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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2004
[_] 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, 2004 the aggregate market value of the voting and
non-voting common stock held by non-affiliates of the registrant was
$65,632,028. At March 31, 2005 the issuer had 18,241,045 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 2005
annual meeting of stockholders are incorporated by reference into Part III of
this report.
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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......... 8
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities........................................ 9
Item 6. Selected Financial Data..................................... 10
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 11
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk ............................................. 28
Item 8. Financial Statements and Supplementary Data:
Report of Independent Registered Public Accounting Firm..... 30
Consolidated Balance Sheets................................. 31
Consolidated Statements of Operations....................... 32
Consolidated Statements of Stockholders' Equity and
Convertible Redeemable Preferred Stock...................... 33
Consolidated Statements of Cash Flows....................... 34
Notes to Consolidated Financial Statements.................. 35
Independent Registered Public Accounting Firm's Report
on Schedule II........................................... 62
Schedule II - Valuation and Qualifying Accounts
and Reserves............................................. 63
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................... 64
Item 9A. Controls and Procedures..................................... 64
Item 9B. Other Information........................................... 64
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 Accounting Fees and Services...................... 65
PART IV
Item 15. Exhibits and Financial Statement Schedules.................. 65
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, Kellwood and Azteca Production International. We also serve
as a specified supplier of trim items to owners of specific brands, brand
licensees and retailers, including Levi Strauss & Co., Express, The Limited,
Lerner, Motherworks and Miller's Outpost, among others. In addition, we
manufacture and distribute zippers under our TALON brand name to manufacturers
for apparel brands and retailers such as Levi Strauss & Co., Wal-Mart and JC
Penny, 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 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.
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
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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 manufacture and distribute zippers under our TALON trademark and
trade names to apparel brands and manufacturers. TALON enjoys tremendous brand
recognition and brand equity in the apparel industry worldwide. 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 and
initiated a new sales and marketing effort for this brand. We have also
developed, and are now implementing, what we refer to as our TALON franchise
strategy, whereby we appoint suitable distributors in various geographic
international regions to finish and sell zippers under the TALON brand name. Our
distributors purchase and install locally equipment for dying and producing
finished zippers. We expect this program to dramatically expand the geographic
footprint of our TALON division. To date, we have entered into six distribution
agreements for the sale of TALON zippers. TALON is promoted both within our trim
packages, as well as a stand-alone product line.
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.
Our 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 enable us to
take advantage of and address the increasingly complicated requirements of the
large and expanding demand for complete trim packages. We plan to continue to
expand operations in Asia, Central and South America and the Caribbean to take
advantage of the large apparel manufacturing markets in these regions.
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
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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.
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 launch of TRIMNET, our Oracle based e-sourcing system has allowed
us to seamlessly supply complete trim packages to apparel brands, retailers and
manufacturers around the world, 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 allows 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 and through
distributors, who we refer to as franchisees, in other international markets. We
have negotiated with distributors that service local markets in Asia and Africa
and have signed six franchise agreements to date. We are continuing to negotiate
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.
TEKFIT. We distribute a proprietary stretch waistband under our
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
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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 presently in litigation with Pro-Fit relating to our rights
under the agreement, as described more fully elsewhere in this report. As we
derive a significant amount of revenue from the sale of products incorporating
the stretch waistband technology, our business, results of operations and
financial condition could be materially adversely affected if our dispute with
Pro-Fit is not resolved in a manner favorable to us.
DESIGN AND DEVELOPMENT
Our in-house creative team produces 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.
CUSTOMERS
We have more than 300 active customers. Our customers include
well-known apparel manufacturers, such as Levi Strauss & Co., The Limited Group,
Motherworks, Kellwood, Azteca Production International and VF Corporation, 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. agreed
to purchase a minimum of $10 million of TEKFIT stretch waistbands, various other
trim products, garment components and services over the two-year term of the
agreement. On July 16, 2004, we amended our exclusive supply agreement with Levi
Strauss & Co. to provide for an additional two-year term through November 2006.
Levi Strauss & Co. also appointed TALON as an approved zipper supplier.
Two major customers accounted for approximately 21.9% of our net sales
on a consolidated basis for the year ended December 31, 2004. Three major
customers, two of which were related parties, accounted for approximately 64.1%
of our net sales on a consolidated basis for the year ended December 31, 2003.
Two major customers, both related parties, accounted for approximately 69.7% of
our net sales on a consolidated basis for the year ended December 31, 2002. Our
results of operations will depend to an extent upon the commercial success of
these customers. If these customers fail to purchase trim products at
anticipated levels, or the relationship terminates, it may have an adverse
affect on our results of operations.
4
If the financial condition of these customers were to deteriorate, resulting in
an impairment of their ability to purchase inventories or repay receivables, it
may also have an adverse affect on our results of operations.
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.
SOURCING AND ASSEMBLY
We have developed expertise in identifying high quality materials,
competitive prices and approved 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 11.4% of our purchases in
2004.
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.
During 2004, we set up a TALON manufacturing facility in Kings
Mountain, North Carolina. This facility manufactures TALON zippers for use in
the Western Hemisphere and will reduce our reliance on our major zipper
supplier. The facility began production in January 2005.
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.
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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.
INVENTORIES
In order to meet the rapid delivery requirements of our TRIMNET
customers, we may be required to carry a substantial amount of inventory on
their behalf. Included in inventories at December 31, 2004 are inventories that
are subject to buyback arrangements with some of 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, as provided by the buyback agreements, 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 18 of the
Notes to the Consolidated Financial Statements included in Item 8 of this
Report.
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 and South America.
A summary of our domestic and international net revenue and long-lived
assets is set forth in Note 18 of the Notes to the Consolidated Financial
Statements in Item 8 of this Report. Approximately 91% of
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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, 2004.
