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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 30, 2003
Commission file number: 0-18926
INNOVO GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2928178
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5900 S. Eastern Ave., Suite 104 Commerce, CA 90040
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (323) 725-5516
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value per share
Indicate by check mark whether the registrant (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 registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of October 14, 2003, there were 21,158,308 shares of the issuer's only
class of common stock outstanding.
INNOVO GROUP INC.
Quarterly Report on Form 10-Q
Page
----
PART I. Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
August 30, 2003 (unaudited) and November 30, 2002 1
Consolidated Condensed Statements of Operations
For the three months ended August 30, 2003 and August 31, 2002,
respectively (unaudited) and for the nine months ended August
30, 2003 and August 31, 2002, respectively (unaudited) 2
Consolidated Condensed Statements of Cash Flows
For the nine months ended August 30, 2003
and August 31, 2002, respectively (unaudited) 3
Notes to Consolidated Condensed Financial Statements (unaudited) 4
Management's Discussion and Analysis of Financial
Item 2. Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 36
Item 4. Controls and Procedures 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 2. Changes in Securities 38
Item 3. Defaults Upon Senior Securities 38
Item 4. Submission of Matters to a Vote of Security Holders 38
Item 5. Other Information 38
Item 6. Exhibit and Reports on Form 8-K 38
2
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
INNOVO GROUP INC AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands except for share data)
08/30/03 11/30/02
----------- ---------
(unaudited) (audited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,410 $ 222
Accounts receivable and due from factor, net of allowance for
uncollectible accounts of $425 (2003) and $383 (2002) 2,818 2,737
Inventories 6,937 5,710
Prepaid expenses & other current assets 1,260 279
--------- ---------
TOTAL CURRENT ASSETS 13,425 8,948
--------- ---------
PROPERTY, PLANT and EQUIPMENT, net 1,761 1,419
GOODWILL 14,501 4,271
INTANGIBLE ASSETS, NET 11,384 487
OTHER ASSETS 19 18
--------- ---------
TOTAL ASSETS $ 41,090 $ 15,143
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 2,947 $ 2,438
Due to related parties 1,000 4,250
Current maturities of long-term debt 802 756
--------- ---------
TOTAL CURRENT LIABILITIES 4,749 7,444
LONG-TERM DEBT, less current maturities 23,817 2,631
8% Redeemable preferred stock, $0.10 par value: Authorized shares-
5,000, 194 shares (2003) and 194 shares (2002) issued & outstanding -- --
STOCKHOLDERS' EQUITY
Common stock, $0.10 par - shares, Authorized 40,000
Issued and outstanding 18,232 (2003), and 14,901 (2002) 18,232 14,901
Additional paid-in capital 50,009 40,343
Accumulated deficit (36,031) (33,507)
Promissory note-officer (703) (703)
Treasury stock (2,565) (2,537)
Accumulated other comprehensive loss (10) (19)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 28,932 18,478
--------- ---------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 57,498 $ 28,553
========= =========
See accompanying notes which are an integral part of these unaudited
consolidated condensed financial statements
1
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(in thousands except per share data)
(unaudited)
Three Months Ended Nine Months Ended
08/30/03 08/31/02 08/30/03 08/31/02
-------- -------- -------- --------
NET REVENUES $ 21,906 $ 10,148 $ 45,834 $ 20,219
COST OF GOODS SOLD 18,013 6,904 35,275 13,869
-------- -------- -------- --------
Gross profit 3,893 3,244 10,559 6,350
OPERATING EXPENSES
Selling, general and administrative 5,228 2,174 11,659 5,218
Depreciation and amortization 723 62 887 178
-------- -------- -------- --------
5,951 2,236 12,546 5,396
INCOME (LOSS) FROM OPERATIONS (2,058) 1,008 (1,987) 954
INTEREST EXPENSE (403) (164) (770) (382)
OTHER INCOME 197 95 371 143
OTHER EXPENSE (24) (7) (62) (36)
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES (2,288) 932 (2,448) 679
INCOME TAXES 24 112 76 148
-------- -------- -------- --------
NET INCOME (LOSS) $ (2,312) $ 820 $ (2,524) $ 531
======== ======== ======== ========
NET INCOME (LOSS) PER SHARE:
Basic $ (0.14) $ 0.06 $ (0.16) $ 0.04
Diluted $ (0.14) $ 0.05 $ (0.16) $ 0.03
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 17,076 14,854 15,646 14,858
Diluted 17,076 15,630 15,646 15,274
See accompanying notes which are an integral part of these unaudited
consolidated condensed financial statements
2
INNOVO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(000's except per share data)
(unaudited)
Nine Months Ended
-----------------------
8/30/2003 8/31/2002
--------- ---------
CASH FLOWS (USED IN) PROVIDED BY OPERATING ACTIVITIES $ (7,615) $ 582
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of fixed assets 6 --
Proceeds from Investment 853 --
Redemption of Preferred Shares (368) --
Purchases of Property, Plant & Equipment (530) (387)
--------- ---------
Cash Used in Investing Activities (39) (387)
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury stock (28) (44)
Payments on notes, payables and long term debt (568) (659)
Factor borrowings -- 216
Related party borrowings 500 --
Proceeds from issuance of stock 9,928 --
--------- ---------
Cash provided by (used in) financing activities 9,832 (487)
Effect of exchange rate on cash 10 --
NET CHANGE IN CASH AND CASH EQUIVALENTS 2,188 (292)
CASH AND CASH EQUIVALENTS, at beginning of period 222 292
--------- ---------
CASH AND CASH EQUIVALENTS, at end of period $ 2,410 $ --
========= =========
See accompanying notes which are an integral part of these unaudited
consolidated condensed financial statements
3
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1-BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of only
normal recurring and consolidating adjustments) considered necessary to present
fairly the balance sheets, the results of operations and cash flows for the
period reported. The accompanying unaudited condensed consolidated financial
statements include the financial results of Innovo Group Inc. ("Innovo Group")
and all its wholly-owned subsidiaries (collectively the "Company" or "we"). All
inter-company balances have been eliminated.
These accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and 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 balance
sheet at November 30, 2002 has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements.
While management believes that the disclosures presented are adequate to
make the information not misleading, it is recommended that the condensed
consolidated financial statements and footnotes be read in conjunction with the
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended November 30, 2002. Operating results for the three-
and nine-month period ended August 30, 2003 are not necessarily indicative of
the results that may be expected for the year ended November 29, 2003.
During the quarter ended August 30, 2003, the Company reclassified freight
charges the Company incurs to ship products to its customers from selling,
general, and administrative expenses to cost of goods sold in the statement of
operations for the 2002 period. This reclassification resulted in a 1 percentage
point decrease in the Company's overall gross margin for the third quarter of
2002.
NOTE 2 - INVENTORY
Inventories are stated at the lower of cost, as determined by the
first-in, first-out method, or market. Inventories consisted of the following
(in thousands):
08/30/03 11/30/02
-------- --------
Finished goods $ 5,993 $ 5,741
Work in progress 620 --
Raw materials 812 74
-------- --------
$ 7,425 $ 5,815
Less allowance for obsolescence and slow moving items (488) (105)
-------- --------
$ 6,937 $ 5,710
======== ========
NOTE 3 - LONG-TERM DEBT
A summary of our long-term debt follows (in thousands):
4
First mortgage loan on Springfield property $ 490 $ 558
Promissory note to Azteca (Blue Concepts) 21,800 --
Promissory note to Azteca (Knit Div. Note 1) 647 786
Promissory note to Azteca (Knit Div. Note 2) 1,682 2,043
-------- --------
Total long-term debt $ 24,619 $ 3,387
Less current maturities 802 756
-------- --------
$ 23,817 $ 2,631
======== ========
NOTE 4-- DUE FROM FACTOR AND SHORT TERM DEBT
On or about June 10, 2003, the Company amended its existing financing
facilities, to be effective as of April 11, 2003, with CIT Commercial Services
("CIT"), a unit of CIT Group, Inc. The Company amended the previous credit
facility to remove the fixed aggregate cap of $800,000 on its inventory based
line for Joe's Jeans, Inc. ("Joe's") and Innovo, Inc. ("Innovo"), wholly-owned
subsidiaries of the Company, to allow for the Company to borrow up to 50% of the
value of certain eligible inventory calculated on the basis of the lower of cost
or market, with cost calculated on a first-in-first out basis. As part of the
refinancing, the Company's wholly-owned subsidiary, Innovo Azteca Apparel, Inc.
("IAA") entered into an inventory based line of credit with CIT based on the
same terms as Joe's and Innovo. IAA did not previously have an inventory based
line of credit. Under the factoring arrangements, the Company may borrow up to
85% of the value of eligible factored receivables outstanding. The factoring
rate that the Company pays to CIT to factor accounts, on which CIT bears some or
all of the credit risk, was lowered to 0.4% and the interest rate associated
with borrowings under the inventory lines and factoring facility were reduced to
the Chase prime rate. The Company has also established a letter of credit
facility with CIT whereby the Company can open letters of credit, for 0.125% of
the face value, with international and domestic suppliers provided the Company
has availability on its inventory line of credit. In addition, the Company also
may elect to factor with CIT its receivables by utilizing an adjustment of the
interest rate as set on a case-by-case basis, whereby certain allocation of risk
would be borne by the Company, depending upon the interest rate adjustment. The
Company records its accounts receivables on the balance sheet net of receivables
factored with CIT, since the factoring of receivables is non-recourse to the
Company. . Further, in the event the Company's loan balance with CIT exceeds the
face value of the receivables factored with CIT, the Company records the
difference between the face value of the factored receivables and the
outstanding loan balance as a liability on the Company's balance sheet as "Due
to Factor". The Company's loan balance as of August 30, 2003 with CIT was
$5,757,000 and the Company had $6,649,000 of factored receivables with CIT as of
August 30, 2003. As a result, the Company had no liability with CIT as of August
30, 2003.
