UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended November 29, 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 (I.R.S. Employer Identification No.)
incorporation or organization)
5804 East Slauson Avenue, Commerce, California 90040
(Address of principal executive offices, including 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 (Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act.) Yes [ ] No [ X ]
The aggregate market value of the voting and non-voting common stock held by
non-affiliates of the registrant based on the closing price of the registrant's
common stock on the NASDAQ Stock Market, Inc. as of May 30, 2003, was
approximately $43,267,092.
The number of shares of the registrant's common stock outstanding as of February
25, 2004 was 25,793,850.
Documents incorporated by reference: Portions of the registrant's definitive
proxy statement to be filed with the Securities and Exchange Commission within
120 days after the end of the fiscal year are incorporated by reference in Part
III of this Annual Report on Form 10-K.
INNOVO GROUP INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED NOVEMBER 29, 2003
Table of Contents
Item
Number Page
- ------ ----
PART I
Item 1. Business 1
Item 2. Properties 26
Item 3. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder 27
Matters
Item 6. Selected Consolidated Financial Data 29
Item 7. Management's Discussion and Analysis of Financial Condition and Results of 30
Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 53
Item 8. Financial Statements and Supplementary Data 54
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 54
Item 9A. Controls and Procedures 54
PART III
Item 10. Directors and Executive Officers of the Registrant 56
Item 11. Executive Compensation 56
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 56
Item 13. Certain Relationships and Related Transactions 56
Item 14. Principal Accountant Fees and Services 56
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 57
Signature Page
PART I
Forward-Looking Statements
Statements contained in this Annual Report on Form 10-K and in future filings
with the Securities and Exchange Commission, or the SEC, in our press releases
or in our other public or shareholder communications that are not purely
historical facts are forward-looking statements. Statements looking forward in
time are included in this Annual Report on Form 10-K pursuant to the "safe
harbor" provision of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements include, without limitation, any statement that may
predict, forecast, indicate, or imply future results, performance, or
achievements, and may contain the words, "believe", "anticipate", "expect",
"estimate", "intend", "plan", "project", "will be", "will continue", "will
likely result", and any variations of such words with similar meanings. These
statements are not guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict, therefore, actual results
may differ materially from those expressed or forecasted in any such
forward-looking statements.
Factors that would cause or contribute to such differences include, but are not
limited to, the risk factors contained or referenced under the headings
"Business," "Risk Factors" and "Managements Discussion and Analysis of Financial
Condition and Results of Operations" set forth in this Annual Report on Form
10-K. Since we operate in a rapidly changing environment, new risk factors can
arise and it is not possible for our management to predict all such risk
factors, nor can it assess the impact of all such risk factors on our business
or the extent to which any factor, or combination of factors, may cause actual
results to differ materially from those contained in any forward-looking
statements. Given these risks and uncertainties, readers are cautioned not to
place undue reliance on forward-looking statements that only speak as of the
date of this filing.
We undertake no obligation to publicly revise these forward-looking statements
to reflect events, circumstances or the occurrence of unanticipated events that
occur subsequent to the date of this Annual Report on Form 10-K. As used in this
Annual Report on Form 10-K, the terms "we", "us", "our", and "Innovo Group"
refer to Innovo Group Inc. and our subsidiaries and affiliates, unless the
context indicates otherwise.
ITEM 1. BUSINESS
Our principal 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 but outsource
the manufacturing to third parties. We sell our products to a large number of
different retail, distributors and private label customers around the world.
Retail customers and distributors purchase finished goods directly from us.
Retail customers then sell the product 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 us 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. Our branded label products, which include
accessories and apparel, are designed, developed and marketed by us internally
pursuant to the license agreement under which we have licensed the brand and/or
mark. We then outsource the manufacturing and distribution of the branded
products. We sell our branded products to the retail customers or distributors.
We are then obligated to pay a certain percentage of royalties on our net sales
of the branded products to the licensor. We believe that we have established a
reputation for our ability to produce a quality branded product in the
marketplace.
We operate our consumer products business through three wholly-owned, operating
subsidiaries, Innovo, Inc., or Innovo, Joe's Jeans, Inc., or Joe's, and Innovo
Azteca Apparel, Inc., or IAA. Our products are currently manufactured by
independent contractors located in Los Angeles, California, Mexico and Asia,
including, Hong Kong, China, Korea, Vietnam and India. The products are then
distributed out of our warehouse facilities located in Los Angeles or directly
from the factory to the customer. For the fiscal year ended November 29, 2003,
or fiscal 2003, approximately 22% of our apparel and accessory products were
manufactured outside of North America. The rest of our accessory and apparel
products for fiscal 2003 were manufactured in the United States (approximately
21%) and Mexico (approximately 57%). All of our products manufactured in Mexico
are manufactured by Azteca Productions International, Inc., or Azteca, and/or
its affiliates, as discussed below. Azteca is controlled by two of our
significant stockholders, Hubert Guez and Paul Guez.
Our operations are comprised of two reportable segments: apparel and accessory,
with the operations of our Joe's and IAA subsidiaries representing the apparel
segment and our Innovo subsidiary conducting business in the accessory segment.
Segment revenues are generated from the sale of consumer products by Joe's, IAA
and Innovo. Our corporate activities are represented by the operations of Innovo
Group Inc., our parent company, or IGI, and our real estate operations are
conducted through our wholly-owned subsidiaries, Leasall Management, Inc., or
Leasall, and Innovo Realty, Inc., or IRI. Our real estate operations do not
currently require a substantial allocation of our resources and are not a
significant part of our management's daily operational functions. Thus, our real
estate
1
operations are not currently defined as a distinct operating segment, but are
classified as "other" along with our other corporate activities.
Strategic Relationship with two of our significant stockholders, Hubert Guez and
Paul Guez, and affiliated companies
Beginning in the summer of 2000, we entered into a series of transactions with
two of our significant stockholders, Hubert Guez and Paul Guez, and their
affiliated companies, such as Azteca and/or Commerce Investment Group LLC, or
Commerce. The Guez brothers and their affiliated companies have in the aggregate
more than 50 years of experience in the apparel industry with a specialty in
denim apparel and related products. As discussed in greater detail below, our
strategic relationship with the Guez brothers and their affiliated companies has
had many tangible benefits for us.
Our relationship with the Guez brothers began in the summer of 2000, when the
Guez brothers through their affiliated company, Commerce, which the Guez
brothers control, invested in our company. Pursuant to a stock and warrant
purchase agreement, Commerce acquired 2,863,637 shares of our common stock and
3,300,000 common stock purchase warrants. An investor rights agreement also
provides Commerce with a contractual right to nominate three individuals to our
board of directors. Commerce has not exercised this right at this time. Based on
a Schedule 13D/A filed by Commerce, the Guez brothers and their affiliates with
the Securities and Exchange Commission on January 20, 2004, Commerce, the Guez
brothers and their affiliates own in the aggregate approximately 17.57% of our
common stock.
As part of Commerce's equity investment in our company, we entered into several
other arrangements with Commerce in order to reduce our manufacturing and
distribution costs and to increase the effectiveness and capacity of our
distribution network. Pursuant to a supply agreement and a distribution
agreement with Commerce, we agreed to purchase all of our accessory products,
which at the time primarily consisted of denim tote bags and aprons, from
Commerce and to have Commerce distribute these products out of its Los Angeles
distribution facility. Commerce manufactures our accessory products out of its
facilities located in Mexico. These agreements were renewed in August 2002 for
an additional two year term and are automatically renewed for additional two
year terms unless terminated by either party with 90 days notice. See "Note 1 -
Business Description - Restructuring of Operations" in the Notes to Consolidated
Financial Statements for a further discussion of the equity investment by and
the terms of the supply and distribution agreements with Commerce.
The strategic relationship entered into with Commerce allowed us to close our
domestic manufacturing and distribution facilities and to move forward with
diversifying our product mix and offerings to include apparel products as
opposed to only accessory products. In an effort to enter into the apparel
market quickly and efficiently we, through IAA, acquired Azteca's knit apparel
division in August 2001 in exchange for 700,000 shares of our common stock and
promissory notes in the amount of $3.6 million. See "Note 3 - Acquisitions -
Azteca Production International, Inc. Knit Division" in the Notes to
Consolidated Financial Statements for a further discussion of this acquisition.
In February 2001, we continued to expand our apparel business by acquiring a
ten-year license for the "Joe's" and "Joe's Jean's" brands from JD Design, LLC
and forming our Joe's subsidiary. See "Business - License Agreements and
Intellectual Property" for a further discussion of this license agreement. Joe's
has exploited this license agreement by creating, designing and marketing
high-end denim apparel products. Our strategic relationship with the Guez
brothers allowed us to quickly and efficiently exploit this license and enter
into the denim apparel market by outsourcing the manufacture and distribution of
the denim apparel products created pursuant to the license to Commerce and its
affiliates.
During fiscal 2001 and 2002, the combined accessory and denim apparel products
purchased from and other services provided by Commerce and/or its affiliates
were approximately $5.7 million and $16.0 million, respectively, or 90% and 80%,
respectively, of our manufacturing and distribution costs for such periods.
During fiscal 2003, our dependence on Commerce and its affiliates decreased for
these services but still constituted 68% of our manufacturing and distribution
costs for fiscal 2003, or approximately $47.9 million of accessory, craft and
denim apparel products from and other services provided by Commerce and/or its
affiliates. While we now use additional suppliers to meet our needs, we intend
to continue to take advantage of Commerce's expertise with denim products so
long as we believe it is in our best interest.
On July 17, 2003, we, through IAA, entered into an asset purchase agreement, or
Blue Concept APA, with Azteca and the Guez brothers. Pursuant to the Blue
Concept APA, we acquired Azteca's Blue Concept division, or the Blue Concept
Division, for a $21.8 million seven-year convertible promissory note, subject to
adjustment, or Blue Concept Note. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations - Recent Acquisitions and
Licenses and - Long Term Debt" and "Note 9 - Long Term Debt - Promissory Note to
Azteca in connection with Blue Concept Division Acquisition" in the Notes to
Consolidated Financial Statement" for a further discussion of certain terms of
this acquisition and the Blue Concept Note. In accordance with the APA and
NASDAQ rules, we are conducting a special stockholders meeting on March 5, 2004,
to approve the conversion of approximately $12.5 million of the Blue Concept
Note into a maximum of 4,166,667 shares of our common stock. In addition, as
part of the transaction, we entered into another supply agreement with an Azteca
affiliate to purchase products to be sold by our Blue Concept Division. See
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of
certain terms of this supply agreement.
2
We have continued to expand our denim product mix by entering into an assignment
with Blue Concept LLC, which is controlled by Paul Guez, for all the rights
benefits and obligations of a license agreement between Blue Concept LLC and
B.J. Vines, Inc., the owner of the Betsey Johnson(R) brand, for exclusive right
to design, market and distribute women's jeans and coordinating denim related
apparel, such as t-shirts and tops under the Betsey Johnson(R) brand name in the
United States, its territories and possessions, and Canada. We did not
compensate Paul Guez for this assignment.
