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EX-23.1 - TALON INTERNATIONAL, INC.exh23-1.htm
EX-21.1 - TALON INTERNATIONAL, INC.exh21-1.htm
EX-32.1 - TALON INTERNATIONAL, INC.exh32-1.htm
EX-31.1 - TALON INTERNATIONAL, INC.exh31-1.htm
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, 2009
 
[_]
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission file number 1-13669
 
TALON INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
(State or Other Jurisdiction of Incorporation or Organization)
95-4654481
(I.R.S. Employer 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:
 
None
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, $.001 par value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes [_]       No [X]
 
Indicate by check mark if the registration is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.Yes [_] No [X]
 
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [_]        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 a large accelerated filer, an accelerated filer or a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).
 
Large accelerated filer [_]
Accelerated filer [_]
Non-accelerated filer [_]
Smaller reporting company [X]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [_]      No [X]
 
At June 30, 2009, the aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant was $1,513,311.
 
At March 29, 2010 the issuer had 20,291,433 shares of Common Stock, $.001 par value, issued and outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
None.
 
 


 
 
TALON INTERNATIONAL, INC.
 
 
 
PART I        Page
       
 
2
       
 
8
       
 
16
       
 
17
       
 
17
 
 
 
 
 
 
PART IV      
       
 
90
 
 
 
 
1

 
 
 
 
Forward Looking Statements
 
This report and other documents we file with the SEC contain forward looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, our business or others on our behalf, our beliefs and our management’s assumptions. In addition, we, or others on our behalf, may make forward looking statements in press releases or written statements, or in our communications and discussions with investors and analysts in the normal course of business through meetings, webcasts, phone calls and conference calls. Words such as “expect,” “anticipate,” “outlook,” “could,” “target,” “project,” “intend,” “plan,” “believe,” “seek,” “estimate,” “should,” “may,” “assume,” “continue,” variations of such words and similar expressions are intended to identify such forward looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. We describe our respective risks, uncertainties and assumptions that could affect the outcome or results of operations in “Item 1A. Risk Factors.” We have based our forward looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that actual outcomes and results may differ materially from what is expressed, implied, or forecast by our forward looking statements. Reference is made in particular to forward looking statements regarding projections or estimates concerning our ability to refinance our debt facility or reach an agreement for an extension or restructuring of our debt with our existing lender;  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; and the global economic environment in general and consumer demand for apparel.  Except as required under the federal securities laws and the rules and regulations of the SEC, we do not have any intention or obligation to update publicly any forward looking statements after the distribution of this report, whether as a result of new information, future events, changes in assumptions, or otherwise.
 

PART I
 
 
General
 
Talon International, Inc. specializes in the manufacturing and distribution of a full range of apparel accessories including zippers and trim items to manufacturers of fashion apparel, specialty retailers and mass merchandisers.  We manufacture and distribute zippers under our Talon® brand name to manufacturers for apparel brands and retailers such as Abercrombie & Fitch, JC Penney, Wal-Mart, Kohl’s, Juicy Couture and Phillips-Van Heusen, among others. We also provide full service outsourced trim design, sourcing and management services and supply specified trim items for manufacturers of fashion apparel such as Victoria’s Secret, Tom Tailor, Abercrombie & Fitch, American Eagle, Polo Ralph Lauren, New York and Company, Express,  and others.  Under our Tekfit® brand, we develop and sell a stretch waistband  that utilizes a patented technology that we license from a third party.
 
We were incorporated in the State of Delaware in 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. During 2006 we formed two wholly owned subsidiaries of Talon International, Inc. (formerly Tag-It Pacific, Inc.): Talon Zipper (Shenzhen) Company Ltd. in China and Talon International Pvt. Ltd., in India. On July 20, 2007 we changed our corporate name from Tag-It Pacific, Inc. to Talon International, Inc.  Our website is www.talonzippers.com.
 
