[LETTERHEAD OF STUBBS, ALDERTON & MARKILES, LLP]
JOHN J. MCILVERY
Partner
Direct Voice 818.444.4502
Direct Fax 818.444.6302
Mobile 626.705.0758
E-Mail jmcilvery@biztechlaw.com
October 30, 2007
VIA FEDERAL EXPRESS
Securities and Exchange Commission
Division of Corporation Finance
100 F Street, N.E.
Washington, D.C. 20549
Attn: Christopher Owings
Mail Stop 3561
Re: TALON INTERNATIONAL INC.
RESPONSES TO STAFF COMMENTS OF SEPTEMBER 6, 2007 WITH RESPECT TO:
REGISTRATION STATEMENT ON FORM S-3
FILE AUGUST 10, 2007
FILE NO. 333-145344
FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 2006
FILED APRIL 13, 2007, AS AMENDED
FORM 10-Q FOR QUARTERLY PERIOD ENDED JUNE 30, 2007
FILE NO. 1-13669
Ladies and Gentlemen:
On behalf of Talon International Inc. (the "COMPANY"), we have enclosed
one copy of the Company's proposed Amendment No. 2 to Annual Report on Form 10-K
for the fiscal year ended December 31, 2006 (the "10-K AMENDMENT"). We have also
enclosed a marked copy of the 10-K Amendment that shows changes to the affected
items of the original Annual Report on Form 10-K filed on April 13, 2007, as
amended by Amendment No. 1 to Annual Report on Form 10-K filed on April 30, 2007
(as previously amended, the "ORIGINAL FORM 10-K"). The 10-K Amendment includes
the additional and amended disclosure the Company proposes to make to the
Original Form 10-K in response to the Staff's comment letter, dated September 6,
2007 (the "COMMENT LETTER").
Additionally, we have set below the Company's responses to the Comment
Letter. The factual information provided herein relating to the Company has been
made available to us by the Company. Paragraph numbering used for each
supplemental response set forth below corresponds to the numbering used in the
Comment Letter.
Securities and Exchange Commission
October 30, 2007
Page 2
Upon resolution of the issues raised by the Staff in the Comment
Letter, the Company will file the 10-K Amendment and response letter via EDGAR,
as well as a pre-effective amendment to the Corporation's Registration Statement
on Form S-3 (File No. 333-145344) (the "S-3 AMENDMENT").
Several of the Staff's comments (notably, Comments 2, 12, 14, 15, 18,
20, 23, and 25) required further explanation, which the Company has provided to
further assist the Staff in understanding the disclosure contained in the
Company's periodic filings. In addition, several of the Staff's inquiries
pertain to the disclosure and reconciliation of valuation reserves for doubtful
accounts and inventory. The Company believes that the disclosures made within
the primary financial statements, footnotes thereto and Management's Discussion
and Analysis of Financial Condition and Results of Operations ("MD&A") were
appropriate and materially complete. As a result of the Staff's comments,
however, the Company did identify inconsistencies in the preparation of Schedule
II to the Original Form 10-K, where certain items were reported inconsistently
in either the "Additions" or "Deductions" columns. The beginning and end of year
reserve balances, however, were correctly reported.
The Staff's principal remaining comments relate to several technical
disclosure omissions (notably, Comments 7, 8, 9, 13, 16, 17, 19, 21, and 22)
that the Company acknowledges were inadvertently omitted. While the Company
believes these disclosures will improve its filings, it does not believe their
omission, considered individually or in the aggregate, resulted in a material
misstatement or that their omission would materially affect a reader's
understanding of the Company, its operations or financial results. The 10-K
Amendment corrects these disclosures.
Comment 26 of the Staff's comments requested the Company to identify
the impact of all of the Staff's comments on the disclosures contained in the
Company's quarterly filing. Many of the Staff's comments were made with respect
to disclosures found only in the Original Form 10-K, and other comments the
Company believes were materially and appropriately addressed in the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2007. With respect
to all remaining comments that are relevant to its quarterly reports, the
Company proposes to address such comments in the Form 10-Q for the quarter ended
September 30, 2007, which the Company will file in mid-November 2007.
The Company's detailed response to the individual comments follows.
Securities and Exchange Commission
October 30, 2007
Page 3
FORM S-3
WHERE YOU CAN FIND MORE INFORMATION, PAGE 16
1. PLEASE SPECIFICALLY INCORPORATE BY REFERENCE YOUR FORM 8-K FILED AUGUST
3, 2007. ALSO, INCLUDE ANY ADDITIONAL REPORTS FILED SUBSEQUENT TO THE
DATE OF FILING THE FORM S-3 SINCE YOU ARE OTHERWISE REQUIRED TO AMEND
THE FORM S-3. SEE COMPLIANCE AND DISCLOSURE INTERPRETATION H.69
REGARDING FORM S-3, ITEM 12(A).
The Company notes the Staff's comment and will incorporate by reference
the periodic filings in the S-3 Amendment.
FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 2006
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, PAGE 20
OVERVIEW, PAGE 20
2. PLEASE INCLUDE A DISCUSSION OF THE EXPECTED EFFECTS ON FUTURE EARNINGS
AND CASH FLOWS RESULTING FROM YOUR 2005 RESTRUCTURING. REFER TO SAB
TOPIC 5:P:4. IN THE DISCUSSION YOU SHOULD:
o QUANTIFY THE EXPECTED EFFECTS OF THE RESTRUCTURING AND
DISCLOSE THE INITIAL PERIOD IN WHICH THOSE EFFECTS ARE
EXPECTED TO BE REALIZED;
o DISCUSS WHETHER THE COST SAVINGS ARE EXPECTED TO BE OFFSET BY
ANTICIPATED INCREASES IN OTHER EXPENSES OR REDUCED REVENUES;
o CLEARLY IDENTIFY THE INCOME STATEMENT LINE ITEMS TO BE
IMPACTED (FOR EXAMPLE, COST OF GOODS SOLD, SELLING EXPENSES,
GENERAL AND ADMINISTRATIVE EXPENSES, ETC.); AND
o DISCUSS WHETHER ACTUAL SAVINGS ANTICIPATED BY THE
RESTRUCTURING ARE BEING ACHIEVED AS EXPECTED AND, IF NOT, THE
REASONS FOR AN OUTCOME DIFFERENT FROM YOUR INITIAL
EXPECTATIONS AND THE LIKELY EFFECTS OF THE DIFFERENT OUTCOME
ON FUTURE OPERATING RESULTS AND LIQUIDITY.
The Company believes that it has complied with the disclosures required
by Statement 146. According to SAB Topic 5: P: 4 "...Statement 146 requires
disclosure, in all periods, including interim periods, until the exit plan is
completed...". In accordance therewith, the Company disclosed in the Original
Form 10-K that the costs associated with the 2005 restructuring plan were
incurred in 2005, and further that the restructuring plan was substantially
completed by December 31, 2005. The nature of the restructuring plan and the
restructuring costs incurred were principally associated with asset dispositions
and impairments and do not generate recurring restructuring costs and/or
benefits. The Company did not incur long-term restructuring obligations and no
Securities and Exchange Commission
October 30, 2007
Page 4
liability for future restructuring charges related to the 2005 restructuring
plan were required to be recorded at the December 31, 2005 or 2006 balance sheet
date.
The Company disclosed the decisions that gave rise to the exit plan as
well as the results on the major income statement line items. The Company
disclosed the nature of the charges where quantitatively and qualitatively
material or significant, and losses from asset impairments were separately
identified from other restructure charges.
Considering that the restructuring plan was completed at the end of
2005, the expected benefits of the actions had been achieved and estimation of
future benefits from the plan was not practical or determinable.