During fiscal 2003, we moved our headquarters and principal executive offices
from 5900 S. Eastern Avenue, Suite 120, Commerce, California 90040 to 5804 East
Slauson Avenue, Commerce, California 90040. The 5804 East Slauson Avenue space
is utilized under a verbal agreement with Azteca, pursuant to which we pay to
Azteca a fee for allocated expenses associated with our use of office and
warehouse space and expenses incurred in connection with maintaining such office
and warehouse space. These allocated expenses include, but are not limited to:
rent, security, office supplies, machine leases and utilities. In addition, we
have verbal agreements with Azteca and/or its affiliates regarding the supply
and distribution of other apparel products we sell.
Other Third Party Manufacturers
As discussed above, historically, we have primarily used Commerce and its
affiliates for our manufacturing needs. In fiscal 2003, we significantly
diversified our apparel products to include a wider array of products,
including, but not limited to, denim products. These non-denim products,
however, including some denim products, are purchased from third party
independent suppliers, including, Commerce and/or its affiliates. While we now
use numerous suppliers to meet our needs, we intend to continue to take
advantage of Commerce's and its affiliate's expertise with denim products if it
is in our best interest.
Headquarters
As discussed above, our headquarters and principal executive offices are located
at 5804 East Slauson Avenue, Commerce, California 90040 and our telephone number
at this location is (323) 725-5516. We also have operational offices and/or
showrooms in Los Angeles, New York, Knoxville, and Hong Kong and third party
showrooms in New York, Los Angeles, Tokyo and Paris.
General Development of Business
Innovo, a Texas corporation, was formed in April 1987 to manufacture and
domestically distribute cut and sewn canvas and nylon consumer products for the
utility, craft, sports licensed and advertising specialty markets. In 1990,
Innovo merged into Elorac Corporation, a "blank check" company, which was
renamed Innovo Group Inc., a Delaware corporation.
In 1991, we acquired the business of NASCO, Inc., or NASCO, a Tennessee
corporation, a manufacturer, importer and distributor of sports-licensed sports
bags, backpacks, and other sporting goods, located in Springfield, Tennessee.
NASCO, subsequently renamed Spirco, Inc., or Spirco, was also engaged in the
marketing of fundraising programs to school and youth organizations. The
fundraising programs involved the sale of magazines, gift wraps, food items and
seasonal gift items.
In 1992, we formed NASCO Products International, Inc., or NPII, a Tennessee
corporation. NPII was formed to focus on the distribution of Innovo Group's
accessory products in the international marketplace. NPII does not currently
have any business activities and we are in the process of dissolving NPII.
In 1993, we sold the youth and school fundraising business of Spirco to QSP,
Inc. During its fiscal year ending 1992, Spirco had incurred significant trade
debt from the losses it incurred in marketing fundraising programs and from
liabilities incurred by NASCO prior to its acquisition by us that were not
disclosed at that time. On August 27, 1993, Spirco filed for reorganization
under Chapter 11 of the U.S. Bankruptcy Code. Neither we, nor Innovo, nor NPII
were a party to such bankruptcy filing by Spirco. Spirco's plan of
reorganization was confirmed by the court on August 5, 1994, and became
effective on November 7, 1994.
In 1994, we formed Leasall, a Tennessee corporation. Leasall acquired Spirco's
equipment and plant and assumed the related equipment and mortgage debt. Leasall
still owns and leases to third parties the plant purchased from Spirco, which
served as our former headquarters in Springfield, Tennessee. Subsequent to the
bankruptcy reorganization, we merged Spirco into us. This merger resulted in us
acquiring direct ownership in the remaining assets of Spirco that Leasall did
not purchase. The Spirco claims, which we had guaranteed, received full payment
through the issuance of shares of our common stock.
In the latter part of 1998, we closed our domestic manufacturing and
distribution facilities in Springfield, Tennessee and relocated our corporate
headquarters, manufacturing and distribution facilities to Knoxville, Tennessee.
We closed the Springfield facility based on our need for a more suitable
facility for our manufacturing needs as well as our need, at that particular
time, for a more skilled labor force to meet our production requirements.
Additionally, in 1998, we brought in additional investors and new management,
and these individuals resided in Knoxville, Tennessee.
3
During fiscal 2000, we restructured our operations by closing our domestic
manufacturing and distribution facilities in Knoxville, Tennessee and realigning
our operational structure to focus on sales and marketing. We also raised
additional working capital and converted certain indebtedness into equity. The
restructuring was undertaken as a condition to the equity investment by
Commerce. In an effort to reduce product costs and increase gross profit, we
shifted our manufacturing to third-party foreign manufacturers, a majority of
which included Commerce's affiliates, and outsourced our distribution to
Commerce's affiliates in an effort to increase the effectiveness and capacity of
our distribution network. See "Business - Strategic Relationship with two of our
significant stockholders, Hubert Guez and Paul Guez, and affiliated companies"
and "Note 1 - Business Description - Restructuring of Operations" in our Notes
to Consolidated Financial Statements for a further discussion of our
relationship with the Guez brothers and the equity investment by and the terms
of the supply and distribution agreements with Commerce.
In February of 2001, we acquired from JD Design LLC, or JD Design, the license
rights to the JD logo and the Joe's Jeans(R) mark for all apparel and accessory
products. In connection with this acquisition, in March of 2001, we formed Joe's
Jeans, Inc., or Joe's, a Delaware corporation, to focus on the design,
production and worldwide marketing of high fashion apparel products bearing the
"Joe's Jeans" brand. See "Note 3 - Acquisitions - Joe's Jeans License" in the
Notes to the Consolidated Financial Statements.
In August of 2001, we, through our newly formed wholly-owned subsidiary, IAA,
acquired Azteca's knit apparel division in order to enter into the apparel and
design business for the private label and retail market. See "Note 3 -
Acquisitions - Azteca Productions International, Inc. Knit Division" in the
Notes to the Consolidated Financial Statements.
In April 2002, we, through our newly formed wholly-owned subsidiary, IRI, to
facilitate the purchase of limited partnership interests, which limited
partnerships were investing in real estate apartment complexes located
throughout the United States. See "Business-Real Estate Transactions" for a
further discussion of IRI's limited partnership interests.
In May 2002, Joe's formed Joe's Jeans Japan, Inc., or JJJ, a Japanese
corporation, to facilitate the distribution of the Joe's(R) and Joe's Jeans(R)
brand in Japan. On July 1, 2003, Joe's entered into a Master Distribution and
Licensing Agreement, or Distribution and Licensing Agreement, with Itochu
Corporation, or Itochu, pursuant to which Itochu obtained certain manufacturing
and licensing rights for the Joe's(R) and Joe's Jeans(R) marks. See "Business
- -License Agreements and Intellectual Property" for a further discussion of the
Distribution and Licensing Agreement with Itochu.
Additionally, in May 2002, Innovo formed Innovo Hong Kong Limited, or IHK, a
Hong Kong corporation. IHK was formed to assist our accessory division with the
design, development and sourcing of accessory products out of East Asia. IHK
also acts as the overseas base for apparel sourcing by virtue of its location in
Hong Kong.
On August 1, 2002, IAA entered into an exclusive 42-month worldwide agreement
for the Bow Wow license, granting IAA the right to produce and market products
bearing the mark and likeness of the popular stage and screen performer, Bow
Wow, formerly known as Lil' Bow Wow. See "Business -License Agreements and
Intellectual Property" for a further discussion of the Bow Wow License.
On February 13, 2003, IAA entered into a 44 month exclusive license agreement
for the United States, its territories and possessions with the recording artist
and entertainer Eve for the license of the Fetish(TM) mark for use with the
production and distribution of apparel and accessory products. See "Business
- -License Agreements and Intellectual Property" for a further discussion of the
Fetish(TM) license.
On July 17, 2003, IAA entered into the Blue Concept APA, with Azteca, Hubert
Guez and Paul Guez, whereby IAA acquired the Blue Concept Division from Azteca.
See "Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" and "Management's Discussion and
Analysis of Financial Conditions and Results of Operations - Long Term Debt" for
further discussion of the terms of the acquisition of the Blue Concept Division
from Azteca.
During fiscal 2003, we consummated five private placements of our common stock
resulting in net proceeds of approximately $17,540,000, after deducting
commissions. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations - Equity Financings" and Item 5 "Market for
Registrant's Common Equity and Related Stockholder Matters" for a further
discussion of the terms of our equity financings.
Due to our growth during the past three years, in addition to the five private
placements of our common stock discussed above, we entered into a series of
transactions to provide us with additional working capital. On June 1, 2001 and
September 10, 2001, we, through our three main operating subsidiaries, Joe's,
Innovo, and IAA, entered into a financing agreement with CIT Commercial
Services, a unit of CIT Group, Inc., or CIT for the factoring of our account
receivables. In August 2002, Joe's and Innovo entered into inventory and
security agreements with CIT which established inventory based lines of credit
for Joe's and Innovo. As a result of the need for additional working capital, on
or about June 10, 2003, we amended our existing financing facilities, to be
effective as of April 11, 2003, with CIT. We have also established a letter of
credit facility with CIT. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" for
further discussion of our financing agreements with CIT.
4
Summary of Significant Fiscal 2003 Developments
General Overview
Our net sales increased to $83,129,000 in fiscal 2003 from $29,609,000 in fiscal
2002, or a 181% increase. This increase is primarily attributable to the
following factors: (i) first time sales of our Fetish(TM) and Shago(R) branded
products; (ii) sales generated from the Blue Concept Division that we acquired
in July 2003; and (iii) continued growth in the developing, sourcing and
distributing of our existing products, such as Joe's Jeans, to new and existing
customers. Our significant net sales increase of 181% was substantially offset
by the initial expenses incurred for this growth, such as: (i) wages from new
hiring needs to support the development of the Fetish(TM) by Eve and Shago(R) by
Bow Wow lines; (ii) increased payroll expenses from the employees we absorbed in
connection with the Blue Concept Division acquisition; (iii) excess inventory
purchased for Fetish(TM) and Shago(R) products; and (iv) inventory writedowns
within Joe's and Innovo caused by operational and distribution inefficiencies.
As a result of these and other costs, as well as the necessity to write off
excess inventory, the result was a net loss of $8,255,000 for fiscal 2003. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a discussion of our financial performance in fiscal 2003.
Accessory
During fiscal 2003, Innovo, which is responsible for our accessory products,
grew its business significantly compared to fiscal 2002. The growth is a result
of Innovo's increased private label and craft sales, initial distribution of our
Fetish(TM) brand of accessories in November 2003. Prior to fiscal 2002, Innovo
did not produce fashion accessory products for the private label market. In
fiscal 2003, Innovo experienced an increase in net sales to $14,026,000 in
fiscal 2003 from $12,072,000 in fiscal 2002, or a 16% increase. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for further discussion of Innovo's financial performance for fiscal
2003.
