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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q/A
(AMENDMENT NO. 1)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2005.
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 by check mark whether the registrant is a shell company (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, 18,241,045 shares issued and outstanding as of November
21, 2005.
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EXPLANATORY NOTE
This Report on Form 10-Q/A amends the Quarterly Report on Form 10-Q for Tag-It
Pacific, Inc. and our subsidiaries for the quarterly period ended September 30,
2005 and is being filed in order to restate our previously issued consolidated
financial statements as of and for the three and nine months ended September 30,
2005. The restatement has been made to properly account for revenues in
accordance with generally accepted accounting principles in connection with a
sale and inventory storage agreement effective in the second quarter of 2005.
See Note 2 - Restatement of Financial Statements, to our consolidated financial
statements for additional discussion. Except for Items 1, 2 and 4 in Part I and
Item 6 of Part II, no other information included in the original Form 10-Q is
amended by this Form 10-Q/A.
2
TAG-IT PACIFIC, INC.
INDEX TO FORM 10-Q/A
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)........................4
Consolidated Balance Sheets as of September 30, 2005
and December 31, 2004.................................................4
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 2005 and 2004.........................5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2005 and 2004.........................6
Notes to the Consolidated Financial Statements........................8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................18
Item 4. Controls and Procedures .............................................33
PART II OTHER INFORMATION
Item 6. Exhibits.............................................................35
CAUTIONARY LEGEND REGARDING FORWARD-LOOKING STATEMENTS
Some of the information in this Quarterly Report on Form 10-Q may
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
both as amended. These forward-looking statements are subject to various risks
and uncertainties. The forward-looking statements include, without limitation,
statements regarding our future business plans and strategies and our future
financial position or results of operations, as well as other statements that
are not historical. You can find many of these statements by looking for words
like "will", "may", "believes", "expects", "anticipates", "plans" and
"estimates" and for similar expressions. Because forward-looking statements
involve risks and uncertainties, there are many factors that could cause the
actual results to differ materially from those expressed or implied. These
include, but are not limited to, economic conditions. This Quarterly Report on
Form 10-Q contains important cautionary statements and a discussion of many of
the factors that could materially affect the accuracy of Tag-It Pacific's
forward-looking statements and such statements and discussions are incorporated
herein by reference. Any subsequent written or oral forward-looking statements
made by us or any person acting on our behalf are qualified in their entirety by
the cautionary statements and factors contained or referred to in this section.
We do not intend or undertake any obligation to update any forward-looking
statements to reflect events or circumstances after the date of this document or
the date on which any subsequent forward-looking statement is made or to reflect
the occurrence of unanticipated events.
3
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2005 2004
------------ ------------
(as restated,
see Note 2)
Assets
Current Assets:
Cash and cash equivalents ................... $ 1,892,377 $ 5,460,662
Trade accounts receivable, net .............. 8,204,539 17,890,044
Trade accounts receivable, related party .... 1,400,000 4,500,000
Inventories, net ............................ 9,838,401 9,305,819
Prepaid expenses and other current assets ... 1,312,442 2,326,245
Deferred income taxes ....................... -- 1,000,000
------------ ------------
Total current assets ...................... 22,647,759 40,482,770
Property and equipment, net of accumulated
depreciation and amortization ............... 7,205,136 9,380,026
Fixed assets held for sale ..................... 826,904 --
Tradename ...................................... 4,110,750 4,110,750
Goodwill ....................................... -- 450,000
License rights ................................. 168,000 259,875
Due from related parties ....................... 589,752 556,550
Other assets ................................... 761,583 1,207,885
------------ ------------
Total assets ................................... $ 36,309,884 $ 56,447,856
============ ============
Liabilities and Stockholders' Equity
Current Liabilities:
Line of credit .............................. $ 59,493 $ 614,506
Accounts payable and accrued expenses ....... 13,954,596 7,460,916
Demand notes payable to related parties ..... 664,971 664,971
Current portion of capital lease obligations 711,197 859,799
Current portion of note payable ............. 183,798 174,975
Note payable ................................ -- 1,400,000
------------ ------------
Total current liabilities ................. 15,574,055 11,175,167
Capital lease obligations, less current portion 956,296 1,220,969
Note payable, less current portion ............. 1,307,145 1,447,855
Secured convertible promissory notes ........... 12,432,557 12,408,623
------------ ------------
Total liabilities ......................... 30,270,053 26,252,614
------------ ------------
Guarantees and contingencies (Note 5)
Stockholders' equity:
Preferred stock, Series A $0.001 par value;
250,000 shares authorized, no shares
issued or outstanding ..................... -- --
Common stock, $0.001 par value, 30,000,000
shares authorized; 18,241,045 shares issued
and outstanding at September 30, 2005;
18,171,301 at December 31, 2004 ........... 18,243 18,173
Additional paid-in capital .................. 51,327,873 51,073,402
Accumulated deficit ......................... (45,306,285) (20,896,333)
------------ ------------
Total stockholders' equity ..................... 6,039,831 30,195,242
------------ ------------
Total liabilities and stockholders' equity ..... $ 36,309,884 $ 56,447,856
============ ============
See accompanying notes to consolidated financial statements.
4
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(as restated, (as restated,
see Note 2) see Note 2)
Net sales .............................. $ 9,472,898 $ 17,004,775 $ 38,167,821 $ 42,088,194
Cost of goods sold ..................... 11,567,128 12,658,879 36,254,108 30,857,994
------------ ------------ ------------ ------------
Gross (loss) profit ................. (2,094,230) 4,345,896 1,913,713 11,230,200
Selling expenses ....................... 549,434 646,000 1,940,283 2,120,598
General and administrative expenses .... 4,908,555 3,226,995 19,649,868 8,875,344
Impairment of goodwill ................. 450,000 -- 450,000 --
Restructuring costs .................... 2,278,835 -- 2,278,835 --
------------ ------------ ------------ ------------
Total operating expenses ............ 8,186,824 3,872,995 24,318,986 10,995,942
(Loss) income from operations .......... (10,281,054) 472,901 (22,405,273) 234,258
Interest expense, net .................. 264,551 161,828 802,400 492,902
------------ ------------ ------------ ------------
(Loss) income before income taxes ...... (10,545,605) 311,073 (23,207,673) (258,644)
(Benefit) provision for income taxes ... (260,731) 100,069 1,202,282 (87,938)
------------ ------------ ------------ ------------
Net (loss) income ................... (10,284,874) 211,004 (24,409,955) (170,706)
Less: Preferred stock dividends ....... -- -- -- 30,505
------------ ------------ ------------ ------------
Net (loss) income to common shareholders $(10,284,874) $ 211,004 $(24,409,955) $ (201,211)
============ ============ ============ ============
Basic (loss) earnings per share ........ $ (0.56) $ 0.01 $ (1.34) $ (0.01)
============ ============ ============ ============
Diluted (loss) earnings per share ...... $ (0.56) $ 0.01 $ (1.34) $ (0.01)
============ ============ ============ ============
Weighted average number of common shares
outstanding:
Basic ............................... 18,241,045 18,112,802 18,220,731 17,036,001
============ ============ ============ ============
Diluted ............................. 18,241,045 18,269,005 18,220,731 17,036,001
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
5
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months
Ended September 30,
----------------------------
2005 2004
------------ ------------
(as restated,
see Note 2)
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net loss ........................................... $(24,409,955) $ (170,706)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization ...................... 1,441,090 1,100,886
Increase in allowance for doubtful accounts ........ 6,195,691 421,943
Increase in deferred tax asset valuation allowance . 1,000,000 --
Increase in inventory valuation reserve ............ 3,918,189 --
Asset impairment due to restructuring .............. 2,036,091 --
Impairment of goodwill ............................. 450,000 --
Common stock issued for services ................... -- 74,825
Warrants issued for services ....................... -- 10,906
Changes in operating assets and liabilities:
Receivables, including related party ............... 6,589,814 (9,110,564)
Inventories ........................................ (4,450,771) 613,526
Other assets ....................................... 337,541 (504,946)
Prepaid expenses and other current assets .......... 1,013,803 (1,720,684)
Accounts payable and accrued expenses .............. 6,576,800 377,567
Income taxes payable ............................... (116,319) (413,212)
------------ ------------
Net cash provided by (used in) operating activities .... 581,974 (9,320,459)
------------ ------------
Cash flows from investing activities:
Acquisition of property and equipment .............. (1,634,024) (1,261,795)
------------ ------------
Cash flows from financing activities:
Repayment of bank line of credit, net .............. (555,013) (2,498,034)
Proceeds from exercise of stock options and warrants 254,541 478,814
Repayment of capital leases ........................ (683,876) (325,268)
Proceeds from capital lease ........................ -- 950,000
Repayment of notes payable ......................... (1,531,887) (900,000)
------------ ------------
Net cash used in financing activities .................. (2,516,235) (2,294,488)
------------ ------------
Net decrease in cash ................................... (3,568,285) (12,876,742)
Cash at beginning of period ............................ 5,460,662 14,442,769
------------ ------------
Cash at end of period .................................. $ 1,892,377 $ 1,566,027
============ ============
Supplemental disclosures of cash flow information:
Cash received (paid) during the period for:
Interest paid ...................................... $ (923,839) $ (474,619)
Income taxes paid .................................. (47,720) (340,119)
Income taxes received .............................. 29,734 2,585
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 ........................... 270,597 249,418
Mortgage note payable .............................. -- 765,000
See accompanying notes to consolidated financial statements.