 
2

 
Our website address provided in this Annual Report on Form 10-K is not intended to function as a hyperlink and the information on our website is not and should not be considered part of this report and is not incorporated by reference in this document.
 
Business Summary
 
We operate our business within three product groups, Talon, Trim and Tekfit.   In our Talon group, we design, engineer, test and distribute zippers under our Talon trademark and trade names to apparel brands and manufacturers.  Talon enjoys brand recognition in the apparel industry worldwide.  Talon is a 100-year-old brand, which is well known for quality and product innovation and 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 worldwide.  We provide a line of high quality zippers, including a specialty zipper for kids clothing, for distribution to apparel manufacturers worldwide, including principally Hong Kong, China, Taiwan, India, Indonesia, Bangladesh, Mexico and Central America and we have sales and marketing teams in most of these areas. We have developed joint manufacturing arrangements in various geographical international local markets to manufacture, finish and distribute zippers under the Talon brand name. Our manufacturing partners operate to our specifications and under our quality requirements, compliance controls and our direct manufacturing and quality assurance supervision, producing finished zippers for our customers in their local markets.  This operating model allows us to significantly improve the speed at which we serve the market and to expand the geographic footprint of our Talon products.   The Talon zipper is promoted both within our trim packages, as well as a stand-alone product line.
 
In our Trim products group, we act as a fully integrated single-source supplier, designer and sourcing agent 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 labels, buttons, rivets, printed marketing material, polybasic, 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 a one-stop outsource service for all trim related matters.  Our teams work with the apparel designers and function as an extension of their staff.
 
If our customer is creating a new pair of pants for their fall collection, our Trim products group will collaborate with them on their design vision, then present examples of their vision in graphic form for all apparel accessory components.  We will design the buttons, snaps, hang tags, labels, zippers, zipper pullers and other items.  Once our customer selects the designs they like, our sourcing and production teams coordinate with our database of manufacturers worldwide to ensure the best manufacturing solution for the items being produced.  The proper manufacturing and sourcing solution is a critical part of our service.  Knowing the best facility or supplier to ensure timely production, the proper paper finishes, distressing or other types of material needs or manufacturing techniques to be used is critical.  Because we perform this function for many different global projects and apparel brands, we have a depth and breadth of knowledge in the manufacturing and sourcing that our customers cannot achieve, and therefore offer a significant value to our customers.  In addition, because we are consistently innovating new items, manufacturing techniques and finishes, we bring many new, fresh and unique ideas to our customers.  Once we identify the appropriate supply source, we create production samples of all of our designs and products and review the samples with our customers so they can make a final decision while looking at the actual items that will be used on the garments.  When the customer selects the appropriate items, we are identified as the sole-source trim supplier for the project, and our customer’s factories are then required to purchase the trim products from us.  Throughout the garment manufacturing process, we consistently monitor the timing and accuracy of the production items to ensure the production items exactly match all samples when delivered to our customer’s apparel factories.
 
 
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We also serve as a specified supplier in our zipper and trim products for a variety of major retail brand and private-label oriented companies.  A specified supplier is a supplier that has been approved for its quality and service by a major retail brand or private-label company.  Apparel contractors manufacturing for the retail brand or private-label company must purchase their zipper and trim requirements from a supplier that has been specified.  We seek to expand our services as a supplier of select items for such customers, to being a preferred or single-source provider of the entire brand customer’s authorized trim and zipper requirements.  Our ability to offer a full range of trim and zipper products is attractive to brand name and private-label oriented customers because it enables the customer 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 advantage to become the preferred or sole vendor of trim and zipper items for all apparel manufacturers contracted for production for that brand name.
 
Our teams of sales employees, representatives, program managers, creative design personnel and global production and distribution coordinators at our facilities located in the United States, Europe, and throughout Southeast Asia enable us to take advantage of and address the increasingly complicated requirements of the large and expanding demand for complete apparel accessory solutions.  We plan to continue to expand operations in Asia, Europe, and Central America to take advantage of the large apparel manufacturing markets in these regions.
 
