================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] Annual Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2003
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-13669
TAG-IT PACIFIC, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
21900 Burbank Blvd., Suite 270
Woodland Hills, California 91367
(Address of Principal Executive Offices) (Zip Code)
(818) 444-4100
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
Common Stock, $.001 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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 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 in Exchange Act Rule 12b-2) Yes [ ] No [X]
At June 30, 2003 the aggregate market value of the voting and
non-voting common stock held by non-affiliates of the registrant was
$46,426,706. At March 23, 2004 the issuer had 18,035,316 shares of Common Stock,
$.001 par value, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the issuer's proxy statement with respect to its 2004
annual meeting of stockholders are incorporated by reference into Part III of
this report.
================================================================================
TAG-IT PACIFIC, INC.
INDEX TO FORM 10-K
PART I Page
Item 1. Business.................................................. 1
Item 2. Properties................................................ 7
Item 3. Legal Proceedings......................................... 7
Item 4. Submission of Matters to a Vote of Security Holders....... 7
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity...... 7
Item 6. Selected Financial Data................................... 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 12
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk ............................................ 29
Item 8. Financial Statements and Supplementary Data:
Report of Independent Certified Public Accountants........ 32
Consolidated Balance Sheets............................... 33
Consolidated Statements of Operations..................... 34
Consolidated Statements of Stockholders' Equity and
Convertible Redeemable Preferred Stock.................. 35
Consolidated Statements of Cash Flows..................... 36
Notes to Consolidated Financial Statements................ 37
Independent Certified Public Accountants' Report
on Schedule II.......................................... 63
Schedule II - Valuation and Qualifying Accounts
and Reserves............................................ 64
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................... 65
Item 9A. Controls and Procedures................................... 65
PART III
Item 10. Directors and Executive Officers of the Registrant........ 65
Item 11. Executive Compensation.................................... 65
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Shareholder Matters......... 65
Item 13. Certain Relationships and Related Transactions............ 65
Item 14. Principal Accountant Fees and Services.................... 66
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K..................................... 66
i
PART I
This Annual Report on Form 10-K contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. We use words
such as "believes", "intends", "expects", "anticipates", "plans", "may", "will"
and similar expressions to identify forward-looking statements. Discussions
containing forward-looking statements may be found in the material set forth
under "Business," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and in other sections of the report. All
forward-looking statements, including, but not limited to, projections or
estimates concerning our business, including demand for our products and
services, mix of revenue streams, ability to control and/or reduce operating
expenses, anticipated gross margins and operating results, cost savings, product
development efforts, general outlook of our business and industry, international
businesses, competitive position, adequate liquidity to fund our operations and
meet our other cash requirements, are inherently uncertain as they are based on
our expectations and assumptions concerning future events. These forward-looking
statements are subject to numerous known and unknown risks and uncertainties.
You should not place undue reliance on these forward-looking statements. Our
actual results could differ materially from those anticipated in the
forward-looking statements for many reasons, including the success of our
product offerings, our ability to expand our customer base, and all other risks
described below in the section entitled "Cautionary Statements and Risk Factors"
appearing in "Management's Discussion and Analysis of Financial Condition and
Risk of Operations" and elsewhere in this report. All forward-looking statements
in this document are made as of the date hereof, based on information available
to us as of the date hereof, and we assume no obligation to update any
forward-looking statement.
ITEM 1. BUSINESS
GENERAL
Tag-It Pacific, Inc. is an apparel company that specializes in the
distribution of a full range of trim items to manufacturers of fashion apparel,
specialty retailers and mass merchandisers. We act as a full service outsourced
trim management department for manufacturers of fashion apparel such as
Abercrombie & Fitch, Tarrant Apparel Group, Kentucky Apparel and Azteca
Production International. We also serve as a specified supplier of trim items to
owners of specific brands, brand licensees and retailers, including Abercrombie
& Fitch, Levi Strauss & Co., Express, The Limited, Lerner and Miller's Outpost,
among others. In addition, we distribute zippers under our TALON brand name to
manufacturers for apparel brands and retailers such as Levi Strauss & Co.,
Wal-Mart, JC Penny and Tropical Sportswear, among others. In 2002, we created a
new division under the TEKFIT brand name. This division develops and sells
apparel components that utilize the patented Pro-Fit technology, including a
stretch waistband. We market these products to the same customers targeted by
our MANAGED TRIM SOLUTION and TALON zipper divisions.
We were incorporated in Delaware in September 1997. We were formed to
serve as the parent holding company of Tag-It, Inc., a California corporation,
Tag-It Printing & Packaging Ltd., which changed its name in 1999 to Tag-It
Pacific (HK) LTD, a BVI corporation, Tagit de Mexico, S.A. de C.V., A.G.S.
Stationery, Inc., a California corporation, and Pacific Trim & Belt, Inc., a
California corporation. All of these companies were consolidated under a parent
limited liability company in October 1997. These companies became our wholly
owned subsidiaries immediately prior to the effective date of our initial public
offering in January 1998. In 2000, we formed two wholly owned subsidiaries of
Tag-It Pacific, Inc: Tag-It Pacific Limited, a Hong Kong corporation, and Talon
International, Inc., a Delaware corporation. Our website is
www.tagitpacific.com.
1
BUSINESS SUMMARY
We have positioned ourselves as a fully integrated single-source
supplier of a full range of trim items for manufacturers of fashion apparel. Our
business focuses on servicing all of the trim requirements of our customers at
the manufacturing and retail brand level of the fashion apparel industry. Trim
items include thread, zippers, stretch waistbands, labels, buttons, rivets,
printed marketing material, polybags, packing cartons, and hangers. Trim items
comprise a relatively small part of the cost of most apparel products but
comprise the vast majority of components necessary to fabricate a typical
apparel product. We offer customers what we call our MANAGED TRIM SOLUTION,
which is an Internet-based supply-chain management system covering the complete
management of development, ordering, production, inventory management and
just-in-time distribution of their trim and packaging requirements.
Traditionally, manufacturers of apparel products have been required to operate
their own apparel trim departments, requiring the manufacturer to maintain a
significant amount of infrastructure to coordinate the buying of trim products
from a large number of vendors. By acting as a single source provider of a full
range of trim items, we allow manufacturers using our MANAGED TRIM SOLUTION to
eliminate the added infrastructure, trim inventory positions, overhead costs and
inefficiencies created by in-house trim departments that deal with a large
number of vendors for the procurement of trim items. We also seek to leverage
our position as a single source supplier of trim items as well as our extensive
expertise in the field of trim distribution and procurement to more efficiently
manage the trim assembly process resulting in faster delivery times and fewer
production delays for our manufacturing customers. Our MANAGED TRIM SOLUTION
also helps to eliminate a manufacturer's need to maintain a trim purchasing and
logistics department.
We distribute zippers under our TALON trademark and trade names to
apparel brands and manufacturers. TALON is a 100-year-old brand, which is well
known for quality and product innovation. TALON was the original pioneer of the
formed wire metal zipper for the jeans industry and is a specified zipper brand
for manufacturers in the sportswear and outerwear markets. We have introduced a
completely revised high quality line of zippers, broadened distribution to Asia,
Mexico and Central America, negotiated with new distributors and initiated a new
sales and marketing effort for this brand. TALON is promoted both within our
trim packages, as well as a stand-alone product line. TALON enjoys tremendous
brand recognition and brand equity in the apparel industry worldwide.
We also serve as a specified supplier for a variety of major retail
brand and private label oriented companies. A specified supplier is a supplier
that has been approved for quality and service by a major retail brand or
private label company. Contractors manufacturing for the major retail brand or
private label company must purchase their trim requirements from a supplier that
has been specified. We seek to expand our services as a vendor of select lines
of trim items for such customers to being a preferred or single source provider
of all of such brand customer's authorized trim requirements. Our ability to
offer brand name and private label oriented customers a full range of trim
products is attractive because it enables our customers to address their quality
and supply needs for all of their trim requirements from a single source,
avoiding the time and expense necessary to monitor quality and supply from
multiple vendors and manufacturer sources. Becoming a specified supplier to
brand customers gives us an opportunity to become the preferred or sole vendor
of trim items for all manufacturers of apparel under that brand name.
We have assembled a team of sales representatives, program managers,
creative design personnel and global production and distribution coordinators at
our facilities located in the United States, Mexico, Hong Kong and the
Caribbean. We plan to continue to expand operations in Hong Kong, Central
America and the Caribbean to take advantage of the large apparel manufacturing
markets in these regions. We believe our marketing strategy and international
distribution operations will enable us to take advantage of and address the
increasingly complicated requirements of the large and expanding demand for
complete trim packages.
2
A significant portion of a typical trim package is comprised of zippers
and thread. In order to secure a stable high-quality source of supply for thread
products, we entered into a supply and co-marketing agreement with Coats
America, an affiliate of Coats, plc, which is a leading thread company in the
apparel industry and operates in more than 65 countries worldwide. The supply
and co-marketing agreement was accompanied by an equity investment by Coats
North America Consolidated, Inc., also an affiliate of Coats, plc, in the amount
of $3 million. Pursuant to the supply and co-marketing agreement, we have agreed
to exclusively promote Coats brand thread in our trim packages.
PRODUCTS
COMPLETE TRIM PACKAGES. We market and supply our customers with
complete trim packages on a per-garment basis which we assemble on behalf of our
customers. Each trim package includes all items of trim that a customer will
need in the manufacture of a particular item of apparel. Our complete trim
packages include a variety of trim items including thread, zippers, labels,
buttons, rivets, polybags, packing cartons and hangers. We also provide in our
complete trim packages printed marketing materials including hang tags,
bar-coded hang tags, pocket flashers, waistband tickets and size stickers that
are attached to products to identify and promote the products, permit automated
data collection, provide brand identification and communicate consumer
information such as a product's retail price, size, fabric content and care
instructions.
We consider a high level of customer service essential to our success.
We combine our high level of customer service with our MANAGED TRIM SOLUTION to
offer our customers a complete trim service product. We believe this
full-service product gives us a competitive edge over companies that only offer
selected trim components because our MANAGED TRIM SOLUTION saves our customers
time and employee work hours in ordering and managing trim orders from several
different suppliers. Our MANAGED TRIM SOLUTION is a business-to-business
e-commerce system that allows us to provide our customers with a customized,
comprehensive system for the management of various aspects of their trim
programs. Our MANAGED TRIM SOLUTION is an Internet-based supply-chain management
system which provides customers with assistance in their ordering, production,
inventory management and just-in-time distribution of their trim and packaging
requirements.