Apparel
Joe's
During fiscal 2003, Joe's continued to establish domestic and international
brand recognition in the high-end fashion apparel industry. In fiscal 2003,
sales of Joe's products increased to $11,476,000 in fiscal 2003 from $9,179,000
in fiscal 2002, or a 25% increase. On July 1, 2003, Joe's entered into a
Distribution and Licensing Agreement with Itochu pursuant to which Itochu
obtained certain manufacturing and licensing rights for the Joe's(R) and Joe's
Jeans(R) marks. As a part of the transaction, Itochu agreed to purchase the
existing inventory of JJJ for approximately $1 million, assume the management
and operations of JJJ's showroom in Tokyo and employ certain employees of JJJ.
As of November 29, 2003, we continued to operate JJJ and will continue to do so
until all operations have ceased. Upon the cessation of all operating
activities, we intend to dissolve the JJJ subsidiary. We will continue to sell
product in Japan through the Distribution and Licensing Agreement with Itochu.
See "Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses." See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations" for further
discussion of Joe's financial performance for fiscal 2003.
IAA
IAA increased its sales to $57,627,000 in fiscal 2003 from $8,358,000 in fiscal
2002, or a 589% increase. The growth is primarily a result of an increase in
revenues from IAA's private label division and in part from first time sales of
Shago(R) and Fetish(TM) apparel products. See "Business - License Agreements and
Intellectual Property" for a further discussion of our license agreements with
Bravado International, Inc. for Shago(R) which we entered into in October 2002,
and with Blondie Rockwell, Inc. for Fetish(TM) which we entered into in February
2003. A substantial amount of the increase in the revenue from our private label
business was a result of our sales subsequent to our acquisition of the Blue
Concept Division by IAA. See "Management's Discussion and Analysis of Financial
Conditions and Results of Operations - Recent Acquisitions and Licenses.
Additionally, on July 17, 2003, our IAA subsidiary entered into an APA with
Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the Blue Concept
Division from Azteca. Pursuant to the terms of the APA, IAA paid $21.8 million
for the Blue Concept Division, subject to adjustment as discussed further in
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of the
acquisition of the Blue Concept Division from Azteca. The purchase price was
paid through the issuance of the Blue Concept Note which is a seven-year
convertible promissory note. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations - Long Term Debt" for further
discussion of the terms of the Blue Concept Note. Also, see "Management's
Discussion and Analysis of Financial Conditions and Results of Operations" for
further discussion of IAA's financial performance for fiscal 2003.
5
Principal Products and Revenue Sources
Our products are created and our revenues are derived through sales from our
Innovo, IAA, and Joe's subsidiaries in the accessory segment and apparel
segment, respectively.
Our net sales by segment for the last three years are shown in the table below:
2003 2002 2001
Accessories 17% 41% 61%
Apparel 83% 59% 39%
--------------------
Total 100% 100% 100%
--------------------
Accessory
Innovo
Innovo, headquartered in Knoxville, Tennessee, designs, develops and markets
accessory consumer products such as fashion handbags, purses, wallets,
backpacks, duffle bags, sports bags, belts, hats and scarves for department
stores, mass merchandisers, specialty chain stores and private label customers.
Additionally, Innovo markets craft products including tote bags and aprons to
mass merchandisers and craft specialty stores. Innovo's products generally are
accompanied by one of Innovo's own logos such as Daily Denim(TM), Dragon Fly
Denim(TM), Clear Gear(TM), Friendship(TM) and Tote Works(TM), the brand of a
private label customer, or the brand of a third party licensor such as Bongo(R),
Shago(R) and Fetish(TM). Innovo's net sales in the accessory segment increased
to $14,026,000 in fiscal 2003 from $12,072,000 for fiscal 2002, or a 16%
increase. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Net Sales" for a further discussion of Innovo's sales in
the accessory segment.
In fiscal 2002, Innovo entered the private label accessory business. As of
November 29, 2003, Innovo produced private label products primarily for American
Eagle Outfitters, Inc. and Limited Brands, Inc.'s Express division. Private
label business accounted for approximately 35% of Innovo's net sales in fiscal
2003 compared to 27% in fiscal 2002. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" for a further discussion of
Innovo's accessory sales. Innovo anticipates continued growth in the private
label market as a result of Innovo's ability to provide quality accessory
products that are fashionably desirable at competitive prices; however, there
can be no assurances that Innovo will be able to increase its market share in
the private label business.
While Innovo initially obtained the license rights to the Bongo(R) mark in the
second quarter of fiscal 2001, in November 2002, Innovo solidified and extended
its relationship with the owner of the Bongo(R) brand, by signing a four-year
license agreement with IP Holdings LLC for the Bongo(R) mark. The agreement
gives Innovo multi-year extension options based on certain performance criteria
for the bag and small pvc/leather goods categories. See "Business - License
Agreements and Intellectual Property" for a further discussion of the License
Agreement for the Bongo (R) mark. Since that time, Innovo has launched the
Bongo(R) line to department stores and specialty stores across the United
States, including Sears, Roebuck and Co., Beall's, Inc., Hecht's, Foley's, and
Robinsons-May. In fiscal 2003, Innovo's Bongo(R) accessory product line
experienced growing demand in the retail marketplace. Gross sales associated
with the Bongo(R) product line continued to grow significantly in fiscal 2003
and represented approximately 21% of Innovo's total gross sales for fiscal 2003.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Net Sales" for a further discussion of Innovo's net sales for its
Bongo(R) product line.
Innovo's IHK subsidiary is headquartered in Hong Kong and assists Innovo with
the development, design and sourcing of the products sold by Innovo to its
customers. IHK allows Innovo to minimize the amount of time required to design,
develop and source its products, thus allowing Innovo to react quickly to
changing markets conditions and to deliver its products in a timely manner.
In addition, in fiscal 2003, as part of our license agreement for the license of
the Fetish(TM) brand, our Innovo subsidiary produced Fetish(TM) branded
accessories such as purses and wallets. The Fetish(TM) branded accessories
accounted for a small percentage of Innovo's overall net sales in fiscal 2003.
See "Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Net Sales" for a further discussion regarding sales associated with
Fetish(TM) products. See "Business - License Agreements and Intellectual
Property" for further discussion of this license agreement.
In fiscal 2003, Innovo experienced increased demand for its craft product lines
due to Innovo's ability to increase its business with its existing customers
such as Wal-Mart, Michaels Stores, Inc., A.C. Moore Arts & Crafts and added an
additional customer, Hobby Lobby. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Net Sales" for a further
discussion of Innovo's sales for its craft product line.
6
The following are the principal products that Innovo distributes in the United
States to the accessory and craft market:
FASHION ACCESSORY GENERAL ACCESSORIES CRAFTS
----------------- ------------------- ------
Purses Travel and Tote Bags Tote Bags
Hand Bags Waist Packs Adult and Children's Aprons
Duffle Bags Duffle Bags Christmas Stockings
Wallets Stadium Totes/Cushions Gourmet/BBQ Aprons
Beach Bags Insulated Lunch Bags
Tote Bags Soft Coolers
Gloves Pencil Cases
Backpacks
Waist Packs
Hats
Scarves
Apparel
Joe's
Joe's, headquartered in Commerce, California was formed in 2001 to design,
develop, and market high-fashion apparel products under the Joe's(R) and Joe's
Jeans(R) brand. Joe's products are typically part of a collection that includes
pants, denim jeans, shirts, sweaters, jackets and other apparel products. In
fiscal 2002, Joe's focused its efforts on establishing the Joe's brand in both
the domestic and international marketplace by continuing to offer its customers
and consumers a fashion forward, quality product. In fiscal 2002, Joe's created
JJJ in an effort to establish the Joe's brand in the Japanese marketplace.
Additionally, in fiscal 2002, Joe's successfully entered the Canadian and
European markets through the use of international distributors, and contributed
to expand within these markets in fiscal 2003 and expanded distribution to other
countries such as Australia and Korea. On July 1, 2003, Joe's entered into a
Distribution and Licensing Agreement with Itochu ("Itochu Agreement"), pursuant
to which Itochu obtained certain manufacturing and licensing rights for the
"Joe's" and "Joe's Jeans" marks. As a part of the transaction, Itochu agreed to
purchase the existing inventory of JJJ for approximately $1 million, assume the
management and operations of JJJ's showroom in Tokyo and employ certain
employees of JJJ. As of November 29, 2003, we continue to operate JJJ and will
continue to do so until all operations have ceased. Upon the cessation of all
operating activities, we intend to dissolve the JJJ subsidiary. We will continue
to sell our products in Japan through our Distribution and Licensing Agreement
with Itochu. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations -Recent Acquisitions and Licenses."
Joe's believes that it has developed a customer base upon which Joe's can grow
its business going forward. Joe's products are sold in the United States and
abroad to upscale retailers and boutiques such as Barneys New York, Inc.,
Bloomingdale's, Inc., Loehmann's, Inc., Nordstrom, Inc., Saks Incorporated,
Intermix and Fred Segal in the United States and other complimentary retailers
in the international market.
Joe's products are primarily marketed to retailers through third party showrooms
located in New York, Los Angeles, and Paris and through its own showroom in
Tokyo. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Net Sales" for a further discussion of Joe's sales.
Joe's product lines include, but are not limited to, the following:
WOMEN MEN
----- ---
Denim Jeans Denim Jeans
Denim Skirts Knit Shirts
Denim Jackets
Leather Jackets
Knit Shirts
Sweaters
Handbags
7
IAA
IAA, headquartered in Commerce, California, was formed in August 2001 to focus
on marketing products to the private label apparel market. IAA has since
diversified to focus not only on its private label business but also the
development of branded apparel products.
As of November 29, 2003, IAA's private label business primarily designed,
sourced and marketed denim jeans for Warnaco, Target Corporation's Mossimo
brand, and, as part of its acquisition of the Blue Concept Division, to American
Eagle Outfitters, Inc., or AEO. Through the Blue Concept Division, IAA sells
primarily denim jeans to AEO, a national retailer. IAA's sales increased to
$57,627,000 in fiscal 2003 from $8,358,000 in fiscal 2002, or a 589% increase. A
large portion of the increase in IAA's sales during fiscal 2003 is attributable
to sales generated from AEO since July 2003, the date of the Blue Concepts
Division acquisition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Net Sales" for a further discussion of
IAA's sales.