Products
 
Talon Zippers - We offer a full line of metal, coil and plastic 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, Europe, Hong Kong, China, Taiwan, India, Indonesia and Bangladesh and through these designated offices to other international markets.
 
We expand our distribution of Talon zippers through the establishment of a combination of Talon owned sales, distribution and manufacturing locations, strategic distribution relationships and joint ventures.  These distributors and manufacturing joint ventures, in combination with Talon owned and affiliated facilities under the Talon brand, improve our time-to-market by eliminating the typical setup and build-out phase for new manufacturing capacity throughout the world by sourcing, finishing and distributing to apparel manufacturers in their local markets.   The branded apparel zipper market is dominated by one company and we have positioned Talon to be a viable global alternative to this competitor and capture an increased market share position.  We leverage the brand awareness of the Talon name by branding other products in our line with the Talon name.
 
Trim - We consider our high level of customer service as a fully integrated single-source supplier essential to our success.  We combine our high level of customer service within our Trim solutions with a history of design and manufacturing expertise to offer our customers a complete trim solution product.  We believe this full-service product gives us a competitive edge over companies that only offer selected trim components because our full service solutions save our customers substantial time in ordering, designing, sampling and managing trim orders from several different suppliers.  Our proprietary tracking and order management system allows us to seamlessly supply trim solutions and products to apparel brands, retailers and manufacturers around the world.
 
We 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 may provide our customers the machinery used to attach the buttons, rivets and snaps we distribute.
 

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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 garments, manufactured anywhere in the world, for sale in the U.S. market and for all U.S. brands for the life of the patent.  We offer apparel manufacturers advanced, patented fabric technologies to utilize in their garments under the Tekfit name.  This technology allows fabrics to be altered through the addition of stretch characteristics resulting in greatly improved fit and comfort.  Pant manufacturers use this technology 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.
 
Our efforts to offer this product technology to customers have been limited by a licensing dispute.  As described more fully in Item 3 “Legal Proceedings” we are  in litigation with Pro-Fit related to our exclusively licensed rights to sell or sublicense stretch waistbands manufactured under Pro-Fit’s patented technology.  The revenues we derive from the sales of products incorporating the stretch waistband technology represented only a small portion of our consolidated revenue for the years 2009, 2008 and 2007 as a consequence of this litigation.
 
 The percentages of total revenue contributed by each of our three primary product groups for the last three fiscal years are as follows:
 
   
Year Ended December 31,
 
   
2009
 
2008
 
2007
 
Product Group Net Revenue:
             
Talon zipper
 
55.1
%
59.0
%
52.2
%
Trim
 
44.7
%
40.6
%
46.1
%
Tekfit
 
0.2
%
0.4
%
1.7
%

 
Design and Development
 
Our in-house creative teams produce products with innovative technology and designs that we believe distinguish our products from those of our competitors.  We support our skills and expertise in material procurement and product-manufacturing coordination with product technology and designs intended to meet fashion demands, as well as functional and cost parameters.  In 2006, we introduced the Talon KidZip® which is a specialty zipper for children’s apparel engineered to surpass industry established strength and safety tests, while maintaining the fashion image and requirements of today’s apparel demands.
 
Many specialty design companies with which we compete have limited engineering, sourcing or manufacturing experience.  These companies create products or 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 design products to function within the limitations imposed by the applicable manufacturing framework.  Using our manufacturing and sourcing experience, we ensure delivery of quality products and we 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 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 in our California, Ohio and China facilities.
 

5


 
Customers
 
We have more than 800 active customers.  Our customers include the designated suppliers of well-known apparel retailers and brands, such as Victoria’s Secret, Tom Tailor, Abercrombie & Fitch, Polo Ralph Lauren, Phillips-Van Heusen, American Eagle and Juicy Couture, among others.  Our customers also include contractors for specialty retailers such as Express and mass merchant retailers such as Wal-Mart, Kohl’s, Penney’s and Target.
 