6
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, 2004. The
balance sheet as of December 31, 2004 has been derived from the audited
financial statements as of that date but omits certain information and footnotes
required for complete financial statements.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal
course of business. This assumption is based on the Company being successful in
restructuring its operations in accordance with the restructuring plan adopted
by the Company's board of directors in August 2005. The Company's independent
registered public accounting firm has informed the Company that it may include
in its report on the Company's financial statements for the year ended December
31, 2005 an explanatory paragraph expressing substantial doubt about the
Company's ability to continue as a going concern if the Company fails to
successfully implement its restructuring initiative.
7
2. RESTATEMENT OF FINANCIAL STATEMENTS
During the year-end financial closing and preparation of the Company's
consolidated financial statements for the year ended December 31, 2005,
management determined that the Company had incorrectly recognized revenue on a
sale and inventory storage agreement that was effective at the end of the second
quarter. In accordance with United States generally accepted accounting
principles the revenue from this transaction should not have been recognized at
the time of the agreement, but rather should have been, and will be, recognized
upon delivery of the products to the customer, the customer's designated
manufacturer, or upon notice from the customer to destroy or dispose of the
goods.
Following is a summary of the effects of these changes on the Company's
consolidated balance sheets as of June 30, 2005 and September 30, 2005, as well
as the effects of these changes on the Company's consolidated statements of
operations and cash flows for the quarterly and year to date periods ending June
30, 2005 and September 30, 2005:
AS OF AND FOR THE THREE MONTHS ENDED JUNE 30, 2005
As previously
reported Adjustments As restated
------------ ------------ ------------
CONSOLIDATED BALANCE SHEET
Accounts Receivable .................... $ 13,352,574 $ (2,833,590) $ 10,518,984
Inventories ............................ 11,948,779 1,617,138 13,565,917
Total current assets ................... 33,703,385 (1,216,452) 32,486,933
Total Assets ........................... 50,042,958 (1,216,452) 48,826,506
Accumulated (deficit) earnings ......... (33,804,959) (1,216,452) (35,021,411)
Total Stockholders' Equity ............. 17,541,157 (1,216,452) 16,324,705
Total Liabilities & Stockholders' Equity 50,042,958 (1,216,452) 48,826,506
CONSOLIDATED STATEMENT OF OPERATIONS
Net sales .............................. 18,473,236 (2,833,590) 15,639,646
Cost of goods sold ..................... 16,500,664 (1,617,138) 14,883,526
Gross (loss) profit .................... 1,972,572 (1,216,452) 756,120
(Loss) income from operations .......... (9,691,169) (1,216,452) (10,907,621)
(Loss) income before income taxes ...... (9,959,190) (1,216,452) (11,175,642)
Net (loss) income ...................... (11,260,186) (1,216,452) (12,476,638)
Net (loss) income to common shareholders (11,260,186) (1,216,452) (12,476,638)
8
FOR THE SIX MONTHS ENDED JUNE 30, 2005
As previously
reported Adjustments As restated
------------ ------------ ------------
CONSOLIDATED STATEMENT OF OPERATIONS
Net sales .............................. $ 31,528,513 $ (2,833,590) $ 28,694,923
Cost of goods sold ..................... 26,304,118 (1,617,138) 24,686,980
Gross (loss) profit .................... 5,224,395 (1,216,452) 4,007,943
(Loss) income from operations .......... (10,908,940) (1,216,452) (12,125,392)
(Loss) income before income taxes ...... (11,445,616) (1,216,452) (12,662,068)
Net (loss) income ...................... (12,908,629) (1,216,452) (14,125,081)
Net (loss) income to common shareholders (12,908,629) (1,216,452) (14,125,081)
CONSOLIDATED STATEMENT OF CASH FLOWS
Net loss ............................... (12,908,629) (1,216,452) (14,125,081)
Receivables, including related parties . (458,222) 2,833,590 2,375,368
Inventory .............................. (4,192,959) (1,617,138) (5,810,097)
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005
As previously
reported Adjustments As restated
------------ ------------ ------------
CONSOLIDATED BALANCE SHEET
Accounts Receivable .................... $ 9,470,783 $ (1,266,244) $ 8,204,539
Inventories ............................ 8,615,953 1,222,448 9,838,401
Total current assets ................... 22,691,555 (43,796) 22,647,759
Total Assets ........................... 36,353,680 (43,796) 36,309,884
Accounts payable and accrued expenses .. 12,849,511 1,105,085 13,954,596
Total current liabilities .............. 14,468,970 1,105,085 15,574,055
Total Liabilities ...................... 29,164,968 1,105,085 30,270,053
Accumulated (deficit) earnings ......... (44,157,404) (1,148,881) (45,306,285)
Total Stockholders' Equity ............. 7,188,712 (1,148,881) 6,039,831
Total Liabilities & Stockholders' Equity 36,353,680 (43,796) 36,309,884
9
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005
As previously
reported Adjustments As restated
------------ ------------ ------------
CONSOLIDATED STATEMENT OF OPERATIONS
Net sales .............................. $ 9,039,507 433,391 9,472,898
Cost of goods sold ..................... 11,201,308 365,820 11,567,128
Gross (loss) profit .................... (2,161,801) 67,571 (2,094,230)
(Loss) income from operations .......... (10,348,625) 67,571 (10,281,054)
(Loss) income before income taxes ...... (10,613,176) 67,571 (10,545,605)
Net (loss) income ...................... (10,352,445) 67,571 (10,284,874)
Net (loss) income to common shareholders (10,352,445) 67,571 (10,284,874)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
As previously
reported Adjustments As restated
------------ ------------ ------------
CONSOLIDATED STATEMENT OF OPERATIONS
Net sales .............................. $ 40,568,020 (2,400,199) 38,167,821
Cost of goods sold ..................... 37,505,426 (1,251,318) 36,254,108
Gross (loss) profit .................... 3,062,594 (1,148,881) 1,913,713
(Loss) income from operations .......... (21,256,392) (1,148,881) (22,405,273)
(Loss) income before income taxes ...... (22,058,792) (1,148,881) (23,207,673)
Net (loss) income ...................... (23,261,074) (1,148,881) (24,409,955)
Net (loss) income to common shareholders (23,261,074) (1,148,881) (24,409,955)
CONSOLIDATED STATEMENT OF CASH FLOWS
Net loss ............................... (23,261,074) (1,148,881) (24,409,955)
Receivables, including related parties . 5,323,570 1,266,244 6,589,814
Inventory .............................. (3,228,323) (1,222,448) (4,450,771)
Accounts payable and accrued expenses .. 5,471,715 1,105,085 6,576,800
10
3. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:
THREE MONTHS ENDED SEPTEMBER 30, 2005 (LOSS) INCOME SHARES PER SHARE
- ------------------------------------- ------------ ------------ ------------
(As restated, (As restated,
see Note 2) see Note 2)
Basic loss per share:
Loss available to common stockholders .. $(10,284,874) 18,241,045 $ (0.56)
Effect of Dilutive Securities:
Options ................................ -- -- --
Warrants ............................... -- -- --
------------ ------------ ------------
Loss available to common stockholders .. $(10,284,874) 18,241,045 $ (0.56)
============ ============ ============
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
============ ============ ============
11
LOSS SHARES PER SHARE
NINE MONTHS ENDED SEPTEMBER 30, 2005 (NUMERATOR) (DENOMINATOR) AMOUNT
- ------------------------------------ ------------ ------------ ------------
(As restated (As restated
see Note 2) see Note 2)
Basic loss per share:
Loss available to common stockholders .. $(24,409,955) 18,220,731 $ (1.34)
Effect of Dilutive Securities:
Options ................................ -- -- --
Warrants ............................... -- -- --
------------ ------------ ------------
Loss available to common stockholders .. $(24,409,955) 18,220,731 $ (1.34)
============ ============ ============
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 .. $ (201,211) 17,036,001 $ (0.01)
============ ============ ============
Warrants to purchase 1,510,479 shares of common stock at between $3.50
and $5.06, options to purchase 1,812,000 shares of common stock at between $1.30
and $5.23, convertible debt of $500,000 convertible at $4.50 per share and
convertible debt of $12.5 million convertible at $3.65 per share were
outstanding for the three and nine months ended September 30, 2005, 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 1,270,200 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.