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 18
of the Notes to the Consolidated Financial Statements in Item 8.
EMPLOYEES
As of December 31, 2004, we had approximately 206 full-time employees,
with approximately 43 employees in Los Angeles, 10 employees in North Carolina,
8 employees in various other cities, 60 employees in Asia, 7 employees in the
Dominican Republic, and 78 employees in Mexico and Central America. 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, 675 square feet of office space in Columbus, Ohio, 54,000
square feet of warehouse space in Gastonia, North Carolina, 5,400 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. The lease
agreements related to these properties expire at various dates through October
2006. We also own a building with 41,650 square feet of manufacturing and
warehouse space in Kings Mountain, North Carolina.
ITEM 3. LEGAL PROCEEDINGS
We have filed suit against Pro-Fit Holdings Limited in the U.S.
District Court for the Central District of California -- TAG-IT PACIFIC, INC. V.
PRO-FIT HOLDINGS LIMITED, CV 04-2694 LGB (RCx) - based on various contractual
and tort claims relating to our exclusive license and intellectual property
agreement, seeking declaratory relief, injunctive relief and damages. Our
agreement with Pro-Fit gives us exclusive rights in certain geographic areas to
Pro-Fit's stretch and rigid waistband technology. Pro-Fit filed an answer
denying the material allegations of the complaint and filed a counterclaim
alleging various contractual and tort claims seeking injunctive relief and
damages. We filed a reply denying the material allegations of Pro-Fit's
pleading. Pro-Fit has since purported to terminate our exclusive license and
intellectual property agreement based on the same alleged breaches of the
agreement that are the subject of our existing litigation, as well as on an
additional basis unsupported by fact. In February 2005, we amended our pleadings
in the litigation to assert additional breaches by Pro-Fit of its obligations to
us under our agreement and under certain additional letter agreements, and for a
declaratory judgment that Pro-Fit's patent No. 5,987,721 is invalid and not
infringed by us. Discovery in this case has commenced. There have been ongoing
negotiations with Pro-Fit to attempt to resolve these disputes. We intend to
proceed with the lawsuit if these negotiations are not concluded in a manner
satisfactory to us. As we derive a significant amount of revenue from the sale
of products incorporating the stretch waistband technology, our business,
results of operations and financial condition could be materially adversely
affected if our dispute with Pro-Fit is not resolved in a manner favorable to
us.
We currently have pending a number of other 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
7
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 2004.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
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, 2004
First Quarter......................... $ 6.14 $ 4.30
Second Quarter........................ 5.99 4.20
Third Quarter......................... 4.35 3.09
Fourth Quarter........................ 4.58 2.81
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
On March 30, 2005, the closing sales price of our Common Stock as
reported on the American Stock Exchange was $5.04 per share. As of March 30,
2005, there were 33 record holders of our Common Stock.
DIVIDENDS
We have never paid dividends on our Common Stock. We intend to retain
any future earnings for use in our business.
9
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)
2000 2001(1) 2002 2003(2) 2004(2,3)
-------- -------- -------- -------- --------
OPERATIONS:
Total revenue ..................................... $ 49,362 $ 43,568 $ 60,073 $ 64,443 $ 55,109
Income (loss) from operations ..................... $ 2,547 $ (253) $ 3,044 $ (5,881) $(14,527)
Net income (loss) ................................. $ 1,539 $ (1,226) $ 1,496 $ (4,745) $(17,609)
Net income (loss) per share - basic ............... $ 0.23 $ (0.16) $ 0.14 $ (0.46) $ (1.02)
Net income (loss) per share - diluted ............. $ 0.21 $ (0.16) $ 0.14 $ (0.46) $ (1.02)
Weighted average shares outstanding - basic ....... 6,838 8,017 9,232 10,651 17,316
Weighted average shares outstanding - diluted ..... 7,283 8,017 9,531 10,651 17,316
FINANCIAL POSITION (AT PERIOD END):
Cash and cash equivalents ......................... $ 128 $ 47 $ 285 $ 14,443 $ 5,461
Total assets ...................................... $ 39,099 $ 40,794 $ 54,055 $ 67,770 $ 56,448
Capital lease obligations, line of credit and notes
payable ........................................... $ 13,828 $ 15,685 $ 21,263 $ 11,759 $ 18,792
Convertible redeemable preferred stock ............ $ -- $ 2,895 $ 2,895 $ 2,895 $ --
Stockholders' equity .............................. $ 14,791 $ 15,428 $ 18,467 $ 43,564 $ 30,195
Total liabilities and stockholders' equity ........ $ 39,099 $ 40,794 $ 54,055 $ 67,770 $ 56,448
PER SHARE DATA (AT END OF PERIOD):
Net book value per common share ................... $ 1.88 $ 1.76 $ 1.98 $ 3.79 $ 1.66
Common shares outstanding ......................... 7,863 8,770 9,320 11,508 18,171
- ----------
(1) We incurred restructuring charges of $1.6 million during the year ended
December 31, 2001.
(2) We incurred restructuring charges of $7.7 million during the year ended
December 31, 2003 and $414,675 during the year ended December 31, 2004.
See Note 22 of the Notes to the Consolidated Financial Statements
included in Item 8 of this Report.
(3) We incurred net charges of $4.3 million from the write-off of
obligations, primarily accounts receivable and inventories, due from a
former major customer (see Note 21 of the Notes to the Consolidated
Financial Statements included in Item 8 of this Report) and other
fourth quarter adjustments totaling $9.5 million during the year ended
December 31, 2004.
10
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, 2004, 2003 and
2002. 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. Except
for historical information, the matters discussed in this Management's
Discussion and Analysis of Financial Condition and Results of Operations are
forward looking statements that involve risks and uncertainties and are based
upon judgments concerning various factors that are beyond our control.