For the years ended December 31, 2009, 2008 and 2007, our three largest customers represented approximately 9%, 8% and 9%, respectively, of consolidated net sales.
 
Sales and Marketing
 
We sell our principal products through our own sales force based in Los Angeles, California, various other cities in the United States, Hong Kong, China, India, Indonesia, Taiwan, and Bangladesh.  We contract with outside sales representatives in Europe, and we develop Central America opportunities through our U.S. sales force and outside sales representatives. We also employ customer service representatives who are assigned to key customers and provide in-house customer service support.  Our 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 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 products are available from numerous sources and are in adequate supply.  We purchase products from several qualified material suppliers.
 
We create most product artwork and any necessary dies and molds used to design and manufacture our products.  All other products that we design and sell are produced by third party vendors or under our direct supervision or through joint manufacturing arrangements.  We are confident in our ability to secure high quality 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.
 
Principally through our China facilities, we distribute Talon zippers, trim items and apparel packaging and coordinate the manufacture and distribution of the full range of our products.  Our China facilities supply several significant trim programs, services customers located in Asia and the Pacific Rim and sources products for our U.S. and European based operations.
 
Intellectual Property Rights and Licenses
 
We have trademarks as well as copyrights, software copyrights and trade names for which we rely on common law protection, including the Talon trademark.  Several of our other trademarks are the subject of applications for federal trademark protection through registration with the United States Patent and Trademark Office, including “Talon”, “Tag-It”, “Kidzip” and “Tekfit”.
 

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We also rely on our Exclusive License and Intellectual Property Rights agreement with Pro-Fit to sell our Tekfit stretch waistbands, which grants us the right to sell or sublicense stretch waistbands manufactured under patented technology developed by Pro-Fit for garments manufactured anywhere in the World for the U.S. market and for all U.S. brands.  These license rights are for the duration of the patents and trade secrets licensed under the agreement.  We are in litigation with Pro-Fit relating to our rights under the agreement, as described more fully elsewhere in this report.
 
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. Backlogs of sales orders are not considered material in the industries in which we compete, which reduces the predictability and reinforces the volatility of these cyclical buying patterns on our sales volume.
 
Inventories
 
In order to meet the rapid delivery requirements of our customers, we may be required to purchase inventories based upon projections made by our customers. In these cases we may carry a substantial amount of inventory on their behalf.  We attempt to manage this risk by obtaining customer commitments to purchase any excess inventories.  These commitments provide that 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.  While these agreements provide us some advantage in the negotiated disposition of these inventories, we cannot be assured that our customers will complete these agreements or that we can enforce these agreements without adversely affecting our business operations.
 
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 YKK and Avery Dennison Corporation have greater name recognition, longer operating histories and greater financial and other resources.
 
Because of our integrated materials procurement and assembly capabilities and our full-service trim solutions, 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 in one industry segment, the distribution of a full range of apparel zipper and trim products to manufacturers of fashion apparel, specialty retailers and mass merchandisers.
 

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Financial Information About Geographic Areas
 
We sell the majority of our products for use by U.S. and European based brands, retailers and manufacturers.  The majority of these customers produce their products or outsource the production of their products in manufacturing facilities located outside of the U.S. or Europe, primarily in Hong Kong, China, Taiwan, India, Indonesia, Bangladesh and Central America.
 
A summary of our domestic and international net sales and long-lived assets is set forth in Item 8 of this Annual Report on Form 10-K, Note 1 and Note 12 of the Notes to Consolidated Financial Statements.
 
We are subject to certain risks referred to in Item 1A, “Risk Factors” and Item 3, “Legal Proceedings”, including those normally attending international and domestic operations, such as changes in economic or political conditions, currency fluctuations, foreign tax claims or assessments, exchange control regulations and the effect of international relations and domestic affairs of foreign countries on the conduct of business, legal proceedings and the availability and pricing of raw materials.
 