The upcoming launch of TRIMNET, our Oracle based e-sourcing system will
allow us to seamlessly supply complete trim packages to apparel brands,
retailers and manufacturers around the world, greatly expanding upon our success
in offering complete trim packages to customers in Mexico over the past several
years. TRIMNET is an upgrade of our MANAGED TRIM SOLUTION software and will
allow us to provide additional services to customers on a global platform.
SEPARATE TRIM COMPONENTS. Separate from our marketing of complete trim
packages, we also provide individual items of trim to certain of our customers
who only need to source a portion of their trim requirements from us. Further,
for selected customers, we also produce customized woven, leather, synthetic,
embroidered and novelty labels and tapes, which can be printed on or woven into
a wide range of fabrics and other materials using various types of high-speed
equipment. As an additional service, we lease to our customers the machinery
used to attach the buttons, rivets and snaps we distribute.
TALON BRAND ZIPPERS. We offer a full line of metal and synthetic
zippers bearing the TALON brand name. TALON zippers are used primarily by
manufacturers in the apparel industry and are distributed through our
distribution facilities in the United States, Mexico and Hong Kong. In addition,
we are negotiating with distributors that service local apparel manufacturing
regions in the United States and overseas. We offer manufacturers
technologically advanced equipment for efficiently handling TALON zippers and
applying them into garments. The branded apparel zipper market is dominated by
one company; YKK (R). We are positioning TALON to be a viable alternative to YKK
(R), and to capture an increased market share position. We also plan to leverage
the brand equity in the TALON name by branding other products in our line with
the TALON name.
3
TEKFIT. We have entered into an Exclusive License and Intellectual
Property Rights agreement with Pro-Fit Holdings Limited. The agreement gives us
the exclusive rights to sell or sublicense stretch waistbands manufactured under
the patented technology developed by Pro-Fit for garments manufactured anywhere
in the world for the U.S. market and all U.S. brands, for the life of the patent
and related know-how. We now offer apparel manufacturers advanced, patented
fabric technologies to utilize in their garments under the TEKFIT name. This
revolutionary technology allows fabrics to be altered through the addition of
stretch characteristics resulting in greatly improved fit and comfort.
Currently, we are supplying Levi Strauss & Co. with TEKFIT waistbands for their
Dockers(R) programs. Our exclusive supply arrangement with Levi Strauss & Co. is
for twill type pants only. This new technology allows pant manufacturers to
build in a stretch factor into standard waistbands that does not alter the
appearance of the garment, but will allow the waist to stretch out and back by
as much as two waist sizes. We are actively working with other large apparel
manufacturers to develop and release the TEKFIT technology in other types of
garments.
DESIGN AND DEVELOPMENT
We have assembled an in-house creative team to produce products with
innovative technology and designs that we believe distinguish our products from
those of our competitors. We support our skills and expertise in material
procurement and product-manufacturing coordination with product technology and
designs intended to meet fashion demands, as well as functional and cost
parameters. Many specialty design companies with which we compete have limited
sourcing or manufacturing experience. These companies create designs that often
cannot be implemented due to difficulties in the manufacturing process, the
expenses of required materials, or a lack of functionality in the resulting
product. We attempt to design products to function within the limitations
imposed by the applicable manufacturing framework. Using our manufacturing and
sourcing experience, we attempt to minimize the time-consuming delays that often
arise in coordinating the efforts of independent design houses and manufacturing
facilities. By supporting our material procurement and product manufacturing
services with design services, we believe that we reduce development and
production costs and deliver products to our customers sooner than many of our
competitors. Our development costs are low, most of which are borne by our
customers. Our design teams are based out of our California and Hong Kong
facilities, including our design team related to our TEKFIT division.
CUSTOMERS
We have more than 300 customers. Our customers include well-known
apparel manufacturers, such as Levi Strauss & Co., Abercrombie & Fitch, The
Limited Group, Tarrant Apparel Group, Kentucky Apparel, Azteca Production
International, VF Corporation and Tropical Sportswear, among others. Our
customers also include contractors for specialty retailers such as Miller's
Outpost and mass merchant retailers such as Wal-Mart.
In July 2002, we entered into an exclusive supply contract with Levi
Strauss & Co. Under the terms of the supply agreement, Levi Strauss & Co. has
agreed to purchase a minimum of $10 million of stretch waistbands, various other
trim products, garment components and services over the two-year term of the
agreement. Levi Strauss & Co. also appointed TALON as an approved zipper
supplier.
SALES AND MARKETING
We sell our principal products through our own sales force based in Los
Angeles, various other cities in the United States, Hong Kong and Mexico. We
also employ customer service representatives who are assigned to key customers
and provide in-house customer service support. Our senior executives have
developed relationships with our major customers at senior levels. These
executives actively participate in marketing and sales functions and the
development of our overall marketing and sales strategies. When we become the
outsourcing vendor for a customer's packaging or trim requirements, we position
ourselves as if we are an in-house department of the customer's trim procurement
operation.
4
A significant portion of our sales is to customers based in the United
States. For the year ended December 31, 2003, sales to United States based
customers for shipments to production facilities in Mexico, Asia and the
Dominican Republic accounted for 44.7%, 19.1% and 23.9%, of our revenues,
respectively. We also market our products to customers in Mexico, Asia, the
Caribbean basin and Central America.
SOURCING AND ASSEMBLY
We have developed expertise in identifying the best materials, prices
and vendors for particular products and raw materials. This expertise enables us
to produce a broad range of packaging and trim products at various price points.
The majority of products that we procure and distribute are purchased on a
finished good basis. Raw materials, including paper products and metals used to
manufacture zippers, used in the assembly of our trim kits are available from
numerous sources and are in adequate supply. We purchase products from several
qualified material suppliers, including Coats North America and its affiliates
which accounted for 19.3% of our purchases in 2003.
We are able to create most product artwork and any necessary films,
dies and molds used to design and manufacture our products. All other products
that we design and sell are produced by third party vendors. We are confident in
our ability to secure high quality alternative manufacturing sources. We intend
to continue to outsource production to qualified vendors, particularly with
respect to manufacturing activities that require substantial investment in
capital equipment.
Through our Hong Kong facility, we distribute TALON zippers, trim items
and apparel packaging and coordinate the manufacture and distribution of the
full range of our products. Our Hong Kong facility supplies several significant
packaging programs, services customers located in Asia and the Pacific Rim and
sources products for our Los Angeles and Mexico based operations.
INTELLECTUAL PROPERTY RIGHTS AND LICENSES
We have trademarks as well as copyrights, software copyrights and trade
names for which we rely on common law protection, including the TALON trademark.
Several of our other trademarks are the subject of applications for federal
trademark protection through registration with the United States Patent and
Trademark Office, including "Tag-It", "Managed Trim Solution" and "TekFit". We
also rely on our Exclusive License and Intellectual Property Rights agreement
with Pro-Fit Holdings Limited to sell our TEKFIT Stretch waistbands. The
agreement gives us the exclusive rights to sell or sublicense stretch waistbands
manufactured under the patented technology developed by Pro-Fit for garments
manufactured anywhere in the world for the U.S. market and all U.S. brands, for
an indefinite term that extends for the duration of the patent and trade secrets
licensed under the agreement.
SEASONALITY
We typically experience seasonal fluctuations in sales volume. These
seasonal fluctuations result in sales volume decreases in the first and fourth
quarters of each year due to the seasonal fluctuations experienced by the
majority of our customers. The apparel industry typically experiences higher
sales volume in the second quarter in preparation for back-to-school purchases,
and the third quarter in preparation for year-end holiday purchases.
5
INVENTORIES
In order to meet the rapid delivery requirements of our MANAGED TRIM
SOLUTION customers, we are required to carry a substantial amount of inventory
on their behalf. Included in inventories at December 31, 2003 are inventories
that are subject to buyback arrangements with these customers. The buyback
arrangements contain provisions related to the inventory purchased on behalf of
these customers. In the event that inventories remain with us in excess of six
to nine months from our receipt of the goods from our vendors or the termination
of production of a customer's product line related to the inventories, the
customer is required to purchase the inventories from us under normal invoice
and selling terms.
COMPETITION
We compete in highly competitive and fragmented industries that include
numerous local and regional companies that provide some or all of the products
we offer. We also compete with United States and international design companies,
distributors and manufacturers of tags, trim, packaging products and zippers.
Some of our competitors, including Paxar Corporation, YKK (R), Universal Button,
Inc., Avery Denison Corporation and Scovill Fasteners, Inc. have greater name
recognition, longer operating histories and, in many cases, substantially
greater financial and other resources.
Because of our integrated materials procurement and assembly
capabilities and our full service MANAGED TRIM SOLUTION, we believe that we are
able to effectively compete for our customers' business, particularly where our
customers require coordination of separately sourced production functions. We
believe that to successfully compete in our industry we must offer superior
product pricing, quality, customer service, design capabilities, delivery lead
times and complete supply-chain management. We also believe the TALON brand name
and the quality of our TALON brand zippers will allow us to gain market share in
the zipper industry. The unique stretch quality of our TEKFIT waistbands will
also allow us to compete effectively in the market for waistband components.
SEGMENT INFORMATION
We operate primarily in one industry segment, the distribution of a
full range of apparel trim products to manufacturers of fashion apparel,
specialty retailers and mass merchandisers. For information regarding the
revenues and assets associated with our geographic segments, see Note 15 of the
Notes to the Consolidated Financial Statements included in Item 8 of this
Report, which is incorporated herein by reference.
INTERNATIONAL
We sell the majority of our products to U.S. based brands, retailers
and manufacturers. The majority of these customers produce their products or
contract out the production of their products in manufacturing facilities
located outside of the U.S., primarily in Mexico, Asia, the Dominican Republic
and Central America.
A summary of our domestic and international net revenue and long-lived
assets is set forth in Note 15 of the Notes to the Consolidated Financial
Statements in Item 8 of this Report, which is incorporated herein by reference.
Approximately 88% of our overall net revenue came from sales to U.S. based or
contract manufacturers' facilities located outside of the United States during
the year ended December 31, 2003.