3. REFERENCE IS MADE TO YOUR DISCLOSURE OF THE $3.6 MILLION RESERVE
INCLUDED IN BAD DEBT EXPENSE IN THE SIXTH PARAGRAPH AND THE INVENTORY
WRITE-DOWN IN THE SEVENTH PARAGRAPH ON PAGE 21. PLEASE TELL US HOW
THESE CHARGES RECONCILE TO THE DISCLOSURES REFLECTED IN SCHEDULE II.
The $3.6 million reserve item disclosed in MD&A is appropriate and is
included in the reserve additions reported in Schedule II. The reconciliation to
this Schedule was not readily apparent, however, in part due to a presentation
inconsistency in Schedule II. Upon further review of the Schedule II reporting
of the 2005 accounts receivable reserve changes, the Company determined that
some changes in 2005 were reported on a net basis in the reserve Additions
column in Schedule II rather than on a gross basis as reserve Deductions in a
manner consistent with the presentation in 2004 and 2006. This inconsistency
resulted in a $1.5 million understatement of both the reserve "Additions" and
"Deductions" of the 2005 Allowance for Doubtful Accounts. The balances of the
reserve account for all periods are correct. The Company will amend Schedule II
in the 10-K Amendment to reflect the appropriate changes, as follows:
Securities and Exchange Commission
October 30, 2007
Page 5
2005 REPORTED ACCOUNT RECEIVABLE ALLOWANCE ITEMS IN SCHEDULE II:
Balance at Balance at
Begining End
of Year Additions Deductions of Year
---------- ---------- ---------- ----------
Allowance for doubtful
accounts for 2005
AS REPORTED ................. $6,086,000 $2,631,000 $7,528,000 $1,189,000
Write-offs reported net
in Additions rather than
Deductions (1) .............. -- 411,000 411,000 --
Changes in estimates included
net in Additions rather than
Deductions (1) .............. -- 1,118,000 1,118,000 --
Allowance for doubtful accounts
for 2005 AS CORRECTED ....... $6,086,000 4,160,000 9,057,000 1,189,000
(1) To conform 2005 reporting with 2004 and 2006 methodology.
With respect to the inventory write-down disclosure in the Original
Form 10-K, the Company reported a write-down of $3.4 million related to the 2005
restructuring plan. This write-down was a direct write-off in the third quarter
of 2005 and was recorded directly to cost of sales. This amount is appropriately
excluded from Schedule II of the Original Form 10-K as it was directly charged
to cost of sales and was not an adjustment of the reserve balances.
During its review of the Staff's comments regarding Schedule II, the
Company performed a complete review of all items in Schedule II and determined
that the compilation of the report during 2004 with respect to the Obsolescence
Reserve included a change in a current year reserve estimate that was reported
as a Deduction and was reported inconsistent with the reporting for 2005 and
2006. The impact of correcting this inconsistency is to decrease both
"Additions" and "Deductions" for the Obsolescence Reserve for 2004 in the amount
of $1.2 million. The balance of the reserve account for all periods is correct.
The Company will further amend Schedule II in the 10-K Amendment to reflect the
appropriate changes, as follows:
Securities and Exchange Commission
October 30, 2007
Page 6
2004 REPORTED INVENTORY OBSOLESCENCE RESERVE IN SCHEDULE II:
Balance at Balance at
Begining End
of Year Additions Deductions of Year
----------- ----------- ----------- -----------
Reserve for obsolescence for 2004
AS REPORTED ................... $ 6,125,000 $ 2,240,000 $ 2,000,000 $ 6,365,000
Current Year reduction in
estimates included in Deduction
rather than in Additions (1) .. -- (1,200,000) (1,200,000) --
Reserve for obsolescence for 2004
AS CORRECTED (1) .............. $ 6,125,000 $ 1,040,000 $ 800,000 $ 6,365,000
(1) To conform 2004 reporting with reporting of 2005 and 2006.
RESULTS OF OPERATIONS, PAGE 22
4. IN CIRCUMSTANCES WHERE YOU IDENTIFY MORE THAN ONE FACTOR ACCOUNTING FOR
A MATERIAL CHANGE IN A FINANCIAL STATEMENT LINE ITEM BETWEEN PERIODS,
PLEASE PROVIDE AN ANALYSIS OF THE UNDERLYING REASONS FOR EACH
SIGNIFICANT CHANGE YOU IDENTIFY. FOR EXAMPLE, YOU SHOULD DISCLOSE THE
REASONS FOR THE DECLINE IN FREIGHT AND DUTY CHARGES, THE REDUCTION IN
INVENTORY ADJUSTMENTS AND OBSOLESCENCE AND THE REDUCTION IN
MANUFACTURING AND OVERHEAD CHARGES IN YOUR DISCUSSION OF COST OF GOODS
SOLD AND THE DECREASES IN LEGAL COSTS, EMPLOYEE AND BENEFIT COSTS,
FACILITY COSTS AND OTHER ADMINISTRATIVE AND TRAVEL COSTS IN YOUR
DISCUSSION OF GENERAL AND ADMINISTRATIVE EXPENSES FOR 2006 AS COMPARED
TO 2005. THESE ARE JUST EXAMPLES OF WHERE YOUR DISCLOSURE COULD BE
IMPROVED AND NOT A COMPLETE LIST.
The Company has explained the changes in its operations and the
objectives of its 2005 restructuring plan throughout the Original Form 10-K. The
discussion of the Company's results of operations, when read in conjunction with
the discussions and footnotes about the restructuring plan and other significant
events, provides reasons for significant changes. To provide more enhanced
disclosure, the Company has included in the 10-K Amendment specific reasons for
significant changes in individual items in the Results of Operations discussion.
5. REFERENCE IS MADE TO THE $2.1 MILLION INCREASE IN YOUR INVENTORY
OBSOLESCENCE RESERVE DISCLOSED IN THE SECOND PARAGRAPH UNDER THE COST
OF GOODS SOLD HEADING ON PAGE 23 AND TO THE $2.6 MILLION NET INCREASE
IN THE RESERVE FOR DOUBTFUL ACCOUNTS DISCLOSED IN THE SECOND PARAGRAPH
UNDER THE GENERAL AND ADMINISTRATIVE EXPENSES HEADING ON PAGE 24.
PLEASE TELL US HOW THESE AMOUNTS RECONCILE TO THE AMOUNTS DISCLOSED IN
SCHEDULE II.
Securities and Exchange Commission
October 30, 2007
Page 7
The increase in the inventory obsolescence expense for the year ended
December 31, 2005 compared to the year ended December 31, 2004 was approximately
$2.1 million. Schedule II (with revisions as noted in response to Comment 3
above) explains approximately $1.5 million of the change in expense from 2004 to
2005. As disclosed in the same sentence in MD&A referred to by the Staff, the
approximate $2.1 change in obsolescence expense includes $0.5 million incurred
in the fourth quarter of 2005. The fourth quarter write-offs of $0.5 million
were direct inventory adjustments and do not affect Schedule II. The sum of the
$1.5 million from the change in the Additions on Schedule II plus the $0.5
million in direct write-offs, with rounding, is the $2.1 million overall change
disclosed.
With respect to the $2.6 million net increase in the doubtful accounts
allowance, the change in the allowance from $6,086,000 at December 31, 2004 to
$1,189,000 at December 31, 2005 is a reduction of $4,897,000. Considering the
balance sheet conversion of accounts receivable to notes receivable and
$7,528,000 in reserves associated with this conversion (see Note 2 to the
consolidated financial statements as well as Note 3 on page 49 of the Annual
Report on Form 10-K for the fiscal year ended December 31, 2005 (the "2005 FORM
10-K")) the net effect on the Allowance for doubtful accounts is an increase of
$2,631,000 (q.v. the total net decrease of $4,897,000 in the reserve, minus the
conversion of the $7,528,000 in reserves to notes receivable).