NOTE 5 --EARNINGS PER SHARE
A reconciliation of the numerator and denominator of basic earnings (loss)
per share and diluted earnings (loss) per share is as follows (in thousands,
except per share data):
5
Three Months Ended Nine Months Ended
-------------------- --------------------
08/30/03 08/31/02 08/30/03 08/31/02
-------- -------- -------- --------
Basic EPS Computation:
Numerator (2,312) 820 (2,524) 531
Denominator:
Weighted Average Common Shares Outstanding 17,076 14,854 15,646 14,858
-------- -------- -------- --------
Total Shares 17,076 14,854 15,646 14,858
-------- -------- -------- --------
Basic EPS $ (0.14) $ 0.06 $ (0.16) $ 0.04
======== ======== ======== ========
Diluted EPS Calculation:
Numerator (2,312) 820 (2,524) 531
Denominator:
Weighted Average Common Shares Outstanding 17,076 14,854 15,646 14,858
Incremental Shares Outstanding from Assumed
Exercise of Options and Warrants -- 776 -- 416
-------- -------- -------- --------
Total Shares 17,076 15,630 15,646 15,274
-------- -------- -------- --------
Diluted EPS $ (0.14) $ 0.05 $ (0.16) $ 0.03
======== ======== ======== ========
9,991,000 options and warrants were excluded from calculation of diluted EPS at
August 30, 2003 as they either had an exercise price in excess of the average
market price of the Company's common stock during the quarter or their effect
would have been ant
1,095,000 options and warrants at August 31, 2002 were excluded from the
calculation of diluted EPS as their effect would have been anti-dilutive
NOTE 6 - OTHER INCOME AND EXPENSE
Other Income and Expense consists of the following (in thousands):
Three Months Ended Nine Months Ended
------------------ ------------------
8/30/03 8/31/02 8/30/03 8/31/02
------- ------- ------- -------
Rental, real estate, and management fee income $ 93 $ 94 $ 269 $ 126
Unrealized gain on foreign currency 100 -- 74 --
Other Items 4 1 28 17
------- ------- ------- -------
Total Other Income $ 197 $ 95 $ 371 $ 143
======= ======= ======= =======
Rental Expense $ (8) $ (7) $ (52) $ (36)
Other Items (16) -- (10) --
------- ------- ------- -------
Total Other Expense $ (24) $ (7) $ (62) $ (36)
======= ======= ======= =======
6
NOTE 7 - EQUITY ISSUANCES
During the third quarter ended August 30, 2003, the Company consummated
two private placements of its common stock to a limited number of "accredited
investors" pursuant to Rule 506 of Regulation D under the Securities Act of
1933, as amended (the "Securities Act"), resulting in net proceeds of
$9,343,075, after all commissions and expenses (including legal and accounting)
to the Company. The first private placement, completed on July 1, 2003 to 34
accredited investors raised net proceeds of $8,750,922 at $3.33 per share. The
Company issued 2,835,481 shares ("I Shares") as a result of the first private
placement, which resulted in an 18.6% increase in our shares of common stock
immediately outstanding prior to this issuance. Sanders Morris Harris, Inc.
("SMH") acted as the placement agent on a best efforts basis for the first
private placement ("SMH Placement"). In consideration of the services rendered
by SMH, SMH was paid 7% of the gross proceeds, plus expenses, for a total of
$690,929.64, and also received a five year warrant entitling SMH to purchase
300,000 shares of common stock at $4.50 per share which becomes exercisable on
January 1, 2004. The second placement was completed on August 29, 2003, and
raised net proceeds of $591,875 at $3.62 per share. The Company issued 175,000
shares ("II Shares" and together with the I Shares the "I and II Shares") to 5
accredited investors as a result of the second private placement, which resulted
in a 0.9% increase in our shares of common stock immediately outstanding prior
to this issuance. Pacific Summit Securities ("PSS") acted as the placement agent
on a best efforts basis for the second private placement ("PSS Placement"). In
consideration of the services rendered by PSS, PSS was paid 6% of gross
proceeds, plus expenses, for a total of $41,625, and also received a warrant
entitling PSS to purchase 17,500 shares of the Company's common stock at $3.62
per share which becomes exercisable on January 1, 2004. Each of the warrants
issued to SMH and PSS includes a cashless exercise option, pursuant to which the
holder thereof can exercise the warrant without paying the exercise price in
cash. If the holder elects to use this cashless exercise option, it will receive
a fewer number our shares than it would have received if the exercise price were
paid in cash. The number of shares of common stock a holder of the warrant would
receive in connection with a cashless exercise is determined in accordance with
a formula set forth in the applicable warrant. The Company intends to use the
proceeds from the transaction for general corporate purposes.
Each buyer of the I and II Shares represented to the Company that he or
she: (i) purchased the I and II Shares for his or her own account, with the
intention of holding the I and II Shares for investment and not with the
intention of participating, directly or indirectly, in any resale or
distribution of the I and II Shares; and (ii) represented to the Company that he
or she is an "Accredited Investor," as that term is defined in Rule 501(a) of
Regulation D under the Securities Act. The I and II Shares were offered and sold
to the buyers in reliance upon Rule 506 of Regulation D, which provides an
exemption from registration under Section 4(2) of the said Act.
NOTE 8 - ITOCHU LICENSING AND DISTRIBUTION AGREEMENT
On July 1, 2003, Joe's entered into a Master Distribution and Licensing
Agreement ("Distribution and Licensing Agreement") with Itochu Corporation
("Itochu"), a Japanese corporation, pursuant to which Itochu obtained certain
manufacturing, licensing, and distribution rights for apparel and accessory
products using the "Joe's" and "Joe's Jeans" trademarks for a period of 42
months.
The Distribution and Licensing Agreement grants Itochu certain rights with
respect to the manufacture, distribution, sale and/or advertisement of certain
Joe's apparel products ("Joe's Products"), including but not limited (i) a
non-exclusive right to use the Joe's and Joe's Jeans marks in connection with
the manufacture of certain licensed Joe's and Joe's Jeans products ("Licensed
Products") throughout the world, and an exclusive right to use the Joe's and
Joe's Jeans marks to manufacture the Licensed Products in Japan; and (ii) an
exclusive right to import and distribute certain imported Joe's Products
("Imported Products") into Japan. These Imported Products will be purchased
directly from Joe's, with Itochu being obligated to purchase a minimum of $5.75
million of Joe's Products over the term of the Agreement. Additionally, Itochu
shall have the right to develop, produce and distribute certain apparel products
bearing the Joe's and Joe's Jeans marks for which Joe's shall receive a global
royalty payment for each contract year equal to the aggregate amount of 6% of
the net sales of all bottoms for both
7
men and women of the products license, and 5% of the net sales of all tops for
both men and women of the licensed products.
As a part of the transaction, Itochu purchased the existing first quality
inventory of the Company's wholly-owned Japanese subsidiary, Joe's Jeans Japan,
Inc. ("JJJ"), for approximately $1.0 million, assumed the management and
operations of JJJ's showroom in Tokyo and employed certain employees of JJJ.
The Company will continue to operate JJJ until all operations have ceased,
including the fulfillment of existing purchase orders from customers and the
collection of all outstanding accounts receivables. Upon the cessation of all
operating activities, the Company intends to dissolve the JJJ subsidiary.
However, the Company will continue to sell product in Japan through its
licensing and distribution agreement with Itochu.
NOTE 9 - BLUE CONCEPTS ACQUISITION
On July 17, 2003, our subsidiary Innovo Azteca Apparel, Inc. ("IAA")
entered into an asset purchase agreement ("APA") with Azteca Production
International, Inc. ("Azteca"), Hubert Guez ("Hubert Guez") and Paul Guez ("Paul
Guez"), whereby IAA acquired the Blue Concepts division (the "Division") of
Azteca. The Division sells primarily denim jeans to American Eagle Outfitters,
Inc. ("AEO"), a national retailer. Hubert Guez and Paul Guez, substantial
stockholders of the Company, together have a controlling interest in Azteca. As
of October 14, 2003, Hubert Guez, Paul Guez and their affiliates beneficially
own approximately 21% of the Company's common stock on a fully diluted basis.
Pursuant to the terms of the APA, IAA paid $21.8 million for the Division,
subject to adjustment as noted below. Pursuant to the APA, IAA employed all 30
of the existing employees of the Division but did not assume any of the
Division's or Azteca's existing liabilities. The purchase price was paid through
the issuance of a seven-year, partially convertible promissory note (the
"Note"). The Note bears interest at a rate of 6% and requires payment of
interest only during the first 24 months and then is fully amortized over the
remaining five-year period. The terms of the transaction further allow the
Company, upon shareholder approval, to convert a portion of the Note into
3,125,000 shares of Company common stock valued at the greater of $4.00 per
share or the market value of the Company's common stock at the date shareholder
approval is obtained. In the event shareholder approval is obtained, the Note
will be reduced to $9.3 million and the shares issued pursuant to the conversion
will be subject to certain lock-up periods. In the event that sales of the
Division fall below $70 million during the first 17 month period ("Period I")
following the closing of the acquisition, or $65 million during the 12 month
period ("Period II") following Period I, certain terms of the APA allow for a
reduction in the purchase price through a decrease in the principal balance of
the Note and/or the return of certain locked-up shares of the Company's common
stock. In the event the Note is reduced during Period I and the sales of the
Division in Period II are greater than $65 million, the Note shall be increased
by half of the amount greater than $65 million but in no event shall the Note be
increased by an amount greater than the decrease in Period I.
In the event the principal amount of the Note needs to be reduced beyond
the outstanding principal balance of such Note, then an amount of the locked-up
shares equal to the balance of the required reduction shall be returned to the
Company. For these purposes, the locked-up shares shall be valued at $4.00 per
share. Additionally, if during the 12-month period following the closing, AEO is
no longer a customer of IAA, the locked-up shares will be returned to the
Company, and any amount remaining on the balance of the Note will be forgiven.
In the event the revenues of the Division decrease to $35 million or less
during Period I or Period II, IAA shall have the right to sell the purchased
assets back to Azteca, and Azteca shall have the right to buy back the purchased
assets for the remaining balance of the Note and any and all Locked Up Shares
shall be returned to the Company. In addition, IAA will pay to Sweet Sportswear,
LLC, an Azteca affiliate, an amount equal to 2.5% of IAA's revenues generated as
a result of sales to AEO.
As part of the transaction, IAA and AZT International SA de CV, a Mexico
corporation and wholly-owned subsidiary of Azteca ("AZT"), entered into a
two-year, renewable, non-exclusive supply agreement ("Supply Agreement") for
products to be sold by Division. Under the terms of the Supply Agreement, the
Company has agreed to market and sell the products to be purchased from AZT the
Company's customers, more particularly the
8
customers of the Division. In addition to the customary obligations, the Supply
Agreement requires that: (i) the Company shall submit written purchase orders to
AZT on a monthly basis specifying (x) the products to be supplied and (y) a
specified shipping date for products to be shipped; (ii) the Company shall give
AZT reasonable time allowances upon placing its purchase orders with AZT prior
to delivery of the products by AZT; (iii) AZT shall receive payment immediately
upon receipt by the Company of invoices for its purchase orders; (iv) the
Company shall have a guaranteed profit margin of 15% on a "per unit" basis; and
(v) the products to be supplied shall be subject to quality control measures by
the Company and by the customer of the Division.
The results of operations of the Division have been included in the
Company's statement of operations from July 17, 2003.