Employees
 
As of December 31, 2009, we had approximately 177 full-time employees including 24 in the United States, 58 employees in Hong Kong, 91 employees in the Peoples Republic of China, 1 in India, 1 in Indonesia, 1 in Taiwan and 1 in Sri Lanka.  Our labor forces are non-union.  We believe that we have satisfactory employee and labor relations.
 
Corporate Governance and Information Related to SEC Filings
 
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form  8-K and amendments to those reports filed with, or furnished to, the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website,  www.talonzippers.com (in the “Investor” section, as soon as reasonably practical after electronic filing with or furnishing of such material to the SEC). We make available on our website our (i) shareholder communications policies, (ii) Code of Ethical Conduct, (iii) the charters of the Audit and Nominating Committees of our Board of Directors and (iv) Employee Complaint Procedures for Accounting and Auditing Matters. These materials are also available free of charge in print to stockholders who request them by writing to: Investor Relations, Talon International, Inc., 21900 Burbank Boulevard, Suite 270, Woodland Hills, CA  91367.  Our website address provided in this Annual Report on Form 10-K is not intended to function as a hyperlink and the information on our website is not and should not be considered part of this report and is not incorporated by reference in this document.
 
 
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.
 

 
8


 
 
We may not be able to refinance or extend our debt facility due at June 30, 2010 and if we cannot we will default on our credit agreement, which would have a material adverse effect on our liquidity, business and operations and ability to continue as a going concern.
 
Our cash flows from operating activities will not be sufficient to repay our obligations under the CVC debt facility which will become due and payable in full on June 30, 2010.  Accordingly an extension or modification of the CVC debt will be required prior to the due date or it will be necessary for us to raise additional debt or equity financing in order to repay the CVC debt. If we cannot obtain an extension or modification of the CVC debt, or raise additional equity or debt to satisfy this requirement we will default on our credit agreement and the lender would have the right to exercise its remedies including enforcement of its lien on substantially all of our assets.
 
 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 operating plans, or meet our debt obligations either of which could have a material adverse effect on our financial condition and results of operations and affect our ability to operate as a going concern.  See Note 2 of the Notes to Consolidated Financial Statements.
 
We will need to raise additional capital or refinance our existing debt structure to meet our current and long term needs.
 
We have historically satisfied our working capital requirements primarily through cash flows generated from operations.  As we continue to expand globally in response to the industry trend to outsource apparel manufacturing to offshore locations, our foreign customers, some of which are backed by U.S. brands and retailers, represent substantially all of our customers.  Our revolving credit facility provides limited financing secured by our accounts receivable, and our current borrowing capability may not provide the level of financing we need to continue in or to expand into additional foreign markets.  We are continuing to evaluate non-traditional financing alternatives and equity transactions to provide capital needed to fund our expansion and operations.
 
Even if we are able to refinance or restructure our existing credit facility, if we experience greater than anticipated reductions in sales, we may need to raise additional capital, or further reduce the scope of our business in order to fully satisfy our future short-term liquidity requirements.  If we cannot raise additional capital or reduce the scope of our business in response to a substantial decline in sales, we may default on our credit agreement.
 
The extent of our future long-term capital requirements will depend on many factors, including our results of operations, future demand for our products, the size and timing of future acquisitions, our borrowing base availability limitations related to eligible accounts receivable and inventories and our expansion into foreign markets.  Our need for additional long-term financing includes the integration and expansion of our operations to maximize the opportunities of our Talon trade name, and the expansion of our operations in Asia, Europe and Central America. 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 and we may need to implement additional cost savings initiatives.
 

9


 
We may not be able to satisfy the financial covenants in our debt agreements and if we cannot, then our lender could declare the debt obligations in default, which would have a material adverse effect on our liquidity, business and operations.
 
Our revolving credit and term loan agreement requires certain covenants, including a minimum level of EBITDA as discussed in Note 6 of the Notes to Consolidated Financial Statements.   If we fail to satisfy the EBITDA covenant in three consecutive quarters, the credit agreement will be in default and can be declared immediately due and payable by the lender.
 