OVERVIEW
Tag-It Pacific, Inc. is an apparel company that specializes in the
distribution of trim items to manufacturers of fashion apparel, specialty
retailers and mass merchandisers. 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 manufacturer and
distributor of zippers under our TALON brand name and a distributor of stretch
waistbands that utilize licensed patented technology under our TEKFIT brand
name.
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 launch of TRIMNET, our Oracle based e-sourcing system has allowed
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 has allowed us
to provide additional services to customers on a global platform.
On November 10, 2004, we refinanced our working capital credit facility
with UPS Capital Global Trade Finance Corporation with a portion of the proceeds
received from a private placement of $12.5 million
11
Secured Convertible Notes Payable. See further discussion under the LIQUIDITY
AND CAPITAL RESOURCES section of this document.
We have developed, and are now implementing, what we refer to as our
TALON franchise strategy, whereby we appoint suitable distributors in various
geographic international regions to finish and sell zippers under the TALON
brand name. Our designated franchisees purchase and install locally equipment
for dying and producing finished zippers, thus minimizing our capital outlay.
The franchisee will then purchase from us large zipper rolls with other
materials such as sliders and produce finished zippers locally, according to
their customers' specifications, in markets around the world, becoming in
essence a local marketer and distributor of the TALON brand. This strategy is
expected to expand the geographic footprint of our TALON division.
We have entered into six franchise agreements for the sale of TALON
zippers. The agreements provide for minimum purchases of TALON zipper products
to be received over the term of the agreements as follows:
Agreement
Region Date Term
- ---------------------- ----------------- ---------
Central Asia October 21, 2004 42 Months
South East Asia November 10, 2004 42 Months
Southern Hemisphere December 21, 2004 66 Months
Asia December 28, 2004 42 Months
South East Asia January 7, 2005 42 Months
Middle East and Africa February 19, 2005 42 Months
During 2004, we set up a TALON manufacturing facility in Kings
Mountain, North Carolina. This facility manufactures TALON zippers for use in
the Western Hemisphere and will reduce our reliance on our current major zipper
supplier. The facility began production in January 2005.
On July 16, 2004, we amended our exclusive supply agreement with Levi
Strauss & Co. to provide for an additional two-year term through November 2006.
In accordance with the supply agreement, Levi is to purchase TEKFIT waistbands
for specific product categories over the term of the agreement. Certain
proprietary products, equipment and technological know-how will be supplied to
Levi on an exclusive basis for specific product categories during the extended
period.
As described more fully elsewhere in this report, we are presently in
litigation with Pro-Fit Holdings Limited relating to our exclusively licensed
rights to sell or sublicense stretch waistbands manufactured under Pro-Fit's
patented technology. We supply Levi with waistbands in reliance on our agreement
with Pro-Fit. As we derive a significant amount of revenue from the sale of
products incorporating the stretch waistband technology, our business, results
of operations and financial condition could be materially adversely affected if
our dispute with Pro-Fit is not resolved in a manner favorable to us.
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.
12
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o Inventory is evaluated on a continual basis and reserve
adjustments are made based on management's estimate of future
sales value, if any, of specific inventory items. Reserve
adjustments are made for the difference between the cost of
the inventory and the estimated market value, if lower, and
charged to operations in the period in which the facts that
give rise to the adjustments become known. A portion of our
total inventories is subject to buyback arrangements with our
customers. The buyback arrangements contain provisions related
to the inventory we purchase and warehouse on behalf of our
customers. 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. See further discussion of inventory write-downs
recorded in the fourth quarter of 2004 below.
o Accounts receivable balances are evaluated on a continual
basis and allowances are provided for potentially
uncollectible accounts based on management's estimate of the
collectibility 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. See further discussion of
accounts receivable reserves recorded during the fourth
quarter of 2004 below.
o We record valuation allowances to reduce our deferred tax
assets to an amount that we believe is more likely than not to
be realized. We consider estimated future taxable income and
ongoing prudent and feasible tax planning strategies in
assessing the need for a valuation allowance. If we determine
that we may not realize all or part of our deferred tax assets
in the future, we will make an adjustment to the carrying
value of the deferred tax asset, which would be reflected as
an 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.
2004 WRITE-OFF OF ACCOUNTS RECEIVABLE AND INVENTORIES FROM A FORMER MAJOR
CUSTOMER
Following negotiations with United Apparel Ventures and its affiliate,
Tarrant Apparel Group, a former major customer of ours, we determined that a
significant portion of the obligations due from this
13
customer, primarily related to accounts receivable and inventories, was
uncollectable. As a result, we wrote-off a net of $4.3 million of obligations
due from this customer, with a remaining receivable balance due from UAV of $4.5
million. Included in general and administrative expenses for the year ended
December 31, 2004 are $4,289,436 of expenses related to the write-off of
obligations due from UAV and Tarrant. UAV agreed to pay the $4.5 million
receivable balance over a nine-month period beginning May 2005. We do not
anticipate any further charges as a result of this write-off.
2004 ALLOWANCE FOR DOUBTFUL ACCOUNTS
Our allowance for doubtful accounts as of December 31, 2004 includes a
reserve of $5.0 million recorded in the fourth quarter of 2004 based on
management's estimate of the collectability of accounts receivable primarily
related to two customers.
2004 RESERVE FOR INVENTORY OBSOLESCENCE
In the fourth quarter of 2004, we recorded inventory write-downs
totaling $2.7 million based on management's estimate of the net realizable value
of certain inventories.