The following table shows the Company's unaudited pro forma consolidated
results of operations for the three months and nine months ended August 30, 2003
and August 31, 2002 assuming the Blue Concepts acquisition had occurred at the
beginning of the respective fiscal years (in thousands):
Three Months Ended Nine Months Ended
08/30/03 08/31/02 08/30/03 08/31/02
-------- -------- -------- --------
Net revenues $ 28,666 $ 41,277 $ 93,425 $ 74,660
Net income (loss) (1,953) 3,139 (692) 2,897
Earnings (loss) per share:
Basic $ (0.10) $ 0.17 $ (0.04) $ 0.16
Diluted $ (0.10) $ 0.17 $ (0.04) $ 0.15
Management and the board of directors entered into the Blue Concepts
acquisition for the following reasons: (i) the Company was able to enter into an
acquisition with a seller with which the Company has a long-standing
relationship; (ii) the Company was able to acquire a profitable business that
has (x) a financial history of producing conservative profit margins with
significant revenues; (iii) Blue Concepts had a strong customer relationship
with AEO, (iv) the manufacturing relationships with Azteca to produce
effectively and efficiently; and (v) was able to acquire the personnel and
talent of a profitable business. Further, although there can be no assurance,
the Division is expected to increase the Company's revenue growth and is
expected to maintain positive cash flows. In the Third Quarter 2003, the
Division accounted for $5,772,000, or 26% of our net revenue. Furthermore, the
APA protects the Company if revenue expectations are not realized by providing
"downside" protections, such as guaranteed sales minimums, and a buy-sell
provision that allows for the sale of the business if revenues do not reach $35
million.
The Blue Concepts acquisition was accounted for under the purchase method
of accounting. Of the $21,800,000 million purchase price, $10,400,000 was
recorded as an intangible asset representing the value of the customer list,
$700,000 was recorded as an intangible asset representing the value of the
non-compete contained in the APA, $511,000 was recorded as an intangible asset
representing the gross profit of the existing purchase orders at Azteca's Blue
Concepts division at the closing of the acquisition and the balance of the
purchase price was booked as goodwill. The purchase price was allocated to the
various assets purchased at their estimated fair values at the date of
acquisition as follows:
Total preliminary purchase price: $ 21,800,000
Identifiable Intangible Assets:
Value of in-house purchase orders $ 511,432
Customer list $ 10,400,000
Non-compete agreement $ 700,000
------------
Total identifiable intangible assets $ 11,611,432
Goodwill: $ 10,188,568
9
NOTE 10 - INCOME TAXES
The Company's income tax expense for the nine months ended August 31, 2003
and August 31, 2002 represents estimated state and foreign income and franchise
tax expense. The effective tax rate for 2003 differs from the statutory rate
primarily as a result of the accrual for state and foreign taxes and the
recording of a valuation allowance which fully offset the benefit of the losses
for the period. For the 2002 period, the tax rate differs from the statutory
rate as a result of the provision for state and foreign taxes and the use of net
operating losses to offset the federal liability for which no benefit had
previously been recognized.
NOTE 11 - STOCK COMPENSATION
The Company follows the guidance set forth in APB No. 25 as it pertains to
the recording of expenses from the issuance of incentive stock options. The
Company has adopted the disclosure-only provisions of SFAS No. 123. Accordingly,
no compensation expense has been recorded in conjunction with options issued to
employees. Had compensation cost been determined based on the fair value of the
options at the grant date and amortized over the option's vesting period,
consistent with the method prescribed by SFAS No. 123, the Company's net income
(loss) would have been (in thousands except per share information):
3 months ended 9 months ended
---------------------- ----------------------
8/30/03 8/31/02 8/30/03 8/31/02
--------- --------- --------- ---------
Net (loss) income as reported $ (2,312) $ 820 $ (2,524) $ 531
Add:
Stock based compensation expense
included in reported net income,
net of related tax effects 25 14 76 57
Deduct:
Total stock based comployee
compensation expense determined
under fair market value based
method for all awards, net of
related tax effects 97 26 392 114
--------- --------- --------- ---------
Pro forma net (loss) income $ (2,384) $ 808 $ (2,840) $ 474
========= ========= ========= =========
Net (loss) income per share
As reported - basic $ (0.14) $ 0.06 $ (0.16) $ 0.04
As reported - diluted $ (0.14) $ 0.05 $ (0.16) $ 0.03
Pro forma - basic $ (0.16) $ 0.05 $ (0.18) $ 0.03
Pro forma - diluted $ (0.16) $ 0.05 $ (0.18) $ 0.03
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions used
for grants in 2003 and 2002; expected volatility of 47% and 38%; risk-free
interest rate of 5.0% and 6.0% expected lives from one to four years and
expected dividends of 0%. The Black-Scholes model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
10
NOTE 12 - REPORTABLE SEGMENTS
During fiscal 2002 and 2003, the Company operated in two segments,
accessories and apparel. The accessories segment represents the Company's
historical line of business as conducted by Innovo. The apparel segment is
comprised of the operations of Joe's and IAA, both of which began in 2001, as a
result of acquisitions of the license for Joe's and Joe's Jeans from JD Design,
LLC and the Knit division from Azteca. The Company's real estate operations and
corporate activities are categorized under "other". The operating segments have
been classified based upon the nature of their respective operations, customer
base and the nature of the products sold.
The following table sets for certain financial date by segment for the periods
indicated (in thousands):
Three Months Ended
08/30/03 Accessories Apparel Other (A) Total
----------------------------------------------------
(in thousands)
Net Revenues from External Customers $ 4,400 $ 17,506 $ -- $ 21,906
Gross Profit 1,039 2,854 -- 3,893
Depreciation & Amortization 8 689 26 723
Operating Income (Loss) 294 (1,613) (739) (2,058)
Nine Months Ended
08/30/03 Accessories Apparel Other (A) Total
----------------------------------------------------
(in thousands)
Net Revenues from External Customers $ 10,329 $ 35,505 $ -- $ 45,834
Gross Profit 2,632 7,927 -- 10,559
Depreciation & Amortization 21 793 73 887
Operating Income (Loss) 418 (456) (1,950) (1,988)
Total Assets (1,055) 30,810 11,335 41,090
11
Three Months Ended
08/31/02 Accessories Apparel Other (A) Total
----------------------------------------------------
(in thousands)
Net Revenues from External Customers $ 4,890 $ 5,258 $ -- $ 10,148
Gross Profit 1,273 1,971 -- 3,244
Depreciation & Amortization 6 46 10 62
Operating Income (Loss) 374 950 (316) 1,008
Nine Months Ended
08/31/02 Accessories Apparel Other (A) Total
----------------------------------------------------
(in thousands)
Net Revenues from External Customers $ 9,261 $ 10,958 $ -- $ 20,219
Gross Profit 2,489 3,860 -- 6,349
Depreciation & Amortization 15 132 31 178
Operating Income (Loss) 509 1,428 (983) 954
Total Assets 142 8,231 6,022 14,395
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
When used in this Quarterly Report on Form 10-Q, the words "may," "will,"
"except," "anticipate," "intend," "estimate," "continue," "believe" and similar
expressions are intended to identify forward-looking statements. Similarly,
statements that describe our future expectations, objectives and goals or
contain projections of our future results of operations or financial condition
are also forward-looking statements. Statements looking forward in time are
included in this Quarterly Report on Form 10-Q pursuant to the "safe harbor"
provision of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, which could cause
actual results to differ materially, including, without limitation, continued
acceptance of the Company's product, product demand, competition, capital
adequacy and the potential inability to raise additional capital if required,
and the risk factors contained in the Company's reports filed with the
Securities and Exchange Commission pursuant to the Securities Exchange Act of
1934, as amended, including its Annual Report on Form 10-K for the year ended
November 30, 2002. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. Our future
results, performance or achievements could differ materially from those
expressed or implied in these forward-looking statements. The Company does not
undertake and specifically declines any obligation to publicly revise these
forward-looking statements to reflect events or circumstances occurring after
the date hereof or to reflect the occurrence of unanticipated events.
The following discussion provides information and analysis of our results
of operations for the three and nine month periods ended August 30, 2003 and the
three- and nine-month periods ended August 31, 2002, and our liquidity and
capital resources. The following discussion and analysis should be read in
conjunction with our Consolidated Condensed Financial Statements included
elsewhere herein.
We completed our acquisition of the Blue Concepts division from Azteca on
July 17, 2003. The results of operations of the Division are included in our
operating results from the date of acquisition. Accordingly, the financial
position and results of operations presented and discussed herein are not
directly comparable between years. See Management's Discussion and Analysis of
Financial Condition and Results of Operations - Recent Acquisitions and
Licenses" for a further discussion of the Blue Concepts acquisition.
12
General
Results of Operations
The following table sets forth certain statements of operations data for the
years indicated (in thousands):
Three Months Ended
------------------------------------
08/30/03 08/31/02 % Change
-------- -------- --------
Net Revenues $ 21,906 $ 10,148 116%
Cost of Goods Sold 18,013 6,904 161%
-------- -------- --------
Gross Profit 3,893 3,244 20%
Selling, General & Administrative 5,228 2,174 140%
Depreciation & Amortization 723 62 1066%
-------- -------- --------
Income (Loss) from Operations (2,058) 1,008 -304%
Interest Expense (403) (164) 146%
Other Income (Expense) 173 88 97%
-------- -------- --------
Income (Loss) before Income Taxes (2,288) 932 -345%
Income Taxes 24 112 -79%
-------- -------- --------
Net Income (Loss) $ (2,312) $ 820 -382%
Nine Months Ended
------------------------------------
08/30/03 08/31/02 % Change
-------- -------- --------
Net Sales $ 45,834 $ 20,219 127%
Cost of Goods Sold 35,275 13,869 154%
-------- -------- --------
Gross Profit 10,559 6,350 66%
Selling, General & Administrative 11,659 5,218 123%
Depreciation & Amortization 887 178 398%
-------- -------- --------
Income (Loss) from Operations (1,987) 954 -308%
Interest Expense (770) (382) 102%
Other Income (Expense) 309 107 189%
-------- -------- --------
Income (Loss) before Income Taxes (2,448) 679 -461%
Income Taxes 76 148 -49%
-------- -------- --------
Net Income (Loss) $ (2,524) $ 531 -575%
13
Comparison of Three Months Ended August 30, 2003 ("Third Quarter 2003") to Three
Months Ended August 31, 2002 ("Third Quarter 2002")
Overview
We increased our net revenues by $11,758,000, from $10,148,000 during the
Third Quarter 2002 to $21,906,000 during the Third Quarter 2003, or an increase
of 116%. Although we increased our net sales by 116%, we generated a net loss of
$2,312,000 during the Third Quarter 2003 compared to net income of $820,000
during the Third Quarter 2002. The primary reasons for our $2,312,000 net loss
are the following:
o Lower gross margins;
o Increased employee wages of $879,000;
o Advertising, marketing and related costs of $628,000 incurred in
order to market and launch the Shago(R) by Bow Wow and Fetish(R) by
Eve;
o Significant increases in legal, accounting, and other professional
fees and insurance of $264,000; and
o Increase in interest expense of $155,000 and depreciation and
amortization costs of $589,000 associated with the acquisition of
the Blue Concepts division from Azteca Production International,
Inc., an affiliate of the Company.