4. 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, 2005 and 2004. If compensation
cost for stock-based compensation had been determined based on the fair value of
the stock options on their dates of grant in accordance with Statement of
Financial Accounting Standards No. 123 the Company's net (loss) income
12
and (loss) earnings per share for the three and nine months ended September 30,
2005 and 2004 would have amounted to the pro forma amounts presented below:
Three Months Nine months
Ended September 30, Ended September 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
(As restated, (As restated,
see Note 2) see Note 2)
Net (loss) income, as reported ................. $(10,284,874) $ 211,004 $(24,409,955) $ (170,706)
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 ................................... (65,332) (5,224) (142,393) (50,004)
------------ ------------ ------------ ------------
Pro forma net (loss) income .................... $(10,350,206) $ 205,780 $(24,552,348) $ (220,710)
============ ============ ============ ============
(Loss) earnings per share:
Basic - as reported ..................... $ (0.56) $ 0.01 $ (1.34) $ (0.01)
Basic - pro forma ....................... $ (0.56) $ 0.01 $ (1.34) $ (0.01)
Diluted - as reported ................... $ (0.56) $ 0.01 $ (1.34) $ (0.01)
Diluted - pro forma ..................... $ (0.56) $ 0.01 $ (1.34) $ (0.01)
5. 2005 RESTRUCTURING PLAN
In an effort to better align the Company's organizational and cost
structures with its future growth opportunities, in August 2005 the Company's
Board of Directors adopted a restructuring plan for the Company that it expects
will be completed by December 2005. The plan includes restructuring the
Company's global operations by eliminating redundancies in its Hong Kong
operation, closing its Mexican facilities, converting its Guatemala facility
from a manufacturing site to a distributor, and closing its North Carolina
manufacturing facility. The Company also intends to focus its sales efforts on
higher margin products, which may result in lower net sales over the next twelve
months. Upon completion of this restructuring, the Company will operate with
fewer employees and reduced associated operating and manufacturing expenses.
The Company has recorded charges in connection with its restructuring
plan in accordance with SFAS No. 146 (As Amended), "Accounting for Costs
Associated with Exit or Disposal Activities." In addition, the Company's
restructuring plan has resulted in the carrying value of certain long-lived
assets, primarily equipment, being impaired. Accordingly, the Company has
recorded a charge to recognize the impairment of these assets in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
It is possible that, upon completion of its restructuring plan by December 2005,
the Company's recorded charges might need to be adjusted to reflect changes in
the disposition of these assets. The Company will continue to monitor its
progress during this restructuring period and adjust its business strategies and
plans to achieve its planned operating efficiencies and costs reductions.
The North Carolina manufacturing facility is a long lived asset that is
classified as "held for sale" because it meets the criteria listed in Paragraph
30 of SFAS 144. Management has the authority and has committed to sell the
asset; the asset is listed for sale with a commercial real estate agent who is
actively
13
marketing the property; the sale of the asset is probable and the sale is
expected to be completed within one year and it is unlikely that this plan will
be changed. The major pieces of equipment used to manufacture zippers are not
classified as held for sale because they do not meet the criteria listed in
Paragraph 30 of SFAS 144 and will therefore be recorded in the balance sheet as
property and equipment.
Total restructuring charges recorded in the third quarter of 2005 were
$6,176,000. The restructuring charges included approximately $3,447,000 of
inventory write-downs, restructuring charges of approximately $2,279,000
consisting of $2,036,000 for the impairment of long-lived assets, primarily
machinery and equipment, $170,000 of one time employee termination benefits and
other costs of $73,000. In addition, an impairment charge to goodwill in the
amount of $450,000 was recorded. This goodwill was associated with an
acquisition made to benefit the Central and South American operations. Since
these operations are being exited, management concluded that this goodwill was
impaired and should be written off. These restructuring charges were recorded on
our Consolidated Statements of Operations for the three month and nine month
periods ended September 30, 2005 in the following line items and amounts:
Cost of goods sold ....................... $3,447,000
Goodwill impairment ...................... 450,000
Restructuring costs ...................... 2,279,000
----------
Total .................................... $6,176,000
==========
6. GUARANTEES AND CONTINGENCIES
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of the Company's
agreements that it has determined are within the scope of FIN 45:
In accordance with the bylaws of the Company, officers and directors
are indemnified for certain events or occurrences arising as a result of the
officer or director's serving in such capacity. The term of the indemnification
period is for the lifetime of the officer or director. The maximum potential
amount of future payments the Company could be required to make under the
indemnification provisions of its bylaws is unlimited. However, the Company has
a director and officer liability insurance policy that reduces its exposure and
enables it to recover a portion of any future amounts paid. As a result of its
insurance policy coverage, the Company believes the estimated fair value of the
indemnification provisions of its bylaws is minimal and therefore, the Company
has not recorded any related liabilities.
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
14
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 has filed suit against Pro-Fit Holdings Limited in the U.S.
District Court for the Central District of California -- TAG-IT PACIFIC, INC. V.
PRO-FIT HOLDINGS LIMITED, CV 04-2694 LGB (RCx) - based on various contractual
and tort claims relating to the Company's exclusive license and intellectual
property agreement, seeking declaratory relief, injunctive relief and damages.
The agreement with Pro-Fit gives the Company exclusive rights in certain
geographic areas to Pro-Fit's stretch and rigid waistband technology. 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. The Company filed a reply denying the material allegations
of Pro-Fit's pleading. Pro-Fit has since purported to terminate the exclusive
license and intellectual property agreement based on the same alleged breaches
of the agreement that are the subject of the parties' existing litigation, as
well as on an additional basis unsupported by fact. In February 2005, the
Company amended its pleadings in the litigation to assert additional breaches by
Pro-Fit of its obligations to the Company under the agreement and under certain
additional letter agreements, and for a declaratory judgment that Pro-Fit's
patent No. 5,987,721 is invalid and not infringed by the Company. Thereafter,
Pro-Fit filed an amended answer and counterclaim denying the material
allegations of the amended complaint and alleging various contractual and tort
claims seeking injunctive relief and damages. Pro-Fit further asserted that the
Company infringed its United States Patent Nos. 5,987,721 and 6,566,285. The
Company filed a reply denying the substantive allegations of the reply. At the
Company's request, the Court bifurcated the contract issues for trial to
commence on January 10, 2006. The parties have filed summary judgment motions
which may dispose of some of the issues in this case prior to trial. The
remaining issues will be tried at a later date. As the Company derives a
significant amount of revenue from the sale of products incorporating the
stretch waistband technology, its business, results of operations and financial
condition could be materially adversely affected if the dispute with Pro-Fit is
not resolved in a manner favorable to the Company. Additionally, the Company has
incurred significant legal fees in this litigation, and unless the case is
settled, the Company will continue to incur additional legal fees in increasing
amounts as the case accelerates to trial.