2004 NET DEFERRED TAX ASSET
In 2004, we incurred additional net operating losses and, as a result,
increased our valuation allowance to $8.9 million from $1.1 million, which
reduced the carrying value of our net deferred tax asset to $1.0 million from
$2.8 million at December 31, 2003. The decrease in the net deferred tax asset
resulted in a charge of $1.8 million against the provision for income taxes in
the fourth quarter of 2004.
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 included 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. All
restructuring costs were incurred and paid for in the fourth quarter of 2003,
and we did not anticipate any further charges as a result of this restructuring
plan. Therefore, no liabilities related to restructuring charges were included
in the balance sheet at December 31, 2003. During the first quarter of 2004,
however, we incurred and recorded residual restructuring charges of $414,675.
14
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
==========
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,
--------------------------------
2004(1) 2003 2002
----- ----- -----
Net sales ................................ 100.0 % 100.0 % 100.0%
Cost of goods sold ....................... 81.3 74.3 74.3
----- ----- -----
Gross profit ............................. 18.7 25.7 25.7
Selling expenses ......................... 5.3 5.8 3.5
General and administrative expenses ...... 39.0 17.1 17.1
Restructuring charges .................... .8 11.9 --
----- ----- -----
Operating (loss) income .................. (26.4)% (9.1)% 5.1%
===== ===== =====
- ----------
(1) Included in general and administrative expenses for the year ended
December 31, 2004 are $4,289,436 (7.8% of net sales) of expenses
related to the write-off of obligations due from United Apparel
Ventures and its affiliate, Tarrant Apparel Group. See further
discussion above and Notes 5 and 21 to the Consolidated Financial
Statements included in Item 8. Included in cost of sales and general
and administrative expenses for the year ended December 31, 2004 are
$2,746,000 (5.0% of net sales) and $5.0 million (9.1% of net sales) of
expenses related to fourth quarter inventory and accounts receivable
reserve adjustments.
The following table sets forth for the years indicated revenues
attributed to countries based on customer delivery locations as a percentage of
net sales:
Year Ended December 31,
---------------------------------
2004 2003 2002
----- ----- -----
United States ........................ 8.8% 13.7% 14.5%
Asia ................................. 23.2 15.0 9.0
Mexico ............................... 39.0 41.1 73.4
Dominican Republic ................... 17.6 22.1 3.1
Central and South America ............ 9.9 5.6 --
Other ................................ 1.5 2.5 --
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
Net sales decreased approximately $9,334,000 (or 14.5%) to $55,109,000
for the year ended December 31, 2004 from $64,443,000 for the year ended
December 31, 2003. The decrease in net sales for the year ended December 31,
2004 was primarily due to a decrease in trim-related sales of approximately
15
$19.1 million from our Tlaxcala, Mexico operations. During the fourth quarter of
2003, we implemented a plan to restructure certain business operations,
including the reduction of our reliance on two significant customers in Mexico,
Tarrant Apparel Group (and its affiliate United Apparel Ventures) and Azteca
Production International, which contributed approximately $25.9 million or 40.2%
of revenues for the year ended December 31, 2003. These customers contributed
approximately $6.8 million or 12.3% of revenues for the year ended December 31,
2004. We were able to replace in excess of 50% of the lost revenue from our
Tlaxcala, Mexico operations during the year ended December 31, 2004 with new
customers primarily in Mexico and Asia. The reduction of our operations in
Mexico was also in response to our efforts to decrease our reliance on our
larger Mexico customers. The decrease in net sales from our Tlaxcala, Mexico
operations was offset by an increase in sales from our TRIMNET programs related
to major U.S. retailers in our Hong Kong and Mexico facilities and an increase
in zipper sales under our TALON brand name in Asia. Fiscal 2004 has been a
transitional year as we experienced the effects of diversifying our customer
base.
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.
Gross profit decreased approximately $6,257,000 (or 37.8%) to
$10,296,000 for the year ended December 31, 2004 from $16,553,000 for the year
ended December 31, 2003. Gross margin as a percentage of net sales decreased to
approximately 18.7% for the year ended December 31, 2004 as compared to 25.7%
for the year ended December 31, 2003. In the fourth quarter of 2004, we recorded
inventory write-downs totaling $2,746,000 (or 5.0% of net sales) based on
management's estimate of the net realizable value of certain inventory. The
decrease in gross profit as a percentage of net sales for the year ended
December 31, 2004 was also due to a change in our product mix during the year.
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, 2004 resulted
from an increase in net sales during the year.
Selling expense decreased approximately $807,000 (or 21.8%) to
$2,899,000 for the year ended December 31, 2004 from $3,706,000 for the year
ended December 31, 2003. As a percentage of net sales, these expenses decreased
to 5.3% for the year ended December 31, 2004 compared to 5.8% for the year ended
December 31, 2003. The decrease in selling expenses during the period was due in
part to a contractual decrease in the royalty rate related to our exclusive
license and intellectual property rights agreement with Pro-Fit Holdings
Limited. We incurred royalties related to this agreement of approximately
$411,000 for the year ended December 31, 2004 compared to $780,000 for the year
ended December 31, 2003. Over the life of the contract, 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. Selling expenses also
decreased due to the implementation of our restructuring plan in the fourth
quarter of 2003.
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,
16
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. Royalties incurred for the year
ended December 31, 2002 amounted to approximately $110,000.
General and administrative expenses increased approximately $10,481,000
(or 95.0%) to $21,509,000 for the year ended December 31, 2004 from $11,028,000
for the year ended December 31, 2003. Following negotiations with United Apparel
Ventures and its affiliate, Tarrant Apparel Group, a former customer of ours, we
determined that a significant portion of the obligations due from this customer
were uncollectable. Included in general and administrative expenses for the year
ended December 31, 2004 are charges of $4,289,000 (or 7.8% of net sales) related
primarily to the write-down of receivables due from UAV and Tarrant. We also
recorded an accounts receivable reserve of $5.0 million (or 9.1% of net sales)
in the fourth quarter of 2004 based on management's estimate of the
collectability of accounts receivable primarily related to two other customers.
