our operations. This may
cause us to lose sales and customers. The types of disruptions that may occur
include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention; and
o Natural disasters.
INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY
EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our
MANAGED TRIM SOLUTION is an Internet-based business-to-business e-commerce
system. To the extent that we fail to adequately continue to update and maintain
the hardware and software implementing the MANAGED TRIM SOLUTION, our customers
may experience interruptions in service due to defects in our hardware or our
source code. In addition, since our MANAGED TRIM SOLUTION is Internet-based,
interruptions in Internet service generally can negatively impact our customers'
ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects
of their trim needs. Such defects or interruptions could result in lost revenues
and lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors,
including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison
Corporation and Scovill Fasteners, Inc., have greater name recognition, longer
operating histories and, in many cases, substantially greater financial and
other resources than we do.
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.
26
OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS
AND CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES. The following factors
could cause the market price of our common stock to decrease, perhaps
substantially:
o The failure of our quarterly operating results to meet
expectations of investors or securities analysts;
o Adverse developments in the financial markets, the apparel
industry and the worldwide or regional economies;
o Interest rates;
o Changes in accounting principles;
o Sales of common stock by existing shareholders or holders of
options;
o Announcements of key developments by our competitors; and
o The reaction of markets and securities analysts to
announcements and developments involving our company.
IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may
include expansion through internal growth, by acquiring complementary businesses
or by establishing strategic relationships with targeted customers and
suppliers. In order to do so or to fund our other activities, we may issue
additional equity securities that could dilute our stockholders' stock
ownership. We may also assume additional debt and incur impairment losses
related to goodwill and other tangible assets if we acquire another company and
this could negatively impact our results of operations.
WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS.
We may consider strategic acquisitions as opportunities arise, subject to the
obtaining of any necessary financing. Acquisitions involve numerous risks,
including diversion of our management's attention away from our operating
activities. We cannot assure our stockholders that we will not encounter
unanticipated problems or liabilities relating to the integration of an acquired
company's operations, nor can we assure our stockholders that we will realize
the anticipated benefits of any future acquisitions.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue
additional shares of preferred stock and some provisions of our certificate of
incorporation and bylaws and of Delaware law could make it more difficult for a
third party to make an unsolicited takeover attempt of us. These anti-takeover
measures may depress the price of our common stock by making it more difficult
for third parties to acquire us by offering to purchase shares of our stock at a
premium to its market price.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD
LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As
of October 29, 2004, our officers and directors and their affiliates
beneficially owned approximately 15.0% 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 17.8% of the outstanding shares of our common stock at October 29,
2004. Gerard Guez and Todd Kay, significant stockholders of Tarrant Apparel
Group, each own approximately 5.5% of the outstanding shares of our common stock
at October 29, 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.
27
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.
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 September 30, 2004,
we purchased forward exchange contracts for British Pounds to hedge the payments
of product purchases through December 2004. These contracts have an aggregate
notional amount of $814,000. The market value of these contracts approximated
their carrying value at September 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 September 30 2004, we had approximately $7.1 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.
28
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 September 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.
Disclosure controls and procedures, no matter how well designed and
implemented, can provide only reasonable assurance of achieving an entity's
disclosure objectives. The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
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.
29
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
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.
30
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: November 15, 2004 TAG-IT PACIFIC, INC.
/S/ RONDA FERGUSON
---------------------------------------
By: Ronda Ferguson
Its: Chief Financial Officer
31