In connection with our discussion below of the results of our operations
for the Third Quarter 2003 compared to the Third Quarter 2002 below, we
explained in greater detail the reasons for the net loss incurred in the Third
Quarter 2003.
Reportable Segments
Our principle business activity involves the design, development and
worldwide marketing of high quality consumer products for the apparel and
accessory markets. We do not manufacture any apparel or accessory products. See
"Management's Discussion & Analysis--Manufacturing, Warehousing and
Distribution" for further discussion of our outsourcing of such services. We
sell our products to over 1,000 different retail, distributors and private label
customers around the world. Retail customers and distributors purchase finished
goods directly from the Company. Retail customers then sell the products through
their retail stores and distributors sell our products to retailers in the
international market place. Private label customers outsource the production and
sourcing of their private label products to the Company and then sell through
their own distribution channels. Private label customers are generally retail
chains who desire to sell apparel and accessory products under their own brand
name. We work with our private label customers to create their own brand image
by custom designing products. In creating a unique brand, our private label
customers may provide samples to us or may select styles already available in
our showrooms. We believe we have established a reputation among these private
label buyers for the ability to arrange for the manufacture of apparel and
accessory products on a reliable, expeditious and cost-effective basis.
During the Third Quarter 2003 and Third Quarter 2002, the Company operated
in two segments: accessories and apparel. The accessories segment represents our
historical line of business of marketing and designing apparel and craft
products, which is conducted by our wholly-owned subsidiary, Innovo, Inc.
("Innovo"). The apparel segment represents the operations of our two-wholly
owned subsidiaries, Joe's Jeans, Inc. ("Joe's") and Innovo Azteca Apparel, Inc.
("IAA"), both of which are involved in the design, development and marketing of
apparel products. The apparel and accessory operating segments have been
classified based upon the nature of their respective operations, customer base
and the nature of the products sold.
The Company's real estate transactions and its other corporate activities
are categorized under "other" and are represented by the operations of Innovo
Group Inc., the parent company, and its two-wholly owned subsidiaries, Leasall
Management, Inc. ("LMI") and Innovo Realty, Inc. ("IRI"), which conduct the
Company's real estate operations. The Company's real estate operations do not
currently require a substantial allocation of the Company's resources and are
not a significant part of management's daily operational functions.
The following table sets forth certain statements of operations data by
segment for the periods indicated (in thousands):
14
Three Months Ended
08/30/03 Accessories Apparel Other (A) Total
---------------------------------------------
(in thousands)
Net Revenues $ 4,400 $ 17,506 $ -- $ 21,906
Gross Profit 1,039 2,854 -- 3,893
Depreciation & Amortization 8 689 26 723
Interest Expense 70 314 19 403
Three Months Ended
08/31/02 Accessories Apparel Other (A) Total
---------------------------------------------
(in thousands)
Net Revenues $ 4,890 $ 5,258 $ -- $ 10,148
Gross Profit 1,273 1,971 -- 3,244
Depreciation & Amortization 6 46 10 62
Interest Expense 48 98 18 164
Three Months Ended
08/30/03 to 08/31/02 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
-----------------------------------------------------------------------------------------
(in thousands)
Net Revenues $ (490) -10% $12,248 233% $ -- N/A $11,758 116%
Gross Profit (234) (18) 883 45 -- N/A 649 20
Depreciation & Amortization 2 33 643 N/A 16 160 661 N/A
Interest Expense 22 46 216 220 1 6 239 146
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
Net Revenues
Net revenues for the Third Quarter 2003 increased to $21,906,000 from
$10,148,000 for the Third Quarter 2002, or an increase of 116%. The primary
reasons for the increase in our net revenues were due: (i) to increased sales to
our private label customers in both the apparel and accessories segments; (ii)
growth in Joe's and Joe's Jeans branded apparel products; and (iii) growth in
sales of our craft products. Craft products primarily consist of canvas and
denim totebags, canvas adult aprons and children's aprons, and backpacks. These
craft products are part of the major product category in an estimated $12
billion craft industry with items sold through major retailers such as Wal-Mart,
Michael's, AC Moore and Joanne's. Accessory products consist of such items as
handbags, hats and other apparel accessories that accompany and complement the
apparel products.
Accessory
Innovo. The Company's accessory segment had net revenues of $4,400,000 in
the Third Quarter 2003 compared to $4,890,000 in the Third Quarter 2002, or a
10% decrease. The 10% decrease is primarily a result of lower sales of Innovo's
branded accessory products carrying the following brand names: Bongo(R),
Friendship(TM) and Clear Gear(TM). More specifically, in the Third Quarter 2003
gross revenues attributable to Innovo's branded accessory products decreased
from $2,296,000 in the Third Quarter 2002 to $1,890,000, or a decrease of 18%.
The primary reasons for the decrease in the net revenues of Innovo's branded
accessory products was slower sales of junior accessories products to most of
our customers. Most of the reductions, moreover, occurred in sales to department
stores, such as May Co. and Dillard's, and specialty retail customers. Innovo's
gross revenues from its craft business decreased from $1,576,000 in the Third
Quarter 2002 to $1,534,000 in the Third Quarter 2003, or a
15
decrease of 3%. Offsetting a portion the decreases in Innovo's branded accessory
and craft businesses was an increase in Innovo's private label accessory sales.
The private label accessory business of the Company increased from $893,000 in
gross revenue in the Third Quarter 2002 to $1,000,000 in gross revenue in the
Third Quarter 2003, or an increase of 12%. This increase was primarily due to
expanded sales to our private label customers.
Apparel
Joe's. Joe's had net revenues of $3,220,000 during the Third Quarter 2003
compared to $2,515,000 in the Third Quarter 2002, or an increase of 28%. Joe's
net revenues from sales in the United States for the Third Quarter 2003 were
$1,589,000 compared to $1,297,000 in the Third Quarter 2002, or a 23% increase.
The balance of Joe's net revenues from the Third Quarter 2003 of $1,632,000 are
attributable to international sales from Joe's subsidiary, Joe's Jeans Japan,
Inc. ("JJJ") in Japan and sales to international distributors located in Canada,
France, England, Australia and Norway. Joe's international net revenue of
$1,632,000 in the Third Quarter 2003 increased by 34% compared to Joe's
international net revenue of $1,217,000 in the Third Quarter 2002. During the
Third Quarter 2003, the Company sold approximately $1,000,000 of product to
Itochu in connection with the licensing of the "Joe's Jeans" brand in Japan. See
"Management's Discussion & Analysis - Recent Acquisitions and Licenses" for
further discussion regarding the Joe's Jeans licensing agreement. The increase
in both U.S. and international net revenue is attributable to growing brand
awareness of the "Joe's" and "Joe's Jeans" brands, which we believe is a result
of our continued marketing efforts and in the Third Quarter 2003 our marketing
expenses for the products sold by Joe's increased by 99% compared to the Third
Quarter 2002, as we discuss in further detail below. Towards the end of the
Third Quarter 2003, Joe's commenced shipping an expanded collection of products,
which includes not only pants in different materials other than denim, but also
tops such as shirts and jackets.
IAA. IAA segregates its operations between two divisions: private label
and branded products. IAA had net revenues of $14,285,000 during the Third
Quarter 2003 compared to $2,744,000 in the Third Quarter 2002, an increase of
approximately 421%. IAA's significant increase in net revenues is attributable
to a substantial increase in sales by IAA's private label division, including
sales to customers acquired through the Blue Concepts acquisition in July of
2003. Of the $14,285,000 of net revenue, $13,067,000, or 91% was attributable to
IAA's private label division. Roughly half of the growth came from increased
sales to our existing customer base, such as Target under the Mossimo label and
Warnaco, with the remaining growth coming from sales to customers of the Blue
Concepts Division. See Note 9 "Blue Concepts Acquisition" and "Management's
Discussion & Analysis--Recent Acquisitions" for further discussion of the Blue
Concepts acquisition.
IAA's branded division is comprised of three branded product lines:
Shago(R) by Bow Wow, Fetish(R) by Eve and Hot Wheels(R) by Mattel. In the Third
Quarter 2003, IAA's branded division only shipped its Shago(R) apparel product
line. Shago(R) apparel products were shipped to retail department stores and
specialty stores in the United States. We commenced shipping apparel products
under the Fetish(TM) apparel product line in September 2003 to retail department
stores and specialty stores in the United States.
Gross Margin
The Company's gross profit increased from $649,000 to $3,893,000 in the
Third Quarter 2003 from $3,244,000 in the Third Quarter 2002, or a 20% increase.
The increase was due to the increase in net revenues. Gross margin decreased to
18% in the Third Quarter 2003 compared to 32% in the Third Quarter 2002. The
decline was primarily attributable to a higher percentage of our total sales
coming from our private label accessory and apparel products and our craft
products. Our private label accessory and apparel products represented
approximately 51% of our total sales during the Third Quarter 2002 compared to
69% of our total sales during the Third Quarter 2003. Our private label and
craft products provide a lower gross margin compared to our branded products
sold to retailers and distributors. Additionally, during the Third Quarter 2003,
the Company wrote down out of season inventory in the IAA division and second
quality inventory held by JJJ. In aggregate, the reserves lowered the Company's
gross margin by one percentage point.
Accessory
Innovo. Innovo's gross profit decreased by $234,000 to $1,039,000 in the
Third Quarter 2003 from
16
$1,273,000 in the Third Quarter 2002, or an 18% decrease. Innovo's gross margin
is a function of its product mix (private label, crafts and branded accessory
products) for a given period. For the reasons stated above, Innovo's branded
accessory products have traditionally experienced higher gross margins than its
craft and private label accessory products. Innovo's gross margin decreased from
approximately 26% in the Third Quarter 2002 to 24% in the Third Quarter 2003
because of an increase in Innovo's net revenue consisting of sales of its
private label and crafts accessory products. Innovo's private label and craft
accessory product sales represented 57% compared to 52% of gross revenues in the
Third Quarter 2003 and Third Quarter 2002, respectively.
Apparel
Joe's. Joe's gross profit decreased from $721,000 to $712,000 in the Third
Quarter 2003 from $1,433,000 in the Third Quarter 2002, or a 50% decrease. Joe's
gross margins decreased from 57% in the Third Quarter 2002 to 22% in the Third
Quarter 2003. Joe's gross margins decreased primarily because JJJ sold the
majority of its inventory to Itochu Corporation ("Itochu") for approximately
$1,000,000, which approximated the Company's carrying value. The sale of the
inventory by JJJ was in connection with the Master Distribution and Licensing
Agreement entered into between Joe's and Itocho on July 1, 2003. See Note 8
"Itochu Licensing and Distribution Agreement" and "Management's Discussion &
Analysis--Recent Acquisitions" for further discussion of this licensing
arrangement. In addition, during the Third Quarter of 2003, the Company reserved
$143,000 of second quality inventory in Japan. The reserve reduced gross margins
by five percentage points. During the Third Quarter of 2003, the Company
experienced a high level of returns due to production delays, which were caused
partially by internal design delays and late product shipments from third party
suppliers. As a result, Joe's gross margin was reduced by 12 percentage points.