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES, PAGE 29
6. TO THE EXTENT MATERIAL PLEASE QUANTIFY AND PROVIDE AN ANALYSIS OF THE
IMPACT OF YOUR CRITICAL ACCOUNTING ESTIMATES ON YOUR FINANCIAL POSITION
AND RESULTS OF OPERATIONS FOR THE YEARS PRESENTED. PLEASE ALSO DISCLOSE
THE EFFECT OF THE CHANGES IN CRITICAL ACCOUNTING ESTIMATES BETWEEN
PERIODS TO THE EXTENT SUCH CHANGES HAD A SIGNIFICANT EFFECT ON YOUR
FINANCIAL POSITION OR OPERATING RESULTS. IN ADDITION, PLEASE INCLUDE A
QUALITATIVE AND QUANTITATIVE ANALYSIS OF THE SENSITIVITY OF REPORTED
RESULTS TO CHANGES IN ASSUMPTIONS, JUDGMENTS, AND ESTIMATES, INCLUDING
THE LIKELIHOOD OF OBTAINING MATERIALLY DIFFERENT RESULTS IF DIFFERENT
ASSUMPTIONS WERE APPLIED. PLEASE REFER TO THE COMMISSION'S GUIDANCE
REGARDING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS, SEC RELEASE NO. 33-8350, ISSUED DECEMBER 19,
2003 AND AVAILABLE ON OUR WEBSITE AT WWW.SEC.GOV.
As noted in our Application of Critical Accounting Policies and
Estimates, the application of these policies and estimates often require
difficult, subjective and/or complex judgments by management. In discussing the
impact of these judgments, the Company made extensive disclosures throughout
several sections of the Original Form 10-K, including in MD&A and numerous
footnotes to the financial statements.
Securities and Exchange Commission
October 30, 2007
Page 8
During the periods reported, the critical accounting policies most
impacting the Company were associated principally with the Company's adopted
restructuring plan, accounts and notes receivable, assets held for sale, idle
and impaired, and inventory reserves. The Company's disclosures regarding these
items are extensive and include detailed discussions of management's reasons for
these charges, the impact of these items on the Company's operating performance
and the key assumptions in the determinations. In particular, pages 21 and 27 of
MD&A in the Original Form 10-K address the impact of the restructuring charges,
assets held for sale, bad debts and inventory write-downs. Footnote 1 discloses
the significance of inventory reserves, the assets held for sale, idle and the
impairment of goodwill. Notes 2, 11 and 18 specifically address accounts and
notes receivable, restructuring charges and collectibility of the Azteca note.
The Company respectfully asserts that inclusion in the Critical
Accounting Policy disclosure of a summary analysis of the impact of these
changes is not practicable and would represent unnecessary duplication of
information disclosed elsewhere in the Original Form 10-K.
The Company believes it has appropriately disclosed the nature and
impact of the critical accounting policies on the results of operations of the
Company and that it has complied with the Commission's guidance with regard to
these matters.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, PAGE 33
BALANCE SHEET, PAGE 36
7. PLEASE TELL US THE ITEMS AND THEIR AMOUNTS INCLUDED IN OTHER ACCRUED
EXPENSES FOR EACH YEAR PRESENTED. IF ANY OF THE ITEMS EXCEED 5 PERCENT
OF THE TOTAL CURRENT LIABILITIES, PLEASE STATE SEPARATELY SUCH ITEMS ON
THE FACE OR IN A NOTE.
The following items and amounts are included in other accrued expenses
for the fiscal year ended December 31, 2006 and 2005:
Securities and Exchange Commission
October 30, 2007
Page 9
12/31/2006 12/31/2005
---------- ----------
Accrued Compensation ............. 692,394 3.1% 719,655 4.8%
Accrued Benefits ................. 167,503 0.7% 1,989 0.0%
Accrued Interest ................. 543,668 2.4% 473,396 3.2%
Inventory Receipts ............... 514,052 2.3% 449,388 3.0%
Customer Refunds ................. 512,339 2.3% 372,042 2.5%
Advance on Inventory for Customer -- 0.0% 1,105,085 7.4%
Accrued Expenses ................. 279,222 1.2% 512,490 3.5%
Notes Payable .................... 164,446 0.7% 98,975 0.7%
Accrued Directors' Fees .......... 266,458 1.2% 226,000 1.5%
Accrued Audit Fees ............... -- 0.0% 21,821 0.1%
Accrued Non-income based taxes ... 96,855 0.4% 64,692 0.4%
Miscellaneous Accrued ............ 61,314 0.3% 10,618 0.1%
Accrued Royalties ................ 61,016 0.3% 112,400 0.8%
---------- ----------
3,359,267 14.9% 4,168,551 28.1%
---------- ----------
Total Current Liabilities Reported 22,470,952 100% 14,850,581 100%
In 2005, one component of other accrued expenses was greater than 5% of
current liabilities. This item reflects a payment from a customer for raw
material inventory purchases and is properly recorded as a current liability as
of the balance sheet date.
The Company inadvertently failed to separately disclose this item in
2005. The Company will correct the disclosure in the 10-K Amendment by
separately identifying the item in the footnotes to the financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS, PAGE 37
8. PLEASE SEPARATELY DISCLOSE YOUR BAD DEBT EXPENSE FOR EACH PERIOD
PRESENTED. REFER TO PARAGRAPH (B)5 OF RULE 5-03 OF REGULATION S-X.
The Company acknowledges its failure to meet the requirement of Rule
5-03(b)(5) of Regulation S-X to disclose the total bad debt expense for each
year reported in the financial statements. The Company will correct the
disclosure in the 10-K Amendment, and will include disclosure of bad debt
expense in future filings as appropriate. The 10-K Amendment will report net
recoveries of $0.5 million in 2006, and net expenses of $5.9 million and $8.4
million for 2005 and 2004, respectively.
9. PLEASE STATE SEPARATELY ON THE FACE OR IN A NOTE INTEREST EXPENSE AND
INTEREST INCOME. REFER TO PARAGRAPHS (B)8 AND (B)9 OF RULE 5-03 OF
REGULATION S-X.
The Company acknowledges its failure to meet the requirement of Rule
5-03 to separately disclose interest expense and interest income. The Company
will correct the disclosure in the 10-K Amendment, and will include separate
disclosure of interest expense
Securities and Exchange Commission
October 30, 2007
Page 10
and interest income in future filings as appropriate. The 10-K Amendment will
report interest expense of $1,356,000, $1,446,000, and $882,000 for fiscal years
ended December 31, 2006, 2005 and 2004, respectively, and interest income of
$368,000, $66,000, and $32,000 for fiscal years ended December 31, 2006, 2005
and 2004, respectively.
Included in interest expense is the amortization of deferred loan fees
and discounts amounting to $311,000 for each of the years ended 2006 and 2005,
and $45,000 for the year ended 2004. These amounts were included in General and
Administrative expenses in the Original Form 10-K and should be included in
Interest Expense, net. The appropriate reclassifications have been made to
reduce General and Administrative expense and increase Interest Expense, net.
Related disclosures in the 2006 Form 10-K Amendment have been updated to reflect
this reclassification of amortized discounts and deferred financing costs.