The Company is subject to certain other legal proceedings and claims
arising in connection with its business. In the opinion of management, there are
currently no claims that will have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
7. NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment." This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123R addresses all forms of share
based payment ("SBP") awards including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
Under SFAS 123R, SBP awards result in a cost that will be measured at fair value
on the awards' grant date, based on the estimated number of awards that are
expected to vest. This statement is effective as of the beginning of the first
annual reporting period that begins after June 15, 2005. The Company has
evaluated the effects of the adoption of this pronouncement and has determined
it will not have a material impact on the Company's financial statements.
15
In December 2004, the FASB issued Statement Accounting Standard
("SFAS") No. 153 "Exchanges of Nonmonetary Assets". This Statement amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods beginning after December
16, 2004. The provisions of this Statement should be applied prospectively. The
adoption of this pronouncement did not have material effect on the Company's
financial statements.
In March, 2005, the Securities and Exchange Commission's ("SEC") Office
of the Chief Accountant and its Division of Corporation Finance released
Financial Accounting Bulletin No. 107, "Share-Based Payment" (SAB 107). SAB 107
provides interpretive guidance related to the interaction between Statement of
Financial Accounting Standard No. 123R "Shared Based Payment" (SFAS 123R) and
certain SEC rules and regulations. SAB 107 provides the staff's views regarding
the valuation of shared-based payment arrangements for public companies and
stresses the importance of including appropriate disclosures within SEC filings,
particularly during the transition to SFAS 123R.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No.
3" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20, "Accounting Changes"
("APB 20") and FASB Statement No. 3, "Reporting Accounting Changes in Interim
Financial Statements," and changes the requirements for the accounting for and
reporting of a change in accounting principle. APB 20 previously required that
most voluntary changes in accounting principle be recognized by including in net
income of the period of the change the cumulative effect of changing to the new
accounting principle. SFAS 154 requires retrospective application to prior
periods' financial statements for voluntary changes in accounting principle.
SFAS 154 is effective for accounting changes and corrections of errors made in
fiscal years beginning after December 15, 2005. The impact of SFAS 154 will
depend on the accounting change, if any, in a future period.
8. SIGNIFICANT ADJUSTMENTS
The Company evaluated its accounts receivable, inventory, accounts
payable, certain other assets and its net deferred tax asset and recorded the
following significant adjustments during the three months ended June 30, 2005:
o Increased allowance for doubtful accounts by $6,381,000 based
upon management's estimate of the collectibility of accounts
receivable related to two customers;
o Increased inventory obsolescence reserve by $1,550,000 based
upon management's estimate of the net realizable value of
certain inventories;
o Recorded additional reserves of $1,523,000 to primarily
reflect an increase in legal accruals, charges related to the
Company's Pro-Fit litigation and a reduction in certain
assets; and
o Reduced the carrying value of the Company's net deferred tax
asset to zero from $1,000,000 at December 31, 2004.
16
9. ACCOUNTS RECEIVABLE
As of September 30, 2005, the Company had accounts receivable from
Azteca Productions International of approximately $10,654,000 less a reserve of
$7,007,000, for a net balance of $3,647,000 recorded on the Company's balance
sheet. The Company is pursuing several payment alternatives with Azteca, one of
which would involve the Company granting to Azteca warrants to purchase shares
of its common stock at a significant premium to market to induce Azteca to
borrow funds, the proceeds of which would be paid to the Company in full
settlement of the outstanding accounts receivable due from Azteca within the
next 60 days. The Company anticipates that the value of the warrants, using the
Black-Scholes valuation method, would be approximately $100,000, and that the
amount paid to the Company, less the cost of the warrants, would be at least
equal to the net amount the Company has recorded in accounts receivable as of
September 30, 2005. If the Company is unable to reach a settlement with Azteca,
it will consider all available alternatives, including bringing suit to collect
the amounts due the Company.
10. SUBSEQUENT EVENT
On October 12, 2005, a purported shareholder class action lawsuit was
filed against the Company and certain officers and directors of the Company in
the United States District Court for the Central District of California alleging
claims under Section 10(b) and Section 20 of the Securities Exchange Act of
1934, as amended, and Rule 10b-5 promulgated thereunder. The case is entitled
HUBERMAN V. TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex). The action
is purportedly brought on behalf of all purchasers of the Company's
publicly-traded securities during the period from November 14, 2003 to August
12, 2005. The Company has accepted service of the complaint and has entered into
a stipulation with plaintiff's counsel to formally respond following the
appointment of lead plaintiff and lead counsel and the anticipated filing of the
consolidated amended complaint. The Company believes the lawsuit to be without
merit and intends to vigorously defend against the lawsuit. At this stage of the
litigation, the Company is not able to reasonably estimate potential losses, if
any, related to the lawsuit.
17
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/A.
This discussion summarizes the significant factors affecting the
consolidated operating results, financial condition and liquidity and cash flows
of Tag-It Pacific, Inc. for the three months and nine months ended September 30,
2005 and 2004. 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.
As part of our restructuring plan which was approved by our Board of
Directors in August 2005, we have developed a new strategic direction for our
trim division and Talon zipper division.
TRIM DIVISION.
We have restructured our trim business to become an outsourced
product development, sourcing and sampling department for the most demanding
brands and retailers. We believe that trim design differentiation among brands
and retailers has become a critical marketing tool for our customers. By
assisting our customers in the development, design and sourcing of trim, we
expect to achieve higher margins for our trim products, create long-term
relationships with our customers, grow our sales to a particular a customer by
supplying trim for a larger proportion of their brands, and better differentiate
our trim sales and services from those of our competitors. We expect our trim
kits to have less of a material contribution to our trim business. We will
continue to supply trim to customers who do not engage us to serve as an
outsourced development, sourcing and sampling department; however, we will not
provide this trim in a preassembled "trim kit."
TALON ZIPPER DIVISION.
We intend to continue to focus on the global expansion of our
Talon zipper division by developing a network of distribution relationships
worldwide. Several of our distribution partners have experienced delays in their
acquisition of necessary zipper equipment, which has delayed the distribution of
Talon zippers in their respective territories. These delays, coupled with other
performance deficiencies, have caused us to terminate several distribution
partners and modify our global expansion plans. We are significantly
streamlining our distribution process, and adopting more flexible procedures for
certifying our distributor's existing equipment to meet our high manufacturing
standards, supplementing this existing equipment only where necessary. In
addition, we are approaching more existing zipper factories to serve as our
distributors in order to reduce the time to market by eliminating the setup and
build-out phase of new factory development.
2005 RESTRUCTURING PLAN
In an effort to better align the Company's organizational and cost
structures with its future growth opportunities, in August 2005 the Company's
Board of Directors adopted a restructuring plan for the
18
Company that it expects will be completed by December 2005. The plan includes
restructuring the Company's global operations by eliminating redundancies in its
Hong Kong operation, closing its Mexican facilities, converting its Guatemala
facility from a manufacturing site to a distributor, and closing its North
Carolina manufacturing facility. The Company also intends to focus its sales
efforts on higher margin products, which may result in lower net sales over the
next twelve months. Upon completion of this restructuring, the Company will
operate with fewer employees and reduced associated operating and manufacturing
expenses.