IAA's private label product lines primarily consist of knit tops and denim
bottoms for both the men's and women's market. The branded sportswear product
lines are focused around fashion oriented tops and bottoms. The product lines
include, but are not limited to the following:
TOPS BOTTOMS
---- -------
Knit Fashion Shirts Fleece Sweatpants
Fashion T-Shirts Knit Pants
Basic T-Shirts Denim Jeans
Fleece Sweatshirts Velour Pants
Thermal Pullovers Sweat Suits
Velour Shirts
Sports Jersey's
Dresses
Blouses
Since establishing IAA's branded division and through year ended November 29,
2003, IAA has entered into license agreements with: (1) recording artist and
entertainer Bow Wow for the right to produce apparel and accessory products
under the Shago(R) mark; (2) the recording artist and entertainer Eve for the
right to produce apparel and accessory products under the Fetish(TM) mark; and
(3) Mattel, Inc. for the right to produce apparel and accessory products under
the Hot Wheels(R) mark. IAA entered into the license agreement for the Bow Wow
license in October of fiscal 2002; the license agreement with Eve in February of
2003; and the license agreement with Mattel in August of 2002. IAA began
shipping its Shago(R) apparel and accessory products in May 2003, and its
Fetish(TM) apparel and accessory products in August 2003. To date, IAA has not
shipped any of its Hot Wheels apparel or accessory products, primarily in
response to feedback from retail buyers at the time of the line's launch in
August 2003 suggesting that consumer demand for the proposed Hot Wheels(R)
product line was insignificant. Pursuant to these license agreements, IAA has
the right to sublicense the accessory category to its affiliated subsidiary
Innovo. See "Business - License Agreements and Intellectual Property" for a
further discussion of the license agreements with Bow Wow, Eve, and Mattel, Inc.
Product Development and Sourcing
Accessory
Innovo
Innovo develops the designs and artwork for all products through its in-house
design staff. Innovo's fashion and licensed accessory products are produced with
the logos or other designs licensed from licensors or produced bearing the
Innovo's own private brands such as Daily Denim(TM), Clear Gear(TM),
Friendship(TM) and Tote Works(TM). See "Business-License Agreements and
Intellectual Property" for a further discussion of Innovo's fashion and licensed
accessory products.
Innovo markets its craft products, without artwork, to be sold for finishing by
retail craft customers. Innovo's craft products are purchased from Commerce or
its affiliates. They manufacture our craft products in Mexico and we also import
some of our craft products from China. Innovo is obligated, as defined in the
supply agreement with Commerce, to purchase all of its craft products from
Commerce through August 2004. In fiscal 2003, Innovo purchased approximately
$2.7 million of craft products from Commerce.
Innovo's sourcing office, IHK, manages much of the design and development of its
products that are sourced out of East Asia. Innovo's products are distributed
out of Los Angeles through an agreement with an affiliate of Commerce or the
products may be shipped directly to Innovo's customers from the country of
origin of the manufactured products.
Innovo obtains its fashion accessory products from overseas suppliers located
mainly in China through short term manufacturing agreements. The independent
contractors that manufacture our products are responsible for obtaining the
necessary supply of raw materials and for manufacturing the products to our
specifications. See "Business-Import and Import Restrictions" for further
discussion
8
of supply of raw materials and manufacturing.
We primarily utilize overseas contractors that employ production facilities
located in China. As a result, our products are subject to certain restrictions
imposed by the Chinese government. To date, we have not been adversely affected
by such restrictions; however, there can be no assurance that future changes in
such restrictions by the Chinese government would not adversely affect us, even
if only temporarily, while we shifted production to other countries or regions
such as Mexico, Korea, Taiwan or Latin America. As anticipated, in fiscal 2003,
all of our sales were derived from imported products that are subject to United
States import quotas, inspection or duties. See "Business--Import and Import
Restrictions."
Apparel
Joe's
Joe's product development is managed internally by a team of designers led by
Joe Dahan, which is responsible for the creation, development and coordination
of the product group offerings within each collection. Joe's typically develops
four collections per year for spring, summer, fall and holiday, with certain
basic styles offered throughout the year. Joe Dahan is an instrumental part of
Joe's design process. The loss of Joe Dahan could potentially have a material
adverse impact on Joe's. In the event of the loss of Joe Dahan, Joe's believes
it could find alternative sources for the development and design of Joe's
products, although there can be no assurances. See "Risk Factors-- The loss of
the services of Mr. Joe Dahan could have a material adverse effect on Joe's
business."
Joe's products are sourced through Commerce or its affiliates or from domestic
contractors generally located in the Los Angeles area. Joe's is not
contractually obligated to purchase its products from Commerce. Joe's staff,
however, controls the production schedules in order to ensure quality and timely
deliveries. Commerce is responsible for the acquisition of the raw materials
necessary for the production of Joe's goods. In the event that Commerce is
unable to acquire the necessary raw materials, Joe's believes that there are
alternative sources from which the raw materials could be acquired. We are
currently reviewing the option of sourcing products from international sources
and/or directly sourcing the products from domestic suppliers. During fiscal
2003, Joe's purchased approximately $2.2 million of goods from Commerce. See
"Business - Strategic Relationship with two of our significant stockholders,
Hubert Guez and Paul Guez, and affiliated companies" for a further discussion of
the supply agreement with Commerce. In fiscal 2003, Joe's changed its inventory
strategy from buying finished goods to buying raw materials and outsourcing the
manufacturing of its own goods as a result of no longer being able to purchase
finished goods from our domestic supplier. Joe's cost to buy raw materials and
outsource the manufacturing of its own goods was significantly higher than its
cost to buy finished goods. In the long term, Joe's believes that this
alteration in inventory strategy will be beneficial since this inventory
strategy should decrease the defects associated second quality goods, which have
a lower cost per unit than first quality goods. Sales of second quality goods
lead to lower gross margins.
While Joe's believes that there are currently alternative sources from which to
outsource the production of Joe's products, in the event the economic climate or
other factors resulted in significant reduction in the number of local
contractors in the Los Angeles area, Joe's business could be negatively
impacted. At this time, Joe's believes that it would be able to find alternative
sources for the production of its products if this was to occur, however, no
assurances can be given that a transition could be completed without a
disruption to Joe's business.
IAA
IAA's private label product development is managed by IAA's internal design and
merchandising staff or in conjunction with the design teams of the customer.
IAA's products are sourced from Mexico through independent contractors, through
Commerce and its affiliates or through independent overseas contractors. During
fiscal 2003, IAA purchased approximately $18.2 million of goods from Commerce
and its affiliates. See "Business - Strategic Relationship with two of our
significant stockholders, Hubert Guez and Paul Guez, and affiliated companies"
IAA's branded division's products are developed by its in-house design team or
through the use of independent freelance designers. IAA's branded division
sources a majority of its products from Mexico and the Far East, including
countries such as China, South Korea, Vietnam and India. IAA's purchases in the
international markets will be subject to the risks associated with the
importation of these type products. See "Business-Import and Import
Restrictions."
IAA relies on Commerce and its affiliates' ability to source and supply its
products. IAA expects its reliance on Commerce and its affiliates to decrease in
the future as it begins to purchase more of its products from third party
suppliers. During fiscal 2003, IAA purchased from Commerce and its affiliates
approximately $41.8 million, or 76%, of its products compared to $16.0 million,
or 80%, of its products in fiscal 2002.
IAA and AZT International SA de CV, a Mexico corporation and wholly-owned
subsidiary of Azteca, or AZT, entered into a two-year, renewable, non-exclusive
supply agreement, or Supply Agreement, for products to be sold by IIA through
the Blue Concept Division. Under the terms of the Supply Agreement, we have
agreed to market and sell the products to be purchased from AZT to certain of
our
9
customers, more particularly IAA customers of the Blue Concept Division. See
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for further discussion regarding
this supply agreement.
We generally purchase our products in U.S. dollars. However, as a result of
using overseas suppliers, the cost of these products may be affected by changes
in the value of the relevant currencies. See "Risk Factors - Our business is
exposed to domestic and foreign currency fluctuations."
Notwithstanding the supply agreement for craft products with Commerce, we do not
have any long-term supply agreements with independent overseas contractors, but
we believe that there are a number of overseas and domestic contractors that
could fulfill our requirements. See "Item 1 - Business Description -
Restructured Operations" in the Notes to the Consolidated Financial Statements
for a further discussion of the supply agreement with Commerce and its
affiliates.
While we attempt to mitigate our exposure to manufacturing, the use of
independent contractors does reduce our control over production and delivery and
exposes us to the other usual risks of sourcing products from independent
suppliers. Our transactions with our foreign manufacturers and suppliers are
subject to the risks of doing business abroad. Imports into the United States
are affected by, among other things, the cost of transportation and the
imposition of import duties and restrictions. The United States and the
countries in which our products are manufactured may, from time to time, impose
new quotas, duties, tariffs or other restrictions, or adjust presently
prevailing quotas, duty or tariff levels, which could affect our operations and
our ability to import products at current or increased levels. We cannot predict
the likelihood or frequency of any such events occurring. See "Business - Import
and Import Restrictions."
License Agreements and Intellectual Property
Accessory
Innovo
On March 26, 2001, Innovo entered into a two-year exclusive license agreement
with Michael Caruso & Company, the original owner of the rights to the Bongo(R)
mark, pursuant to which Innovo obtained the right to design, manufacture and
distribute bags and small leather/pvc goods bearing the Bongo(R) mark. According
to the original terms of the license agreement, the license was to expire on
March 31, 2003. However, in November 2002, Innovo entered into an amendment
effective April 1, 2003 with IP Holdings LLC, the assignee of the Bongo(R) mark,
to extend the term of the license agreement to March 31, 2007. The extended
agreement offers Innovo the potential for multi-year extensions tied to certain
performance criteria.
Innovo pays a five percent royalty and a two percent advertising fee on the net
sales of Innovo's goods bearing the Bongo(R) mark. Pursuant to the terms of the
license agreement, Innovo is required to pay minimum royalties in the amount of
$312,500 prior to the expiration of the license agreement. In accordance with
the terms of the agreement, Innovo has the exclusive right to sell, market,
distribute, advertise and promote the Bongo(R) products in the United States,
including its territories and possessions, Mexico, Central and South America and
Canada. The licensor has the right to terminate the agreement in the event
Innovo breaches any material terms of the agreement.
In fiscal 2003, Innovo's collegiate and Major League Baseball sports-licensed
accessory products were discontinued because we are placing more time and
resources towards developing more fashion oriented product lines that we believe
will have greater potential in the marketplace. This cancellation has not had a
material adverse effect on Innovo's products or revenues for fiscal 2003, as
they represented a small portion of products and revenues in prior years.
Due to the cancellation of its sports-licensed accessory products, Innovo has
placed more time and resources towards developing more fashion oriented product
lines that Innovo believes will have greater potential in the marketplace.
Innovo's craft line includes tote bags imprinted with the E.A.R.T.H. ("EVERY
AMERICAN'S RESPONSIBILITY TO HELP") BAG(R) mark. E.A.R.T.H. Bags(R) are marketed
as a reusable bag that represents an environmentally conscious alternative to
paper or plastic bags. Sales of E.A.R.T.H. Bags(R), while significant in
Innovo's early years, have not been significant in the last five years. Innovo
still considers the mark to be an asset.
Furthermore, pursuant to the license agreements entered into by IAA, Innovo, as
a sublicensee, has the right to produce accessories for the branded label market
bearing the Shago(R), Fetish(TM) and Hot Wheels(R) marks pursuant to the terms
of those license agreements. See "License Agreements and Intellectual Property -
IAA" for a further discussion of the Shago(R), Fetish(TM) and Hot Wheels(R)
license agreements.