CONSOLIDATED STATEMENTS OF CASH FLOWS, PAGE 39
10. REFERENCE IS MADE TO THE INCREASE (DECREASE) IN ALLOWANCE FOR DOUBTFUL
ACCOUNTS AND INVENTORY VALUATION RESERVE LINE ITEMS AND TO THE
DISCLOSURE IN SCHEDULE II. IT APPEARS THAT THE AMOUNTS DISCLOSED IN THE
INCREASE (DECREASE) IN ALLOWANCE FOR DOUBTFUL ACCOUNTS LINE ITEM FOR
2006 AND 2004 REPRESENT THE CHANGE IN THE ALLOWANCE WHILE THE INCREASE
IN THE ALLOWANCE FOR DOUBTFUL ACCOUNTS FOR 2005 REPRESENTS THE
ADDITIONS TO THE ALLOWANCE. ALSO, IT APPEARS THAT THE AMOUNTS DISCLOSED
IN THE INCREASE (DECREASE) IN THE INVENTORY VALUATION RESERVE LINE ITEM
FOR 2006 AND 2005 REPRESENT THE CHANGE IN THE RESERVE WHILE THE CHANGE
IN THE RESERVE FOR 2004 IS NOT PRESENTED. PLEASE TELL US WHY THESE
DISCLOSURES ARE NOT CONSISTENT FOR EACH PERIOD PRESENTED. IN ADDITION,
AS IT APPEARS YOU ARE PRESENTING THESE ITEMS AS NON-CASH CHARGES AND
CREDITS, PLEASE EXPLAIN TO US WHY IT IS APPROPRIATE TO OFFSET
WRITE-OFFS AND RECOVERIES OF ACCOUNTS RECEIVABLE AND WRITE-OFFS OF
INVENTORY AGAINST YOUR PROVISIONS FOR BAD DEBTS AND INVENTORY
VALUATION.
With respect to the disclosure in the consolidated statement cash flows
for the allowance for doubtful accounts, all years are reported consistently.
When the change in the allowance for doubtful accounts for 2005 is combined with
the impact related to the non-cash conversion of the accounts receivable to a
note receivable as explained in Note 2 - Accounts and Note Receivable on page 48
of the Original Form 10-K, the change in the reserve is a net reduction of
$2.631 million, as reported. The reconciliation to this amount is as follows:
Securities and Exchange Commission
October 30, 2007
Page 11
RECONCILIATION OF 2005 CHANGE IN ALLOWANCE FOR DOUBTFUL ACCOUNTS TO STATEMENT OF
CASH FLOWS DISCLOSURE:
Allowance for Doubtful Accounts at December 31, 2004 $ 6,086,000
Provisions to Increase Allowance for Doubtful Accounts
(as revised in Item 3) 4,160,000
Deductions reducing the Allowance for Doubtful Accounts
in 2006 (as revised) (1,529,000)
------------
Sub-total of changes in allowance excluding conversion of
trade account to note receivable 2,631,000
Conversion of Accounts Receivable to Note Receivable:
Account Receivable Reduction - Gross Balance (10,968,000)
Note Receivable Established (see Stmt of Cas Flows) 3,440,000
Allowance for Doubtful Account Converted with Account
Receivable (7,528,000)
------------
Allowance for Doubtful Accounts at December 31, 2005 $ 1,189,000
============
During 2005 and 2006, due to the significance of changes occurring in
the Company's inventory and inventory reserves, the Company determined that
reporting the changes in these components of net inventory in the consolidated
statement of cash flows was more meaningful than simply reporting the net change
in inventory as a single item, as is more typical.
When the Company began reporting the components of inventory separately
in the 2005 Form 10-K, the differences in the gross and net changes in inventory
during 2004 were immaterial and the methodology applied in 2005 and 2006 was not
applied to 2004. This resulted in an inconsistency in the reporting of this item
for 2004. The amount that would have been reported as a non-cash increase in the
inventory valuation reserve is $240,000. The offset would be a reduction in the
inventory changes presented in operating assets and liabilities of the same
amount. To ensure consistency with all years reported, the change in inventory
in 2004 has been corrected to show the components, consistent with 2005 and
2006.
With respect to the Staff's request to explain the appropriateness of
offsetting write-offs and recoveries of receivables and write-offs of inventory
against their respective provisions, please see the response to Comment 24,
which defines the Company's procedure in reporting provisions for bad debts and
inventory valuation changes. Also, as noted in response to Comment 3, the
Company identified two adjustments to Schedule II for prior periods. The
consideration of these changes in reviewing Schedule II will assist in answering
the Staff's comments.
11. CASH RECEIPTS FROM THE SALES OF GOODS, INCLUDING RECEIPTS OF LONG-TERM
NOTES RECEIVABLE ARISING FROM THOSE SALES, SHOULD BE PRESENTED AS
OPERATING CASH INFLOWS. PLEASE TELL US THE BASIS IN GAAP FOR YOUR
CLASSIFICATION OF NOTE RECEIVABLE COLLECTIONS AS CASH INFLOWS FROM
FINANCING ACTIVITIES. OTHERWISE REVISE AS APPROPRIATE. REFER TO THE
GUIDANCE IN PARAGRAPH 22 OF SFAS 95.
The Company recorded the collections on note receivable as a source of
cash from financing because the note receivable was established under an
Agreement and General
Securities and Exchange Commission
October 30, 2007
Page 12
Release related to the omnibus settlement of all business aspects of the
relationship between the Company and the third party. While this settlement
included a resolution of long-outstanding accounts receivable, it also resolved
general business disputes regarding the business relationship, purchase
commitments, etc.
Although the Company acknowledges that GAAP guidance suggests that
collections previously associated with operating assets should generally be
reported as from operating sources, the Company believed that this transaction
qualified as an exception within the GAAP guidance. Given that, upon this
agreement, the third party also ceased to be a significant on-going operating
customer, the Company believed that the classification of collections on this
note receivable as an item of operating cash flow would potentially mislead the
reader to believe that operating cash flows were greater than current on-going
operations were producing.
In light of the Staff's comments and other modifications being made to
the Original Form 10-K, in the 10-K Amendment the Company will modify the
presentation of these collections as from operating activities, and will include
additional disclosure in MD&A regarding the non-recurring nature of these
proceeds.
12. PLEASE TELL US THE NATURE OF THE PROCEEDS FROM CAPITAL LEASE
OBLIGATIONS CLASSIFIED AS CASH INFLOWS FROM FINANCING ACTIVITIES. ALSO
EXPLAIN TO US WHY THIS ITEM IS NOT REPORTED IN INFORMATION ABOUT
NON-CASH INVESTING AND FINANCING ACTIVITIES. REFER TO PARAGRAPH 32 OF
SFAS 95. IF APPROPRIATE, PLEASE REVISE.
The Company disclosed a cash receipt on its consolidated statement of
cash flows in the financing activity section in 2004 of $950,000 related to the
financing of Company equipment. The Company had acquired the asset in late 2003
for cash and shortly thereafter in 2004, secured lease financing for the
equipment acquired and was directly reimbursed by the financing agency for the
prior disbursement.
According to Statement 95, paragraph 19(b), cash inflows from financing
activities include "Proceeds from issuing bonds, mortgages, notes, and from
other short- or long-term borrowing." Based on the receipt of proceeds from the
capital lease financing agreement in 2004, this receipt was reported as a 2004
"long-term borrowing" and a cash transaction for the period. The Company
believes the proceeds from the long term financing which was obtained in the
subsequent year is appropriately classified as a cash inflow from financing
activities.
Securities and Exchange Commission
October 30, 2007
Page 13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, PAGE 40
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, PAGE 40
INVENTORIES, PAGE 41
13. PLEASE DISCLOSE THE BASIS OF DETERMINING INVENTORY COSTS (I.E., FIFO,
LIFO, OR AVERAGE) AND THE NATURE OF COST ELEMENTS INCLUDED IN
INVENTORY. REFER TO PARAGRAPH 6(B) OF RULE 5-02 OF REGULATION S-X.