For a discussion of risks attendant to our foreign operations, see "IF
WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL NOT BE ABLE
TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS.", under Cautionary
Statements and Risk Factors, in Item 7 of this Report, "Quantitative and
Qualitative Disclosure about Market Risk" in Item 7A of this Report and Note 15
of the Notes to the Consolidated Financial Statements in Item 8, which are
incorporated herein by reference.
6
EMPLOYEES
As of December 31, 2003, we had approximately 188 full-time employees,
with approximately 45 employees in Los Angeles, 9 employees in North Carolina,
10 employees in various other cities, 30 employees in Hong Kong, 8 employees in
the Dominican Republic and 86 employees in Tlaxcala, Mexico. Our labor forces in
the United States and Hong Kong are non-union. The employees at our Mexico
facility are represented by a collective bargaining unit, the Federacion De
Trabajadores Del Estado de Tlaxcala. We believe that we have satisfactory
employee and labor relations.
ITEM 2. PROPERTIES
Our headquarters is located in Woodland Hills, California, where we
lease approximately 8,800 square feet of administrative and product development
space. In addition to our Woodland Hills facility, we lease 2,500 square feet of
warehouse space in Gardena, California, 2,175 square feet of office space in
Goleta, California, 168 square feet of office space in Columbus, Ohio, 54,000
square feet of warehouse space in Gastonia, North Carolina, 17,000 square feet
of warehouse space in Dallas, North Carolina, 5,900 square feet of office and
warehouse space in Kwun Tong, Hong Kong, 4,100 square feet of warehouse space in
Santiago, Dominican Republic, and 22,000 square feet of warehouse, distribution
and administration space in Tlaxcala, Mexico.
ITEM 3. LEGAL PROCEEDINGS
We currently have pending a number of claims, suits and complaints that
arise in the ordinary course of our business. We believe that we have
meritorious defenses to these claims and that the claims are either covered by
insurance or, after taking into account the insurance in place, would not have a
material effect on our consolidated financial condition if adversely determined
against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 2003.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
COMMON STOCK
Tag-It Pacific's Common Stock is traded on the American Stock Exchange
under the symbol "TAG". The following table sets forth, for the periods
indicated, the high and low sales prices for the Common Stock as reported by the
American Stock Exchange.
HIGH LOW
---- ---
YEAR ENDED DECEMBER 31, 2002
First Quarter...................... $ 3.99 $ 3.50
Second Quarter..................... 4.24 3.45
Third Quarter...................... 4.20 3.60
Fourth Quarter..................... 3.99 3.40
YEAR ENDED DECEMBER 31, 2003
First Quarter...................... $ 3.79 $ 3.50
Second Quarter..................... 5.80 3.50
Third Quarter...................... 6.20 4.15
Fourth Quarter..................... 5.25 4.39
7
On March 19, 2004, the closing sales price of our Common Stock as
reported on the American Stock Exchange was $5.84 per share. As of March 19,
2004, there were 69 record holders of our Common Stock.
RECENT SALES OF UNREGISTERED SECURITIES
CONVERTIBLE PREFERRED STOCK FINANCING
In December 2003, we sold shares of our Series D Convertible Preferred
Stock to the following investors: Apogee Fund, L.P.; Atlas Capital (Q.P.) L.P.;
Atlas Capital Management Master Fund, Ltd.; George L. Ball; Bellfield Capital
Partners, L.P.; Bonanza Master Fund, Ltd; Rodger A. Clemens, Special Retirement
Account; Richard Perlman; B.L. Corley, Jr.; Flyline Holdings, Ltd.; John H.
Gray; Incline Capital, L.P.; Tom and Nancy Juda Living Trust; Richard D. Kinder;
Robert Larry Kinney; Luke J. Drury Non-Exempt Trust; Mark J. Drury Non-Exempt
Trust; Matthew J. Drury Non-Exempt Trust; Michaelyn J. Drury Non-Exempt Trust;
Tanya Drury; John S. Lemak; Ben T. Morris; John I. Mundy; Pequot Navigator
Offshore Fund Inc.; Pequot Navigator Onshore Fund LP; Pequot Scout Fund, LP; The
Pinnacle Fund, L.P.; Precept Capital Master Fund, G.P.; James Price; Portside
Growth and Opportunity Fund; RAM Trading, Ltd.; David May; Nolan Ryan; Brad D.
Sanders; Bret D. Sanders; Christine M. Sanders; Don A. Sanders; Katherine U.
Sanders; Laura K. Sanders; Sanders Opportunity Fund, L.P.; Sanders Opportunity
Fund (Institutional), L.P.; Sandor Capital Master Fund, L.P.; Grant E. Sims and
Patricia Sims; Southwell Partners, L.P.; Susan Sanders Todd; Paul Tate & Laura
M. Tate TIC; Walker Smith Capital Master Fund; Walker Smith International Fund,
Ltd.; Don Weir and Julie Ellen Weir; Eric Glen Weir; Lisa Dawn Weir; Westpark
Capital, L.P.; WS Opportunity Fund International, Ltd.; and WS Opportunity
Master Fund. Pursuant to the terms of the subscription agreements, we sold to
the investors an aggregate of 572,818 shares of our Series D Convertible
Preferred Stock at a price per share of $44.00 for gross proceeds to us of
approximately $25,200,000 before commissions and expenses. Except as required by
law, the preferred shares had no voting rights. Commencing June 1, 2004, each
preferred share would have begun to accrue a quarterly dividend of $0.55 (as
adjusted for stock dividends, combinations, splits or similar events), payable
March 31, June 30, September 30, and December 31 of each year with the first
payment due September 30, 2004. In the event of a liquidation, dissolution or
winding-up of the Company, the preferred shares would have been entitled to
receive, prior to any distribution on the common stock, a distribution equal to
$44.00 per preferred share (as adjusted for stock dividends, combinations,
splits or similar events) plus all accrued and unpaid dividends.
At a special meeting of stockholders on February 11, 2004, our
stockholders approved the issuance of 5,728,180 shares of our common stock upon
conversion of the Series D Convertible Preferred Stock held by the investors. At
the conclusion of this meeting, each preferred share automatically converted
into 10 shares of our common stock, for an aggregate of 5,728,180 shares of
common stock.
Sanders Morris Harris Inc. acted as placement agent in connection with
the December 2003 private placement financing transaction. For their services as
placement agent, we paid Sanders Morris Harris Inc. a fee equal to 7.5%, or
approximately $1,890,000, of our gross proceeds from the financing. We also paid
for the out-of-pocket expenses incurred by Sanders Morris Harris Inc. of
$45,000. In addition, we issued to Sanders Morris Harris Inc. a warrant to
purchase 572,818 shares of our common stock at an exercise price of $4.74 per
share. The warrant has a term of 5 years, and vests and becomes exercisable in
full on June 18, 2004.
Pursuant to the purchase agreements, each of the recipients of the
securities represented, and we reasonably believed, that such recipient (i) was
acquiring the securities for his or its own account with the present intention
of holding such securities for investment purposes only and not with a view to,
or for sale in connection with, any distribution of such securities (other than
a distribution in compliance with all applicable federal and state securities
laws); (ii) was an experienced and sophisticated investor and has such knowledge
and experience in financial and business matters that it is capable of
evaluating the relative merits
8
and the risks of an investment in the securities and of protecting his or its
own interests in connection with the transaction; (iii) was willing to bear and
was capable of bearing the economic risk of an investment in the securities; and
(iv) was an "accredited investor" as that term is defined under Rule 501(a)(8)
of Regulation D promulgated by the Securities Exchange Commission under the
Securities Act of 1933. Each of the certificates representing the securities
contained a customary legend restricting resale of the securities. The issuance
and sale of these securities was exempt from the registration and prospectus
delivery requirements of the Securities Act of 1933 pursuant to Section 4(2) of
the Securities Act of 1933 (in accordance with Rule 506 of Regulation D) as a
transaction not involving any public offering.
STOCK GRANT AGREEMENTS
Pursuant to Stock Grant Agreements between us and Herman Roup, dated
December 1, 2001, January 1, 2002 and July 17, 2002, we issued to Mr. Roup an
aggregate of 42,000 shares of common stock during the year ended December 31,
2003 and 20,500 shares of common stock in 2004 for services provided to the
Company. Pursuant to the agreements, Mr. Roup represented, and we reasonably
believed, that he (i) was acquiring the securities for his or its own account
with the present intention of holding such securities for investment purposes
only and not with a view to, or for sale in connection with, any distribution of
such securities (other than a distribution in compliance with all applicable
federal and state securities laws); (ii) was an experienced and sophisticated
investor and has such knowledge and experience in financial and business matters
that it is capable of evaluating the relative merits and the risks of an
investment in the securities and of protecting his or its own interests in
connection with the transaction; (iii) was willing to bear and was capable of
bearing the economic risk of an investment in the securities; and (iv) was an
"accredited investor" as that term is defined under Rule 501(a)(8) of Regulation
D promulgated by the Securities Exchange Commission under the Securities Act of
1933. Each of the certificates representing the securities contained a customary
legend restricting resale of the securities. The issuance and sale of these
securities was exempt from the registration and prospectus delivery requirements
of the Securities Act of 1933 pursuant to Section 4(2) of the Securities Act of
1933 (in accordance with Rule 506 of Regulation D) as a transaction not
involving any public offering.
DIVIDENDS
We have never paid dividends on our Common Stock. We intend to retain
any future earnings for use in our business. We are restricted from making cash
dividend payments on our common stock under our senior credit facility with UPS
Capital Global Trade Finance Corporation.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth certain information as of December 31,
2003 regarding equity compensation plans (including individual compensation
arrangements) under which our equity securities are authorized for issuance:
NUMBER OF SECURITIES
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE REMAINING AVAILABLE
BE ISSUED UPON EXERCISE EXERCISE PRICE OF FOR FUTURE ISSUANCE
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, UNDER EQUITY
WARRANTS AND RIGHTS WARRANTS AND RIGHTS COMPENSATION PLANS
----------------------- -------------------- --------------------
Equity compensation plans
approved by security holders..... 1,978,000 $3.55 599,500
Equity compensation plans not
approved by security holders..... 1,277,885 $4.58 -
----------------------- -------------------- --------------------
Total......................... 3,255,885 $3.95 599,500
======================= ==================== ====================
See Note 12 to the Consolidated Financial Statements for information
regarding the material features of the above security holders approved plan.