10
Apparel
Joe's
In February 2001, Joe's acquired the license rights to the JD logo and the Joe's
Jeans(R) mark for all apparel and accessory products. The license agreement with
JD Design, LLC, or JD Design, has a ten-year term with two ten-year renewal
periods upon there being no material default at the end of each period.
Additionally, pursuant to the terms of the agreements, Joe Dahan is to receive a
three percent royalty on the net revenues of sales of Joe's(R) and Joe's
Jeans(R) products, subject to additional royalty amounts in the event certain
sales and gross profit thresholds are met on an annual basis.
On July 1, 2003, Joe's entered into a Distribution and Licensing Agreement with
Itochu, pursuant to which Itochu obtained certain manufacturing and licensing
rights for the "Joe's" and "Joe's Jeans" marks. As a part of the transaction,
Itochu agreed to purchase the existing inventory of JJJ for approximately $1
million, assume the management and operations of JJJ's showroom in Tokyo and
employ certain employees of JJJ. As of November 29, 2003, we continue to operate
JJJ and will continue to do so until all operations have ceased. Upon the
cessation of all operating activities, we intend to dissolve the JJJ subsidiary.
We will continue to sell product in Japan through our Distribution and Licensing
Agreement with Itochu. See "Management's Discussion and Analysis of Financial
Conditions and Results of Operations -Recent Acquisitions and Licenses" for
further discussion regarding this license and distribution agreement.
As the licensee and on behalf of JD Design, we have applied for protection with
the United States Patent and Trademark Office, as well as with various foreign
jurisdictions, such as Australia, Canada, the European Union, Japan, Korea and
New Zealand, for trademark protection for certain of "Joe's" logos and "Joe's
Jeans" marks for apparel and accessory products. As of November 29, 2003, two
trademark registrations have been issued in the United States and five trademark
registrations have been issued internationally. We continue to prosecute two
pending trademark applications in the United States and 24 pending trademark
applications internationally that we believe are necessary to protect these
trademarks fully.
IAA
On August 1, 2002, IAA entered into an exclusive 42-month worldwide agreement
for the Bow Wow license, granting IAA the right to produce and market products
bearing the Shago(R) mark and likeness of the popular stage and screen
performer. The IAA division has created and marketed a wide range of apparel for
boys and plans on doing the same for girls. The license agreement between IAA,
Bravado International Group, the agency with the master license and rights to
Bow Wow, and LBW Entertainment, Inc. calls for the performer to make at least
one public appearance every six months during the term of the agreement to
promote the Bow Wow products, as well as use his best efforts to promote and
market these products on a daily basis. Additional terms of the license
agreement allows IAA to market boys and girls products bearing the Bow Wow brand
to all distribution channels, the right of first refusal on all other Bow Wow
related product categories during the term of the license agreement, and the
right of first of refusal on proposed transactions by the licensor with third
parties upon the expiration of the agreement. The agreement calls for IAA to pay
an eight percent royalty on the nets sales of goods bearing Bow Wow related
marks. IAA is obligated to pay a minimum net royalty in the amount of $75,000 on
or before January 31, 2005. In the event IAA defaults upon any material terms of
the agreement, the licensor shall have the right to terminate the agreement.
Furthermore, IAA has the right to sublicense the accessory product's category to
Innovo.
On February 13, 2003, our IAA subsidiary entered into a 44 month exclusive
license agreement for the United States, its territories and possessions with
the recording artist and entertainer Eve for the license of the Fetish(TM) mark
for use with the production and distribution of apparel and accessory products.
We have guaranteed minimum net sales obligations for apparel and accessories of
$8 million in the first 18 months of the agreement, $10 million in the following
12 month period and $12 million in the 12 month period following thereafter.
According to the terms of the agreement we are required to pay an eight percent
royalty and a two percent advertising fee on the nets sales of products bearing
the Fetish(TM) logo. In the event we do not meet the minimum guaranteed sales,
we will be obligated to make royalty and advertising payments equal to the
minimum guaranteed sales multiplied by the royalty rate of eight percent and the
advertising fee of two percent. Such minimum royalty payments will equal $2.4
million in the aggregate over the term of the license agreement. We also have
the right of first refusal with respect to the license rights for the Fetish(TM)
mark in the apparel and accessories category upon the expiration of the
agreement, subject to us meeting certain sales performance targets during the
term of the agreement. Additionally, we have the right of first refusal for the
apparel and accessory categories in territories in which we do not currently
have the license rights for the Fetish(TM) mark.
In July 2002, IAA entered into a five-year license agreement with Mattel, Inc.
to produce Hot Wheels(R) branded adult apparel and accessories in the United
States, Canada and Puerto Rico to be targeted to men and women in the junior and
contemporary markets, or the Hot Wheels(R) License. IAA may terminate the Hot
Wheels(R) License in any year by paying the remaining balance of that year's
minimum royalty guarantees plus the subsequent year's minimum royalty
guarantees. The total minimum royalties due for the entire 5 years term is $1.05
million in the aggregate. Royalties paid by IAA earned in excess of the minimum
royalty requirements for any one given year may be credited towards the
shortfall amount of the minimum required royalties in any subsequent period
during the term of the license agreement. According to the terms of the Hot
Wheels(R) License, IAA has the right to sublicense the accessory product's
category to Innovo. The Hot Wheels(R) License calls for a royalty rate of seven
percent royalty and a two percent advertising fee on the net sales of goods
bearing the Hot Wheels(R) mark. In the event IAA defaults upon any material
terms, the licensor shall have the right to terminate the agreement. In fiscal
2003, IAA had no sales under this license agreement. The absence of sales from
the Hot Wheels(R) License was primarily due to insignificant orders placed for
the product at the initial launch of the line at the MAGIC apparel trade show in
Las Vegas in August 2003 as a result of apparent interest in the consumer
marketplace. While, as of November 29, 2003, we are still contractually
obligated under the Hot Wheels(R) License, we have been in discussion with
Mattel regarding these and other concerns surrounding the consumer demand for
the product.
11
The following sets forth certain information concerning the license agreements
currently held by us:
Licensor/Mark Types of Products Geographical Areas Minimum Royalties Expiration Date
------------- ----------------- ------------------ ----------------- ---------------
JD Design LLC Apparel and accessories Worldwide N/A 2/11/31
(Joe's Jeans)
Blondie Rockwell, Inc. Apparel and accessories United States, its $2.4 million in the 7/31/06
(Eve, Fetish(TM)) Territories and possessions aggregate
Bravado International Apparel and accessories United States $75,000 prior to 2/1/06
Group, Inc. 1/31/05
(Bow Wow, Shago(R))
IP Holdings LLC Bags, small leather/pvc United States, its $312,500 prior to 3/31/07
(Bongo(R)) goods territories and possessions, expiration
Mexico, Central and South
America, Canada
Mattel, Inc. Apparel and accessories United States, Canada and $1.05 million in the 12/31/07
(Hot Wheels(R)) Puerto Rico aggregate
We believe that we will continue to be able to obtain the renewal of all
material licenses; however, there can be no assurance that competition for an
expiring license from another entity, or other factors will not result in the
non-renewal of a license. As we continue to expand our business in the
international marketplace, our trademarks or the trademarks we license may not
be able to be adequately protected. See "Risk Factors -- Our trademark and other
intellectual property rights may not be adequately protected outside the United
States."
Customers
Accessory
Innovo
During fiscal 2003, Innovo sold products to a mix of mass merchandisers,
department stores, craft chain stores and other retail accounts. We estimate
that Innovo's products are carried by over 548 customers in over 6,000 retail
outlets in the United States. In marketing Innovo's products, Innovo attempts to
emphasize the competitive pricing and quality of its products, its ability to
assist customers in designing marketing programs, its short lead times and the
high success rate our customers have had with our products. Generally, Innovo's
accounts are serviced by Innovo's sales personnel working with marketing
organizations that have sales representatives that are compensated on a
commission basis. Innovo's New York City showroom is used to showcase all
product lines developed by Innovo and to help facilitate sales for all accounts.
In fiscal 2003, Innovo sold its products to private label customers such as
American Eagle Outfitters, Inc., Claire's Stores, Inc. and Hot Topic. Innovo
currently sells it products to retailers such as Wal-Mart, Inc., A.C. Moore Arts
& Crafts, Hobby Lobby, Joanne's, Inc., Michaels Stores, Inc., Sears, Roebuck and
Co., 579 Stores, Beall's, Inc., The May Department Stores Company, which
includes, Hecht's, Foley's, and Robinsons-May, J. C. Penney Company, Inc.,
Claire's Stores, Inc., The Wet Seal, Inc., and Federated Department Stores,
Inc., which includes Macy's East and Macy's West.
For fiscal 2003, Innovo's three largest customers, American Eagle Outfitters,
Inc., Wal-Mart, Inc. and Michaels Stores, Inc. accounted for approximately 62%
of its net sales. The loss of any of these three customers would have a material
adverse effect on Innovo.
Apparel
Joe's
Joe's products are sold to consumers through high-end department stores and
boutiques located throughout the world. For Joe's domestic sales, Joe's has
entered into sales agreements with third party showrooms where retailers review
the latest collections offered by Joe's and place orders. The showrooms provide
Joe's with purchase orders from the retailers. Joe's then distributes the
products from its Los Angeles distribution facility. Joe's currently has
domestic agreements with showrooms in Los Angeles and New York and these
12
showrooms have representatives throughout the United States.
Joe's products are sold in Japan through its subsidiary JJJ. JJJ operates a
company-operated showroom in Tokyo through which Joe's products are sold to
retailers. On July 1, 2003, Joe's entered into a Distribution and Licensing
Agreement with Itochu, pursuant to which Itochu obtained certain distribution
and licensing rights for the "Joe's" and "Joe's Jeans" marks. We will continue
to sell product in Japan through our Distribution and Licensing Agreement with
Itochu. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations -Recent Acquisitions and Licenses" for further discussion
regarding this license and distribution agreement. Additionally, Joe's is
currently selling its products in Europe, Canada, Australia and Korea through
distributors who purchase the product directly from Joe's and then distribute
the product in to the local markets. Revenues generated by JJJ represented
approximately 26% of Joe's total net sales in fiscal 2003. See Management's
Discussion and Analysis of Financial Conditions and Results of Operations - Net
Sales" for further discussion of Joe's net sales.
We currently sell to domestic retailers such as Barneys New York, Inc., Saks
Incorporated, Federated Department Stores, Inc. which includes, Bloomingdale's,
Inc. and Macy's, Inc., Intermix, Fred Segal and Loehmann's and in Japan to
retailers such as Sanei International, Interplanet, Free's Shops, Isetan,
Mitsukoshi New York Runway and Barneys New York, Inc.
Also, on February 16, 2004, Joe's entered into a Master Distribution Agreement,
or MDA, with Beyond Blue, Inc., or Beyond Blue, whereby Joe's granted Beyond
Blue exclusive distribution rights for Joe's products outside the United States.