The Company has recorded charges in connection with its restructuring
plan in accordance with SFAS No. 146 (As Amended), "Accounting for Costs
Associated with Exit or Disposal Activities." In addition, the Company's
restructuring plan has resulted in the carrying value of certain long-lived
assets, primarily equipment, being impaired. Accordingly, the Company has
recorded a charge to recognize the impairment of these assets in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
It is possible that, upon completion of its restructuring plan by December 2005,
the Company's recorded charges might need to be adjusted to reflect changes in
the disposition of these assets. The Company will continue to monitor its
progress during this restructuring period and adjust its business strategies and
plans to achieve its planned operating efficiencies and costs reductions.
The North Carolina manufacturing facility is a long lived asset that is
classified as "held for sale" because it meets the criteria listed in Paragraph
30 of SFAS 144. Management has the authority and has committed to sell the
asset; the asset is listed for sale with a commercial real estate agent who is
actively marketing the property; the sale of the asset is probable and the sale
is expected to be completed within one year and it is unlikely that this plan
will be changed. The major pieces of equipment used to manufacture zippers are
not classified as held for sale because they do not meet the criteria listed in
Paragraph 30 of SFAS 144 and will therefore be recorded in the balance sheet as
property and equipment.
Total restructuring charges recorded in the third quarter of 2005 were
$6,176,000. The restructuring charges included approximately $3,447,000 of
inventory write-downs, restructuring charges of approximately $2,279,000
consisting of $2,036,000 for the impairment of long-lived assets, primarily
machinery and equipment, $170,000 of one time employee termination benefits and
other costs of $73,000. In addition, an impairment charge to goodwill in the
amount of $450,000 was recorded. This goodwill was associated with an
acquisition made to benefit the Central and South American operations. Since
these operations are being exited, management concluded that this goodwill was
impaired and should be written off. These restructuring charges were recorded on
our Consolidated Statements of Operations for the three month and nine month
periods ended September 30, 2005 in the following line items and amounts:
Cost of goods sold ....................... $3,447,000
Goodwill ................................. 450,000
Restructuring costs ...................... 2,279,000
----------
Total .................................... $6,176,000
==========
SHAREHOLDER LAWSUIT
On October 12, 2005, a purported shareholder class action lawsuit was
filed against us and certain of our officers and directors in the United States
District Court for the Central District of California alleging claims under
Section 10(b) and Section 20 of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5 promulgated thereunder. The case is entitled HUBERMAN V. TAG-IT
PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex). The action is purportedly
brought on behalf of all purchasers of our publicly-traded securities during the
period from November 14, 2003 to August 12, 2005. We have accepted service of
the complaint and have entered into a stipulation with plaintiff's counsel to
formally respond following the
19
appointment of lead plaintiff and lead counsel and the anticipated filing of the
consolidated amended complaint. Although we believe that we and the other
defendants have meritorious defenses to the class action complaint and intend to
contest the lawsuit vigorously, an adverse resolution of any of the lawsuit
could have a material adverse effect on our financial position and results of
operations. At this stage of the litigation, we are not able to reasonably
estimate potential losses, if any, related to the lawsuit.
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 uncollectible
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 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, and require that these customers purchase the
inventories from us in accordance with the applicable buyback
arrangements. 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.
See further discussion below of reserve for inventory
obsolescence recorded in the third quarter of 2005.
o Accounts receivable balances are evaluated on a continual
basis and allowances are provided for potentially
uncollectible 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 may not realize all or part of our deferred tax assets
in the future, we will make an adjustment to the carrying
value of the deferred tax asset, which would be reflected as
an
20
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.
At September 30, 2005, the carrying value of our net deferred
tax asset was zero because we could not determine that it was
more likely than not that the deferred tax asset would be
realized.
o Intangible assets are evaluated on a continual basis and
impairment adjustments are made based on management's
valuation of identified reporting units related to goodwill,
the valuation of intangible assets with indefinite lives and
the reassessment of the useful lives related to other
intangible assets with definite useful lives. Impairment
adjustments are made for the difference between the carrying
value of the intangible asset and the estimated valuation and
charged to operations in the period in which the facts that
give rise to the adjustments become known.
o Long-lived assets are evaluated on a continual basis and
impairment adjustments are made based upon management's
valuations. As part of the 2005 Restructuring Plan, certain
long-lived assets, primarily machinery and equipment, were
impaired and their values adjusted accordingly.
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,
--------------------- ---------------------
2005 2004 2005 2004
-------- -------- -------- --------
(as restated, (as restated,
see Note 2) see Note 2)
Net sales ......................... 100.0 % 100.0 % 100.0 % 100.0%
Cost of goods sold ................ 122.1 74.4 95.0 73.3
-------- -------- -------- --------
Gross (loss) profit ............... (22.1) 25.6 5.0 26.7
Selling expenses .................. 5.8 3.8 5.1 5.0
General and administrative expenses 51.8 19.0 51.5 21.1
Impairment of goodwill ............ 4.7 0.0 1.2 0.0
Restructuring costs ............... 24.1 0.0 6.0 0.0
-------- -------- -------- --------
Operating (loss) income ........... (108.5)% 2.8 % (58.8)% 0.6 %
======== ======== ======== ========
21
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,
-------------------- --------------------
2005 2004 2005 2004
-------- -------- -------- --------
(as restated, (as restated,
see Note 2) see Note 2)
United States ............... 17.7% 9.7% 12.5% 8.7%
Asia ........................ 43.2 19.3 37.8 22.2
Mexico ...................... 8.7 44.9 25.8 40.2
Dominican Republic .......... 15.7 15.8 14.1 18.2
Central and South America ... 9.4 7.4 7.4 9.3
Other ....................... 5.3 2.9 2.4 1.4
-------- -------- -------- --------
100.0% 100.0% 100.0% 100.0%
======== ======== ======== ========
Net sales for the three months ended September 30, 2005 were
$9,473,000, a decrease of $7,532,000 or 44.3% compared to the net sales of
$17,005,000 for the three months ended September 30, 2004. This decrease was
primarily due to a decrease in sales to our Mexican customers of trim and, to a
lesser extent, Talon zippers due to an industry shift of apparel production from
Latin America to Asia. As reported elsewhere, we are responding to these market
changes by reducing our Mexican operation and focusing our efforts on the Asian
market. Asian sales of our Talon zippers and trim products increased 23%. Sales
of our Tekfit waistband decreased because of lower demand from the single
customer for this product.
Net sales for the nine months ended September 30, 2005 were
$38,168,000, a decrease of $3,920,000 or 9.3% compared to net sales of
$42,088,000 for the nine months ended September 30, 2004. This decrease in net
sales occurred in our Mexican operation in the third quarter as the market for
trim and zipper products moved from Latin America to Asia. For the period, sales
of Talon zippers and trim products by our Asian operation increased
approximately 38% over the same period in the prior year. During this period
sales of our Tekfit waistband decreased because of lower demand from the single
customer for this product.
Gross loss was $2,094,000 for the three months ended September 30, 2005
compared to a gross profit of $4,346,000, or 25.6% of sales, for the three
months ended September 30, 2004. The gross loss included an inventory write down
associated with the restructuring plan of $3,447,000. Excluding the inventory
restructuring write down, gross profit would have been $1,353,000, or 14.3% of
net sales. This amount was adversely affected by the low sales volume resulting
in certain fixed costs being absorbed by lower sales and inventory adjustments
unrelated to the restructuring plan.
Gross profit decreased approximately $9,316,000, or 83.0% to $1,914,000
for the nine months ended September 30, 2005 from $11,230,000 for the nine
months ended September 30, 2004. Gross profit as a percentage of net sales
decreased to approximately 5.0% for the nine months ended September 30, 2005 as
compared to 26.7% for the nine months ended September 30, 2004. The decrease in
gross profit was due to the inventory write down of $3,447,000 associated with
the restructuring plan, an increase in our inventory obsolescence reserve of
$1,550,000 recorded in the second quarter of 2005, unabsorbed overhead costs
incurred in our North Carolina manufacturing facility, additional charges
associated with unrealized charge backs to vendors and customers recorded in the
second quarter and credits issued to a customer during the first quarter for
defective products received from Pro-Fit Holdings.