9
Warrants issued pursuant to equity compensation plans not approved by
security holders are summarized as follows:
o 20,000 warrants issued for services in 2001, are exercisable
at $5.00 per share and expire in July 2004.
o 5,000 warrants issued for services in 2001, are exercisable at
$4.57 per share and expire in July 2004.
o 10,000 warrants issued for services in 2001, are exercisable
at $3.65 per share and expire in August 2004.
o 39,235 warrants issued for services in 1997, are exercisable
at $0.71 per share and expire in December 2007.
o 172,500 warrants issued for services in 2003, are exercisable
at $5.06 per share and expire in May 2008.
o 572,818 warrants issued for services in 2003, are exercisable
at $4.74 per share and expire in December 2008.
o 229,166 warrant issued in conjunction with private placement
transaction in 2001 and 2002, are exercisable at $4.34 per
share and expire at various date through February 2007.
o 229,166 warrant issued in conjunction with private placement
transaction in 2001 and 2002, are exercisable at $4.73 per
share and expire at various date through February 2007.
Each of the above plans provides that the number of shares with respect
to which options and warrants may be granted, and the number of shares of Common
Stock subject to an outstanding option or warrant, shall be proportionately
adjusted in the event of a subdivisions or consolidation of shares or the
payment of a stock dividend on Common Stock.
10
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data should be read in conjunction
with our consolidated financial statements. The information set forth below is
not necessarily indicative of results of future operations, and should be read
in conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and notes thereto included in Item 8, "Financial Statements and Supplementary
Data" of this Form 10-K in order to understand fully factors that may affect the
comparability of the financial data presented below.
TAG-IT PACIFIC, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA
FISCAL YEARS ENDED DECEMBER 31,
(In Thousands Except Per Share Information)
1999 2000 2001(1) 2002 2003(2)
-------- -------- -------- -------- --------
OPERATIONS:
- -----------
Total revenue ..................................... $ 32,385 $ 49,362 $ 43,568 $ 60,073 $ 64,443
Income (loss) from operations ..................... $ 2,406 $ 2,547 $ (253) $ 3,044 $ (5,881)
Net income (loss) ................................. $ 1,731 $ 1,539 $ (1,226) $ 1,496 $ (4,745)
Net income (loss) per share - basic ............... $ 0.26 $ 0.23 $ (0.16) $ 0.14 $ (0.46)
Net income (loss) per share - diluted ............. $ 0.23 $ 0.21 $ (0.16) $ 0.14 $ (0.46)
Weighted average shares outstanding - basic ....... 6,734 6,838 8,017 9,232 10,651
Weighted average sharesoutstanding - diluted ...... 7,399 7,283 8,017 9,531 10,651
FINANCIAL POSITION (AT PERIOD END):
- -----------------------------------
Cash, cash equivalents and short-term investments . $ 101 $ 128 $ 47 $ 285 $ 14,443
Total assets ...................................... $ 19,855 $ 39,099 $ 40,794 $ 54,055 $ 67,770
Capital lease obligations and notes payable ....... $ 1,031 $ 3,873 $ 6,024 $ 5,329 $ 4,664
Convertible redeemable preferred stock ............ $ -- $ -- $ 2,895 $ 2,895 $ 2,895
Stockholders' equity .............................. $ 8,861 $ 14,791 $ 15,428 $ 18,467 $ 43,564
Total liabilities and stockholders' equity ........ $ 19,855 $ 39,099 $ 40,794 $ 54,055 $ 67,770
PER SHARE DATA (AT END OF PERIOD):
Net book value per common share ................... $ 1.31 $ 1.88 $ 1.76 $ 1.98 $ 3.79
Common shares outstanding ......................... 6,778 7,863 8,770 9,320 11,508
- ----------
(1) We incurred restructuring charges of $1,561,623 during the year ended
December 31, 2001. See Note 18 of the Notes to the Consolidated Financial
Statements included in Item 8 of this Report.
(2) We incurred restructuring charges of $7,700,047 during the year ended
December 31, 2003. See Note 18 of the Notes to the Consolidated Financial
Statements included in Item 8 of this Report.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This discussion summarizes the significant factors affecting the
consolidated operating results, financial condition and liquidity and cash flows
of Tag-It Pacific, Inc. for the fiscal years ended December 31, 2003, 2002 and
2001. The following discussion and analysis should be read together with the
Consolidated Financial Statements of Tag-It Pacific, Inc. and the notes to the
Consolidated Financial Statements included elsewhere in this Form 10-K.
OVERVIEW
Tag-It Pacific, Inc. is an apparel company that specializes in the
distribution of trim items to manufacturers of fashion apparel, specialty
retailers and mass merchandisers. We act as a full service outsourced trim
management department for manufacturers, a specified supplier of trim items to
owners of specific brands, brand licensees and retailers, a distributor of
zippers under our TALON brand name and a distributor of stretch waistbands that
utilize licensed patented technology.
The global apparel industry served by our company continues to undergo
dramatic change within its traditional supply chain. Large retail brands such as
Levi Strauss & Co. and other major brands have largely moved away from owning
their manufacturing operations and have increasingly embraced an outsourced
production model. These brands today are primarily focused on design, marketing
and sourcing. As sourcing has gained prominence in these organizations, they
have become increasingly adept at responding to changing market conditions with
respect to labor costs, trade policies and other areas, and are more capable of
shifting production to new geographic areas.
As the separation of the retail brands and apparel production has
grown, the disintermediation of the retail brands and the underlying suppliers
of apparel component products such as trim has become substantially more
pronounced. The management of trim procurement, including ordering, production,
inventory management and just-in-time distribution to a brand's manufacturers,
has become an increasingly cumbersome task given (i) the proliferation of
brands, styles and divisions within the major retail brands and (ii) the growing
pace of globalization within the apparel manufacturing industry.
While the global apparel industry is in the midst of restructuring its
supply chain, the trim product industry has not evolved and remains highly
fragmented, with no single player providing the global scope, integrated product
set or service focus required for the broader industry evolution to succeed. We
believe these trends present an attractive opportunity for a fully-integrated
single source supplier of trim products, to successfully interface between the
retail brands, their manufacturing partners and other underlying trim component
suppliers. Our objective is to provide the global apparel industry with
innovative products and distribution solutions that improve both the quality of
fashion apparel and the efficiency of the industry itself.
The upcoming launch of TRIMNET, our Oracle based e-sourcing system will
allow us to seamlessly supply complete trim packages to apparel brands,
retailers and manufacturers around the world, greatly expanding upon our success
in offering complete trim packages to customers in Mexico over the past several
years. TRIMNET is an upgrade of our MANAGED TRIM SOLUTION software and will
allow us to provide additional services to customers on a global platform.
12
2003 RESTRUCTURING PLAN
During the fourth quarter of 2003, we implemented a plan to restructure
certain business operations. In accordance with the restructuring plan, we
incurred costs related to the reduction of our Mexico operations, including the
relocation of our Florida operations to North Carolina and the downsizing of our
corporate operations by eliminating certain corporate expenses related to
operations, sales and marketing and general and administrative expenses. The
reduction of our operations in Mexico was in response to the following:
o An anticipated reduction in sales volume from our larger
Mexico customers;
o Our efforts to decrease our reliance on our larger Mexico
customers; and
o Our difficulty obtaining financing in Mexico due to the
location of assets outside the U.S. and customer concentration
and other limits imposed by financial institutions.
The reduction of our operations in Mexico is estimated to reduce our
working capital requirements and improve our cash flow, among other things.
Total restructuring charges for the year ended 2003 amounted to
$7,700,047. Restructuring charges include approximately $4.3 million of
inventory write-downs, $1.6 million of additional reserves for doubtful accounts
receivable, $1 million of costs incurred related to the reduction of operations
in Mexico, including the relocation of inventory and facilities, $500,000 of
benefits paid to terminated employees and $300,000 of other costs. We do not
anticipate any further charges as a result of this restructuring plan. All
restructuring costs were incurred and paid for in the fourth quarter of 2003
and, therefore, there are no liabilities related to restructuring charges
included in the balance sheet at December 31, 2003.
Restructuring charges for the year ended December 31, 2003 related to
the following expense categories included in the Company's statement of
operations are as follows:
Amount
----------
Cost of goods sold ........................................ $4,931,218
Selling expenses .......................................... 143,442
General and administrative expenses ....................... 2,625,387
----------
Total restructuring charges ............................... $7,700,047
==========
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to our valuation of inventory and our allowance for uncollectable
accounts receivable. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
13
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o Inventory is evaluated on a continual basis and reserve
adjustments are made based on management's estimate of future
sales value, if any, of specific inventory items. Reserve
adjustments are made for the difference between the cost of
the inventory and the estimated market value and charged to
operations in the period in which the facts that give rise to
the adjustments become known. A substantial portion of our
total inventories is subject to buyback arrangements with our
customers. The buyback arrangements contain provisions related
to the inventory we purchase and warehouse on behalf of our
customers. In the event that inventories remain with us in
excess of six to nine months from our receipt of the goods
from our vendors or the termination of production of a
customer's product line related to the inventories, the
customer is required to purchase the inventories from us under
normal invoice and selling terms. If the financial condition
of a customer were to deteriorate, resulting in an impairment
of its ability to purchase inventories, an additional
adjustment may be required. These buyback arrangements are
considered in management's estimate of future market value of
inventories.
o Accounts receivable balances are evaluated on a continual
basis and allowances are provided for potentially
uncollectable accounts based on management's estimate of the
collectability of customer accounts. If the financial
condition of a customer were to deteriorate, resulting in an
impairment of its ability to make payments, an additional
allowance may be required. Allowance adjustments are charged
to operations in the period in which the facts that give rise
to the adjustments become known.
o We record valuation allowances to reduce our deferred tax
assets to an amount that we believe is more likely than not to
be realized. We consider estimated future taxable income and
ongoing prudent and feasible tax planning strategies in
accessing the need for a valuation allowance. If we determine
that we will not realize all or part of our deferred tax
assets in the future, we would make an adjustment to the
carrying value of the deferred tax asset, which would be
reflected as an income tax expense. Conversely, if we
determine that we will realize a deferred tax asset, which
currently has a valuation allowance, we would be required to
reverse the valuation allowance, which would be reflected as
an income tax benefit.
o Intangible assets are evaluated on a continual basis and
impairment adjustments are made based on management's
valuation of identified reporting units related to goodwill,
the valuation of intangible assets with indefinite lives and
the reassessment of the useful lives related to other
intangible assets with definite useful lives. Impairment
adjustments are made for the difference between the carrying
value of the intangible asset and the estimated valuation and
charged to operations in the period in which the facts that
give rise to the adjustments become known.
o Sales are recorded at the time of shipment, at which point
title transfers to the customer, and when collection is
reasonably assured.