In anticipation of not being able to meet required covenants due to various reasons, we either negotiate for changes in the relative covenants or negotiate a waiver with the lender.   However, our expectations of future operating results and continued compliance with all debt covenants cannot be assured and our lender’s actions are not controllable by us.  If we are in default under the loan agreement, all amounts due under the loan agreement can be declared immediately due and payable and, unless we are able to secure alternative financing to repay the lender in full, the lender would have the right to exercise its remedies including enforcement of its lien on substantially all of our assets.  Further, if the debt is placed in default, we would be required to reduce our expenses, including curtailing operations and to raise capital through the sale of assets, issuance of equity or otherwise, any of which could have a material adverse effect on our financial condition and results of operations and affect our ability to operate as a going concern. See Note 2 of the Notes to Consolidated Financial Statements regarding going concern.
 
The ongoing U.S. and global financial and economic uncertainties could negatively affect our business, results of operations and financial condition.
 
The recent financial crisis affecting the global banking system and financial markets and the going concern threats to financial institutions have resulted in a tightening in the credit markets; a low level of liquidity in many financial markets; and extreme volatility in credit, fixed income and equity markets.  Certain apparel manufacturers and retailers, including some of our customers may experience financial difficulties that 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 suppliers. There can be no assurance that we will remain a preferred supplier 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 and financial condition.
 
In addition, our performance is subject to worldwide economic conditions and their impact on levels of consumer spending that affect not only the ultimate consumer, but also retailers, which are served by many of our largest customers. Consumer spending has remained depressed in early 2010 after deteriorating significantly in 2008 and 2009, and it may remain depressed or be subject to further deterioration for the foreseeable future. The worldwide apparel industry is heavily influenced by general economic cycles. Purchases of fashion apparel and accessories tend to decline in periods of recession or uncertainty regarding future economic prospects, as disposable income declines. Many factors affect the level of consumer spending in the apparel industries, including, among others: prevailing economic conditions, levels of employment, salaries and wage rates, energy costs, interest rates, the availability of consumer credit, taxation and consumer confidence in future economic conditions. During periods of recession or economic uncertainty, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, or maintain our earnings from operations as a percentage of net sales. As a result, our operating results may be adversely and materially affected by sustained or further downward trends in the United States or global economy.

 
10



 
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.  The loss of the services of 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.  As described above, our credit facility with CVC becomes due on June 30, 2010, and we will not have sufficient cash to repay our obligations to CVC.  Unless and until we are able to reach an agreement to refinance or restructure the debt, the uncertainty created by this situation may make it more difficult to retain our key management personnel.
 
The current global credit crisis has increased our credit risks with vendors and customers.
 
We extend credit to some vendors by supplying them products. If any of these vendors are unable to honor their commitments to us, due to bankruptcy, cessation of operations or otherwise, we will likely experience losses on the products we provided and lose profit margins on the unshipped orders. Most of our customers are extended credit terms which are approved by us internally.  While we have attempted to cover as much of our credit risks as possible, not all of our risks can be fully hedged due to the current credit crisis. Such exposure may translate into losses should there be any adverse changes to the financial condition of certain customers.
 
Our operating results in our Tekfit product group could be adversely affected if we are unsuccessful in resolving a dispute that now exists regarding our rights under our exclusive license and intellectual property agreement with Pro-Fit.
 
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.  We are in litigation with Pro-Fit regarding our rights. See Item 3, “Legal Proceedings” for discussion of this litigation. Our business in this product group, and our future results of operations and financial condition could be adversely affected if we are unable to reach a settlement in a manner acceptable to us and ensuing litigation is not resolved in a manner favorable to us. Additionally, we have incurred significant legal fees in this litigation, and unless the case is settled, we could continue to incur additional legal fees in increasing amounts to protect our license position.
 