Selling expenses decreased approximately $97,000 or 15.0% to $549,000
for the three months ended September 30, 2005 compared to $646,000 for the prior
year period. A portion of this decrease
22
resulted from the restructuring plan implemented during the third quarter. As a
percentage of sales, selling expenses were 5.7% of sales compared to 3.8% of
sales because we were unable to reduce expenses in direct proportion to the
sales decrease.
Selling expenses for the nine month period ended September 30, 2005
were $1,940,000 or 5.1% of sales compared to $2,121,000 or 5.0% of sales for the
nine month period ended September 30, 2004. Selling expenses decreased
approximately $181,000 because of cost containment efforts.
General and administrative expenses increased $1,682,000 or 52.1% to
$4,909,000 for the three months ended September 30, 2005 compared to $3,227,000
for the three months ended September 30, 2004. This increase in general and
administrative expense is primarily due to higher legal expenses associated with
our litigation with Pro-Fit Holdings Limited. Unless this case is settled, we
will continue to incur additional legal fees in increasing amounts as the case
accelerates to trial. This increase in general and administrative expenses was
partially offset by a reduction in employee costs in September as a result of
the implementation of our restructuring plan.
General and administrative expenses increased approximately $10,775,000
to $19,650,000 for the nine months ended September 30, 2005 from $8,875,000 for
the nine months ended September 30, 2004. This increase in general and
administrative expenses was due primarily to an increase of $6,381,000 in the
reserve for doubtful accounts recorded in the second quarter of 2005, higher
legal expenses of approximately $2,351,000 related primarily to the Pro-Fit
litigation, and generally higher employment levels through the first eight
months of the period.
During the third quarter of 2005 we recorded a restructuring charge of
$6,176,000. These restructuring charges were recorded on our Consolidated
Statements of Operations for the three month and nine month periods ended
September 30, 2005 in the following line items and amounts:
Cost of goods sold ..................... $3,447,000
Goodwill impairment .................... 450,000
Restructuring costs .................... 2,279,000
----------
Total .................................. $6,176,000
==========
Net interest expense increased approximately $103,000, or 63.6%, to
$265,000 for the three months ended September 30, 2005 from $162,000 for the
three months ended September 30, 2004. Net interest expense increased
approximately $309,000, or 62.7%, to $802,000 for the nine months ended
September 30, 2005 from $493,000 for the nine months ended September 30, 2004.
The interest expense increases for both the three month and nine month periods
were primarily due to higher debt levels associated with the $12.5 million
secured convertible notes partially offset by a reduction in other indebtedness.
The benefit for income taxes for the three months ended September 30,
2005 resulted from adjustments between our US and Hong Kong operations to better
align expenses with revenues. These adjustments resulted in a tax benefit of
$261,000. For the three months ended September 30, 2004 we recorded a tax
provision of $100,000.
The provision for income taxes for the nine months ended September 30,
2005 amounted to approximately $1,202,000 compared to an income tax benefit of
$88,000 for the nine months ended September 30, 2004. The provision for income
taxes increased due to an increase in our deferred tax asset valuation
allowance. Based on our net operating losses, there is not sufficient evidence
to determine that it
23
is more likely than not that we will be able to utilize our net operating loss
carry forwards to offset future taxable income.
Net loss was approximately $10,285,000 for the three months ended
September 30, 2005 as compared to net income of $211,000 for the three months
ended September 30, 2004. Net loss was approximately $24,410,000 for the nine
months ended September 30, 2005 as compared to a net loss of $201,000 for the
nine months ended September 30, 2004.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased to $1,892,000 at September 30, 2005
from $5,460,000 at December 31, 2004. The decrease resulted from approximately
$582,000 of cash provided by operating activities, $1,634,000 of cash used in
investing activities and $2,516,000 of cash used in financing activities.
Net cash provided by operating activities was approximately $582,000
for the nine months ended September 30, 2005 and cash used by operations was
approximately $9,320,000 for the nine months ended September 30, 2004. Cash
provided by operating activities for the nine months ended September resulted
primarily from a decrease in accounts receivables because of lower sales during
the third quarter of 2005, a decrease in related party accounts receivables, an
increase in accounts payable and accrued expenses which were partially offset by
an increase in inventories.
Net cash used in operating activities was approximately $9,320,000 for
the nine months ended September 30, 2004. 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.
Net cash used in investing activities was approximately $1,634,000 and
$1,262,000 for the nine months ended September 30, 2005 and 2004, respectively.
Net cash used in investing activities for the nine months ended September 30,
2005 consisted primarily of capital expenditures for purchases of equipment. Net
cash used in investing activities for the nine months ended September 30, 2004
consisted primarily of capital equipment related to the exclusive supply
agreement we entered into with Levi Strauss & Co. and the purchase of additional
TALON zipper equipment.
Net cash used in financing activities was approximately $2,516,000 and
$2,294,000 for the nine months ended September 30, 2005 and 2004, respectively.
Net cash used in financing activities for the nine months ended September 30,
2005 primarily reflects the repayment of borrowings under our bank line of
credit facility, repayment of notes payable and capital leases, partially offset
by funds raised from the exercise of stock options and warrants. 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 notes
payable, offset by funds raised from the exercise of stock options and warrants
and the proceeds from a capital lease obligation.
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
24
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 cash or require conversion if certain conditions are met. In connection with
the issuance of the Notes, we issued to the Note holders warrants to purchase up
to 171,235 shares of common stock. The warrants have a term of five years, an
exercise price of $3.65 per share and vested 30 days after closing. We have
registered with the SEC, the resale by the holders of the shares issuable upon
conversion of the Notes and exercise of the warrants.
Amounts borrowed under our foreign factoring agreement as of September
30, 2005 amounted to approximately $59,000. At September 30, 2004, outstanding
borrowings under our UPS Capital credit facility, including amounts borrowed
under our foreign factoring agreement, amounted to approximately $4,597,000.
In 2005, we entered into a letter of credit facility with Wells Fargo
Bank. This facility provides for letters of credit up to a maximum of $1.5
million, expires in November 2005 and is secured by cash on hand managed by
Wells Fargo Bank. At September 30, 2005, outstanding letters of credit under the
Wells Fargo facility amounted to $50,000.
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, 2005 and 2004, the amount factored with
recourse and included in trade accounts receivable was approximately $1,401,000
and $872,000. Outstanding advances as of September 30, 2005 and 2004 amounted to
approximately $59,000 and $512,000 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.
We have incurred significant legal fees in our litigation with Pro-Fit
Holdings Limited. Unless the case is settled, we will continue to incur
additional legal fees in increasing amounts as the case accelerates to trial.
As of September 30, 2005, we had accounts receivable from Azteca
Productions International of approximately $10,654,000 less a reserve of
$7,007,000, for a net balance of $3,647,000 recorded on our balance sheet. We
are pursuing several payment alternatives with Azteca, one of which would
involve us granting to Azteca warrants to purchase shares of our common stock at
a significant premium to market to induce Azteca to borrow funds, the proceeds
of which would be paid to us in full settlement of the outstanding accounts
receivable due from Azteca within the next 60 days. We anticipate that the value
of the warrants, using the Black-Scholes valuation method, would be
approximately $100,000, and that the amount paid to us, less the cost of the
warrants, would be at least equal to the net amount we have recorded in accounts
receivable as of September 30, 2005. If we are unable to reach a settlement with
Azteca, we will consider all available alternatives, including bringing suit to
collect the amounts due us.
25
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. This conclusion is based on the assumption that
we will be successful in restructuring our operations in accordance with the
restructuring plan adopted by our board of directors in August 2005, and that we
will collect at least $4 million in cash from Azteca Productions International
in payment of outstanding accounts receivable within the next 60 days. If we are
unable to successfully fully implement our restructuring initiative or collect
the receivable, or experience greater than anticipated reductions in sales, we
may need to raise additional capital or further reduce the scope of our business
in order to fully satisfy our future short-term liquidity requirements. If we
cannot raise additional capital or reduce the scope of our business in response
to our failure to implement our restructuring initiative in accordance with our
plan, there may be substantial doubt about our ability to continue as a going
concern. Our auditors have informed us that they may include in their report on
our financial statements for the year ended December 31, 2005 an explanatory
paragraph expressing substantial doubt about our ability to continue as a going
concern if we fail to successfully implement our restructuring initiative.