14
2001 RESTRUCTURING PLAN
During the first quarter of 2001, we implemented a plan to restructure
certain of our business operations. In accordance with the restructuring plan,
we closed our Tijuana, Mexico, facilities and relocated our TALON brand
operations to Miami, Florida. In addition, we incurred costs related to the
reduction of our Hong Kong operations, the relocation of our corporate
headquarters from Los Angeles, California, to Woodland Hills, California, and
the downsizing of our corporate operations by eliminating certain corporate
expenses related to sales and marketing, customer service and general and
administrative expenses. Total restructuring charges amounted to $1,561,623 and
were charged to operations primarily in the first quarter of 2001.
RESULTS OF OPERATIONS
The following table sets forth for the years indicated selected
statements of operations data shown as a percentage of net sales:
YEAR ENDED
DECEMBER 31,
--------------------------------
2003 2002 2001
------- ------- -------
Net sales .............................. 100.0% 100.0% 100.0%
Cost of goods sold ..................... 74.3 74.3 72.7
------- ------- -------
Gross profit ........................... 25.7 25.7 27.3
Selling expenses ....................... 5.8 3.5 3.8
General and administrative expenses .... 17.1 17.1 20.5
Restructuring charges .................. 11.9 -- 3.6
------- ------- -------
Operating (loss) income ................ (9.1)% 5.1% (0.6)%
======= ======= =======
The following table sets forth for the years indicated revenues
attributed to countries based on the location of the customer as a percentage of
net sales:
Year Ended December 31,
-------------------------------------
2003 2002 2001
------- ------- -------
United States ................... 12.3% 14.5% 33.3%
Asia ............................ 19.1 9.0 4.5
Mexico .......................... 44.7 73.4 62.2
Dominican Republic .............. 23.9 3.1 --
------- ------- -------
100.0% 100.0% 100.0%
======= ======= =======
Net sales increased approximately $4,370,000 (or 7.3%) to $64,443,000
for the year ended December 31, 2003 from $60,073,000 for the year ended
December 31, 2002. The increase in net sales was primarily due to the addition
of sales under our TEKFIT stretch waistband division. In late 2002, we created a
new division under the TEKFIT brand name. This division develops and sells
apparel components that utilize the patented Pro-Fit technology, including a
stretch waistband sold under our exclusive supply agreement with Levi Strauss &
Co. The increase in net sales was also attributable to an increase in sales from
our Hong Kong subsidiary for programs related to major U.S. retailers and an
increase in zipper sales under our TALON brand name to our MANAGED TRIM
SOLUTION(TM) customers in Mexico and our other Talon customers in Mexico and
Asia. The increase in net sales was offset by a decrease in trim-related sales
from our Tlaxcala, Mexico operations under our MANAGED TRIM SOLUTION(TM) trim
package program. This decrease is due in part to our efforts to decrease our
reliance on certain customers and to further diversify our customer base.
15
Net sales increased approximately $16,505,000 (or 37.9%) to $60,073,000
for the year ended December 31, 2002 from $43,568,000 for the year ended
December 31, 2001. The increase in net sales was primarily due to an increase in
trim-related sales from our Tlaxcala, Mexico operations under our MANAGED TRIM
SOLUTION(TM) trim package program. The increase in net sales was also
attributable to an increase in zipper sales under our TALON brand name to our
MANAGED TRIM SOLUTION(TM) customers in Mexico and our other Talon customers in
Mexico and Asia. TALON has been successful in becoming an approved zipper vendor
for major brands and retailers which has allowed us to increase our sales to
these customers. Our purchase of the TALON brand name and trademarks in December
2001 has enabled us to better control our product offerings, selling prices and
profit margins.
Gross profit increased approximately $1,113,000 (or 7.2%) to
$16,553,000 for the year ended December 31, 2003 from $15,440,000 for the year
ended December 31, 2002. Gross margin as a percentage of net sales remained
consistent at approximately 25.7% for the years ended December 31, 2003 and
2002. The increase in gross profit for the year ended December 31, 2003 resulted
from an increase in net sales during the year.
Gross profit increased approximately $3,551,000 (or 29.9%) to
$15,440,000 for the year ended December 31, 2002 from $11,889,000 for the year
ended December 31, 2001. Gross margin as a percentage of net sales decreased to
approximately 25.7% for the year ended December 31, 2002 as compared to 27.3%
for the year ended December 31, 2001. The decrease in gross profit as a
percentage of net sales for the year ended December 31, 2002 was primarily due
to an increase in zipper sales under our TALON brand name to our MANAGED TRIM
SOLUTION(TM) customers in Mexico during the year. Talon products have a lower
gross margin than other products included within the complete trim packages we
offer to our customers through our MANAGED TRIM SOLUTION(TM). The decrease in
gross margin as a percentage of net sales for the year ended December 31, 2002
was offset by a further reduction of manufacturing and facility costs which was
a direct result of the implementation of our restructuring plan in the first
quarter of 2001.
Selling expense increased approximately $1,580,000 (or 74.3%) to
$3,706,000 for the year ended December 31, 2003 from $2,126,000 for the year
ended December 31, 2002. As a percentage of net sales, these expenses increased
to 5.8% for the year ended December 31, 2003 compared to 3.5% for the year ended
December 31, 2002. The increase in selling expenses during the year was due
primarily to royalty and other expenses related to our exclusive license and
intellectual property rights agreement with Pro-Fit Holdings Limited incurred
during the year, the addition of sales personnel in our Hong Kong facility and
increased marketing efforts to promote our updated Oracle-based MANAGED TRIM
SOLUTION(TM) system. We are in the process of completing an update of our
MANAGED TRIM SOLUTION(TM) system which will enable us to further sell complete
trim packages to new locations on a global basis. Royalty expense related to our
exclusive license and intellectual property rights agreement with Pro-Fit
Holdings Limited amounted to approximately $780,000 for the year ended December
31, 2003. We pay royalties of 6% on related sales of up to $10 million, 4% of
related sales from $10-20 million and 3% on related sales in excess of $20
million. Royalties incurred for the year ended December 31, 2002 amounted to
approximately $110,000.
Selling expense increased approximately $487,000 (or 29.7%) to
$2,126,000 for the year ended December 31, 2002 from $1,639,000 for the year
ended December 31, 2001. As a percentage of net sales, these expenses decreased
to 3.5% for the year ended December 31, 2002 compared to 3.8% for the year ended
December 31, 2001. The increase in selling expenses was due to our efforts to
obtain approval from major brands and retailers of the TALON brand zipper and
the implementation of our new sales and marketing plan for the TALON brand. In
addition, we hired additional personnel to support the exclusive waistband
license agreement we entered into in April 2002. The increase in these selling
expenses was partially offset by a reduction of our sales force under our
MANAGED TRIM SOLUTION(TM) program, which was part of our restructuring plan that
we implemented in the first quarter of 2001. For the year ended December 31,
2002, selling expenses increased at a slower rate than the increase in net
sales, resulting in a decrease in selling expenses as a percentage of net sales.
16
General and administrative expenses increased approximately $758,000
(or 7.4%) to $11,028,000 for the year ended December 31, 2003 from $10,270,000
for the year ended December 31, 2002. The increase in these expenses was due
primarily to expenses incurred related to our exclusive waistband license
agreement and the amortization of intangible assets incurred as a result of the
exclusive waistband technology license rights we acquired in April 2002. As a
percentage of net sales, these expenses remained consistent at 17.1% for the
years ended December 31, 2003 and 2002, because the rate of increase in net
sales did not exceed that of general and administrative expenses.
General and administrative expenses increased approximately $1,329,000
(or 14.9%) to $10,270,000 for the year ended December 31, 2002 from $8,941,000
for the year ended December 31, 2001. The increase in these expenses was due
primarily to additional staffing and other expenses incurred related to our
Tlaxcala, Mexico operations, the amortization of intangible assets incurred as a
result of the exclusive waistband technology license rights we acquired in April
2002 and additional adjustments for bad debts of approximately $633,000 recorded
during the year. As a percentage of net sales, these expenses decreased to 17.1%
for the year ended December 31, 2002 compared to 20.5% for the year ended
December 31, 2001, as the rate of increase in net sales exceeded that of general
and administrative expenses.
Interest expense decreased approximately $73,000 (or 5.8%) to
$1,196,000 for the year ended December 31, 2003 from $1,269,000 for the year
ended December 31, 2002. Borrowings under our UPS Capital credit facility
decreased during the year ended December 31, 2003 due to proceeds received from
our private placement transactions in May and December 2003 in which we raised
approximately $29 million from the sale of common and preferred stock. The
decrease in borrowings under our UPS Capital credit facility was offset by
increased borrowings due to expanded operations in Asia and the Dominican
Republic.
Interest expense decreased approximately $128,000 (or 9.2%) to
$1,269,000 for the year ended December 31, 2002 from $1,397,000 for the year
ended December 31, 2001. On May 30, 2001, we replaced our credit facility with a
new facility with UPS Capital Global Trade Finance Corporation, which provided
for increased borrowing availability and a more favorable interest rate of prime
plus 2%. We incurred financing charges of approximately $570,000, including
legal, consulting and closing costs, in the first two quarters of 2001 related
to our efforts to replace our prior credit facility. Our borrowings under the
new UPS Capital credit facility increased during the year ended December 31,
2002 due to increased sales and expanded operations in Mexico and Asia. The
increase in interest expense due to increased borrowings during the year was
offset by decreases in the prime rate from prior periods.
The benefit for income taxes amounted to approximately $2,333,000 for
the year ended December 31, 2003 as compared to a provision for income taxes of
$279,000 for the year ended December 31, 2002. Income taxes decreased for the
year ended December 31, 2003 primarily due to the decreased taxable income as a
result of the net loss incurred for the year ended December 31, 2003.