IAA. IAA's gross profit increased by $1,604,000 or 298% to $2,142,000 in
the Third Quarter 2003 from $538,000 in the Third Quarter 2002. Approximately
50% of the gross profit increase is attributable to the acquisition of the Blue
Concepts division on July 17, 2003. IAA's gross margins decreased from 20% in
the Third Quarter 2002 to 15% in the Third Quarter 2003. The decrease is
attributable to lower gross margins associated with sales of apparel products to
American Eagle Outfitters, Inc. ("AEO"). During the Third Quarter 2003, AEO was
IAA's largest customer. In conjunction with the purchase of the Blue Concepts
division, IAA entered into a two-year, renewable supply agreement with the
Azteca whereby IAA has the non-exclusive right to buy goods with a guaranteed
15% gross margin. See Note 9 "Blue Concepts Acquisition" and "Management's
Discussion & Analysis--Recent Acquisitions" for further discussion of the Blue
Concepts Acquisition. IAA also experienced lower gross margins because a higher
percentage of its total sales in the Third Quarter 2003 consisted of second
quality private label apparel products sold to discounters, which typically
carry lower gross margins. Finally, during the Third Quarter 2003, IAA took a
reserve against slow moving inventory which resulted in a one percentage point
decrease in gross margin.
Selling, General and Administrative Expense
The Company incurred selling, general and administrative ("SG&A") expenses
of $5,228,000 in the Third Quarter 2003 compared to $2,174,000 in the Third
Quarter 2002, or an approximately 140% increase. The SG&A increase is largely a
result of (1) an increase in expenditures to establish and market the Company's
branded products, primarily IAA's Shago(R) and Fetish(R) apparel lines, (2) the
hiring of (a) 30 employees as a result of the Blue Concepts acquisition and (b)
other employees to support or facilitate increased sales, and (3) increased
outside legal, accounting and other professional fees as a result of continued
growth of the business during the Third Quarter 2003.
More specifically as discussed in greater detail below, the Company
incurred (1) $628,000 in the Third Quarter 2003 compared to no dollars spent in
the Third Quarter 2002 to establish and market our branded products and (2)
$1,569,000 in the Third Quarter 2003 compared to $690,000 in the Third Quarter
2002, or a 127% increase as result of hiring additional employees and wage
increases and (3) $301,000 in the Third Quarter 2003 compared to $85,000 in the
Third Quarter 2002, or a 254% increase, with respect to increased legal,
accounting and other professional fees.
17
Accessory
Innovo. Innovo's SG&A expenses decreased from $893,000 during the Third
Quarter 2002 to $737,000 in the Third Quarter 2003, or a 17% decrease. Employee
wages increased from $222,000 during the Third Quarter 2002 to $315,000 in the
Third Quarter 2003, or a 42% increase, as a result of hiring additional sales
personnel instead of using outside sales representatives. Wage increases were
offset by lower commission and royalty expenses. Commissions were lower due to a
shift to using in-house sales staff instead of outsourcing sales to sales
representatives, that work for sales commissions. Royalties were lower as a
function of lower sales. Third Quarter 2003 commission expense declined to
$65,000 from $110,000 in the Third Quarter 2002, or a 41% decrease. In addition,
Third Quarter 2003 royalty expense decreased to $32,000 from $147,000 in Third
Quarter 2002, or a 78% decrease. During the Third Quarter 2003, the Company also
did not have expenditures on trade shows, whereas in the Third Quarter 2002 the
Company spent $22,000 on trade shows. In addition, as a result of increased
quality and shipping control, charge-backs decreased from $86,000 during the
Third Quarter 2002 to $3,000 during the Third Quarter 2003, or a decrease of
97%. Charge-backs are expenses the Company incurs as a result of shipping too
little or defective product.
Apparel
Joe's. Joe's SG&A expenses increased from $785,000 during the Third
Quarter 2002 to $1,318,000 during the Third Quarter 2003, or a 68% increase.
During the Third Quarter 2003 Joe's hired additional employees in order to
expand its product lines from denim pants to include a full collection of pants
and tops in various materials. Joe's expensed $400,000 in employee wages during
the Third Quarter 2003 compared to $292,000 in the Third Quarter 2002. Other
employee-related costs, such as insurance, employee training and contract labor
increased 444% to $84,000 in Third Quarter 2003 from $16,000 in Third Quarter
2002. Joe's expensed $142,000 during the Third Quarter 2003 compared to $9,000
in Third Quarter 2002, or an increase of 1,478%, in legal and accounting fees,
the majority of which was attributable to the license arrangement with Itochu.
See "Note 8 - Itochu Licensing and Distribution Agreement" and "Management's
Discussion & Analysis--Recent Acquisitions" for further discussion of the Itochu
licensing arrangements.
Joe's further increased its expenditures on marketing and developing the
Joe's and Joe's Jeans brands. Joe's markets its brands through participation in
trade shows and advertising in national print publications. During the Third
Quarter 2003 Joe's expended $175,000 compared to $92,000 in Third Quarter 2002,
or a 90% increase, in marketing its brands at trade shows and samples, and
advertising. Joe's advertising expenses also increased from $25,000 in the Third
Quarter 2002 to $49,000 in the Third Quarter 2003, or a 96% increase.
IAA. IAA's SG&A increased from $191,000 in the Third Quarter 2002 to
$2,459,000 in the Third Quarter 2003, or a 1,187% increase of which $627,000, or
26%, of SG&A was a result of the expense incurred by IAA to market and promote
its branded products. IAA expended during the Third Quarter 2003: (1) $266,000
advertising expenses for primarily for billboards, photo shoots and national
print publications, such as Vibe, Honey and Women's Wear Daily compared to none
in the Third Quarter 2002 and (2) $362,000 for the semi-annual trade show MAGIC
held in Las Vegas Nevada and related launch expenses for the Fetish(R) apparel
and accessory line and $85,000 for samples of its apparel products compared to
none in the Third Quarter 2002.
During the Third Quarter 2003, IAA had substantially higher employee costs
associated with the expansion primarily of its branded products. Third Quarter
2003 employee wages increased to $642,000 from $94,000 in the Third Quarter
2002, or a 583% increase. Of the $642,000 in total wages, $431,000, or 67% was
associated with employees working in the branded division with the balance
associated with the private label division.
In addition, IAA's factoring expense incurred under its inventory and
receivables based line of credit agreements with CIT Commercial Services
increased as a result of increased sales. Factoring expenses increased from
$54,000 in the Third Quarter 2002 to $124,000 in the Third Quarter 2003, or an
increase of 130%. The Company pays CIT a fee to buy its receivables. During the
Third Quarter of 2003 travel expense increased to $143,000 from $4,000, or
3,475% as a result of the larger employee base. During the Third Quarter of 2003
royalty expense increased to $100,000 versus $0 in the Third Quarter of 2002 as
a result of the launch of Shago and Fetish branded products in Third Quarter
2003.
18
The balance of the approximate $1,500,000 of additional SG&A for the Third
Quarter 2003 is attributable to the growth of our business from IAA having net
revenues of $2,744,000 and seven employees in the Third Quarter 2002 to
$14,285,000 net revenues and 75 employees in 2003.
Other
IGI. IGI, which reflects the corporate expenses of the Company and
operates under the "other" segment, does not have revenues. For the Third
Quarter 2003, IGI's expenses, excluding interest, depreciation and amortization,
increased from $298,000 in Third Quarter 2002 to $688,000, or an approximately
131% increase. IGI's management level wages increased from $57,000 in the Third
Quarter 2002 to $212,000 in the Third Quarter 2003, or a 272% increase,
primarily as a result of hiring additional management level employees including
the Company's new Chief Financial Officer and the Company's new Chief Operating
Officer, in order to provide the infrastructure necessary to handle the
Company's growth. Legal, accounting and professional fees in the Third Quarter
2003 were $158,000 compared to $79,000 in the Second Quarter 2002, as a result
of our activities during the Third Quarter 2003, such as the license agreement
with Itochu. Finally, during the Third Quarter of 2003, with the increasing size
of the Company, insurance expense increased to $74,000 from $29,000 in the Third
Quarter of 2002, or an increase of 155% and investor relations expense increased
to $68,000 in the Third Quarter of 2003 compared to $41,000 in the Third Quarter
of 2002, or an increase of 66%.
LMI. LMI's Third Quarter 2003 SG&A expense increased from $7,000 in the
Third Quarter 2002 to $26,000, or an increase of 271%, primarily due to $22,000
of expenses incurred to maintain and operate the Company's former manufacturing
facility and headquarters located in Springfield, TN, which is now partially
leased to third party tenants. The balance of the $4,000 was spent by LMI on
Tennessee property taxes.
IRI. During the Third Quarters of 2002 and 2003, IRI did not have any SG&A
expense.
Depreciation and Amortization Expenses
Depreciation and amortization expenses for the Company increased from
$62,000 in the Third Quarter 2002 to $723,000 in the Third Quarter 2003, or a
1,066% increase. The increase is primarily attributable to (1) the depreciation
and amortization associated with the purchase of the Blue Concepts division and
(2) and the purchase of a booth for the tradeshow MAGIC. More specifically, in
connection with the Blue Concepts acquisition in Third Quarter 2003, the Company
amortized $589,000 of the intangible assets based upon the fair value of (a) the
majority of the gross profit associated with existing purchase orders at
closing, (b) the non-compete provisions contained in the asset purchase
agreement for the purchase of Blue Concepts and (c) the intangible value of the
customer list obtained. The Company also depreciated $50,000 of the expense
related to the purchase of the booth for the MAGIC tradeshow. The remaining
depreciation and amortization expense of $84,000 is due to (i) deprecation of
$19,000 in connection with the Springfield, TN facility and related leasehold
improvements, (ii) amortization of $12,000 in connection with the licensing
rights to the Joe's Jeans trademarks acquired on February 7, 2001, (iii)
amortization of $30,000 from the purchase of the Knit Division from Azteca on
August 24, 2001, and (iv) depreciation of $23,000 related to small operational
assets such as furniture, fixtures, machinery and software.
Interest Expense
The Company's combined interest expense for the Third Quarter 2003 was
$403,000 compared to $164,000 for the Third Quarter 2002, or a 146% increase.