The extent of our future long-term 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 and South American 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.
RELATED PARTY TRANSACTIONS
Gerard Guez and Todd Kay, executive officers and significant
shareholders of Tarrant Apparel Group, are significant stockholders of ours.
Total sales to Tarrant Apparel Group and its affiliate, United Apparel Ventures,
amounted to approximately $165,000 and $698,000 for the nine months ended
September 30, 2005 and 2004, respectively. As of September 30, 2005, accounts
receivable, related party included $1,400,000 due from Tarrant's affiliate,
United Apparel Ventures. United Apparel Ventures agreed to pay its remaining
balance over an eight-month period beginning May 2005.
As of September 30, 2005 and 2004, we had outstanding related-party
debt of approximately $665,000 and $850,000, at interest rates ranging from 7%
to 11%, and additional non-related-party debt of $25,200 at an interest rate of
10%. The majority of related-party debt is due on demand, with the remainder due
and payable on the fifteenth day following the date of delivery of written
demand for payment.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment." This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123R addresses all forms of share
based
26
payment ("SBP") awards including shares issued under employee stock purchase
plans, stock options, restricted stock and stock appreciation rights. Under SFAS
123R, SBP awards result in a cost that will be measured at fair value on the
awards' grant date, based on the estimated number of awards that are expected to
vest. This statement is effective as of the beginning of the first annual
reporting period that begins after June 15, 2005. The Company has evaluated the
effects of the adoption of this pronouncement and has determined it will not
have a material impact on the Company's financial statements.
In December 2004, the FASB issued Statement Accounting Standard
("SFAS") No. 153 "Exchanges of Nonmonetary Assets". This Statement amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods beginning after December
16, 2004. The provisions of this Statement should be applied prospectively. The
adoption of this pronouncement did not have material effect on our financial
statements.
In March, 2005, the Securities and Exchange Commission's ("SEC") Office
of the Chief Accountant and its Division of Corporation Finance released
Financial Accounting Bulletin No. 107, "Share-Based Payment" (SAB 107). SAB 107
provides interpretive guidance related to the interaction between Statement of
Financial Accounting Standard No. 123R "Shared Based Payment" (SFAS 123R) and
certain SEC rules and regulations. SAB 107 provides the staff's views regarding
the valuation of shared-based payment arrangements for public companies and
stresses the importance of including appropriate disclosures within SEC filings,
particularly during the transition to SFAS 123R.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No.
3" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20, "Accounting Changes"
("APB 20") and FASB Statement No. 3, "Reporting Accounting Changes in Interim
Financial Statements," and changes the requirements for the accounting for and
reporting of a change in accounting principle. APB 20 previously required that
most voluntary changes in accounting principle be recognized by including in net
income of the period of the change the cumulative effect of changing to the new
accounting principle. SFAS 154 requires retrospective application to prior
periods' financial statements for voluntary changes in accounting principle.
SFAS 154 is effective for accounting changes and corrections of errors made in
fiscal years beginning after December 15, 2005. The impact of SFAS 154 will
depend on the accounting change, if any, in a future period.
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.
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
27
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. Pro-Fit has since purported to
terminate our exclusive license and intellectual property agreement based on the
same alleged breaches of the agreement that are the subject of our existing
litigation, as well as on an additional basis unsupported by fact. In February
2005, we amended our pleadings in the litigation to assert additional breaches
by Pro-Fit of its obligations to us under our agreement and under certain
additional letter agreements, and for a declaratory judgment that Pro-Fit's
patent No. 5,987,721 is invalid and not infringed by us. Thereafter, Pro-Fit
filed an amended answer and counterclaim denying the material allegations of the
amended complaint and alleging various contractual and tort claims seeking
injunctive relief and damages. Pro-Fit further asserted that we infringed its
United States Patent Nos. 5,987,721 and 6,566,285. We filed a reply denying the
substantive allegations of the reply. At our request, the Court bifurcated the
contract issues for trial to commence on January 10, 2006. The parties have
filed summary judgment motions which may dispose of some of the issues in this
case prior to trial. The remaining issues will be tried at a later date.
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. Additionally, we
have incurred significant legal fees in this litigation, and unless the case is
settled, we will continue to incur additional legal fees in increasing amounts
as the case accelerates to trial.
FAILURE TO MANAGE OUR CORPORATE RESTRUCTURING COULD IMPAIR OUR
BUSINESS. In an effort to better align our organizational and cost structures
with our future growth opportunities, in August 2005 our Board of Directors
adopted a restructuring plan for our company that we expect will be completed in
December 2005. The plan includes reorganizing our global operations by
eliminating redundancies in our Hong Kong operation, reducing the functions
performed at our Mexico facilities, converting our Guatemala facility from a
manufacturing site to a distributor, and closing our North Carolina
manufacturing facility. While we expect that the restructuring will result in
reduced operating costs and improved operating results and cash flows, there can
be no assurance that these results will be achieved. We recorded a restructuring
charge during the third quarter of 2005 of approximately $6.2 million. We face
many challenges related to our decision implement this restructuring plan,
including that we may not execute the restructuring effectively, and our
expectation that we will benefit from greater efficiencies may not be realized.
Any failure on our part to successfully manage these challenges or other
unanticipated consequences may result in loss of customers and sales, which
could cause our results to differ materially from management's current
expectations. The challenges we face include:
o Our ability to execute successfully through business cycles
while we continue to implement the restructuring plan and cost
reductions;
o Our ability to meet and achieve the benefits of our
cost-reduction goals and otherwise successfully adapt our cost
structures to continuing changes in business conditions;
o The risk that our cost-cutting initiatives will impair our
ability to develop products and remain competitive and to
operate effectively;
o We may experience delays in implementing our restructuring
plan and incur additional costs;
28
o We may experience decreases in employee morale; and
o We may experience unanticipated expenses in winding down
manufacturing operations, including labor costs, which may
adversely affect our results of operations in the short term.
If we are unable to successfully fully implement our restructuring
initiative, or experience greater than anticipated reductions in sales, we may
need to raise additional capital or further reduce the scope of our business in
order to fully satisfy our future short-term liquidity requirements. If we
cannot raise additional capital or reduce the scope of our business in response
to our failure to implement our restructuring initiative in accordance with our
plan, there may be substantial doubt about our ability to continue as a going
concern. Our auditors have informed us that they may include in their audit
report on our financial statements for the year ending December 31, 2005 an
explanatory paragraph expressing substantial doubt about our ability to continue
as a going concern if we fail to successfully implement our restructuring
initiative.
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 a borrowing base credit agreement, 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, the lender 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.
IF CUSTOMERS DEFAULT ON BUYBACK AGREEMENTS WITH US, WE WILL BE LEFT
HOLDING NON-SALABLE INVENTORY. Inventories include goods that are subject to
buyback agreements with our customers. Under these buyback agreements, some of
our customers are required to purchase 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 non-salable inventory and this would have a negative
impact on our income.
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
29
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.
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. In the past, following periods of volatility in
the market price of a company's securities, securities class action litigation
has often been instituted against such a company. For instance, in October 2005,
a purported securities class action lawsuit was filed against us.
THE OUTCOME OF LITIGATION IN WHICH WE HAVE BEEN NAMED AS A DEFENDANT IS
UNPREDICTABLE AND AN ADVERSE DECISION IN ANY SUCH MATTER COULD HAVE A MATERIAL
ADVERSE AFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS. We are
defendants in a number of litigation matters. These claims may divert financial
and management resources that would otherwise be used to benefit our operations.