In the 10-K Amendment, the Company will modify the disclosure regarding
the cost basis of inventory from "Inventories are stated at the lower of cost of
market value..." to "Inventories are stated at the lower of cost, based on the
first-in, first-out basis, or market value..." The disclosure in the 10-K
Amendment also will indicate the components of inventory costs.
PROPERTY AND EQUIPMENT AND ASSETS HELD FOR SALE, PAGE 41
14. WE NOTE THAT YOU HAVE NOT REDEPLOYED THE EQUIPMENT RENDERED IDLE FROM
THE CLOSING OF YOUR PRODUCTION AND ASSEMBLY OPERATIONS IN NORTH
CAROLINA AND MEXICO IN CONNECTION WITH THE 2005 RESTRUCTURING PLAN.
PLEASE TELL US WHEN YOU LAST TESTED THE ASSETS FOR RECOVERABILITY AND
THE RESULTS OF YOUR IMPAIRMENT TEST. ALSO TELL US THE SIGNIFICANT
ASSUMPTIONS USED TO TEST THE ASSETS FOR RECOVERABILITY AND THE STATUS
OF YOUR REDEPLOYMENT EFFORTS.
The Company has idle assets (held for use) from the closed
manufacturing facility in North Carolina. The Company's policy requires testing
for impairment of idle assets on a quarterly basis, or as other events and facts
become known, if sooner. The most recent test for indication of impairment was
completed in conjunction with the June 30, 2007 quarterly report filing and
indicted no impairment of the idle equipment held for use in North Carolina.
The significant assumptions used to test the recoverability of the cost
of these assets include 1) successful re-deployment of the zipper manufacturing
equipment to strategically located manufacturing operations outside of the
United States, 2) successful negotiations with and establishment of
relationships with foreign manufacturers, 3) the identification/relocation of
selected equipment to a processor of a dyeing facility, and 4) the continued
operations of the Company and sales of its related products.
The undiscounted cash flows model assumptions include 1) a progressive
increase in production processes utilizing company equipment by reducing work
done by outside contractors up to volumes of $3.5 to $5.0 million annually over
the functional life of the assets, 2) savings on direct sourcing of raw
materials, 3) existing gross profit margins on products, and 4) appropriate
management/overhead support costs for the facilities.
Securities and Exchange Commission
October 30, 2007
Page 14
The Company's redeployment efforts are progressing with the
identification of two international manufacturing partners substantially
complete and the preparation of facilities to house the equipment in process.
The equipment has been extracted from the prior manufacturing plant and has been
crated and readied for shipment to the Company's manufacturing partners'
facilities which will occur after appropriate modifications to these facilities
have been completed. The Company expects to have a substantial portion of these
assets redeployed by the end of 2007.
REVENUE RECOGNITION, PAGE 46
15. PLEASE TELL US THE SIGNIFICANCE OF YOUR PROVISIONS AND RESERVES FOR
SALES REBATES FOR THE YEARS PRESENTED. ALSO TELL US WHAT CONSIDERATION
YOU GAVE TO ADDRESSING SALES REBATES IN YOUR DISCUSSION OF APPLICATION
OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES ON PAGE 29.
The volume of sales rebates and discounts represent less than 1% of
gross revenues for each of the three years presented (0.49% historical rate over
the years reported), and are immaterial. The Company's policy is to determine
the rebate or discount at the time of sale and to record such rebate or discount
against revenues at the time the specific revenues are recognized. Thus, there
is no allowance for sales rebates and discounts on the balance sheet and no
inclusion of such an allowance on Schedule II.
With respect to the Company's consideration of addressing sales rebates
and discounts in critical accounting policies and estimates on page 29 of the
Original Form 10-K, the Company believes that rebates and discounts are
immaterial and do not warrant separate disclosure in its critical accounting
policies or estimates.
NOTE 7 - SECURED CONVERTIBLE PROMISSORY NOTES, PAGE 51
16. WE NOTE THAT YOU ARE RESTRICTED FROM PAYING DIVIDENDS UNDER THE
COVENANTS OF YOUR SECURED CONVERTIBLE PROMISSORY NOTES. PLEASE DESCRIBE
THE MOST SIGNIFICANT RESTRICTIONS ON THE PAYMENT OF DIVIDENDS,
INDICATING THEIR SOURCES, THEIR PERTINENT PROVISIONS AND THE AMOUNT OF
RETAINED EARNINGS OR NET INCOME RESTRICTED OR FREE OF RESTRICTIONS AS
REQUIRED BY RULE 4-08(E)(1) OF REGULATION S-X.
The Company will include disclosure of the restrictions on the
Company's ability to pay dividends prior to conversion or repayment of the
convertible promissory notes in the 10-K Amendment.
NOTE 8 - STOCKHOLDERS' EQUITY AND CONVERTIBLE REDEEMABLE PREFERRED STOCK, PAGE
52
SERIES D PREFERRED STOCK PRIVATE PLACEMENT TRANSACTION, PAGE 52
Securities and Exchange Commission
October 30, 2007
Page 15
17. PLEASE DISCLOSE THE EXERCISE PRICE OF THE WARRANTS ISSUED IN CONNECTION
WITH THE PRIVATE PLACEMENT IN THE FIRST PARAGRAPH ON PAGE 53.
The Company will include the additional disclosure requested by the
Staff in the 10-K Amendment.
NOTE 11 - 2005 RESTRUCTURING PLAN
18. PLEASE EXPLAIN TO US WHY YOUR CLASSIFICATION OF THE NORTH CAROLINA
MANUFACTURING PLANT AS "HELD FOR SALE" MEETS THE CRITERIA IN PARAGRAPH
30 OF SFAS 144. PLEASE SPECIFICALLY ADDRESS THE EXCEPTION TO THE
ONE-YEAR REQUIREMENT IN PARAGRAPH 31 OF SFAS 144.
The North Carolina manufacturing facility is classified as "held for
sale" in accordance with the guidelines of Statement 144, paragraphs 30 and 31.
Management had the authority to approve the disposal action of the facility and
committed to a plan to sell the facility in conjunction with the 2005
restructuring plan (SFAS144P. 30 (a)). The facility is available for immediate
sale in its present condition (SFAS144P. 30 (b)). Management has initiated and
pursues actions to locate a buyer and list the property with commercial real
estate brokers to complete the sale of the facility (SFAS144P. 30(c)). The sale
of the facility is probable as evidenced by inquiry by several potential buyers
that did not close due to market and regional conditions beyond the Company's
control (SFAS144P. 30 (d)).
Statement 144, paragraph 30(d) calls for the probable sale within one
year, except as provided for in paragraph 31 (See "One year limitation" below).
The facility is a substantial special use real estate asset in a rural
marketplace and has been listed with several commercial property brokers at
prices determined by the brokers and by local market conditions to be
competitive and at fair market value. The Company has lowered the price of the
building and is not expecting to recover a premium on the sale of the facility
(SFAS144P. 30 (e)). The Company's plan to dispose of the facility is not likely
to be changed and the plan is not expected to be withdrawn (SFAS144P. 30 (f)).
ONE-YEAR LIMITATION
Statement 144, paragraph 31(c), provides for an exception to the
one-year limitation to sale date, "If during the initial one-year period,
circumstances arise that previously were considered unlikely and, as a result, a
long-lived asset (disposal group) previously classified as held for sale is not
sold by the end of that period and (1) during the initial one-year period the
entity initiated actions necessary to respond to the change in circumstances,
(2) the asset (group) is being actively marketed at a price that is reasonable
given the change in circumstances, and (3) the criteria in paragraph 30 are
met."