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 our larger customers.  If these customers fail to purchase our products at anticipated levels, or our relationship with these customers or the retailers they serve terminates, it may have an adverse effect on our results because:
 
 
·
We will lose a primary source of revenue if these customers choose not to purchase our products or services;
 
 
·
We may lose the specific nomination of the retailer or brand;
 
 
·
We may not be able to reduce fixed costs incurred in developing the relationship with these customers in a timely manner;
 
 
·
We may not be able to recoup setup and inventory costs;
 
 
·
We may be left holding inventory that cannot be sold to other customers; and
 
 
·
We may not be able to collect our receivables from them.
 

 
11

 
 
If customers default on inventory purchase commitments with us, we will be left holding non-salable inventory.
 
We hold inventories for specific customer programs, which the customers have committed to purchase.  If any customer defaults on these commitments, or insists on markdowns, we may incur a charge in connection with our holding non-salable inventory and this would have a negative impact on our operations and cash flow.
 
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.
 
Our products may not comply with various industry and governmental regulations and our customers may incur losses in their products or operations as a consequence of our non-compliance.
 
Our products are produced under strict supervision and controls to ensure that all materials and manufacturing processes comply with the industry and governmental regulations governing the markets in which these products are sold.  However, if these controls fail to detect or prevent non-compliant materials from entering the manufacturing process, our products could cause damages to our customer’s products or processes and could also result in fines being incurred.  The possible damages and fines could significantly exceed the value of our products and these risks may not be covered by our insurance policies.
 
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:
 
 
·
The volume and timing of customer orders received during the quarter;
 
 
·
The timing and magnitude of customers’ marketing campaigns;
 
 
·
The loss or addition of a major customer or of a major retailer nomination;
 
 
·
The availability and pricing of materials for our products;
 
 
·
The increased expenses incurred in connection with the introduction of new products;
 
 
·
Currency fluctuations;
 
 
·
Delays caused by third parties; and
 
 
·
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 could be adversely affected.  In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against such a company. In October 2005, a securities class action lawsuit was filed against us. See Item 3, “Legal Proceedings” for a detailed description of this lawsuit which is now settled.
 
 
12

 
 
The outcome of any litigation in which we have been named as a defendant is unpredictable and an adverse decision in any such matter could have a material adverse effect on our financial position and results of operations.

We are defendants in various litigation matters. These claims may divert financial and management resources that would otherwise be used to benefit our operations. Although we believe that we have meritorious defenses to the claims made in each and all of the litigation matters to which we have been named a party and we intend to contest each lawsuit vigorously, no assurances can be given that the results of these matters will be favorable to us.

We maintain product liability and director and officer insurance that we regard as reasonably adequate to protect us from potential claims; however we cannot assure you that it will be adequate to cover any losses. Further, the costs of insurance have increased dramatically in recent years, and the availability of coverage has decreased. As a result, we cannot assure you that we will be able to maintain our current levels of insurance at a reasonable cost, or at all.

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. Backlogs of sales orders are not considered material in the industries in which we compete, which reduces the predictability and reinforces the volatility of these cyclical buying patterns on our sales volume.
 
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 worldwide operations with the information systems of our principal offices in California.  Our failure to do so could result in lost revenues, delay financial reporting or have adverse effects on the information reported.
 
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:
 
 
·
Foreign trade disruptions;
 
 
·
Import restrictions;
 
 
·
Labor disruptions;
 
 
·
Embargoes;
 
 
·
Government intervention;
 
 
·
Natural disasters; or
 
 
·
Regional pandemics.
 

13

 
 
Internet-based systems that we rely upon for our order tracking and management systems may experience disruptions and as a result we may lose revenues and customers.
 
To the extent that we fail to adequately update and maintain the hardware and software implementing our integrated systems, our customers may be delayed or interrupted due to defects in our hardware or our source code.  In addition, since our software is Internet-based, interruptions in Internet service generally can negatively impact our ability to use our systems to monitor and manage various aspects of our customer’s 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 have greater name recognition, longer operating histories and 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.
 
If our products infringe any other person’s proprietary rights, we may be sued and have to pay 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.
 