The Company's interest expense is primarily associated with: (i) $181,000 of
interest expense from our factoring and inventory lines of credit from CIT
Commercial Services, Inc. ("CIT") used to help support our working capital
increases; (ii) $48,000 of interest expense from the knit acquisition purchase
notes totaling $3,600,000 issued in connection with the purchase of the knit
division from Azteca Productions Int'l; (iii) $10,000 of interest expense from
two loans of $250,000 each provided by Marc Crossman, the Company's Chief
Financial Officer, to the Company on February 7, 2003 and February 13, 2003;
(iv) $9,000 of interest expense from a $490,000 mortgage on the Company's former
manufacturing facility and headquarters in Springfield, TN; and (v) $155,000 of
interest expense incurred as a result of the $21,800,000 convertible note issued
as a part of the purchase of the Blue Concepts acquisition. See "Management's
Discussion
19
and Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources" for a further discussion of these financing arrangements.
Other Income
The Company had other income net of other expenses of $173,000 in the
Third Quarter 2003 compared to other income net of other expenses of $88,000 in
Third Quarter 2002, representing an increase of 97%.
IRI. Other income for the Third Quarter 2003, includes $85,000 of income
from a quarterly sub-asset management fee that IRI receives pursuant to a
sub-asset management agreement entered into on April 5, 2002 ("Sub-Asset
Management Agreement") in connection with the acquisition by IRI of a 30%
limited partnership interest in 22 separate limited partnerships, which acquired
28 apartment complexes at various locations throughout the United States
("Limited Partnership Real Estate Acquisition"). Part of the consideration
accepted by the sellers in the Limited Partnership Real Estate Acquisition was
195,000 shares of the Company's $100 Redeemable 8% Cumulative Preferred Stock,
Series A (the "Series A Preferred Stock"). The Company is not entitled to any
cash flow or proceeds from the sales of the properties until all shares of the
Series A Preferred Stock have been redeemed. Until such time, the Company only
receives the quarterly sub-asset management fee. In the Third Quarter 2002, IRI
generated $88,000 of income from the sub-asset management fee.
Joe's and LMI. Additionally, the Company had $104,000 of other income from
Joe's during the Third Quarter 2003 versus no other income in the Third Quarter
2002. The vast majority of Joe's other income was unrealized Japanese currency
translation income of $100,000. Offsetting a portion of other income was net
rental expenses of $9,000 from tenants who are occupying the Company's former
manufacturing facility located in Springfield, TN.
Net Income
The Company generated a net loss of $2,312,000 for the Third Quarter 2003
compared to net income of $820,000 for the Third Quarter 2002. The net loss for
the Third Quarter 2003 versus net income for the Third Quarter 2002 is largely
the result of (1) lower gross margins; (2) increased employee wages of $879,000;
(2) increased advertising, marketing and related costs of $628,000 incurred in
order to market and launch the Shago(R) by Bow Wow and Fetish(R) by Eve brands;
(3) significant increases in legal, accounting, and other professional fees and
insurance of $264,000; (4) an increase in interest expense of $155,000 and
depreciation and amortization costs of $589,000 associated with the acquisition
of the Blue Concepts division from Azteca Production International, Inc., an
affiliate of the Company during the Third Quarter 2003 as discussed in greater
detail above.
Comparison of Nine Months Ended August 30, 2003 to Nine Months Ended August 31,
2002
Overview
We increased our net sales by $25,615,000 from $20,219,000 during the
first nine months of 2002 to $45,834,000 during the first nine months of fiscal
2003, or an increase of 127%. Although we increased our net sales by 127%, we
generated a net loss of $2,524,000 during the first nine months of 2003 compared
to net income of $531,000 during the first nine months of 2002. The primary
reasons for our $2,524,000 net loss are due to the following factors:
o Lower gross margins;
o Increased employee wages of $1,921,000;
o Advertising, marketing and related costs of $759,000 incurred in
order to market and launch the Shago(R) by Bow Wow and Fetish(R) by
Eve;
o Significant increases in legal, accounting, and other professional
fees and insurance of $733,000; and
20
o Increase in interest expense of $155,000 and depreciation and
amortization costs of $589,000 associated with the acquisition of
the Blue Concepts division from Azteca Production International,
Inc., an affiliate of the Company.
In connection with our discussion of the results of our operations for the
first nine months of fiscal 2003 compared to the first nine months of fiscal
2002 below, we have explained in greater detail the reasons for the net loss
incurred in the first nine months of fiscal 2003.
Reportable Segments
See "Management's Discussion & Analysis - Comparison of Three Months Ended
August 30, 2003 ("Third Quarter 2003") to Three Months Ended August 31, 2002
("Third Quarter 2002")" for further discussion regarding the Company's
Reportable Segments.
The following table sets forth certain statement of operations data by
segment for the periods indicated (in thousands):
Nine Months Ended
08/30/03 Accessories Apparel Other (A) Total
---------------------------------------------
(in thousands)
Net Revenues $ 10,329 $ 35,505 $ -- $ 45,834
Gross Profit 2,632 7,927 -- 10,559
Depreciation & Amortization 21 793 73 887
Interest Expense 166 564 40 770
Nine Months Ended
08/31/02 Accessories Apparel Other (A) Total
---------------------------------------------
(in thousands)
Net Revenues $ 9,261 $ 10,958 $ -- $ 20,219
Gross Profit 2,489 3,860 1 6,350
Depreciation & Amortization 15 132 31 178
Interest Expense 84 248 50 382
Nine Months Ended
08/30/03 to 08/31/02 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
------------------------------------------------------------------------------------------
(in thousands)
Net Revenues $ 1,068 12% $24,547 224% $ -- N/A $25,615 127%
Gross Profit 143 6 4,067 105 (1) N/A 4,209 66
Depreciation & Amortization 6 40 661 N/A 42 135 709 398
Interest Expense 82 98 316 127 (10) (20) 388 102
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
Net Revenues
Net revenues for the nine months ended August 30, 3003 increased to
$45,834,000 from $20,219,000 for the nine months ended August 31, 3002, or an
increase of 127%. The primary reasons for the increase in our net revenues were
due: (i) to increased sales to our private label customers in both the apparel
and accessories segments; (ii) growth in Joe's and Joe's Jeans branded apparel
products; and (iii) growth in sales of our craft products. Craft products
primarily consist of canvas and denim totebags, canvas adult aprons and
children's aprons, and backpacks. These craft products are part of the major
product category in an estimated $12 billion craft industry with items sold
through major retailers such as Wal-Mart, Michael's, AC Moore and Joanne's.
Accessory products consist of such items as handbags, hats and other apparel
accessories that accompany and complement the apparel products.
21
Accessory
Innovo. The Company's accessory segment had net revenues of $10,329,000 in
the first nine months of fiscal 2003 compared to $9,261,000 in the first nine
months of fiscal 2002, or a 12% increase. The 12% increase is primarily a result
of increased sales of its private label accessory products. More specifically,
gross sales to private label customers increased 104% from $1,636,000 in the
first nine months of fiscal 2002 to $3,339,000 in the first nine months of
fiscal 2003. Innovo's gross revenue from its craft business was up 10% from
$3,791,000 in the first nine months of 2002 to $4,166,000 in the first nine
months of fiscal 2003. This increase was a result of demand from the vast
majority of our traditional craft customers. In the first nine months of fiscal
2003 gross sales of branded accessory product decreased by 20% to $2,782,000
versus the year ago period. The primary reasons for the decrease in the gross
revenues of Innovo's branded accessory products was a reduction in: (i) our
customer's buying plans; (ii) slower sales of junior accessories to most of our
customers, which occurred primarily in sales to department stores, such as May
Co. and Dillards, and specialty retail customers.
Apparel
Joe's. Joe's had net revenues of $7,986,000 during the first nine months
of fiscal 2003 compared to $5,957,000 in the first nine months of fiscal 2002,
or an increase of 34%. Joe's net revenues from sales in the United States for
the First nine months of fiscal 2003 were $4,476,000 compared to $3,383,000 in
the First nine months of fiscal 2002, or a 32% increase. The balance of Joe's
net revenues from the First nine months of fiscal 2003 of $3,511,000 are
attributable to international sales from Joe's subsidiary, Joe's Jeans Japan,
Inc. ("JJJ") in Japan and sales to international distributors located in Canada,
France, England, Australia and Norway. Joe's international net revenue of
$3,511,000 in the first nine months of fiscal 2003 increased by 36% compared to
Joe's international net revenue of $2,574,000 in the first nine months of fiscal
2002. The increase in both U.S. and international net revenue is attributable to
growing brand awareness of the "Joe's" and "Joe's Jeans" brands, which we
believe is a result of our continued marketing efforts. In addition,
international revenues benefited from the sale of the majority of it first
quality inventory in Joe's subsidiary Jeans Japan, Inc. to Itochu for
approximately $1,000,000 pursuant to the licensing and distribution agreement
with Itochu. In the first nine months of fiscal 2003 our marketing expenses for
the products sold by Joe's increased by 160% compared to the First nine months
of fiscal 2002, as we discuss in further detail below. Towards the end of the
first nine months of fiscal of 2003, Joe's commenced shipping an expanded
collection, which includes not only pants in different fabrications other than
denim, but also tops such as shirts and jackets.
IAA. IAA segregates its operations between two divisions: private label
and branded products. IAA generated net revenues of $27,519,000 during the First
nine months of fiscal 2003 compared to $5,000,000 in the First nine months of
fiscal 2002, an increase of approximately 450%. IAA's significant increase in
net revenues is attributable to a substantial increase in sales by IAA's private
label division. Of the $27,519,000 of net revenue, $26,235,000, or 95% was
attributable to IAA's private label division. The increase is a result of sales
from the Blue Concepts acquisition and increased sales to Target under the
Mossimo label. See Note 9 "Blue Concepts Acquisition" and "Management's
Discussion & Analysis--Recent Acquisitions" for further discussion of the Blue
Concepts acquisition.
IAA's branded division is comprised of three branded product lines:
Shago(R) by Bow Wow, Fetish(R) by Eve and Hot Wheels(R) by Mattel. Is all of the
net revenue attributable to Shago(R). During the first nine months of fiscal
2003, IAA's branded division only shipped its Shago(R) apparel product line.
Shago(R) apparel products were shipped to retail department stores and clothing
boutiques in the United States. We commenced shipping apparel products under the
Fetish(R) apparel product line in September 2003 to retail department stores and
clothing boutiques in the United States. Although we can provide no assurance,
we expect to begin shipping apparel products under the Hot Wheels(R) licensed
brand during the First Quarter of 2004.
Gross Margin
The Company's gross profit increased by $4,209,000 to $10,558,000 in the
first nine months of fiscal 2003 from $6,349,000 in the first nine months of
fiscal 2002, an increase of 66%. The Company's gross margin decreased
22
to 23% in the first nine months of fiscal 2003 compared to 31% in the first nine
months of fiscal 2002. The decline was primarily attributable to a higher
percentage of our total sales coming from our private label accessory and
apparel products and our craft products. Our private label accessory and apparel
products represented approximately 51% of our total sales during the first nine
months of fiscal 2002 compared to 71% of our total sales during the first nine
months of fiscal 2003. Our private label apparel and accessory and craft
products provide a lower gross margin compared to our branded products sold to
retailers and distributors. Additionally, during the First nine months of fiscal
2003, the Company wrote down out of season inventory in the IAA division and
second quality inventory in the Joe's division. In aggregate, the reserves
lowered the Company's gross margin by one percentage point.