The increase in general and administrative expenses was also due to the hiring
of additional employees related to the expansion of our Asian operations,
including our TALON franchising strategy. Additional administrative employees
were also hired for our new TALON manufacturing facility in North Carolina. This
facility began production in January 2005. In the first quarter of 2004, we
incurred additional restructuring charges of $414,675 (or .8% of net sales)
related to the final residual costs associated with our restructuring plan
implemented in the fourth quarter of 2003. This one-time charge was offset by a
decrease in salaries and related benefits and other costs as a result of the
implementation of our restructuring plan in the fourth quarter of 2003. As a
percentage of net sales, these expenses increased to 39.0% (22.2% before
customer write-offs and other fourth quarter charges) for the year ended
December 31, 2004 compared to 17.1% for the year ended December 31, 2003.
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.
Interest expense decreased approximately $391,000 (or 32.7%) to
$805,000 for the year ended December 31, 2004 from $1,196,000 for the year ended
December 31, 2003. Borrowings under our UPS Capital credit facility decreased
during the year ended December 31, 2004 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. In
November 2004, we raised $12.5 million from the sale of 6% secured convertible
notes payable. Borrowings under our UPS credit facility were at prime plus 2%
and 4%.
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.
17
The provision for income taxes amounted to approximately $2,277,000 for
the year ended December 31, 2004 as compared to a benefit for income taxes of
$2,333,000 for the year ended December 31, 2003. The income tax provision as a
percentage of loss before income taxes increased to 14.9% for the year ended
December 31, 2004 from an income tax benefit of 33.0% for the year ended
December 31, 2003 due primarily to the increase in the net deferred tax asset
valuation allowance related to net operating loss carryforwards to $8.9 million
at December 31, 2004 from $1.1 million at December 31, 2003,which reduced the
carrying value of our net deferred tax asset to $1.0 million from $2.8 million.
The decrease in the net deferred tax asset resulted in a charge of $1.8 million
against the provision for income taxes in 2004.
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.
Net loss was $17,609,000 for the year ended December 31, 2004, as
compared to $4,745,000 for the year ended December 31, 2003, due primarily to
the write-off of obligations, primarily accounts receivable and inventories,
from a former major customer incurred during the fourth quarter of 2004 of $4.3
million, other fourth quarter losses of $7.7 million, a decrease in the net
deferred tax asset of $1.8 million and decreases in net sales, as discussed
above.
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.
Preferred stock dividends amounted to approximately $31,000 for the
year ended December 31, 2004 as compared to $194,000 for the year ended December
31, 2003. 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 $17,639,000 and $4,939,000 for the
years ended December 31, 2004 and 2003. Basic and diluted loss per share was
$1.02 and $0.46 for the years ended December 31, 2004 and 2003.
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.
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.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased to $5,461,000 at December 31, 2004
from $14,443,000 at December 31, 2003. The decrease resulted from approximately
$11,382,000 of cash used by operating activities, $3,616,000 of cash used in
investing activities, partially offset by $6,016,000 of cash provided by
financing activities.
Net cash used in operating activities was approximately $11,382,000,
$2,086,000 and $5,440,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Cash used in operating activities for the year ended December 31,
2004 resulted primarily from a net loss of approximately $17.6 million, which
includes $4.3 million in charges related to the write-off of obligations,
primarily accounts receivable and
18
inventories, from a former major customer incurred in the fourth quarter of
2004, $7.7 million of fourth quarter adjustments related to accounts receivable
and inventories and increased accounts receivable of $7.6 million, offset by
decreased inventories of $7.8 million, depreciation and amortization of $1.5
million, a $1.8 million decrease in the net deferred tax asset, increased
allowance for doubtful accounts of $4.0 million and accounts payable and accrued
expenses of $1.6 million. The increase in accounts receivable during the period
was due primarily to slower customer collections of non-related party
receivables during the year. Non-related party trade receivables increased by an
additional $6.6 million due to the inclusion of receivables that were previously
classified as related party trade receivables. 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.
Net cash used in investing activities was approximately $3,616,000,
$2,516,000 and $1,268,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Net cash used in investing activities for the year ended December
31, 2004 consisted primarily of capital expenditures for computer equipment, the
purchase of additional TALON zipper equipment and building, land and leasehold
improvements related to our new TALON manufacturing facility in North Carolina.
The building and land purchase of the TALON manufacturing facility was treated
as a non-cash financing transaction. 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 provided by financing activities was approximately $6,016,000,
$18,759,000 and $6,947,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. Net cash provided by financing activities for the year ended
December 31, 2004 primarily reflects funds raised from secured convertible
promissory notes of $12.5 million, the exercise of stock options and warrants,
proceeds from notes payable and a capital lease obligation, offset by the
repayment of borrowings under our credit facility and notes payable. 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.
We currently satisfy our working capital requirements primarily through
cash flows generated from operations, sales of equity securities and borrowings
from institutional investors and individual accredited investors. On November
10, 2004, we paid off our working capital credit facility with UPS Capital
Global Trade Finance Corporation with a portion of the proceeds received from a
private placement of $12.5 million of Secured Convertible Promissory Notes. The
Secured Convertible Promissory Notes are convertible into common stock at a
price of $3.65 per share, bear interest at 6% payable quarterly, are due
November 9, 2007 and are secured by the TALON trademarks. The Notes are
convertible at the option of the holder at any time after closing. We may repay
the Notes at any time after one year from the closing date with a 15% prepayment
penalty. At maturity, we may repay the Notes in cash or require conversion if
certain conditions
19
are met. In connection with the issuance of the Notes, we issued to the Note
holders warrants to purchase up to 171,235 shares of common stock. The warrants
have a term of five years, an exercise price of $3.65 per share and vested 30
days after closing. We have registered with the SEC, the resale by the holders
of the shares issuable upon conversion of the options and exercise of the
warrants.