Securities and Exchange Commission
October 30, 2007
Page 16
With respect to paragraph 31, the Company did not anticipate the
limited demand for commercial special use facilities in the North Carolina
market and has actively marketed the property through multiple commercial real
estate brokers. The Company has lowered its listing price below market
comparable levels and requires all offers of purchase, lease, or other to be
presented for their consideration. The Company continues to explore other means
to dispose of this facility. All other requirements of Statement 144 paragraph
30 are met and the Company believes that the North Carolina facility is properly
classified as "held for sale" at December 31, 2006 as reported in the Form 10-K.
In conjunction with the Company's policies, this facility is evaluated at least
quarterly for continued qualification as a property held for sale and for any
possible impairment.
The Company noted in its review of this comment that the outstanding
mortgage associated with this property had not been separately disclosed.
Accordingly, this information has been added in the 10-K Amendment.
NOTE 12 - INCOME TAXES, PAGE 60
19. PLEASE DISCLOSE THE CUMULATIVE AMOUNT OF UNDISTRIBUTED EARNINGS OF YOUR
FOREIGN SUBSIDIARIES. REFER TO PARAGRAPH 44.B OF SFAS 109.
At December 31, 2006 and 2005, undistributed earnings from the
Company's foreign subsidiaries were $4,581,000 and $4,689,000, respectively. The
Company will include disclosure of these amounts in the footnote disclosure
included in 10-K Amendment.
NOTE 13 - COMMITMENTS AND CONTINGENCIES, PAGE 62
20. PLEASE DISCLOSE WHETHER YOU HAVE ACCRUED AN ESTIMATED LOSS WITH RESPECT
TO THE MEXICAN FEDERAL TAX AUTHORITY CLAIM DISCLOSED ON PAGE 64. IF
NOT, PLEASE GIVE AN ESTIMATE OF THE POSSIBLE LOSS OR RANGE OF LOSS OR
STATE THAT SUCH AN ESTIMATE CANNOT BE MADE. REFER TO PARAGRAPH 10 OF
SFAS 5.
The Company believes that it met the disclosure requirements of
Statement 5 in the contingencies related to the Mexican Tax Authority. The
Company disclosed the fact that these claims are "defective on both procedural
and documentary grounds" and, accordingly, determination of a probable loss is
not possible. The Company noted that these claims were not expected to have a
material adverse impact. The Company will include in the 10-K Amendment,
additional disclosure that the "an estimate of the possible loss or range of
loss cannot be made at this time".
NOTE 14 - GEOGRAPHIC INFORMATION, PAGE 65
21. YOU DISCLOSE THAT THERE IS NOT ENOUGH DIFFERENCE BETWEEN THE TYPES OF
PRODUCTS DEVELOPED OR DISTRIBUTED BY YOU TO ACCOUNT FOR THE PRODUCTS
SEPARATELY OR TO
Securities and Exchange Commission
October 30, 2007
Page 17
JUSTIFY SEGMENT REPORTING BY PRODUCT TYPE. YET, WE NOTE THAT YOU
DISCLOSE THE APPROXIMATE AMOUNT OF SALES OF PRODUCTS INCORPORATING THE
STRETCH WAISTBAND TECHNOLOGY ON PAGE 20 AND DISCUSS SALES OF TRIM AND
TALON PRODUCTS IN RESULTS OF OPERATIONS ON PAGE 22. PLEASE TELL US
WHETHER SALES BY PRODUCT ARE REPORTED IN THE FINANCIAL INFORMATION USED
TO PRODUCE YOUR GENERAL PURPOSE FINANCIAL STATEMENTS. IF SO, TELL US
WHY DISCLOSURE OF REVENUES BY PRODUCT OR EACH GROUP OF SIMILAR PRODUCTS
IS NOT MEANINGFUL TO THE USERS OF YOUR FINANCIAL STATEMENTS. OTHERWISE,
PLEASE DISCLOSE REVENUES BY PRODUCT OR EACH GROUP OF SIMILAR PRODUCTS
AS REQUIRED BY PARAGRAPH 37 OF SFAS 131. IN THAT REGARD, IT APPEARS
THAT TALON ZIPPER, TRIM PRODUCT AND TEKFIT REVENUE DISCLOSURES FOR EACH
YEAR PRESENTED MAY BE APPROPRIATE.
While the Company operates in a single reportable segment, the
manufacture and distribution of apparel accessories, the Company has not had a
reliable means to record and report the operating performance by product types
and services offered to its customers. Since 2006, the Company has been, and
currently is, undertaking reporting improvements, including the installation of
new systems that will assist in recording and reporting by product types and
services. The sales by product have been partially tracked or reported in our
general use financial statements, but until recently, the product group
information could not reliably or practically be assembled for reporting in
accordance with paragraph 37 of Statement 131. In the Company's latest quarterly
report, the Company included disclosure of revenue performance by product type,
and the Company intends to expand it disclosure of product group revenues in its
Annual Report on Form 10-K for the fiscal year ended December 31, 2007.
The Company has completed its compilation of revenue information by
product group for prior periods, and will include this disclosure in the 10-K
Amendment.
NOTE 17 - QUARTERLY RESULTS, PAGE 67
22. PLEASE DISCLOSE GROSS PROFIT FOR EACH PERIOD PRESENTED. REFER TO ITEM
302(A)(1) OF REGULATION S-K.
The Company will include the requested disclosure in the 10-K Amendment
and in future filings.
Amounts to be included in the quarterly results disclosure in the
footnotes are as follows:
4th 3rd 2nd 1st
----------- ----------- ----------- -----------
2006 Gross Profit ...... $ 3,350,600 $ 4,148,406 $ 4,127,237 $ 2,842,725
2005 Gross Profit (Loss) $(1,652,918) $(2,094,230) $ 756,120 $ 3,251,823
Securities and Exchange Commission
October 30, 2007
Page 18
ITEM 9A. CONTROLS AND PROCEDURES, PAGE 68
23. WE NOTE YOUR STATEMENT THAT "DISCLOSURE CONTROLS AND PROCEDURES, NO
MATTER HOW WELL DESIGNED AND OPERATED, CAN PROVIDE ONLY REASONABLE,
RATHER THAN ABSOLUTE, ASSURANCE OF ACHIEVING THE DESIRED CONTROL
OBJECTIVES." WE ALSO NOTE YOUR CONCLUSION THAT YOUR DISCLOSURE CONTROLS
AND PROCEDURES WERE EFFECTIVE AT THE REASONABLE ASSURANCE LEVEL. PLEASE
REVISE TO ALSO STATE, IF TRUE, THAT YOUR DISCLOSURE CONTROLS AND
PROCEDURES ARE DESIGNED TO PROVIDE REASONABLE ASSURANCE OF ACHIEVING
THEIR OBJECTIVES. IN THE ALTERNATIVE, REMOVE THE REFERENCES TO THE
LEVEL OF ASSURANCE OF YOUR DISCLOSURE CONTROLS AND PROCEDURES. PLEASE
REFER TO SECTION II.F.4 OF MANAGEMENT'S REPORT ON INTERNAL CONTROL ON
INTERNAL CONTROL OVER FINANCIAL REPORTING AND CERTIFICATION OF
DISCLOSURE IN EXCHANGE ACT PERIODIC REPORTS, SEC RELEASE NO. 33-8238,
AVAILABLE ON OUR WEBSITE AT
HTTP://WWW.SEC.GOV/RULES/FINAL/33-8238.HTM>.