The MDA provided for the continuation of existing distribution agreements, such
as the Itochu Agreement. The MDA was entered into in an effort to capitalize
upon Joe's international brand recognition, to utilize Beyond Blue's experience
in international distribution of high-end fashion denim apparel lines and to
manage international distribution through the use of sub-distributors and sales
agents in foreign markets. See "Business - Subsequent Events" for further
discussion of the MDA between Joe's and Beyond Blue.
The Joe's Jeans website (www.joesjeans.com) has been built to advance the
brand's image and to allow consumers to review the latest collection of
products. Joe's currently uses both online and print advertising to create brand
awareness with customers as well as consumers.
For fiscal 2003, Joe's three largest customers accounted for approximately 21%
of its net sales. The loss of any of these customers would not have a material
adverse affect on Joe's.
IAA
IAA develops apparel products for the private label and branded product markets.
At year ended November 29, 2003, IAA primarily distributed its private label
products primarily to Target Corporation's Mossimo division, or Target, and
American Eagle Outfitters, Inc., or AEO.
During fiscal 2003, sales to Target Corporation, AEO, and Warnaco, which IAA
ceased selling products to in fiscal 2003, represented approximately 18%, 48%
and 10%, respectively, of IAA's net sales.
Pursuant to the license agreements for Shago(R), Fetish(TM) and Hot Wheels(R),
IAA may sell apparel and accessory products to certain agreed upon channels of
distribution set forth in the various license agreements. Currently, IAA
distributes its Shago(R) apparel and accessory products to Federated Department
Stores, Inc., which includes Macy's East and Macy's West, Jimmy Jazz and City
Blues. IAA distributes its Fetish(TM) apparel and accessory products to
Federated Department Stores, Inc., which includes Macy's East and Macy's West,
Robinsons-May, Demo, Up Against the Wall, Epic and Man Alive.
We do not enter into long-term agreements with any of our customers. Instead, we
receive individual purchase order commitments from our customers. A decision by
the controlling owner of a group of stores or any other significant customer,
whether motivated by competitive conditions, financial difficulties or
otherwise, to decrease the amount of merchandise purchased from us, or to change
their manner of doing business with us, could have a material adverse effect on
our financial condition and results of operations. See "Risk Factors--A
substantial portion of our net sales and gross profit is derived from a small
number of large customers."
Our business has historically been seasonal by nature. While we believe that as
a result of our growing product lines and expanding business model, our business
should be less seasonal in future periods. Furthermore, a majority of our
revenues are generated during our third and fourth quarters. See
"Business-Seasonality of Business and Working Capital" for further discussion of
the seasonality of our business.
Seasonality of Business and Working Capital
We have historically experienced and expect to continue to experience seasonal
fluctuations in sales and net earnings. Historically, a significant amount of
our net sales and a majority of our net earnings have been realized during the
third and fourth quarter. In the second quarter in order to prepare for peak
sales that occur during the third quarter, we build inventory levels, which
results in higher
13
liquidity needs as compared to the other quarters in the fiscal year. If sales
were materially different from seasonal norms during the third quarter, our
annual operating results could be materially affected. Accordingly, our results
for the individual quarters are not necessarily indicative of the results to be
expected for the entire year.
Due to our growth during fiscal 2003, we entered into a series of transactions
to provide us with additional working capital. On June 1, 2001 and September 10,
2001, we, through our three main operating subsidiaries, Joe's, Innovo, and IAA,
entered into financing agreements with CIT Commercial Services, a unit of CIT
Group Inc, or CIT for the factoring of our account receivables. In August 2002,
Joe's and Innovo each entered into certain amendments to their respective
factoring agreements, which included inventory security agreements, to permit
each subsidiary to obtain advances of up to 50% of the eligible inventory up to
$400,000 each. As a result of necessity for additional working capital, on or
about June 10, 2003, the existing financing facilities with CIT for our
subsidiaries were amended, to be effective as of April 11, 2003, primarily to
remove the fixed aggregate cap of $800,000 on their inventory security
agreements to allow for Innovo and Joe's to borrow up to 50% of the value of
certain eligible inventory. In connection with these amendments, IAA entered
into an inventory security agreement with CIT based upon the same terms as Joe's
and Innovo. Cross guarantees were executed by and among the subsidiaries and we
also entered into a guarantee for our subsidiaries' obligations in connection
with the amendments to the existing credit facilities. We have also established
a letter of credit facility with CIT. As of November 29, 2003, we had a loan
balance with CIT of $8,786,000, the majority of which was collateralized against
non-recourse factored receivables. As of November 29, 2003, we had $8,536,000 of
factored receivables with CIT and an aggregate amount of $2,149,000 of unused
letters of credit outstanding. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources"
for further discussion of our financing agreements with CIT.
Additionally, in fiscal 2003, we consummated five private placements of our
common stock resulting in net proceeds of approximately $17,540,000, after
deducting commissions. During our first private placement completed on March 19,
2003 we issued 165,000 shares of our common stock to 17 accredited investors at
$2.65 per share, raising net proceeds of approximately $407,000. During our
second private placement completed on March 26, 2003, we issued 63,500 shares of
our common stock to 5 accredited investors at $2.65 per share, raising net
proceeds of approximately $156,000. During our third private placement completed
on July 1, 2003, we issued 2,835,481 shares to 34 accredited investors at $3.33
per share, raising net proceeds of approximately $8,751,000. As part of this
private placement, and in addition to commissions paid, warrants to purchase
300,000 shares of our common stock at $4.50 were issued to the placement agent,
Sanders Morris Harris, Inc. During our fourth private placement completed on
August 29, 2003, we issued 175,000 shares of our common stock to 5 accredited
investors at $3.62 per share, raising net proceeds of approximately $592,000. As
part of this private placement, and in addition to commissions paid, warrants to
purchase 17,500 shares of our common stock at $3.62 were issued to the placement
agent, Pacific Summit Securities. During our fifth private placement which was
completely funded on or before November 29, 2003, but completed on December 1,
2004, we issued 2,996,667 shares of our common stock to 14 accredited investors
at $3.00 per share, and warrants to purchase 599,333 shares of our common stock
to certain of these investors at $4.00 per share raising net proceeds of
approximately $10,704,000. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations -Equity Financings" and "Risk
Factors - Equity Financings" and Item 5 "Market for Registrant's Common Equity
and Related Stockholder Matters" for a further discussion of our equity
financings.
These equity financings and amended financing agreements with CIT were necessary
to support our growth in fiscal 2003. Such growth is associated with our
obligations pursuant to the license agreements for the Shago(R) and Fetish(TM)
marks, respectively. Based upon our historical growth, we may need to obtain
additional working capital in order to meet our operational needs in fiscal
2004. We believe that we will be able to address these needs by increasing the
availability of funds offered to us under our financing agreements with CIT or
other financial institutions or by obtaining additional capital through debt or
equity financing. See "Managements Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital Resources." We believe
that any additional capital, to the extent needed, may be obtained from the sale
of equity securities or through short-term working capital loans. However, there
can be no assurance that this or other financing will be available if needed.
The inability of us to be able to fulfill any interim working capital
requirements would force us to constrict our operations.
Backlog
Although we may, at any given time, have significant business booked in advance
of ship dates, customers' purchase orders are typically filled and shipped
within two to six weeks. As of November 29, 2003, there were no significant
backlogs.
Competition
The industries in which we operate are fragmented and highly competitive in the
United States and on a worldwide basis. We compete for consumers with a large
number of apparel and accessory products similar to ours. We do not hold a
dominant competitive position, and our ability to sell our products is dependent
upon the anticipated popularity of our designs, the brands our products bear,
the price and quality of our products and our ability to meet our customers'
delivery schedules.
We believe that we are competitive in each of the above- described segments with
companies producing goods of like quality and pricing, and that new product
development, product identity through marketing, promotions and low price points
will allow us to maintain our
14
competitive position. However, many of our competitors possess substantially
greater financial, technical and other resources than us , including the ability
to implement more extensive marketing campaigns. Furthermore, the intense
competition and the rapid changes in consumer preferences constitute significant
risk factors in our operations. As we expand globally, we continue to encounter
additional sources of competition. See "Risk Factors--We face intense
competition in the worldwide apparel and accessory industry."
Imports and Import Restrictions
Our transactions with our foreign manufacturers and suppliers are subject to the
risks of doing business abroad. Imports into the United States are affected by,
among other things, the cost of transportation and the imposition of import
duties and restrictions. The countries in which our products might be
manufactured may, from time to time, impose new quotas, duties, tariffs or other
restrictions, or adjust presently prevailing quotas, duty or tariff levels,
which could affect our operations and our ability to import products at current
or increased levels. We cannot predict the likelihood or frequency of any such
events occurring. The enactment of any additional duties, quotas or restrictions
could result in increases in the cost of our products generally and might
adversely affect our sales and profitability.
Our import operations are subject to constraints imposed by bilateral textile
agreements between the United States and a number of foreign countries,
including Hong Kong, China, Taiwan and Korea. These agreements impose quotas on
the amount and type of goods that can be imported into the United States from
these countries. Such agreements also allow the United States to impose, at any
time, restraints on the importation of categories of merchandise that, under the
terms of the agreements, are not subject to specified limits. Our imported
products are also subject to United States customs duties and, in the ordinary
course of business, we are from time to time subject to claims by the United
States Customs Service for duties and other charges.
We monitor duty, tariff and quota-related developments and continually seek to
minimize its potential exposure to quota- related risks through, among other
measures, geographical diversification of our manufacturing sources, the
maintenance of overseas offices, allocation of overseas production to
merchandise categories where more quota is available and shifting of production
among countries and manufacturers.
Because our foreign manufacturers are located at greater geographic distances
from us than our domestic manufacturers, we are generally required to allow
greater lead time for foreign orders, which reduces our manufacturing
flexibility. Foreign imports are also affected by the high cost of
transportation into the United States.
In addition to the factors outlined above, our future import operations may be
adversely affected by political instability resulting in the disruption of trade
from exporting countries, any significant fluctuation in the value of the dollar
against foreign currencies and restrictions on the transfer of funds.
Human Resources
As of February 1, 2004, we had 201 full-time employees. IGI employed 11
individuals, Innovo employed 65 individuals, Joe's employed 38 individuals, and
IAA employed 87 individuals located in our various offices.
Real Estate Transactions
IRI
In April 2002, IRI acquired a 30% limited partnership interest in each of 22
separate partnerships. These partnerships simultaneously acquired 28 apartment
complexes at various locations throughout the United States consisting of
approximately 4,000 apartment units, or Properties. A portion of the aggregate
$98,080,000 purchase price was paid through the transfer of 195,295 shares of
our $100, 8% Series A Redeemable Cumulative Preferred Stock, or the Series A
Preferred Shares, to the sellers of the Properties. The balance of the purchase
price was paid by Metra Capital, LLC, or Metra Capital, in the amount of
$5,924,000, or the Metra Capital Contribution, and through proceeds from a Bank
of America loan, in the amount $72,625,000.