At December 31, 2004, there were no outstanding borrowings under our
UPS Capital credit facility which was terminated in November 2004. Amounts
borrowed under our foreign factoring agreement as of December 31, 2004 amounted
to approximately $615,000. At December 31, 2003, outstanding borrowings under
our UPS Capital credit facility, including amounts borrowed under our foreign
factoring agreement, amounted to approximately $7,096,000. There were no open
letters of credit at December 31, 2004 and 2003.
Pursuant to the terms of a foreign factoring agreement under our UPS
Capital credit facility, UPS Capital purchased our eligible accounts receivable
and assumed the credit risk with respect to those foreign accounts for which UPS
Capital had given its prior approval. If UPS Capital did not assume the credit
risk for a receivable, the collection risk associated with the receivable
remained with us. We paid a fixed commission rate and borrowed up to 85% of
eligible accounts receivable under our credit facility. Included in due from
factor as of December 31, 2003 are trade accounts receivable factored without
recourse of approximately $65,000. Included in due from factor are outstanding
advances due to UPS Capital under this factoring arrangement amounting to
approximately $55,000 at December 31, 2003. There were no factored accounts
receivable of advances from factor under the UPS credit facility as of December
31, 2004.
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, 2004 and 2003, the amount factored with
recourse and included in trade accounts receivable was approximately $1,559,000
and $316,000. Outstanding advances as of December 31, 2004 and 2003 amounted to
approximately $615,000 and $411,000 and are included in the line of credit
balance.
As we continue to respond to the current industry trend of large retail
brands to outsource apparel manufacturing to offshore locations, our foreign
customers, though backed by U.S. brands and retailers, are increasing. This
makes receivables based financing with traditional U.S. banks more difficult.
Our current borrowings may not provide the level of financing we may need to
expand into additional foreign markets. As a result, we are continuing to
evaluate non-traditional financing of our foreign assets.
Our trade receivables, net of allowance for doubtful accounts,
increased to $22,390,000 at December 31, 2004 from $19,253,000 at December 31,
2003. This increase was due primarily to increased non-related party receivables
of approximately $3.7 million due to increased sales to non-related party
customers and slower collections. This increase is net of a $5.0 million reserve
for bad debts provided in the fourth quarter of 2004, based on management's
estimate of the collectability of our customer accounts. Non-related party trade
receivables increased by an additional $6.6 million due to the inclusion of
receivables that were previously classified as related party trade receivables.
As a result of the sale of its ownership in our common stock, Azteca Production
International is no longer considered a related party customer. The increase in
non-related party receivables was offset by a decrease in related party trade
receivables of approximately $7.2 million resulting from decreased sales to
related parties during the year and the write-off of outstanding accounts
receivable obligations due from United Apparel Ventures and its affiliate,
Tarrant Apparel Group. Following negotiations with United Apparel Ventures and
its affiliate, Tarrant Apparel Group, a former major customer of ours, we
determined that a significant portion of the obligations due from this customer
were uncollectable. This resulted in a write-off of $6.9 million of accounts
receivable due from Tarrant and
20
UAV and a net receivable balance due from UAV of $4.5 million at December 31,
2004. UAV agreed to pay the $4.5 million receivable balance over a nine-month
period beginning May 2005.
Our net deferred tax asset at December 31, 2004 amounted to $1.0
million compared to $2.8 million at December 31, 2003. Our deferred tax asset
valuation allowance increased to $8.9 million at December 31, 2004 from $1.1
million at December 31, 2003. The decrease in the net deferred tax asset
resulted in a charge of $1.8 million against the provision for income taxes in
the fourth quarter of 2004. At December 31, 2004, we had Federal and state net
operating loss carryforwards of approximately $21.6 million and $12.9 million,
respectively, available to offset future taxable income. Our net operating
losses may be limited in future periods if the ownership of the Company changes
by more than 50% within a three-year period. As of December 31, 2004, none of
our net operating losses have been limited.
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. 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 and our expansion
into foreign markets. Our need for additional long-term financing includes the
integration and expansion of our operations to exploit our rights under our
TALON trade name, the expansion of our operations in the Asian, Central and
South American and Caribbean markets and the further development of our
waistband technology. If our cash from operations is less than anticipated or
our working capital requirements and capital expenditures are greater than we
expect, we may need to raise additional debt or equity financing in order to
provide for our operations. We are continually evaluating various financing
strategies to be used to expand our business and fund future growth or
acquisitions. There can be no assurance that additional debt or equity financing
will be available on acceptable terms or at all. If we are unable to secure
additional financing, we may not be able to execute our plans for expansion,
including expansion into foreign markets to promote our TALON brand tradename,
and we may need to implement additional cost savings initiatives.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at December 31,
2004 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
- ------------------------- ----------- ----------- ----------- ----------- -----------
Note payable ............ $ 1,501,500 $ 1,501,500 $ -- $ -- $ --
Capital lease obligations $ 2,454,068 $ 1,023,793 $ 1,251,263 $ 179,012 $ --
Notes payable to related
parties (1) ............. $ 734,021 $ 734,021 $ -- $ -- $ --
Operating leases ........ $ 1,145,827 $ 724,009 $ 421,818 $ -- $ --
Line of credit .......... $ 654,449 $ 654,449 $ -- $ -- $ --
Note payable ............ $ 27,720 $ 27,720 $ -- $ -- $ --
Notes payable ........... $ 2,060,326 $ 276,009 $ 828,027 $ 956,290 $ --
Convertible notes payable $14,645,205 $ 750,000 $13,895,205 $ -- $ --
- ----------
(1) The majority of 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.