The Company will modify its Item 9A disclosure in the 10-K Amendment in
response to the Staff's comment, and will include similar disclosure in all
future filings that require similar disclosure regarding the Company's
disclosure controls and procedures.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES, PAGE 72
24. IT DOES NOT APPEAR THAT ADDITIONS TO RESERVES REFLECT PROVISIONS FOR
DOUBTFUL ACCOUNTS AND INVENTORY VALUATION RESERVES CHARGED TO
OPERATIONS OR THAT DEDUCTIONS REFLECT THE WRITE-OFFS (AND/OR
RECOVERIES) AGAINST THE ASSET ACCOUNTS FOR EACH OF THE PERIODS
PRESENTED. PLEASE ADVISE. ALSO, THE NATURE OF ITEMS REFLECTED IN
DEDUCTIONS IS UNCLEAR. PLEASE INCLUDE A FOOTNOTE TO THE TABLE THAT
DESCRIBES THE ITEMS INCLUDED IN THE DEDUCTIONS COLUMN. REFER TO RULE
12-09 OF REGULATION S-X.
The Company acknowledges the Staff's comment and previously has
addressed the presentation of Schedule II in response to Comments 3, 5, 10 and
15. The Company will include in the 10-K Amendment a revised Schedule II as
previously indicated. In addition, the Company will include the following
footnotes to Schedule II, disclosing the Company's procedures for reporting
amounts as additions and deductions for each group of valuation and qualifying
accounts:
1. Additions to the allowance for doubtful accounts include
provisions for uncollectible accounts. Bad debt expense
includes (and Additions in Schedule II exclude) net recoveries
of $712,000 for the year ended December 31, 2006, and net
direct write-offs of $1,698,000 and $2,916,000 for the years
ended December 31, 2005 and 2004, respectively. Additions to
the inventory obsolescence reserve include current year
provisions.
2. Deductions from the allowance for doubtful accounts include
amounts applied to write-offs, reversals of prior period
provisions and, for the year ended
Securities and Exchange Commission
October 30, 2007
Page 19
December 31, 2005 deductions include $7,528,000 related to the
conversion of a trade account receivable to a note receivable.
Deductions from the inventory obsolescence reserves include
application of allowance against obsolete, excess, or slow
moving inventory disposed of during the period.
25. PLEASE REVISE TO INCLUDE YOUR ALLOWANCE FOR SALES RETURNS, IF MATERIAL.
REFER TO RULES 5-04 AND 12-09 OF REGULATION S-X.
The nature of the Company's products as well as the relative small
value of individual items results in product returns that are infrequent and
immaterial. Accordingly the Company does not provide a reserve for such returns,
but recognizes them as they occur.
FORM 10-Q FOR QUARTERLY PERIOD ENDED JUNE 30, 2007
26. PLEASE ADDRESS THE COMMENTS ABOVE AS APPLICABLE.
Comments previously addressed that are not applicable to the Form 10-Q
for the Quarterly Period Ended June 30, 2007 (the "JUNE 10-Q") are Comments 1,
3, 5, 10, 12, 16, 17, 18, 19, 22, 24 and 25.
Comment 2: The restructuring plan was substantially completed at
December 31, 2005. MD&A in the June 10-Q explains the operating results of the
restructured organization. No restructuring reserves existed at December 31,
2006 or June 30, 2007.
Comment 4: The Company provided substantial disclosure with respect to
material changes in financial statement line items for the reported periods. The
Company does not believe that this Comment requires additional disclosure in the
June 10-Q.
Comment 6: The Company did not change the methods it uses to determine
its critical accounting estimates since the filing of the Original Form 10-K.
For the period presented, the Company believes the disclosure included in the
June 10-Q with respect critical accounting policies meets the requirements of
SEC Release 33-8350.
Comment 7: With respect to accrued expenses, no items individually
exceeded 5% of total current liabilities at June 30, 2007.
Comment 8: The Company disclosed the bad debt expense in the June 10-Q
for the periods presented.
Comment 9: Interest expense for the three and six months ended June 30,
2007 was $360,000 and $677,000, respectively, compared to $338,000 and $676,000
for the same periods in 2006, respectively. Interest income for the three and
six months ended June 30, 2007 was $94,000 and $186,000, respectively, compared
to $109,000 and $160,000 for the same periods in 2006, respectively. The Company
proposes to include separate disclosure of
Securities and Exchange Commission
October 30, 2007
Page 20
interest expense and interest income in its Form 10-Q for the Quarterly Period
Ended September 30, 2007 and in all future filings.
Comment 11: The Company will modify its Form 10-Q disclosure on a
prospective basis as noted in response to Comment 11 above.
Comment 13: The Company will modify its Form 10-Q disclosure on a
prospective basis as noted in response to Comment 13 above.
Comment 14: The response to Comment 14 above addresses the Staff's
comment on idle assets with respect to June 10-Q.
Comment 15: The response to Comment 15 above applies to sales rebates
and discounts for the three and six months ended June 30, 2007 and 2006. These
amounts are immaterial to the financial statements and therefore are not
separately disclosed.
Comment 20: The Company will modify its Form 10-Q disclosure on a
prospective basis as noted in response to Comment 20 above.
Comment 21: The Company will modify its Form 10-Q disclosure on a
prospective basis as noted in response to Comment 21 above.
Comment 23: The Company will modify its Form 10-Q disclosure on a
prospective basis as noted in response to Comment 23 above.
PART I. FINANCIAL INFORMATION, PAGE 3
ITEM 1. FINANCIAL STATEMENTS, PAGE 3
CONSOLIDATED BALANCE SHEETS, PAGE 3
27. PLEASE TELL US HOW YOU ACCOUNT FOR RECOVERABLE AND ACCRUED LEGAL COSTS
RELATED TO OUTSTANDING LITIGATION AND THE REASONS FOR THE SIGNIFICANT
CHANGES IN THESE LINE ITEMS DURING THE QUARTERS ENDED MARCH 31, 2007
AND JUNE 30, 2007. PLEASE ALSO TELL US THE GENERAL TERMS OF YOUR
INSURANCE POLICIES THAT PROVIDE FOR REIMBURSEMENT OF LEGAL COSTS.
The Company records legal expenses as a general and administrative
expense in the period incurred. If legal fees payable become material, the
Company discloses the amount separately as a component of current liabilities.
In legal actions where the Company's defense costs are insured, the amount
incurred, in excess of the Company's deductible under the insurance coverage, is
accrued as recoverable legal costs from the insurance carrier.
Securities and Exchange Commission
October 30, 2007
Page 21
The Company incurred significant legal expenses related to two items in
2005 and 2006: 1) the litigation between the Company and Pro-Fit continuing from
2004 and 2) the class action lawsuit brought against the Company on October 12,
2005.
The Company incurred and paid legal costs related to the class action
lawsuit during 2005 and 2006 up to the amount of its deductible. The Company's
Directors and Officers insurance policy provides for reimbursement of defense
costs up to the value of the policy after the Company has paid its stated
deductible. During the first and second quarter of 2007 the Company incurred
significant legal costs in preparation of a scheduled trial date of May 1, 2007.
Having previously met and paid the Company's deductible under this policy, the
legal costs incurred with respect to the class action litigation were subject to
reimbursement by our insurer. Amounts incurred and paid in excess of the
Company's deductible were accrued as legal costs recoverable from the insurer.
During the third quarter of this year, substantially all defense costs
outstanding at June 30, 2007 have been paid by the insurer.
The Company incurred substantial legal costs related to the Pro-fit
action principally in the first quarter and second quarter of 2006. In June
2006, the Company entered into a note payable agreement with its legal counsel
to settle the outstanding fees. The effect was a reduction in accrued legal fees
and an increase of notes payable of $1.65 million as noted in the June 30, 2006
Form 10-Q, page 12, second paragraph. The note payable was paid according to
terms for 2006 and 2007 and paid in full during the second quarter 2007.