Accessory
Innovo. Innovo's gross profit increased by $143,000 to $2,632,000 in the
first nine months of fiscal 2003 from $2,489,000 in the first nine months of
fiscal 2002, a increase of 6%. Innovo's gross margin is a function of its
product mix (private label, crafts and branded accessory products) for a given
period. For the reasons stated above, Innovo's branded accessory products have
traditionally experienced higher gross margins than its craft and private label
accessory products. Innovo's gross margin decreased from approximately 27% in
the first nine months of fiscal 2002 to 25% in the first nine months of fiscal
2003 because of an increase in Innovo's net revenue consisting of sales of its
private label and crafts accessory products. Innovo's private label and craft
accessory product sales represented 73% compared to 60% of gross revenues in the
first nine months of fiscal 2003 and first nine months of fiscal 2002,
respectively.
Apparel
Joe's. Joe's gross profit increased by $504,000 to $3,386,000 in the first
nine months of fiscal 2003 from $2,882,000 in the First nine months of fiscal
2002, an increase of 17%. Joe's gross margins decreased from 48% in the first
nine months of fiscal 2002 to 42% in the First nine months of fiscal 2003. Joe's
gross margins decreased primarily because JJJ sold the majority of its inventory
to Itochu Corporation ("Itochu") for approximately $1,000,000, which
approximated the Company's carrying value. The sale of the inventory by JJJ was
in connection with the Master Distribution and Licensing Agreement entered into
between Joe's and Itocho on July 1, 2003. See Note 7 "Equity Issuance" and
"Management's Discussion & Analysis--Recent Acquisitions" for further discussion
of this licensing arrangement. In addition, during the first nine months of
fiscal of 2003, the Company took a reserve of $143,000 against second quality
inventory in Japan. The reserve reduced gross margins by two percentage points.
During the first nine months of fiscal of 2003, the Company experienced a high
level of returns due to late shipments which were caused partially by internal
design delays and late product shipments from third party suppliers. As a result
of the returns, Joe's gross margin was reduced by 10 percentage points.
IAA. IAA's gross profit increased by $3,562,000 to $4,540,000 in the first
nine months of fiscal 2003 from $978,000 in the first nine months of fiscal
2002, an increase of 364%. IAA's gross margins decreased from 20% in the first
nine months of fiscal 2002 to 16% in the first nine months of fiscal 2003. The
decrease is attributable to lower gross margins associated with sales of apparel
products to American Eagle Outfitters, Inc. ("AEO"). For the first nine months
of fiscal 2003, AEO was IAA's third largest customer. In conjunction with the
purchase of the Blue Concepts division, IAA entered into a two-year, renewable
supply agreement with the Azteca whereby IAA has the non-exclusive right to buy
goods with a guaranteed 15% gross margin. See Note 9 "Blue Concepts Acquisition"
and "Management's Discussion & Analysis--Recent Acquisitions" for further
discussion of the Blue Concepts Acquisition. IAA also experienced lower gross
margins because a higher percentage of its total sales in the First nine months
of fiscal 2003 consisted of second quality private label apparel products sold
to discounters, which typically carry lower gross margins. Finally, during the
first nine months of fiscal 2003, IAA took a reserve against slow moving
inventory which had the effect of reducing gross margins by one percentage
point.
Selling, General and Administrative Expense
The Company incurred selling, general and administrative ("SG&A") expenses
of $11,658,000 in the first nine months of fiscal 2003 compared to $5,216,000 in
the first nine months of fiscal 2002, or an approximately 124% increase. The
SG&A increase is largely a result of (1) an increase in expenditures to
establish and market our branded products, primarily IAA's Shago(R) and
Fetish(R) apparel lines, (2) the hiring of (a) 30 employees as a result
23
of the Blue Concepts acquisition and (b) employees to support the increased
sales of Innovo, IAA and Joe's, and (3) increased outside legal, accounting and
other professional fees as a result of continued growth of the business during
the first nine months of fiscal 2003.
More specifically as discussed in greater detail below, the Company spent
(1) $759,000 in the first nine months of fiscal 2003 compared to no dollars
spent in the first nine months of fiscal 2002 to establish and market our
branded products and (2) $3,615,000 in the first nine months of fiscal 2003
compared to $1,695,000 in the first nine months of fiscal 2002, or a 113%
increase as result of hiring additional employees and wage increases (3)
$950,000 in the first nine months of fiscal 2003 compared to $308,000 in the
first nine months of fiscal 2002, or a 208% increase, with respect to increased
legal, accounting and other professional fees.
Accessory
Innovo. Innovo's SG&A expenses increased from $1,966,000 during the First
nine months of fiscal 2002 to $2,192,000 in the First nine months of fiscal
2003, or a 11% increase. Employee wages increased from $577,000 during the first
nine months of fiscal 2002 to $902,000 in the first nine months of fiscal 2003,
or a 56% increase, as a result of hiring additional sales personnel instead of
using outside sales representatives. Wage expense increases were offset by lower
commission and royalty expenses. Commission expense was lower due to a shift to
using in-house sales staff instead of outsourcing sales to sales
representatives, which work for sales commissions. During the first nine months
of fiscal 2003 commission expense declined to $131,000 from $227,000 in the
First nine months of fiscal 2002, or a 42% decrease.
Apparel
Joe's. Joe's SG&A expenses increased from $1,831,000 during the first nine
months of fiscal 2002 to $3,950,000 during the First nine months of fiscal 2003,
or a 116% increase, primarily as a result of: (i) increased hiring of employees
in order to expand its product lines from denim pants to include a full
collection of pants and tops in various materials; (ii) and severance payments
and professional fees incurred in connection with the licensing arrangements
with Itochu. Joe's paid $274,000 in severance to certain employees in Japan in
connection with the Itochu Licensing and Distribution Agreement compared to $0
paid in the first nine months of fiscal 2002. Joe's paid $294,000 during the
First nine months of fiscal 2003 compared to $26,000 in first nine months of
fiscal 2002, or an increase of 1,031%, in legal and accounting fees, the vast
majority of which was attributable to the license arrangements with Itochu.
Joe's paid $1,191,000 in employee wages during the first nine months of fiscal
2003 compared to $592,000 in the first nine months of fiscal 2002, or an
increase of 101%.. See "Note 8 - Itochu Licensing and Distribution Agreement"
and "Management's Discussion & Analysis--Recent Acquisitions" for further
discussion of the Itochu licensing arrangements.
Joe's further increased its expenditures on marketing and developing the
Joe's and Joe's Jeans brands. Joe's markets its brands through participation in
trade shows and advertising in national print publications. During the first
nine months of fiscal 2003 Joe's spent $221,000 compared to $125,000 in first
nine months of fiscal 2002, or a 77% increase, in marketing its brands at trade
shows. Joe's advertising expenses also increased from $102,000 in the first nine
months of fiscal 2002 to $266,000 in the first nine months of fiscal 2003, or a
161% increase. Joe's sample expenses that it incurs to develop its products also
increased from $55,000 in the first nine months of fiscal 2002 to $183,000 in
the first nine months of fiscal 2003, or a 233% increase.
IAA. IAA's SG&A increased from $468,000 in the first nine months of fiscal
2002 to $3,639,000 in the First nine months of fiscal 2003, or a 678% increase.
$759,000 or 21% of the SG&A increase is a result of the expense incurred by IAA
to market and promote its branded products. IAA spent during the first nine
months of fiscal 2003: (1) $301,000 on advertising expenses primarily for
billboards, photo shoots and national print publications, such as Vibe, Honey
and Women's Wear Daily compared to $0 in the first nine months of fiscal 2002
and (2) $458,000 for the semi-annual trade show MAGIC held in Las Vegas Nevada
and related launch expenses for the Fetish(R) apparel and accessory line and (3)
$125,000 for samples of its apparel products compared to $2,000 in the first
nine months of fiscal 2002.
During the first nine months of fiscal 2003, IAA had substantially higher
employee costs primarily
24
associated with the expansion of its branded products and with employees
acquired in connection with the acquisition of Blue Concepts. During the first
nine months of fiscal 2003 employee wages increased to $1,030,000 from $352,000
in the First nine months of fiscal 2002, or a 193% increase.
In addition, IAA factoring expense incurred under its inventory and
receivables based line of credit agreements with CIT Commercial Services
increased as a result of increased sales. Factoring expenses increased from
$75,000 in the first nine months of fiscal 2002 to $288,000 in the first nine
months of fiscal 2003, or an increase of 284%. The Company pays CIT a fee to buy
its receivables. During the first nine months of fiscal of 2003 travel expense
increased to $249,000 from $13,000, or 1,815% as a result of the larger employee
base. During the first nine months of fiscal of 2003 royalty expense increased
to $160,000 versus $0 in the first nine months of fiscal of 2002 as a result of
the launch of its branded products in 2003.
Other
IGI. IGI, which reflects the corporate expenses of the Company and
operates under the "other" segment does not have revenues. For the first nine
months of fiscal 2003, IGI's expenses, excluding interest, depreciation and
amortization, increased from $907,000 in first nine months of fiscal 2002 to
$1,826,000, or a 101% increase. IGI's wages increased from $173,000 in the first
nine months of fiscal 2002 to $492,000 in the first nine months of fiscal 2003,
or a 184% increase. During the first nine months of fiscal 2003 the Company
hired additional management level employees, including the Company's new Chief
Financial Officer and the Company's new Chief Operating Officer, in order to
provide the infrastructure necessary to handle the Company's growth. Legal,
accounting and professional fees in the first nine months of fiscal 2003 were
$611,000 compared to $235,000 in the first nine months of fiscal 2002, or an
increase of 160%, as a result of the growing size of the company. Also a result
of the increasing size of the company, insurance expense increased to $184,000
in the first nine months of fiscal 2003 from $98,000 in the first nine months of
fiscal of 2002, or an increase of 88%.
LMI. LMI's first nine months of fiscal 2003 SG&A expense increased from
$19,000 in the first nine months of fiscal 2002 to $45,000, or an increase of
137%, primarily due $30,000 of expenses incurred to maintain and operate the
Company's former manufacturing facility and headquarters located in Springfield,
TN, which is now partially leased to third party tenants. The balance of $15,000
was spent by LMI on miscellaneous expenses and Tennessee property taxes.
IRI. During the first nine months of fiscals of 2003, IRI's SG&A expense
decreased to $7,000 from $25,000 during the first nine months of fiscal 2002, or
a decrease of 72%. The majority of IRI's SG&A expense in both periods was
primarily legal and accounting fees.