At December 31, 2004 and 2003, 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.
21
RELATED PARTY TRANSACTIONS
For a description of transactions to which we were or will be a party,
and in which any director, executive officer, shareholder of more than 5% of our
common stock or any member of their immediate family had or will have a direct
or indirect material interest, see Note 20 of the Notes to the Consolidated
Financial Statements included in Item 8 of this Report.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment." This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123R addresses all forms of share
based payment ("SBP") awards including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
Under SFAS 123R, SBP awards result in a cost that will be measured at fair value
on the awards' grant date, based on the estimated number of awards that are
expected to vest. This statement is effective as of the beginning of the first
interim or annual reporting period that begins after December 15, 2005. We have
evaluated the effects of the adoption of this pronouncement and have determined
it will not have a material impact on our financial statements.
In November 2004, the FASB issued SFAS No. 151 "Inventory Costs" (SFAS
151). This statement amends the guidance in ARB No. 43, Chapter 4, "Inventory
Pricing," to clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs, and wasted material (spoilage). SFAS 151
requires that those items be recognized as current-period charges. In addition,
this Statement requires that allocation of fixed production overheads to costs
of conversion be based upon the normal capacity of the production facilities.
The provisions of SFAS 151 are effective for inventory cost incurred in fiscal
years beginning after June 15, 2005. As such, we are required to adopt these
provisions at the beginning of fiscal 2006. The adoption of this pronouncement
is not expected to have material effect on our financial statements.
In December 2004, the FASB issued Statement Accounting Standard
("SFAS") No. 153 "Exchanges of Nonmonetary Assets." This Statement amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods beginning after December
16, 2004. The provisions of this Statement should be applied prospectively. The
adoption of this pronouncement is not expected to have material effect on our
financial statements.
In October 2004, the American Jobs Creation Act of 2004 (Act) became
effective in the U.S. Two provisions of the Act may impact the provision
(benefit) for income taxes in future periods, namely those related to the
Qualified Production Activities Deduction (QPA) and Foreign Earnings
Repatriation (FER).
The QPA will be effective for our U.S. federal tax return year
beginning after December 31, 2004. In summary, the Act provides for a percentage
deduction of earnings from qualified production activities, as defined,
commencing with an initial deduction of 3 percent for tax years beginning in
2005 and increasing to 9 percent for tax years beginning after 2009, with the
result that the Statutory federal tax rate currently applicable to our qualified
production activities of 35 percent could be reduced initially to 33.95 percent
and ultimately to 31.85 percent. However, the Act also provides for the phased
elimination of the Extraterritorial Income Exclusion provisions of the Internal
Revenue Code, which have previously resulted in tax benefits to both CCN and
IMC. Due to the interaction of the law provisions noted above as well as the
particulars of our tax position, the ultimate effect of the QPA on our future
provision (benefit) for income taxes has not
22
been determined at this time. The FASB issued FASB Staff Position FAS 109-1,
Application of FASB Statement No.109, Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004, (FSP 109-1) in December 2004. FSP 109-1 requires that tax
benefits resulting from the QPA should be recognized no earlier than the year in
which they are reported in the entity's tax return, and that there is to be no
revaluation of recorded deferred tax assets and liabilities as would be the case
had there been a change in an applicable statutory rate.
The FER provision of the Act provides generally for a one-time 85
percent dividends received deduction for qualifying repatriations of foreign
earnings to the U.S. Qualified repatriated funds must be reinvested in the U.S.
in certain qualifying activities and expenditures, as defined by the Act. In
December 2004, the FASB issued FASB Staff Position FAS 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004 (FSP 109-2). FSP 109-2 allows additional time
for entities potentially impacted by the FER provision to determine whether any
foreign earnings will be repatriated under said provisions. At this time, we
have not undertaken an evaluation of the application of the FER provision and
any potential benefits of effecting repatriations under said provision. Numerous
factors, including previous actual and deemed repatriations under federal tax
law provisions, are factors impacting the availability of the FER provision and
its potential benefit to the us, if any. We intend to examine the issue and will
provide updates in subsequent periods.
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In addition to other information contained in this report, readers should
carefully consider the following cautionary statements and risk factors.
OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY
EFFECTED IF WE ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING
OUR RIGHTS UNDER OUR EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY AGREEMENT
("AGREEMENT") WITH PRO-FIT HOLDINGS. Pursuant to our Agreement with Pro-Fit
Holdings Limited, we have exclusive rights in certain geographic areas to
Pro-Fit's stretch and rigid waistband technology. By letter dated April 6, 2004,
Pro-Fit alleged various breaches of the Agreement which we dispute. To prevent
Pro-Fit in the future from terminating the Agreement based on alleged breaches
that we do not regard as meritorious, we filed a lawsuit against Pro-Fit in the
U.S. District Court for the Central District of California, based on various
contractual and tort claims seeking declaratory relief, injunctive relief and
damages. Pro-Fit filed an answer denying the material allegations of the
complaint and filed a counterclaim alleging various contractual and tort claims
seeking injunctive relief and damages. We filed a reply denying the material
allegations of Pro-Fit's pleading. Pro-Fit has since purported to terminate our
exclusive license and intellectual property agreement based on the same alleged
breaches of the agreement that are the subject of our existing litigation, as
well as on an additional basis unsupported by fact. In February 2005, we amended
our pleadings in the litigation to assert additional breaches by Pro-Fit of its
obligations to us under our agreement and under certain additional letter
agreements, and for a declaratory judgment that Pro-Fit's patent No. 5,987,721
is invalid and not infringed by us. Discovery in this case has commenced. There
have been ongoing negotiations with Pro-Fit to attempt to resolve these
disputes. We intend to proceed with the lawsuit if these negotiations are not
concluded in a manner satisfactory to us.