Although we believe that we have meritorious defenses to the claims made in each
and all of the litigation matters to which we have been named a party, and
intend to contest each lawsuit vigorously, no assurances can be given that the
results of these matters will be favorable to us. An adverse resolution of any
of these lawsuits could have a material adverse affect on our financial position
and results of operations.
We maintain product liability and director and officer insurance that
we regard as reasonably adequate to protect us from potential claims, however we
cannot assure you that it will. Further, the costs of insurance have increased
dramatically in recent years, and the availability of coverage has decreased. As
a
30
result, we cannot assure you that we will be able to maintain our current
product liability insurance at a reasonable cost, or at all.
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 facility 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.
In connection with our restructuring, we significantly reduced the number of
employees within our company, which has increased our reliance on those
employees that have remained with the company. The loss of the services of key
employees could have a material adverse effect on our business, including our
ability to establish and maintain client relationships. Our future success will
depend in large part upon our ability to attract and retain personnel with a
variety of sales, operating and managerial skills.
IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL
NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently,
we do not operate duplicate facilities in different geographic areas. Therefore,
in the event of a regional disruption where we maintain one or more of our
facilities, it is unlikely that we could shift our operations to a different
geographic region and we may have to cease or curtail our operations. This may
cause us to lose sales and customers. The types of disruptions that may occur
include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention; and
o Natural disasters.
INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY
EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our
MANAGED TRIM SOLUTION is an Internet-based business-to-business e-commerce
system. To the extent that we fail to adequately continue to update and maintain
the hardware and software implementing the MANAGED TRIM SOLUTION, our customers
may experience interruptions in service due to defects in our hardware or our
source code. In addition, since our MANAGED TRIM SOLUTION is Internet-based,
interruptions in Internet service generally can negatively impact our customers'
ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects
of their trim needs. Such defects or interruptions could result in lost revenues
and lost customers.
31
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors,
including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison
Corporation and Scovill Fasteners, Inc., have greater name recognition, longer
operating histories and, in many cases, substantially greater financial and
other resources than we do.
UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR
LITIGATION COSTS AND ADVERSELY AFFECT OUR SALES. We rely on trademark, trade
secret and copyright laws to protect our designs and other proprietary property
worldwide. We cannot be certain that these laws will be sufficient to protect
our property. In particular, the laws of some countries in which our products
are distributed or may be distributed in the future may not protect our products
and intellectual rights to the same extent as the laws of the United States. If
litigation is necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others, such litigation could result in substantial
costs and diversion of resources. This could have a material adverse effect on
our operating results and financial condition. Ultimately, we may be unable, for
financial or other reasons, to enforce our rights under intellectual property
laws, which could result in lost sales.
IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY
BE SUED AND HAVE TO PAY LARGE LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR
DISCONTINUE SELLING OUR PRODUCTS. From time to time in our industry, third
parties allege infringement of their proprietary rights. Any infringement
claims, whether or not meritorious, could result in costly litigation or require
us to enter into royalty or licensing agreements as a means of settlement. If we
are found to have infringed the proprietary rights of others, we could be
required to pay damages, cease sales of the infringing products and redesign the
products or discontinue their sale. Any of these outcomes, individually or
collectively, could have a material adverse effect on our operating results and
financial condition.
OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS
AND CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES. The following factors
could cause the market price of our common stock to decrease, perhaps
substantially:
o The failure of our quarterly operating results to meet
expectations of investors or securities analysts;
o Adverse developments in the financial markets, the apparel
industry and the worldwide or regional economies;
o Interest rates;
o Changes in accounting principles;
o Sales of common stock by existing shareholders or holders of
options;
o Announcements of key developments by our competitors; and
o The reaction of markets and securities analysts to
announcements and developments involving our company.
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
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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 currently do not have
any plans to pursue any potential 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 November 21, 2005, our officers and directors and their affiliates
beneficially owned approximately 22.6% 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 25.3% of the outstanding shares of our common stock at November
21, 2005. As a result, our officers and directors and the Dyne family are able
to exert considerable influence over the outcome of any matters submitted to a
vote of the holders of our common stock, including the election of our Board of
Directors. The voting power of these stockholders could also discourage others
from seeking to acquire control of us through the purchase of our common stock,
which might depress the price of our common stock.
WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED
SECURITY MEASURES IN RESPONSE TO TERRORISM. Our business depends on the free
flow of products and services through the channels of commerce. Recently, in
response to terrorists' activities and threats aimed at the United States,
transportation, mail, financial and other services have been slowed or stopped
altogether. Further delays or stoppages in transportation, mail, financial or
other services could have a material adverse effect on our business, results of
operations and financial condition. Furthermore, we may experience an increase
in operating costs, such as costs for transportation, insurance and security as
a result of the activities and potential activities. We may also experience
delays in receiving payments from payers that have been affected by the
terrorist activities and potential activities. The United States economy in
general is being adversely affected by the terrorist activities and potential
activities and any economic downturn could adversely impact our results of
operations, impair our ability to raise capital or otherwise adversely affect
our ability to grow our business.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures, which we have designed
to ensure that information required to be disclosed in our reports under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms, and
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that such information is accumulated and communicated to management, including
our Chief Executive Officer and Chief Financial Officer, to allow timely
decisions regarding disclosure. In response to recent legislation and proposed
regulations, we reviewed our internal control structure and our disclosure
controls and procedures.
In the course of conducting its review of our financial statements for
the fiscal quarters ended June 30, 2005 and September 30, 2005, our independent
registered public accounting firm, BDO Seidman, LLP informed members of our
senior management and the Audit Committee of our Board of Directors that they
had discovered significant deficiencies in our internal control over financial
reporting that alone and in the aggregate constituted a "material weakness,"
which is defined under standards established by the Public Company Accounting
Oversight Board as a deficiency that could result in more than a remote
likelihood that a material misstatement of the annual or interim financial
statements will not be prevented or detected.
The deficiencies identified consisted of our recording significant
post-closing adjustments in our financial statements for the quarters ended June
30, 2005 and September 30, 2005, which were identified by BDO Seidman, LLP in
connection with its review of the financial statements, indicating a material
weakness in our quarterly financial statement closing process. BDO Seidman, LLP
identified the same material weakness in our annual financial statement closing
process in connection with its audit of our financial statements for the fiscal
year ended December 31, 2004. In order to address this material weakness
identified in the annual financial statement closing process, we implemented
additional review procedures over the selection and monitoring of appropriate
assumptions and estimates affecting these accounting practices. There were no
post-closing adjustments as of March 31, 2005, the first quarterly period
following implementation of additional review procedures. The deficiencies,
however, were again present in the closing process for our financial statements
for the second and third quarters of 2005.
Members of the Company's management, including the Company's Chief
Executive Officer, Stephen Forte, and then-serving Chief Financial Officer,
August DeLuca, evaluated the effectiveness of our disclosure controls and
procedures, as defined by paragraph (e) of Exchange Act Rules 13a-15 or 15d-15,
as of September 30, 2005, the end of the period covered by this Quarterly
Report. Based upon that evaluation, Mr. Forte and Mr. DeLuca concluded that the
Company's disclosure controls and procedures were not effective.
Subsequently, in the course of preparing and reviewing our annual
financial statements for the year ended December 31, 2005, members of current
management, including Stephen Forte, Chief Executive Officer, and Lonnie
Schnell, Chief Financial Officer, determined that material weaknesses in our
internal control over financial reporting continued to exist. These material
weaknesses included an error in the second and third quarters of 2005 in the
application of generally accepted accounting principles in the recording of
revenues during the periods. As a result, we determined to restate our financial
statements for the second and third quarters of 2005 to correct the recording of
revenues and corresponding net loss figures for those periods as a result of a
sale and inventory storage agreement that was effective in the second quarter.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
There were no significant changes in our internal controls over
financial reporting that occurred during the third quarter that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
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PART II
OTHER INFORMATION
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
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: April 17, 2006 TAG-IT PACIFIC, INC.
` /S/ LONNIE D. SCHNELL
----------------------------------------
By: Lonnie D. Schnell
Its: Chief Financial Officer
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