Depreciation and Amortization Expenses
Depreciation and amortization expenses for the Company increased from
$178,000 in the First nine months of fiscal 2002 to $887,000 in the First nine
months of fiscal 2003, or a 398% increase. The increase is primarily
attributable to (1) the depreciation and amortization associated with the
purchase of the Blue Concepts division and (2) and the purchase of a booth for
the tradeshow MAGIC. More specifically, in connection with the Blue Concepts
acquisition in first nine months of fiscal 2003, the Company amortized $589,000
for amortization of the intangible assets based upon the fair value of (a) the
majority of the gross profit associated with existing purchase orders at
closing, (b) the non-compete provisions contained in the asset purchase
agreement for the purchase of Blue Concepts and (c) the intangible value of the
customer list obtained. The Company also depreciated $50,000 of the expense
related to the purchase of the booth for the MAGIC tradeshow. The remaining
depreciation and amortization expense of $248,000 is due to (i) deprecation of
$56,000 in connection with the Springfield, TN facility and related leasehold
improvements, (ii) amortization of $36,000 in connection with the licensing
rights to the Joe's Jeans trademarks acquired on February 7, 2001(iii)
amortization of $90,000 from the purchase of the Knit Division from Azteca on
August 24, 2001, and (iv) depreciation of $66,000 related to small operational
assets such as furniture, fixtures, machinery and software.
25
Interest Expense
The Company's combined interest expense for the first nine months of
fiscal 2003 was $770,000 compared to $382,000 for the First nine months of
fiscal 2002, an increase of 102%. The Company's interest expense is primarily
associated with (1) $420,000 of interest expense from our factoring and
inventory lines of credit from CIT Commercial Services, Inc. ("CIT") used to
help support our working capital increases, (2) $154,000 of interest expense
from the knit acquisition purchase notes totaling $3,600,000 issued in
connection with the purchase of the knit division from Azteca Productions Int'l,
(3) $20,000 of interest expense from two loans of $250,000 each provided by Marc
Crossman, the Company's Chief Financial Officer, to the Company on February 7,
2003 and February 13, 2003, (4) $21,000 of interest expense from a $490,000
mortgage on the Company's former manufacturing facility and headquarters in
Springfield, TN, and (5) $155,000 of interest expense incurred as a result of
the $21,800,000 convertible note issued as a part of the purchase of the Blue
Concepts acquisition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" for a
further discussion of these financing arrangements.
Other Income
The Company had other income net of other expenses of $309,000 in the
First nine months of fiscal 2003 compared to other income net of other expenses
of $107,000 in First nine months of fiscal 2002, representing an increase of
189%.
IRI. Other income for the first nine months of fiscal 2003, includes
$244,000 of income from a sub-asset management fee that IRI receives pursuant to
a sub-asset management agreement entered into on April 5, 2002 ("Sub-Asset
Management Agreement") in connection with the acquisition by IRI of a 30%
limited partnership interest in 22 separate limited partnerships, which acquired
28 apartment complexes at various locations throughout the United States
("Limited Partnership Real Estate Acquisition"). Part of the consideration
accepted by the sellers in the Limited Partnership Real Estate Acquisition was
195,000 shares of the Company's $100 Redeemable 8% Cumulative Preferred Stock,
Series A (the "Series A Preferred Stock"). The Company is not entitled to any
cash flow or proceeds from the sales of the properties until all shares of the
Series A Preferred Stock have been redeemed. Until such time, the Company only
receives the quarterly sub-asset management fee. In the first nine months of
fiscal 2002, IRI generated $88,000 of income from the sub-asset management fee.
Joe's and LMI. Additionally, the Company had $81,000 of other income from
Joe's during the first nine months of fiscal 2003 versus $0 other income in the
First nine months of fiscal 2002. The vast majority of Joe's other income was
unrealized Japanese currency translation income of $74,000. Offsetting a portion
of other income was rental expense, net of rental income, of $27,000 from
tenants who are occupying the Company's former manufacturing facility located in
Springfield, TN.
Net Income
The Company generated a net loss of $2,524,000 for the First nine months
of fiscal 2003 compared to net income of $531,000 for the First nine months of
fiscal 2002. The net loss for the First nine months of fiscal 2003 versus net
income for the First nine months of fiscal 2002 is largely the result of (1)
lower gross margins; (2) increased employee wages of $1,921,000; (2) increased
advertising, marketing and related costs of $759,000 incurred in order to market
and launch the Shago(R) by Bow Wow and Fetish(R) by Eve brands; (3) significant
increases in legal, accounting, and other professional fees and insurance of
$733,000; (4) an increase in interest expense of $155,000 and depreciation and
amortization costs of $589,000 associated with the acquisition of the Blue
Concepts division from Azteca Production International, Inc., an affiliate of
the Company during the First nine months of fiscal 2003 as discussed in greater
detail above.
Liquidity and Capital Resources
The Company's primary sources of liquidity are cash flows from operations,
trade payables credit from vendors and related parties and borrowings from the
factoring of accounts receivables and borrowing against inventory.
26
Cash used for operating activities during the nine months ended August 30,
2003 was $7,615,000 compared to cash provided by operating activities of
$582,000 during the nine months ended August 31, 2002. During the period, the
Company used cash to purchase inventory, reduce related party payables and fund
operating expenses. Cash used in operating activities combined with cash used in
investing activities and repayment of debt was offset by cash generated through
a related party borrowing of $500,000 and the proceeds from four equity
issuances providing net proceeds of $9,906,213. During the period, the Company
generated $2,188,000 of cash versus a use of cash of $292,000 in the year ago
period.
The Company is dependent on credit arrangements with suppliers and
factoring and inventory based lines of credit agreements for working capital
needs. From time to time, the Company has obtained short-term working capital
loans from senior members of management and from members of the Board of
Directors, and conducted equity financing through private placements.
The Company relied on the following primary sources to fund operations
during the Third Quarter 2003:
- A financing and inventory based line of credit agreements with CIT
Commercial Services, a unit of CIT Group, Inc. ("CIT")
- Cash balances
- Trade payables credit with its domestic and international suppliers
- Trade payables credit from related parties
- Two equity financings through private placements
On June 1, 2001, the Company, through its three main operating
subsidiaries, Joe's, Innovo, and IAA, entered into a financing agreement with
CIT for the factoring of the Company's accounts receivables. Pursuant to the
terms of the agreements the Company, at its option, can sell its accounts
receivables to CIT for factoring and then borrow up to 85% of the amount CIT
factors against the receivables on a non-recourse basis, provided that CIT
approves such accounts receivable in advance. The Company may at its option also
factor non-approved receivables on a recourse basis. The Company continues to be
obligated in the event of product defects and other disputes, unrelated to the
credit worthiness of the customer. The agreements called for a 0.8% factoring
fee on accounts factored with CIT and a per annum interest rate equal to the
greater of the Chase prime rate plus 0.25% on funds borrowed against the
factored receivables or 6% per annum.
In August 2002, Joe's and Innovo entered into inventory and security
agreements with CIT which establised inventory based lines of credit for Joe's
and Innovo. According to the terms of the inventory security agreements, amounts
loaned against certain eligible inventory were to bear an interest rate equal to
the greater of the Chase prime rate plus 25% or 6.0% per annum. Under these
agreements, the Company was restricted in regards to how much CIT will loan
against the inventory. The restrictions limited the amount Joe's and Innovo
could borrow against its inventory at $400,000 for each subsidiary.
On or about June 10, 2003, the Company amended its existing financing
facilities, to be effective as of April 11, 2003, with CIT Commercial Services
("CIT"), a unit of CIT Group, Inc. The Company amended the original inventory
service agreements by removing the fixed caps on its inventory based line for
Joe's and Innovo thereon allowing the Company to borrow up to 50% of the value
of certain eligible inventory calculated on the basis of the lower of cost or
market, with cost calculated on a first-in-first out basis. As part of the
refinancing, the Company's IAA subsidiary agreement entered into an inventory
based line of credit with CIT based on the same terms as the amended agreements
between CIT and Joe's and Innovo because IAA did not previously have an
inventory based line of credit. With respect to all the factoring agreements
between the Company and CIT, the factoring rate that the Company pays to CIT for
factoring accounts receivable on which the Company bears some or all of the
credit risk was lowered to 0.4% and the interest rate associated with borrowings
both under the inventory lines and factored accounts receivable were reduced to
the Chase prime rate. The Company has also established a letter of credit
facility with CIT.
Based on the Company's anticipated internal growth in 2003, the Company
believes that it has the working capital resources necessary to meet the
operational needs associated with such growth in the next twelve months. During
the Third Quarter 2003, the Company raised additional working capital through
two equity financings. The
27
Company believes that with the equity financing and the amended financing
agreements with CIT, it has addressed its short-term working capital needs. See
"Management's Discussion and Analysis on Financial Results and Operational
Conditions--Equity Financing."
However, if the Company grows beyond its current anticipated expectations,
the Company believes that it might be necessary to obtain additional working
capital through debt or equity financing. The Company believes that any
additional capital, to the extent needed, could be obtained from the sale of
equity securities or short-term working capital loans. There can be no assurance
that this or other financing will be available if needed. The inability of the
Company to be able to fulfill any interim working capital requirements would
force the Company to constrict its operations. The Company believes that the
relatively moderate rate of inflation over the past few years has not had a
significant impact on the Company's revenues or profitability.
Equity Financings
During the third quarter ended August 30, 2003, the Company consummated
two private placements of its common stock to a limited number of "accredited
investors" pursuant to Rule 506 of Regulation D under the Securities Act of
1933, as amended (the "Securities Act"), resulting in net proceeds of
$9,343,075, after all commissions and expenses (including legal and accounting)
to the Company. The first private placement, completed on July 1, 2003 to 34
accredited investors raised net proceeds of $8,750,922 at $3.33 per share. The
Company issued 2,835,481 shares ("I Shares") as a result of the first private
placement, which resulted in an 18.6% increase in our shares of common stock
outstanding prior to this issuance. Sanders Morris Harris, Inc. ("SMH") acted as
the placement agent on a best efforts basis for the first private placement
("SMH Placement"). In consideration of the services rendered by SMH, SMH was
paid 7% of the gross proceeds, plus expenses, for a total of $690,929.64, and
also received a five year warrant entitling SMH to purchase 300,000 shares of
common stock at $4.50 per share which is exercisable on January 1, 2004. The
second placement was completed on August 29, 2003, and raised net proceeds of
$591,875 at $3.62 per share. The Company issued 175,000 shares ("II Shares" and
together with the I Shares the "I and II Shares") to 5 accredited investors as a
result of the second private placement. Pacific Summit Securities, Inc. ("PSS")
acted as the placement agent on a best efforts basis for the second private
placement ("PSS Placement"). In consideration of the services rendered by PSS,
PSS was paid 6% of gross proceeds, plus expenses, for a total of $41,6