CONSOLIDATED STATEMENT OF CASH FLOWS, PAGE 5
28. THE STATEMENTS SHOULD EXPLAIN THE CHANGE DURING EACH OF THE PERIODS IN
CASH AND CASH EQUIVALENTS. REFER TO PARAGRAPH 7 OF SFAS 95. CHANGES IN
RESTRICTED CASH ARE GENERALLY PRESENTED SEPARATELY WITHIN THE INVESTING
SECTION OF THE STATEMENTS. PLEASE REVISE OR ADVISE.
The Company used the description of cash and restricted cash to
highlight the transaction explained in Notes 9 and 10 (first paragraph) to the
June 10-Q. Consistent with Statement 95, the nature of the $9.5 million proceeds
from the term note could appropriately have been reported as a cash equivalent.
The proceeds from the term note were held in an investment account in the
Company's name with disbursement subject to the lenders approval. The funds were
set aside at closing pending the eventual disbursement to and release from the
previously existing convertible notes that the term note was designated to pay.
All of the convertible promissory notes were paid within approximately 30 days
(short-term) of the balance sheet date and the funds held in the escrow account
were fully disbursed.
The Company reported the funds as "restricted" so as not to mislead the
reader that these funds were available for general purposes. Note 9 clarifies
the intended use of the proceeds from the term note. While the Company believes
the disclosures on the consolidated statement of cash flows and in Notes 9 and
10 to the unaudited consolidated
Securities and Exchange Commission
October 30, 2007
Page 22
financial statements do not mislead the reader, in future filings the Company
will combine restricted cash and cash and cash equivalents and eliminate the
reference to restricted cash on the consolidated statement of cash flows.
29. WE NOTE THAT ACCOUNTS PAYABLE AND ACCRUED LEGAL CONVERTED TO NOTES
PAYABLE IN SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION WAS NOT
REFLECTED IN YOUR AUDITED FINANCIAL STATEMENTS. PLEASE ADVISE.
The Company reported the amount of the accounts payable and accrued
legal converted to notes payable in the audited financial statements at December
31, 2006; however, the amount was inadvertently included on the line "Accounts
receivable, net converted to notes receivable" which referenced a prior year
disclosure. The amount will be prospectively reported on a separate line in the
supplemental information to the consolidated cash flows entitled Accounts
payable and accrued legal converted to notes payable.
NOTE 10. SUBSEQUENT EVENTS, PAGE 30
30. PLEASE TELL US THE FACTS AND CIRCUMSTANCES THAT LED YOU TO CONCLUDE
THAT IT IS NOT PROBABLE THAT AMOUNTS DUE FROM AZTECA PRODUCTION
INTERNATIONAL, INC. ARE IMPAIRED AS OF THE BALANCE SHEET DATE. IF IT IS
PROBABLE THAT THE NOTE RECEIVABLE IS IMPAIRED, PLEASE EXPLAIN TO US WHY
YOU ARE UNABLE TO REASONABLY ESTIMATE THE IMPAIRMENT LOSS. PLEASE
ADDRESS THE RECOGNITION AND MEASUREMENT PRINCIPLES OF SFAS 114 IN YOUR
RESPONSE.
The general guidance to recognize a contingency loss is contained in
Statement 5, paragraph 8. The guidance from Statement 5 requires that a loss be
1) probable based on information available prior to the issuance of the
financial statements, and 2) reasonably estimatable. Specific guidance on
impairments of loans under Statement 114, paragraph 8, provides "A loan is
impaired when, based on current information and events, it is probable that a
creditor will be unable to collect all amounts due according to the contractual
terms of the loan agreement."
Statement 114 is clear about not providing guidance on determining the
probability: "This Statement does not specify how a creditor should determine
that it is probable that it will be unable to collect all amounts due according
to the contractual terms of the loan. A creditor should apply its normal loan
review procedures in making the judgment. An insignificant delay or
insignificant shortfall in amount of payment does not require the application of
this Statement. A loan is not impaired during a period of delay in payment if
the creditor expects to collect all amounts due including interest accrued at
the contractual interest rate for the period of delay."
As of the filing date of the June 10-Q on August 14, 2007, the Company
did not have sufficient information indicating the Company would not be able to
collect all amounts due
Securities and Exchange Commission
October 30, 2007
Page 23
according to the contractual terms of the loan agreement. The maker was in
compliance with all terms of the contractual agreement as of August 14, 2007 and
although one payment was delinquent, the maker had a contractual cure period to
resolve the delinquency, and at the time expressed their full intention and
belief that they would make the payment within the specified time period. The
maker has been a substantial operating apparel business conducting operations
with major apparel brands. Our industry awareness of their customers indicated
the prospect that they would continue to be able to resolve their immediate
problems and complete the payments on our note. The maker and a number of
affiliated companies are the subject of a significant adverse legal judgment
currently under appeal. It was a consequence of this impending judgment and
preparation for appeal that the maker asserted had temporarily impacted their
ability to make timely payments. Based upon the maker's previous payment
history, the Company's conversations with the maker through that date and
analysis of their operating position, there were no indications that the maker
would not be able to comply with the terms of the loan agreement.
The Company filed a Form 8-K on September 14, 2007 with respect to new
information that became available on September 10, 2007 regarding the
probability of collecting all amounts due according to the contractual terms of
this note. Based on the new information, the company deemed the note
uncollectible and impaired as of September 10, 2007.
ITEM 4. CONTROL PROCEDURES, PAGE 30
31. WE NOTE THAT YOU STATE THERE WERE NO SIGNIFICANT CHANGES IN YOUR
INTERNAL CONTROL OVER FINANCIAL REPORTING. WE ALSO NOTE SIMILAR
DISCLOSURE IN FORM 10-Q FOR FISCAL QUARTER ENDED MARCH 31, 2007. PLEASE
CONFIRM WITH US, IF TRUE, THAT THERE WERE NO CHANGES IN THE INTERNAL
CONTROLS THAT OCCURRED DURING THE QUARTERS THAT HAS MATERIALLY AFFECTED
OR IS REASONABLY LIKELY TO MATERIALLY AFFECT, YOUR INTERNAL CONTROL
OVER FINANCIAL REPORTING. IN FUTURE FILINGS, PLEASE DISCLOSE ANY CHANGE
IN INTERNAL CONTROL THAT OCCURRED DURING THE LAST FISCAL QUARTER THAT
HAS MATERIALLY AFFECTED, OR IS REASONABLY LIKELY TO AFFECT, YOUR
INTERNAL CONTROL OVER FINANCIAL REPORTING. REFER TO ITEM 308(C) OF
REGULATION S-K.
The Company has not made significant changes in its internal controls
over financial reporting during either the first or second quarter of 2007. The
Company continually evaluates its controls over financial reporting. The Company
is conducting its Section 404, Sarbanes-Oxley testing and to date has not
identified any material weaknesses or significant deficiencies in its controls
over financial reporting. The Company will include appropriate disclosures about
significant changes in its internal control structure in future filings.
* * * * *
Securities and Exchange Commission
October 30, 2007
Page 24
We hope the above has been responsive to the Staff's comments. If you
have any questions or require any additional information or documents, please
telephone me at (818) 444-4502.
Sincerely,
/s/ John J. McIlvery
---------------------------------
John J. McIlvery
Encl.
cc: Lonnie Schnell, Company CFO
Adam Phippen, SEC Staff Accountant
Anita Karu, SEC Attorney-Adviser