The provision for income taxes amounted to approximately $279,000 for
the year ended December 31, 2002 as compared to a benefit for income taxes of
$423,000 for the year ended December 31, 2001. Income taxes increased for the
year ended December 31, 2003 primarily due to the increased taxable income as a
result of the net loss incurred for the year ended December 31, 2001.
Net loss was $4,745,000 for the year ended December 31, 2003 as
compared to net income of $1,496,000 for the year ended December 31, 2002, due
primarily to the restructuring charges incurred during 2003 of $7.7 million and
increases in selling and general and administrative expenses, offset by an
increase in net sales of $4.4 million, as discussed above.
Net income was $1,496,000 for the year ended December 31, 2002 as
compared to a net loss of $1,226,000 for the year ended December 31, 2001, due
primarily to an increase in net sales, offset by increases in selling and
general and administrative expenses and a decrease in gross margin, as discussed
above.
17
Preferred stock dividends amounted to approximately $194,000 for the
year ended December 31, 2003 as compared to $184,000 for the year ended December
31, 2002. Preferred stock dividends represent earned dividends at 6% of the
stated value per annum of the Series C convertible redeemable preferred stock.
In February 2004, the holders of the Series C convertible redeemable preferred
stock converted all 759,494 shares of the Series C Preferred Stock, plus
$458,707 of accrued dividends, into 700,144 shares of our common stock. Net loss
available to common stockholders amounted to $4,939,000 for the year ended
December 31, 2003 compared to net income available to common stockholders of
$1,312,000 for the year ended December 31, 2002. Basic and diluted loss per
share was $0.46 for the year ended December 31, 2003. Basic and diluted earnings
per share was $0.14 for the year ended December 31, 2002.
Preferred stock dividends amounted to approximately $184,000 for the
year ended December 31, 2002 as compared to $50,000 for the year ended December
31, 2001. Preferred stock dividends represent earned dividends at 6% of the
stated value per annum of the Series C convertible redeemable preferred stock.
Net income available to common stockholders amounted to $1,312,000 for the year
ended December 31, 2002 compared to net loss available to common stockholders of
$1,276,000 for the year ended December 31, 2001. Basic and diluted earnings per
share was $0.14 for the year ended December 31, 2002. Basic and diluted loss per
share was $0.16 for the year ended December 31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased to $14,443,000 at December 31, 2003
from $285,000 at December 31, 2002. The increase resulted from $18,759,000 of
cash provided by financing activities, offset by $2,086,000 and $2,516,000 of
cash used in operating and investing activities, respectively.
Net cash used in operating activities was approximately $2,086,000,
$5,440,000 and $2,100,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. Cash used by operating activities for the year ended December 31,
2003 resulted primarily from a net loss of approximately $4,745,000, offset by
depreciation and amortization expense of approximately $1,280,000, a write-down
in inventory of approximately $4,266,000 and an increase in allowance for
doubtful accounts of approximately $1,642,000, both related to our corporate
restructuring. Cash used by operating activities further resulted from the
realization of deferred income of approximately $1,028,000 due to advances made
by a customer in 2002, an increase in deferred income taxes of approximately
$2,709,000 due primarily to current year losses, and a reduction in accounts
payable and accrued expenses of approximately $1,139,000, offset by a further
decrease in inventory of $1,742,000. Cash used in operating activities for the
year ended December 31, 2002 resulted primarily from increased inventories and
receivables, which was partially offset by increases in accounts payable and
accrued expenses and net income. Cash used in operations for the year ended
December 31, 2001 resulted primarily from increased inventories, other assets
and net losses, and decreased accounts payable and accrued expenses.
Net cash used in investing activities was approximately $2,516,000,
$1,268,000 and $667,000 for the years ended December 31, 2003, 2002 and 2001,
respectively. Net cash used in investing activities for the year ended December
31, 2003 consisted primarily of capital expenditures for equipment related to
the exclusive supply agreement we entered into with Levi Strauss & Co. and the
purchase of additional TALON zipper equipment. During the period, we also
purchased computer equipment and software for the implementation of a new
Oracle-based computer system. This purchase was treated as a non-cash capital
lease obligation. Net cash used in investing activities for the year ended
December 31, 2002 consisted primarily of capital expenditures for machinery and
equipment. Net cash used in investing activities for the year ended December 31,
2001 consisted primarily of capital expenditures for computer equipment and
upgrades and additional loans to related parties.
18
Net cash provided by financing activities was approximately
$18,759,000, $6,947,000 and $2,687,000 for the years ended December 31, 2003,
2002 and 2001, respectively. Net cash provided by financing activities for the
year ended December 31, 2003 primarily reflects funds raised from private
placement transactions of approximately $29.4 million, offset by decreased
borrowings under our credit facility and the repayment of notes payable. Net
cash provided by financing activities for the year ended December 31, 2002
primarily reflects increased borrowings under our credit facility and funds
raised from private placement transactions, offset by the repayment of notes
payable. Net cash provided by financing activities for the year ended December
31, 2001 primarily reflects funds raised from private placement transactions and
proceeds from the issuance of Series C Convertible Redeemable preferred stock,
offset by the repayment of a bank overdraft.
We currently satisfy our working capital requirements primarily through
cash flows generated from operations, sales of equity securities and borrowings
under our credit facility with UPS Capital. Our maximum availability under the
credit facility is $13 million. At December 31, 2003 and 2002, outstanding
borrowings under our UPS Capital credit facility, including amounts borrowed
under the term loan and foreign factoring agreement, amounted to approximately
$7,096,000 and $15,934,000, respectively. There were no open letters of credit
under our UPS Capital credit facility at December 31, 2003. Open letters of
credit amounted to approximately $1,5370,000 at December 31, 2002.
The initial term of our agreement with UPS Capital is three years,
expiring May 30, 2004, and the facility is secured by substantially all of our
assets. The interest rate of the credit facility is at the prime rate plus 2% on
advances and the prime rate plus 4% on the term loan. On November 17, 2003, the
credit facility was amended to provide for a term loan of $6 million in addition
to the revolving credit facility with a maximum availability of $7 million. The
term loan provides for monthly payments beginning December 15, 2003 through
March 1, 2004. We are currently pursuing alternative working capital credit
arrangements to replace the UPS Capital credit facility upon its expiration.
The credit facility requires that we comply with certain financial
covenants including net worth, fixed charge ratio and capital expenditures. We
were in compliance with all financial covenants at December 31, 2003. The amount
we can borrow under the credit facility is determined based on a defined
borrowing base formula related to eligible accounts receivable and inventories.
Our borrowing base availability ranged from approximately $4,192,000 to
$18,829,000 from January 1, 2003 to December 31, 2003. A significant decrease in
eligible accounts receivable and inventories due to customer concentration
levels and the aging of inventories, among other factors, can have an adverse
effect on our borrowing capabilities under our credit facility, which
thereafter, may not be adequate to satisfy our working capital requirements.
Eligible accounts receivable are reduced if our accounts receivable customer
balances are concentrated with a particular customer in excess of the
percentages allowed under our agreement with UPS Capital. In addition, we have
typically experienced seasonal fluctuations in sales volume. These seasonal
fluctuations result in sales volume decreases in the first and fourth quarters
of each year due to the seasonal fluctuations experienced by the majority of our
customers. During these quarters, borrowing availability under our credit
facility may decrease as a result of decreases in eligible accounts receivables
generated from our sales. As a result of our concentration of business with
Tarrant Apparel Group and Azteca Production International, our eligible
receivables have been limited under the UPS Capital facility over the past year.
If our business becomes further dependant on one or a limited number of
customers or if we experience future significant seasonal reductions in
receivables, our availability under the UPS Capital credit facility would be
correspondingly reduced. If this were to occur, we would be required to seek
additional financing which may not be available on attractive terms and, if such
financing is unavailable, we may be unable to meet our working capital
requirements.
19
The UPS Capital credit facility contains customary covenants
restricting our activities as well as those of our subsidiaries, including
limitations on certain transactions related to the disposition of assets;
mergers; entering into operating leases or capital leases; entering into
transactions involving subsidiaries and related parties outside of the ordinary
course of business; incurring indebtedness or granting liens or negative pledges
on our assets; making loans or other investments; paying dividends or
repurchasing stock or other securities; guarantying third party obligations;
repaying subordinated debt; and making changes in our corporate structure.
Pursuant to the terms of a foreign factoring agreement under our UPS
Capital credit facility, UPS Capital purchases our eligible accounts receivable
and assumes the credit risk with respect to those foreign accounts for which UPS
Capital has given its prior approval. If UPS Capital does not assume the credit
risk for a receivable, the collection risk associated with the receivable
remains with us. We pay a fixed commission rate and may borrow up to 85% of
eligible accounts receivable under our credit facility. Included in due from
factor as of December 31, 2003 and 2002 are trade accounts receivable factored
without recourse of approximately $65,000 and $292,000. Included in due from
factor are outstanding advances due to UPS Capital under this factoring
arrangement amounting to approximately $55,000 and $248,000 at December 31, 2003
and 2002.
Pursuant to the terms of a factoring agreement for our Hong Kong
subsidiary, Tag-It Pacific Limited, the factor purchases our eligible accounts
receivable and assumes the credit risk with respect to those accounts for which
the factor has given its prior approval. If the factor does not assume the
credit risk for a receivable, the collection risk associated with the receivable
remains with us. We pay a fixed commission rate and may borrow up to 80% of
eligible accounts receivable. Interest is charged at 1.5% over the Hong Kong
Dollar prime rate. As of December 31, 2003 and 2002, the amount factored with
recourse and included in trade accounts receivable was approximately $316,000
and $241,000. Outstanding advances as of December 31, 2003 amounted to
approximately $411,000 and are included in the line of credit balance. There
were no outstanding advances as of December 31, 2002.
As we continue to respond to the current industry trend of large retail
brands to outsource apparel manufacturing to offshore locations, our foreign
customers, though backed by U.S. brands and retailers, are increasing. This
makes receivables based financing with traditional U.S. banks more difficult.
Our current credit facility may not provide the level of financing we may need
to expand into additional foreign markets. As a result, we are continuing to
evaluate non-traditional financing of our foreign assets.