We had originally issued the Series A Preferred Shares to IRI in exchange for
all shares of its common stock. IRI then acquired a 30% limited partnership
interest in each of the 22 separate limited partnerships in exchange for the
Series A Preferred Stock, which then transferred the Series A Preferred Shares
to the sellers of the Properties.
Some of our stockholders, including one of our substantial stockholders, Messrs.
Paul Guez, and Simon Mizrachi and their affiliates have invested in each of the
22 separate partnerships. Each of Messrs. Guez and Mizrachi, together with their
respective affiliates, own 50% of the membership interests of Third Millennium.
Third Millennium is the managing member of Metra Capital, which owns 100% of the
membership interest in each of the 22 separate limited liability companies, or
collectively, the General Partners and together with Metra Capital, the Metra
Partners, that hold a 1% general partnership interest in each of the 22 separate
limited partnerships that own the Properties. Metra Capital also owns 69% of the
limited partnership interest in each of the 22 separate limited partnerships.
Messrs. Guez and Mizrachi and their affiliates own 19% of the membership
interest of Metra Capital. Based on the Schedule 13D/A filed by Messrs.
15
Simon Mizrachi and Joseph Mizrachi on October 30, 2003, and the Schedule 13D/A
filed by Hubert Guez and Paul Guez on January 20, 2004, the Mizrachi's
beneficially owned approximately 1% of our shares and the Guez's beneficially
own 17.57% of our shares in the aggregate. Effective February 21, 2003, the
Mizrachi's ceased to be the beneficial owners of more than five percent of our
securities. Furthermore, in connection with investments made by (1) Commerce and
other investors affiliated with Hubert Guez and Paul Guez, or collectively, the
Commerce Group, and (2) Mr. Joseph Mizrachi and Simon Mizrachi through three
entities controlled by the Mizrachi's, in 2000, each of the Commerce Group and
Mr. Joseph Mizrachi have the right to designate three individuals or one
individual, respectively, for election to our board of directors.
Pursuant to each of the limited partnership agreements, the Metra Partners
receive at least quarterly (either from cash flow and/or property sale proceeds)
an amount sufficient to provide the Metra Partners (1) a 15% cumulative compound
annual rate of return on the outstanding amount of the Metra Capital
Contribution that has not been previously returned to them through prior
distributions of cash flow and/or property sale proceeds and (2) a cumulative
annual amount of .50% of the average outstanding balance of the average
outstanding balance of the mortgage indebtedness secured by any of the
Properties. In addition, in the event of a distribution solely due to a property
sale proceeds after the above distributions have been made to the Metra
Partners, Metra Partners also receive an amount equal to 125% of the amount of
the Metra Capital Contribution allocated to the Property sold until the Metra
Partners have received from all previous cash flow or property sale
distributions an amount equal to its Metra Capital Contribution.
Third Millennium receives on a quarterly basis from cash flows and/or property
sale proceeds an amount equal to $63,000 until it receives an aggregate of
$252,000.
After the above distributions have been made, and if any cash is available for
distribution, IRI is to receive at least quarterly in the case of cash flow
distributions and at the time of property sale distributions an amount
sufficient for it to pay the 8% coupon on the Series A Preferred Shares and then
any remaining amounts left for distribution to redeem a portion or all of the
Series A Preferred Shares.
After all of the Series A Preferred Shares have been redeemed ($19.5 million),
future distributions are split between Metra Partners and IRI, with Metra
Partners receiving 70% of such distribution and IRI receiving the balance. In
addition, IRI receives a quarterly sub-asset management fee of $85,000.
The 8% Series A Preferred Shares coupon is funded entirely and solely through
partnership distributions as discussed above. If sufficient funds are not
available for the payment of a full quarterly 8% coupon, then partial payments
shall be made to the extent funds are available. Unpaid dividends accrue.
Partnership distribution amounts remaining after the payment of all accrued
dividends must be used by us to redeem outstanding the Series A Preferred
Shares. The Series A Preferred Shares have a redemption price of $100 per share.
In the event that the partnership distributions received by us are insufficient
to cover the 8% coupon or the redeem the Series A Preferred Shares, we will have
no obligation to cover any shortcomings so long as all distributions from the
partnership are properly applied to the payment of dividends and the redemption
of the Series A Preferred Shares. We may however be liable to the holders of the
Series A Preferred Shares for the breach of certain covenants, including, but
not limited to, if IRI fails (i) to deposit distributions from the partnerships
into a sinking fund which funds are to be distributed to the holders of the
Series A Preferred Shares as a dividend or redemption of the Series A Preferred
Shares or (ii) to enforce its rights to receive distributions from the limited
partnerships. If, after all of the Properties are sold and the proceeds of the
sale of the Properties and cash flow derived from such Properties have either
been applied to the payment of the 8% coupon and the redemption of the Series A
Preferred Shares or deposited into the sinking fund for that purpose, and the
total amount of funds remaining in the Sinking Fund is insufficient to pay the
full 8% coupon and the full Redemption Price for all then outstanding the Series
A Preferred Shares, then we, or IRI, must pay $1.00 in total into the Sinking
Fund and the Redemption Price will be adjusted so that it equals (x) the total
amount in the sinking fund available for distribution, minus (y) all direct
costs of maintaining the Sinking Fund and making distributions therefrom,
divided by (z) the number of then outstanding Preferred Shares. The adjusted
Redemption Price will represent full and final payment for the redemption of all
the Series A Preferred Shares.
We have not given accounting recognition to the value of our investment in the
limited partnerships, because we have determined that the asset is contingent
and will only have value to the extent that cash flow from the operations of the
properties or from the sale of underlying assets is in excess of the 8% coupon
and redemption of the Series A Preferred Shares. As discussed above, we are
obligated to pay the 8% coupon and redeem the Series A Preferred Shares from our
partnership distributions, prior to us being able to recover the underlying
value of our investment. Additionally, we have determined that the Series A
Preferred Shares will not be accounted for as a component of equity as the
shares are redeemable outside of our control. No value has been ascribed to the
Series A Preferred Shares for financial reporting purposes as we are obligated
to pay the 8% coupon or redeem the shares only if we receive cash flow from the
limited partnerships adequate to make the payments. We have included the
quarterly management fee paid to IRI in other income using the accrual basis of
accounting.
During fiscal 2003, IRI had no operations or transactions other than its
quarterly sub-asset management fee as discussed above.
16
Financial Information about Geographical Areas
See "Note 13 - Segment Disclosures -Operations by Geographic Area" in the Notes
to Consolidated Financial Statements for further discussion of financial
information about geographical areas.
Available Information
Our World Wide Web address is www.innovogroup.com, and we maintain a website at
that address. We make available on or through our World Wide Web website,
without charge, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15 (d) of the Securities Exchange Act of 1934, as
amended, as soon as reasonably practicable after such reports are electronically
filed with or furnished to the SEC. Although we maintain a website at
www.innovogroup.com, we do not intend that the information available through our
website be incorporated into this Annual Report on Form 10-K. In addition, any
materials filed with, or furnished to, the SEC may be read and copied at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 or
viewed on line at www.sec.gov. Information regarding the operation of the Public
Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.
Executive Officers
The following table sets forth certain information regarding our executive
officers:
Name Age Position
- ---- --- --------
Samuel J. (Jay) Furrow, Jr...... 30 Chief Executive Officer and Director
Patricia Anderson............... 43 President and Director
Marc B. Crossman................ 32 Chief Financial Officer and Director
Shane Whalen.................... 33 Chief Operating Officer
Samuel J. (Jay) Furrow, Jr. has served as our Chief Executive Officer since July
2002 and a member of our Board of Directors since January 1999. Prior to that,
Mr. Furrow served as our President from December 2000 until July 2002, served as
our Chief Operating Officer from April 1999 until July 2002, our Acting Chief
Financial Officer from August 2000 until July 2002, and our Vice-President for
Corporate Development and In-House Counsel from August 1998 until April 1999.
Patricia Anderson has served as our President since July 2002 and a member of
our Board of Directors since August 1990. Ms. Anderson has also served as
President of Innovo since 1987. Prior to that, Ms. Anderson served as our Chief
Executive Officer from December 2000 until July 2002, our President from August
1990 until December 2000, and Chairman of our Board of Directors from August
1990 until August 1997.
Marc B. Crossman has served as our Chief Financial Officer since March 2003 and
a member of our Board of Directors since January 1999.
Shane Whalen has served as our Chief Operating Officer since April 2003.
Subsequent Events
On February 6, 2004, we, through IAA, entered into an assignment with Blue
Concept LLC, which is controlled by Paul Guez for all the rights benefits and
obligations of a license agreement between Blue Concept LLC and B.J. Vines,
Inc., the licensor of the Betsey Johnson(R) apparel brand. The license agreement
provides for the exclusive right to design, market and distribute women's jeans
and coordinating denim related apparel, such as t-shirts and tops, under the
Betsey Johnson(R) brand name in the United States, its territories and
possessions, and Canada. The license agreement allows for an initial four-year
term with a renewal option subject to certain sales levels being met. We are
required to pay royalties of eight percent on net sales and spend two percent of
net sales on advertising. The license agreement provides that certain minimum
guaranteed royalties and minimum net sales must be met in each annual period.
The minimum royalties to be paid in the aggregate are $1.28 million and minimum
net sales range form $2.5 million to $5.5 million. The agreement may be renewed
upon expiration of the initial 4 year term for an additional three years. We
anticipate introducing the Betsey Johnson(R) products in the third quarter of
2004.
On February 16, 2004, Joe's entered into a Master Distribution Agreement ("MDA")
with Beyond Blue, Inc., or Beyond Blue, whereby Joe's granted Beyond Blue
exclusive distribution rights for Joe's products outside the United States.
Beyond Blue, a Los Angeles-based company that specializes in international
consulting, distribution and licensing for apparel products, secured an
exclusive right to distribute Joe's products outside the United States, subject
to current license agreements such as the license with Itochu and Joe's Canadian
distributor remaining in place. Under the MDA, Beyond Blue will be establishing
sub-distributors and sales agents in certain international markets through
sub-distribution agreements. These sub-distribution agreements shall govern, but
not be limited to, such items as: (i) minimum sample charges paid by each
sub-distributor; (ii) minimum advertising requirements to be borne by each
sub-distributor; and (iii) an assignment provision that allows Joe's to take
over the sub-distribution agreements in the event that Beyond
17
Blue defaults under the MDA. The MDA also provides for the continuation of
existing distribution agreements, such as the Itochu Agreement. The term of the
MDA shall be for three years, subject to Beyond Blue purchasing certain minimum
amounts of product from Joe's during three annual periods, with the first annual
period being for 18 months.
18
Certain Risk Factors
The following risk factors should be read carefully in connection with
evaluating our business and the forward-looking statements contained in this
Annual Report on Form 10-K. Any of the following risks could materially
adversely affect our business, our operating results, our financial condition
and the actual outcome of matters as to which forward-looking statements are
made in this Annual Report on Form 10-K.