We derive a significant amount of revenues from the sale of products
incorporating the stretch waistband technology. Our business, results of
operations and financial condition could be materially adversely affected if we
are unable to conclude our present negotiations in a manner acceptable to us and
ensuing litigation is not resolved in a manner favorable to us.
IF WE LOSE OUR LARGER CUSTOMERS OR THEY FAIL TO PURCHASE AT ANTICIPATED
LEVELS, OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED. Our results
of operations will depend to a significant extent upon the commercial success of
23
our larger customers. If these customers fail to purchase our trim products at
anticipated levels, or our relationship with these customers terminates, it may
have an adverse affect on our results because:
o We will lose a primary source of revenue if these customers
choose not to purchase our products or services;
o We may not be able to reduce fixed costs incurred in
developing the relationship with these customers in a timely
manner;
o We may not be able to recoup setup and inventory costs;
o We may be left holding inventory that cannot be sold to other
customers; and
o We may not be able to collect our receivables from them.
WE MAY NOT BE ABLE TO ENFORCE THE MINIMUM PURCHASE REQUIREMENTS AND
OTHER OBLIGATIONS OF OUR TALON DISTRIBUTORS. Expansion of our TALON zipper
business depends in a large part on what we refer to as our TALON franchise
strategy. We appoint distributors in various geographic international regions to
finish and sell zippers under the TALON brand name. In return for the exclusive
right to finish and sell zippers in selected territories, each distributor
agrees to purchase a minimum quantity of zipper components from us over the term
of our agreement. These distributors are foreign entities located primarily in
emerging markets in Asia, Latin America, the Middle East and Africa. Despite a
distributor's contractual commitments to us, we may be unable to enforce the
distributor's minimum purchase guarantee or recover damages or other relief
following a default, which could result in lower than projected revenues for our
TALON division.
CONCENTRATION OF RECEIVABLES FROM OUR LARGER CUSTOMERS MAKES RECEIVABLE
BASED FINANCING DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGER CUSTOMERS
FAIL TO PAY US, OUR CASH FLOW WOULD BE SEVERELY AFFECTED. Our business relies
heavily on a relatively small number of customers. This concentration of our
business reduces the amount we can borrow from our lenders under receivables
based financing agreements. Under a borrowing base credit agreement, for
instance, if accounts receivable due us from a particular customer exceed a
specified percentage of the total eligible accounts receivable against which we
can borrower, the lender will not lend against the receivables that exceed the
specified percentage. If we are unable to collect any large receivables due us,
our cash flow would be severely impacted.
IF CUSTOMERS DEFAULT ON BUYBACK AGREEMENTS WITH US, WE WILL BE LEFT
HOLDING UNSALABLE INVENTORY. Inventories include goods that are subject to
buyback agreements with our customers. Under these buyback agreements, some of
our customers are required to purchase inventories from us under normal invoice
and selling terms, if any inventory which we purchase on their behalf remains in
our hands longer than agreed by the customer from the time we received the goods
from our vendors. If any customer defaults on these buyback provisions or
insists on markdowns, we may incur a charge in connection with our holding
significant amounts of unsalable inventory and this would have a negative impact
on our income.
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS WORSEN. Our
revenues depend on the health of the economy and the growth of our customers and
potential future customers. When economic conditions weaken, certain apparel
manufacturers and retailers, including some of our customers, have experienced
in the past, and may experience in the future, financial difficulties which
increase the risk of extending credit to such customers. Customers adversely
affected by economic conditions have also 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.
24
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.
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.
25
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 our MANAGED TRIM SOLUTION is Internet-based,
interruptions in Internet service generally can negatively impact our customers'
ability to use the MANAGED TRIM SOLUTION to monitor and manage various aspects
of their trim needs. Such defects or interruptions could result in lost revenues
and lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors,
including Paxar Corporation, YKK, Universal Button, Inc., Avery Dennison
Corporation and Scovill Fasteners, Inc., have greater name recognition, longer
operating histories and, in many cases, substantially greater financial and
other resources than we do.
UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR
LITIGATION COSTS AND ADVERSELY AFFECT OUR SALES. We rely on trademark, trade
secret and copyright laws to protect our designs and other proprietary property
worldwide. We cannot be certain that these laws will be sufficient to protect
our property. In particular, the laws of some countries in which our products
are distributed or may be distributed in the future may not protect our products
and intellectual rights to the same extent as the laws of the United States. If
litigation is necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others, such litigation could result in substantial
costs and diversion of resources. This could have a material adverse effect on
our operating results and financial condition. Ultimately, we may be unable, for
financial or other reasons, to enforce our rights under intellectual property
laws, which could result in lost sales.
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IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY
BE SUED AND HAVE TO PAY LARGE LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR
DISCONTINUE SELLING OUR PRODUCTS. From time to time in our industry, third
parties allege infringement of their proprietary rights. Any infringement
claims, whether or not meritorious, could result in costly litigation or require
us to enter into royalty or licensing agreements as a means of settlement. If we
are found to have infringed the proprietary rights of others, we could be
required to pay damages, cease sales of the infringing products and redesign the
products or discontinue their sale. Any of these outcomes, individually or
collectively, could have a material adverse effect on our operating results and
financial condition.
OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS
AND CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES. The following factors
could cause the market price of our common stock to decrease, perhaps
substantially:
o The failure of our quarterly operating results to meet
expectations of investors or securities analysts;
o Adverse development