On December 18, 2003, we sold an aggregate of 572,818 shares of
non-voting Series D Convertible Preferred Stock, at a price of $44.00 per share,
to institutional investors and individual accredited investors in a private
placement transaction. We received net proceeds of $23,083,693 after commissions
and other offering expenses. As of December 31, 2003, we have applied
approximately $9.2 million of the proceeds against our credit facility with UPS
Capital and vendor payables. Each share of Series D Convertible Preferred Stock
was automatically converted into 10 shares of common stock, for an aggregate of
5,728,180 shares of common stock, following approval of the conversion by our
stockholders at a special meeting held on February 11, 2004. We have registered
the common shares issued upon conversion of the Series D Convertible Preferred
Stock with the Securities and Exchange Commission for resale by the investors.
In conjunction with the private placement transaction, we issued 572,818
warrants to the placement agent. The warrants are exercisable beginning June 18,
2004 through December 18, 2008 and have a per share exercise price of $4.74.
20
On May 30, 2003, we raised approximately $6,037,500 in a private
placement transaction with five institutional investors. Pursuant to a
securities purchase agreement with these institutional investors, we sold
1,725,000 shares of our common stock at a price per share of $3.50. After
commissions and expenses, we received net proceeds of approximately $5.5
million. We have applied the proceeds against vendor payables, equipment
purchases and other working capital requirements. We have registered the shares
issued in the private placement with the Securities and Exchange Commission for
resale by the investors. In conjunction with the private placement transaction,
we issued 172,500 warrants to the placement agent. The warrants are exercisable
beginning August 30, 2003 through May 30, 2008 and have a per share exercise
price of $5.06.
Our trade receivables decreased to $19,253,000 at December 31, 2003
from $20,468,000 at December 31, 2002. This decrease was due primarily to
decreased related party trade receivables of approximately $3.0 million
resulting from decreased sales to related parties during the year. The decrease
in related party receivables was offset by an increase in non-related party
receivables of approximately $1.8 million due to increased sales to non-related
party customers, offset by increased collections from non-related party
customers.
During the year ended 2003, we increased our net deferred tax asset to
$2,800,000 from $91,000 at December 31, 2002. The increase in our net deferred
tax asset results primarily from current year losses. At December 31, 2003, we
had Federal and state net operating loss carryforwards of approximately $9.2
million and $5.1 million, respectively, available to offset future taxable
income.
We believe that our existing cash and cash equivalents and anticipated
cash flows from our operating activities and available financing will be
sufficient to fund our minimum working capital and capital expenditure needs for
at least the next twelve months. We expect to receive quarterly cash payments of
a minimum of $1.25 million under our supply agreement with Levi Strauss & Co.
through August 2004. The extent of our future capital requirements will depend
on many factors, including our results of operations, future demand for our
products, the size and timing of future acquisitions, our borrowing base
availability limitations related to eligible accounts receivable and inventories
and our expansion into foreign markets. Our need for additional long-term
financing includes the integration and expansion of our operations to exploit
our rights under our TALON trade name, the expansion of our operations in the
Asian, Central American and Caribbean markets and the further development of our
waistband technology. If our cash from operations is less than anticipated or
our working capital requirements and capital expenditures are greater than we
expect, we may need to raise additional debt or equity financing in order to
provide for our operations. We are continually evaluating various financing
strategies to be used to expand our business and fund future growth or
acquisitions. There can be no assurance that additional debt or equity financing
will be available on acceptable terms or at all. If we are unable to secure
additional financing, we may not be able to execute our plans for expansion,
including expansion into foreign markets to promote our TALON brand tradename,
and we may need to implement additional cost savings initiatives.
21
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at December 31,
2003 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:
Payments Due by Period
-----------------------------------------------------------
Less than 1-3 4-5 After
Contractual Obligations Total 1 Year Years Years 5 Years
- ----------------------------- ---------- ---------- ---------- ------- --------
Subordinated note payable ... $2,600,000 $1,200,000 $1,400,000 $ -- $ --
Capital lease obligations ... $1,213,933 $ 562,742 $ 651,191 $ -- $ --
Subordinated notes payable to
related parties (1) ......... $ 849,971 $ 849,971 $ -- $ -- $ --
Operating leases ............ $1,660,855 $ 721,211 $ 939,644 $ -- $ --
Line of credit .............. $7,095,514 $7,095,514 $ -- $ -- $ --
Note payable ................ $ 25,200 $ 25,200 $ -- $ -- $ --
Royalty Payments ............ $ 369,315 $ -- $ 369,315 $ -- $ --
- ----------
(1) The majority of subordinated notes payable to related parties are due
on demand with the remainder due and payable on the fifteenth day
following the date of delivery of written demand for payment.
On December 31, 2002, we indirectly guaranteed the indebtedness of two
of our suppliers through the issuance by a related party of letters of credit to
purchase goods and equipment totaling $1.5 million. Financing costs due to the
related party amounted to approximately $15,000. The letters of credit expired
on March 27, 2003 and June 26, 2003. There were no outstanding letters of credit
at December 31, 2003.
At December 31, 2003 and 2002, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
RELATED PARTY TRANSACTIONS
On September 20, 2001, we entered into a ten-year co-marketing and
supply agreement with Coats American, Inc., an affiliate of Coats plc, as well
as a preferred stock purchase agreement with Coats North America Consolidated,
Inc., also an affiliate of Coats plc. The co-marketing and supply agreement
provides for selected introductions into Coats' customer base and has the
potential to accelerate our growth plans and to introduce our MANAGED TRIM
SOLUTION(TM) to apparel manufacturers on a broader basis. Pursuant to the terms
of the co-marketing and supply agreement, our trim packages will exclusively
offer thread manufactured by Coats. Pursuant to the terms of the preferred stock
purchase agreement, we received a cash investment of $3 million from Coats North
America Consolidated in exchange for 759,494 shares of series C convertible
redeemable preferred stock. In February 2004, Coats converted all 759,494 shares
of Series C Preferred Stock, plus $458,707 of accrued dividends, into 700,144
shares of our common stock.
22
We have entered into an exclusive supply agreement with Azteca
Production International, Inc., AZT International SA D RL and Commerce
Investment Group, LLC. Pursuant to this supply agreement, we provide all
trim-related products for certain programs manufactured by Azteca Production
International. The agreement provides for a minimum aggregate total of $10
million in annual purchases by Azteca Production International and its
affiliates during each year of the three-year term of the agreement, if and to
the extent, we are able to provide trim products on a basis that is competitive
in terms of price and quality. In accordance with the supply agreement, we
issued 1,000,000 shares of our common stock to Commerce Investment Group, LLC.
We also have a supply agreement with Tarrant Apparel Group and have
been supplying Tarrant Apparel Group with all of its trim requirements under our
MANAGED TRIM SOLUTION(TM) system since 1998. The exclusive supply agreement with
Tarrant Apparel Group has an indefinite term. Pricing and terms are consistent
with competitive vendors. At the time we entered into this supply agreement, we
also sold 2,390,000 shares of our common stock to KG Investment, LLC, an entity
then owned by Gerard Guez and Todd Kay, executive officers and significant
shareholders of Tarrant Apparel Group.
Sales under our supply agreements with Azteca Production International
and Tarrant Apparel Group, and their affiliates, amounted to approximately 40.2%
and 69.7% of our total sales for the years ended December 2003 and 2002,
respectively. Sales under these supply agreements as a percentage of total sales
for the year ending December 2004 are anticipated to be lower than the year
ended December 2003. This decrease is due in part to our efforts to decrease our
reliance on these customers and to further diversify our customer base. Our
results of operations will depend to an extent upon the commercial success of
Azteca Production International and Tarrant Apparel Group. If Azteca Production
International and Tarrant Apparel Group fail to purchase our trim products at
anticipated levels, or our relationship with Azteca Production International or
Tarrant Apparel Group terminates, it may have an adverse affect on our results
of operations. Included in trade accounts receivable, related parties at
December 31, 2003, is approximately $11.7 million due from Tarrant Apparel Group
and Azteca Production International, and their affiliates.
Included in inventories at December 31, 2003 are inventories of
approximately $6.5 million that are subject to buyback arrangements with Tarrant
Apparel Group and Azteca Production International. The buyback arrangements
contain provisions related to the inventory purchased on behalf of these
customers. In the event that inventories remain with us in excess of six to nine
months from our receipt of the goods from our vendors or the termination of
production of a customer's product line related to the inventories, the customer
is required to purchase the inventories from us under normal invoice and selling
terms. During the year ended December 31, 2003, we sold approximately $4.6
million in inventory to Tarrant Apparel Group and Azteca Production
International pursuant to these buyback arrangements. If the financial condition
of Tarrant Apparel Group and Azteca Production International were to
deteriorate, resulting in an impairment of their ability to purchase inventories
or pay receivables, it may have an adverse affect on our results of operations.
As of December 31, 2003 and 2002, we had outstanding related-party debt
of approximately $850,000 and $1,350,000, respectively, at interest rates
ranging from 7% to 11%, and additional non-related-party debt of $25,200 at an
interest rate of 10%. The majority of related-party debt is due on demand, with
the remainder due and payable on the fifteenth day following the date of
delivery of written demand for payment. On October 4, 2002, we entered into a
note payable agreement with a related party in the amount of $500,000 to fund
additional working capital requirements. The note payable was unsecured, due on
demand, accrued interest at 4% and was subordinated to UPS Capital. This note
was re-paid on February 28, 2003.
23
NEW ACCOUNTING PRONOUNCEMENTS
In December 2003, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 104 (SAB No. 104), "REVENUE RECOGNITION", which
codifies, revises and rescinds certain sections of SAB No. 101, "REVENUE
Recognition", in order to make this interpretive guidance consistent with
current authoritative accounting and auditing guidance and SEC rules and
regulations. The changes noted in SAB No. 104 did not have a material effect on
our consolidated results of operations, consolidated financial position or
consolidated cash flows.
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 150, ACCOUNTING FOR CERTAIN
INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY ("FAS 150"),
which establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. FAS 150
requires an issuer to classify a financial instrument that is within its scope,
which may have previously been reported as equity, as a liability (or an asset
in some circumstances). This statement is effective at the beginning of the
first interim period beginning after June 15, 2003 for public companies. We
adopted this Statement as of July 1, 2003 and it had no material impact on our
financial statements.