Risk Factors Relating to our Common Stock
We do not anticipate paying dividends on our common stock in the foreseeable
future.
We have not paid any dividends nor do we anticipate paying any dividends on our
common stock in the foreseeable future. We intend to retain earnings, if any, to
fund our operations and to develop and expand our business.
We have a substantial number of authorized common and preferred shares available
for future issuance that could cause dilution of our stockholder's interest and
adversely impact the rights of holders of our common stock.
We have a total of 40,000,000 shares of common stock and 5,000,000 shares of
"blank check" preferred stock authorized for issuance. As of February 25, 2004,
we had 14,135,150 shares of common stock and 4,806,000 shares of preferred stock
available for issuance. In fiscal 2003, we raised net proceeds of $17,540,000
through the sale of 6,235,648 shares of our common stock and 916,833 shares of
common stock purchase warrants in private placement transactions. On March 5,
2004, we are holding a special meeting of our stockholders to approve the
conversion of $12.5 million in principal amount of indebtedness from a
convertible promissory note issued in connection with the purchase of the Blue
Concepts Division from Azteca into a maximum of 4,166,667 shares of our common
stock. We expect to continue to seek financing which could result in the
issuance of additional shares of our capital stock and/or rights to acquire
additional shares of our capital stock. Those additional issuances of capital
stock would result in a reduction of your percentage interest in us.
Furthermore, the book value per share of our common stock may be reduced. This
reduction would occur if the exercise price of the options or warrants or the
conversion ratio of the preferred stock was lower than the book value per share
of our common stock at the time of such exercise or conversion.
The addition of a substantial number of shares of our common stock into the
market or by the registration of any of our other securities under the
Securities Act may significantly and negatively affect the prevailing market
price for our common stock. The future sales of shares of our common stock
issuable upon the exercise of outstanding warrants and options may have a
depressive effect on the market price of our common stock, as such warrants and
options would be more likely to be exercised at a time when the price of our
common stock is greater than the exercise price.
Our board of directors has the power to establish the dividend rates,
preferential payments on any liquidation, voting rights, redemption and
conversion terms and privileges for any series of our preferred stock. The sale
or issuance of any shares of our preferred stock having rights superior to those
of our common stock may result in a decrease in the value or market price of our
common stock. The issuance of preferred stock could have the effect of delaying,
deferring or preventing a change of ownership without further vote or action by
our stockholders and may adversely affect the voting and other rights of the
holders of our common stock.
We are controlled by our management and other related parties.
As of February 4, 2004, our executive officers and directors beneficially owned
approximately 24.82% of our outstanding securities. Furthermore, in connection
with investments made by (1) Commerce and other investors affiliated with Hubert
Guez and Paul Guez, or collectively, the Commerce Group, and (2) Mr. Joseph
Mizrachi in fiscal 2000, both Commerce Group and Mr. Mizrachi each have the
right to designate three individuals and one individual respectively, for
election to the board of directors. If any or all of the Commerce Group or
Mizrachi designated directors are elected, then the Board has the obligation to
appoint at least one Commerce and/or Mizrachi designated director to each of its
committees. Based on the Schedule 13D/A filed by Messrs. Simon Mizrachi and
Joseph Mizrachi on October 30, 2003, the Mizrachi's beneficially owned
approximately 1.2% of our shares and the Schedule 13D/A filed by Messrs. Hubert
Guez and Paul Guez on January 20, 2004, the Guez's beneficially owned
approximately 17.56% of our shares in the aggregate. As of February 21, 2003,
the Mizrachi's ceased to be the beneficial owners of more than 5% of our
securities. In the event that our stockholders approve the conversion of the
Blue Concept Note into a maximum of 4,166,667 shares of our common stock at the
special meeting of stockholders that we are holding on March 5, 2004, as
discussed above in "Business - Strategic Relationship with two of our
significant stockholders, Hubert Guez and Paul Guez, and affiliated companies,"
then the Guez's will beneficially own approximately 33.73% of our common stock
in the aggregate. We are unable to predict the effect that sales into the market
of 4,166,667 shares may
19
have on the then prevailing market price of our common stock. On February 25,
2004, the last reported sale price of our common stock on the Nasdaq SmallCap
Market was $2.85. During the four week period prior to February 25, 2004, the
average daily trading volume of our common stock was 80,755 shares. It is likely
that market sales of the 4,166,667 shares offered for sale (or the potential for
those sales even if they do not actually occur) may have the effect of
depressing the market price of our common stock. As a result, the potential
resale and possible fluctuations in trading volume of such a substantial amount
of our stock may affect the share price negatively beyond our control.
Because of their stock ownership and/or positions with us, these persons have
been and will continue to be in a position to greatly influence the election of
directors, and thus, control our affairs. Additionally, our bylaws limit the
ability of stockholders to call a meeting of the stockholders. These bylaw
provisions could have the effect of discouraging a takeover of us, and therefore
may adversely affect the market price and liquidity of our securities. We are
also subject to a Delaware statute regulating business combinations that may
hinder or delay a change in control. The anti-takeover provisions of the
Delaware statute may adversely affect the market price and liquidity of our
securities.
Our common stock price is extremely volatile and may decrease rapidly.
The trading price and volume of our common stock has historically been subject
to wide fluctuation in response to variations in actual or anticipated operating
results, announcements of new product lines or by us or our competitors, and
general conditions in the apparel and accessory industry. In the 52 week period
prior to November 29, 2003, the closing price of our common stock has ranged
from $2.33 - $7.80. In addition, stock markets generally have experienced
extreme price and volume trading volatility in recent years. This volatility has
had a substantial effect on the market prices of securities of many companies
for reasons frequently unrelated to the operating performance of the specific
companies. These broad market fluctuations may significantly and negatively
affect the market price of our common stock.
If we cannot meet the Nasdaq SmallCap Market maintenance requirements and Nasdaq
Rules, Nasdaq may delist our common stock which could negatively affect the
price of the common stock and your ability to sell the common stock.
In the future, we may not be able to meet the listing maintenance requirements
of the Nasdaq SmallCap Market and Nasdaq rules, which require, among other
things, minimum net tangible assets of $2 million, a minimum bid price for our
common stock of $1.00, and stockholder approval prior to the issuance of
securities in connection with a transaction involving the sale or issuance of
common stock equal to 20 percent or more of a company's outstanding common stock
before the issuance for less than the greater of book or market value of the
stock. If we are unable to satisfy the Nasdaq criteria for maintaining listing,
our common stock would be subject to delisting. Trading, if any, of our common
stock would thereafter be conducted in the over-the-counter market, in the
so-called "pink sheets" or on the National Association of Securities Dealers,
Inc., or NASD, "electronic bulletin board." As a consequence of any such
delisting, a stockholder would likely find it more difficult to dispose of, or
to obtain accurate quotations as to the prices, of our common stock.
If Nasdaq delists our common stock you would need to comply with the penny stock
regulations which could make it more difficult to sell your common stock.
In the event that our securities are not listed on the Nasdaq SmallCap Market,
trading of the common stock would be conducted in the "pink sheets" or through
the NASD's Electronic Bulletin Board and covered by Rule 15g-9 under the
Securities Exchange Act of 1934. Under such rule, broker/dealers who recommend
these securities to persons other than established customers and accredited
investors must make a special written suitability determination for the
subscriber and receive the subscriber's written agreement to a transaction prior
to sale. Securities are exempt from this rule if the market price is at least
$5.00 per share.
The Securities and Exchange Commission adopted regulations that generally define
a penny stock as any equity security that has a market price of less than $5.00
per share, with certain exceptions. Unless an exception is available, the
regulations require the delivery, prior to any transaction involving a penny
stock, of a disclosure schedule explaining the penny stock market and the risks
associated with it. If our common stock were considered a penny stock, the
ability of broker/dealers to sell our common stock and the ability of our
stockholders to sell their securities in the secondary market would be limited.
As a result, the market liquidity for our common stock would be severely and
adversely affected. We cannot assure you that trading in our securities will not
be subject to these or other regulations in the future which would negatively
affect the market for such securities.
Risk Factors Relating to our Operations
Due to our negative cash flows we could be required to cut back or stop
operations if we are unable to raise or obtain needed funding.
Our ability to continue operations will depend on our positive cash flow, if
any, from future operations and on our ability to raise additional funds through
equity or debt financing. As of November 29, 2003, we have raised net proceeds
of approximately $17,540,000, in the aggregate through the sale of shares of
6,235,648 our common stock and 916,833 shares of common stock purchase warrants
in five private placement transactions and had an outstanding loan balance of
$8,786,000 with CIT with whom we have entered into
20
financing agreements. These sources of financing are used to fund our continuing
operations and for working capital. As of November 29, 2003, we had $8,536,000
of factored receivables with CIT and $2,149,000 of unused letter of credit
outstanding in the aggregate. While we had a $332,000 liability with CIT as of
November 29, 2003 due to the amount of factored receivables, our financial
position may change such that there may be the need for us to continue to raise
needed funds through a mix of equity and debt financing to fund its operations
and working capital. Equity financing will usually result in existing
stockholders becoming "diluted" or owning a smaller percentage of the total
shares outstanding as of the date of such dilution. A high degree of dilutions
can make it difficult for the price of our common stock to rise rapidly, among
other things. Dilution also lessens a stockholder's voting power.
We do not know if we will be able to continue to raise additional funding or if
such funding will be available on favorable terms. We could be required to cut
back or stop operations if we are unable to raise or obtain needed funding.
Our cash requirements to run our business have been and will continue to be
significant.
Since 1997, our negative operating cash flow and losses from continuing
operations have been as follows:
(Negative) positive Cash
Flow
from Operating (Losses) income
Activities of from
Continuing Operations Continuing Operations
--------------------- ---------------------
Fiscal Year Ended:
- ------------------
November 29, 2003 ($ 9,857,000) ($8,317,000)
November 30, 2002 $1,504,000 $ 572,000
December 1, 2001 ($ 632,000) ($ 618,000)
November 30, 2000 ($ 4,598,000) ($ 5,056,000)
November 30, 1999 ($ 2,124,000) ($ 1,340,000)
November 30, 1998 ($ 1,238,000) ($ 2,267,000)
November 30, 1997 ($ 1,339,000) ($ 1,729,000)
Since November 30, 1997, we have experienced negative cash flow from our
operating activities except for the year ending November 30, 2002. As of
November 29, 2003, we had an accumulated deficit of approximately $41,824,000.
Although we have undertaken numerous measures to increase sales and operate more
efficiently, we may experience further losses and negative cash flows. We can
give you no assurance that we will in fact operate profitably in the future.
We must expand sales of our existing products and successfully introduce new
products that respond to constantly changing fashion trends and consumer demands
to increase revenues and attain profitability.
Our success will depend on our ability to expand sales of our current products
to new and existing customers, as well as the development or acquisition of new
product designs and the acquisition of new licenses that appeal to a broad range
of consumers. We have little control over the demand for our existing products,
and we cannot assure you that the new products