In April 2003, the FASB issued SFAS No. 149, "AMENDMENT OF STATEMENT
133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("FAS No. 149"). FAS No.
149 amends and clarifies the accounting guidance on derivative instruments
(including certain derivative instruments embedded in other contracts) and
hedging activities that fall within the scope of FAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." FAS No. 149 also amends certain
other existing pronouncements, which will result in more consistent reporting of
contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. This Statement is effective for
contracts entered into or modified after June 30, 2003, with certain exceptions,
and for hedging relationships designated after June 30, 2003. We do not have any
contracts that are derivatives or that contain embedded derivatives.
In January 2003, the FASB issued FASB Interpretation No. 46,
CONSOLIDATION OF VARIABLE INTEREST ENTITIES, an interpretation of Accounting
Research Bulletins ("ARB") No. 51, CONSOLIDATED FINANCIAL STATEMENTS ("FIN 46").
FIN 46 clarifies the application of ARB No. 51 to certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
The adoption of FIN 46 did not have a material impact on our financial position
and results of operations.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, ACCOUNTING FOR STOCK-BASED COMPENSATION -- TRANSITION AND
DISCLOSURE ("FAS 148"), which amends Statement of Financial Accounting Standards
No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("FAS 123"). FAS 148 provides
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, FAS 148
amends the disclosure requirements of FAS 123 to require more prominent and more
frequent disclosures in financial statements of the effects of stock-based
compensation. The transition guidance and annual disclosure provisions of FAS
148 are effective for fiscal years ending after December 15, 2002. The interim
disclosure provisions are effective for financial reports containing condensed
financial statements for interim periods beginning after December 15, 2002. The
adoption of FAS 148 did not have a material impact on our consolidated balance
sheet or results of operations as we intend to continue to account for our
equity based compensation plans using the intrinsic value method. We have
provided the interim disclosures required by FAS 148 beginning in the first
quarter of 2003.
24
In November 2002, the FASB issued Interpretation No. 45, GUARANTOR'S
ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT
GUARANTEES OF INDEBTEDNESS TO OTHERS, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees
issued. The interpretation also clarifies that a guarantor is required to
recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of the
interpretation are applicable to guarantees issued or modified after December
31, 2002 and are not expected to have a material effect on our financial
statements. The disclosure requirements are effective for financial statements
of interim and annual periods ending after December 31, 2002. We adopted this
Statement as of January 1, 2003 and it had no material impact on our financial
statements.
In June 2002, the FASB issued FAS No. 146, ACCOUNTING FOR COSTS
ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES, which addresses accounting for
restructuring and similar costs. FAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force ("EITF") Issue No. 94-3. We
have adopted the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. FAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of a company's commitment to an exit plan. FAS No. 146
also establishes that the liability should initially be measured and recorded at
fair value. Accordingly, FAS No. 146 affects the timing of recognizing current
and future restructuring costs as well as the amount recognized.
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In addition to other information contained in this report, readers should
carefully consider the following cautionary statements and risk factors.
IF WE LOSE OUR LARGEST CUSTOMERS OR THEY FAIL TO PURCHASE AT
ANTICIPATED LEVELS, OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED.
Our results of operations will depend to a significant extent upon the
commercial success of our largest customers. If these customers fail to purchase
our trim products at anticipated levels, or our relationship with these
customers terminates, it may have an adverse affect on our results because:
o We will lose a primary source of revenue if these customers
choose not to purchase our products or services;
o We may not be able to reduce fixed costs incurred in
developing the relationship with these customers in a timely
manner;
o We may not be able to recoup setup and inventory costs;
o We may be left holding inventory that cannot be sold to other
customers; and
o We may not be able to collect our receivables from them.
CONCENTRATION OF RECEIVABLES FROM OUR LARGEST CUSTOMERS MAKES
RECEIVABLE BASED FINANCING DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGEST
CUSTOMERS FAIL TO PAY US, OUR CASH FLOW WOULD BE SEVERELY AFFECTED. Our business
relies heavily on a relatively small number of customers, including Levi Strauss
& Co., Tarrant Apparel Group and its affiliate, United Apparel Ventures, LLC and
Azteca Production International Inc. and its affiliates. This concentration of
our business reduces the amount we can borrow from our lenders under receivables
based financing agreements. Under our credit agreement with UPS Capital, for
instance, if accounts receivable due us from a particular customer exceed a
specified percentage of the total eligible accounts receivable against which we
can borrower, UPS Capital will not lend against the receivables that exceed the
specified
25
percentage. Gerard Guez, the founder, Chairman and Chief Executive Officer, and
a significant stockholder of Tarrant Apparel Group and Hubert Guez, the founder,
Chief Executive Officer and President, and a significant stockholder of Azteca
Production International, are brothers. In addition, Tarrant Apparel Group and
Azteca Production International combined own United Apparel Ventures, LLC. This
relationship between our customers further concentrates our receivables risk
significantly among this family group. Further, if we are unable to collect any
large receivables due us, our cash flow would be severely impacted.
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS WORSEN. Our
revenues depend on the health of the economy and the growth of our customers and
potential future customers. When economic conditions weaken, certain apparel
manufacturers and retailers, including some of our customers, have experienced
in the past, and may experience in the future, financial difficulties which
increase the risk of extending credit to such customers. Customers adversely
affected by economic conditions have also attempted to improve their own
operating efficiencies by concentrating their purchasing power among a narrowing
group of vendors. There can be no assurance that we will remain a preferred
vendor to our existing customers. A decrease in business from or loss of a major
customer could have a material adverse effect on our results of operations.
Further, if the economic conditions in the United States worsen or if a wider or
global economic slowdown occurs, we may experience a material adverse impact on
our business, operating results, and financial condition.
BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, WE MAY NOT BE ABLE
TO ALWAYS OBTAIN MATERIALS WHEN WE NEED THEM AND WE MAY LOSE SALES AND
CUSTOMERS. Lead times for materials we order can vary significantly and depend
on many factors, including the specific supplier, the contract terms and the
demand for particular materials at a given time. From time to time, we may
experience fluctuations in the prices, and disruptions in the supply, of
materials. Shortages or disruptions in the supply of materials, or our inability
to procure materials from alternate sources at acceptable prices in a timely
manner, could lead us to miss deadlines for orders and lose sales and customers.
IF WE ARE NOT ABLE TO MANAGE OUR RAPID EXPANSION AND GROWTH, WE COULD
INCUR UNFORESEEN COSTS OR DELAYS AND OUR REPUTATION AND RELIABILITY IN THE
MARKETPLACE AND OUR REVENUES WILL BE ADVERSELY AFFECTED. The growth of our
operations and activities has placed and will continue to place a significant
strain on our management, operational, financial and accounting resources. If we
cannot implement and improve our financial and management information and
reporting systems, we may not be able to implement our growth strategies
successfully and our revenues will be adversely affected. In addition, if we
cannot hire, train, motivate and manage new employees, including management and
operating personnel in sufficient numbers, and integrate them into our overall
operations and culture, our ability to manage future growth, increase production
levels and effectively market and distribute our products may be significantly
impaired.
WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS
IN OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND
STOCK PRICE VOLATILITY. We operate in an industry that is subject to significant
fluctuations in operating results from quarter to quarter, which may lead to
unexpected reductions in revenues and stock price volatility. Factors that may
influence our quarterly operating results include:
o The volume and timing of customer orders received during the
quarter;
o The timing and magnitude of customers' marketing campaigns;
o The loss or addition of a major customer;
o The availability and pricing of materials for our products;
o The increased expenses incurred in connection with the
introduction of new products;
o Currency fluctuations;
o Delays caused by third parties; and
o Changes in our product mix or in the relative contribution to
sales of our subsidiaries.
26
Due to these factors, it is possible that in some quarters our
operating results may be below our stockholders' expectations and those of
public market analysts. If this occurs, the price of our common stock would
likely be adversely affected.
OUR CUSTOMERS HAVE CYCLICAL BUYING PATTERNS WHICH MAY CAUSE US TO HAVE
PERIODS OF LOW SALES VOLUME. Most of our customers are in the apparel industry.
The apparel industry historically has been subject to substantial cyclical
variations. Our business has experienced, and we expect our business to continue
to experience, significant cyclical fluctuations due, in part, to customer
buying patterns, which may result in periods of low sales usually in the first
and fourth quarters of our financial year.
OUR BUSINESS MODEL IS DEPENDENT ON INTEGRATION OF INFORMATION SYSTEMS
ON A GLOBAL BASIS AND, TO THE EXTENT THAT WE FAIL TO MAINTAIN AND SUPPORT OUR
INFORMATION SYSTEMS, IT CAN RESULT IN LOST REVENUES. We must consolidate and
centralize the management of our subsidiaries and significantly expand and
improve our financial and operating controls. Additionally, we must effectively
integrate the information systems of our Hong Kong, Mexico and Caribbean
facilities with the information systems of our principal offices in California.
Our failure to do so could result in lost revenues, delay financial reporting or
adversely affect availability of funds under our credit facilities.
THE LOSS OF KEY MANAGEMENT AND SALES PERSONNEL COULD ADVERSELY AFFECT
OUR BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE
SALES. Our success has and will continue to depend to a significant extent upon
key management and sales personnel, many of whom would be difficult to replace,
particularly Colin Dyne, our Chief Executive Officer. Colin Dyne is not bound by
an employment agreement. The loss of the services of Colin Dyne or the services
of other key employees could have a material adverse effect on our business,
including our ability to establish and maintain client relationships. Our future
success will depend in large part upon our ability to attract and retain
personnel with a variety of sales, operating and managerial skills.
IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL
NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently,
we do not operate duplicate facilities in different geographic areas. Therefore,
in the event of a regional disruption where we maintain one or more of our
facilities, it is unlikely that we could shift our operations to a different
geographic region and we may have to cease or curtail our operations. This may
cause us to lose sales and customers. The types of disruptions that may occur
include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention; and
o Natural disasters.
INTERNET-BASED SYSTEMS THAT HOST OUR MANAGED TRIM SOLUTION MAY
EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our
MANAGED TRIM SOLUTION is an Internet-based business-to-business e-commerce
system. To the extent that we fail to adequately continue to update and maintain
the hardware and software implementing the MANAGED TRIM SOLUTION, our customers
may experience interruptions in service due to defects in our hardware or our
source code. In addition, since