Counterfeit products are not uncommon in the apparel industry and our customers may make claims against us for products we have not produced adversely impacting us by these false claims.
 
Counterfeiting of valuable trade names is commonplace in the apparel industry and while there are industries organizations and federal laws designed to protect the brand owner, these counterfeit products are not always detected and it can be difficult to prove the manufacturing source of these products.  Accordingly, we may be adversely affected if counterfeit products damage our relationships with customers, and we incur costs to prove these products are counterfeit, to defend ourselves against false claims and to pay for false claims.
 
 
14

 
 
During the second quarter of 2009 it was discovered that certain Chinese factories had counterfeited Talon zippers in conjunction with certain of our former employees, and sold these products to existing and potential customers. We have initiated efforts to eliminate and prosecute all offenders. Counterfeiting of known quality brand products is commonplace within China and in particular where retailers limit their sources to recognized brands such as Talon.  The full extent of counterfeiting of Talon products, its effect on our business operations and the costs to investigate and eliminate this activity are ongoing and are generally undeterminable. However based upon evidence available we believe the impact is not significant to our current overall operations.  We continue to work closely with major retailers to identify these activities within the marketplace and will aggressively combat these efforts worldwide to protect the Talon brand.
 
We have experienced and may continue to experience major fluctuations in the market price for our common stock.
 
The following factors could cause the market price of our common stock to decrease, perhaps substantially:
 
 
·
The failure of our quarterly operating results to meet expectations of investors or securities analysts;
 
 
·
Adverse developments in the financial markets, the apparel industry and the worldwide or regional economies;
 
 
·
Interest rates;
 
 
·
Changes in accounting principles;
 
 
·
Intellectual property and legal matters;
 
 
·
Sales of common stock by existing shareholders or holders of options;
 
 
·
Announcements of key developments by our competitors;
 
 
·
Changed perceptions about our ability to renegotiate or replace our credit and revolving term loan agreement before maturity at June 30, 2010; and
 
 
·
The reaction of markets and securities analysts to announcements and developments involving our company.
 
If we need to sell or issue additional shares of common stock or assume additional debt to finance future growth, our stockholders’ ownership could be diluted or our earnings could be adversely impacted.
 
Our business strategy may include expansion through internal growth, by acquiring complementary businesses or by establishing strategic relationships with targeted customers and suppliers.  In order to do so or to fund our other activities, we may issue additional equity securities that could dilute our stockholders’ value.  We may also assume additional debt and incur impairment losses to our intangible assets if we acquire another company.
 
We may not be able to realize the anticipated benefits of acquisitions.
 
We may consider strategic acquisitions as opportunities arise, subject to the obtaining of any necessary financing.  Acquisitions involve numerous risks, including diversion of our management’s attention away from our operating activities.  We cannot assure you that we will not encounter unanticipated problems or liabilities relating to the integration of an acquired company’s operations, nor can we assure you that we will realize the anticipated benefits of any future acquisitions.
 
 
15

 
 
 
Our actual tax liabilities may differ from estimated tax resulting in unfavorable adjustments to our future results.
 
The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities.  Our estimate of the potential outcome of uncertain tax issues is subject to our assessment of relevant risks, facts and circumstances existing at that time. Our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, which may impact our effective tax rate and our financial results.
 
We have adopted a number of anti-takeover measures that may depress the price of our common stock.
 
Our stockholders’ rights plan, our ability to issue additional shares of preferred stock and some provisions of our certificate of incorporation and bylaws and of Delaware law could make it more difficult for a third party to make an unsolicited takeover attempt of us.  These anti-takeover measures may depress the price of our common stock by making it more difficult for third parties to acquire us by offering to purchase shares of our stock at a premium to its market price.
 
Insiders own a significant portion of our common stock, which could limit our stockholders’ ability to influence the outcome of key transactions.
 
As of March 29, 2010, our officers and directors and their affiliates owned approximately 19.6% of the outstanding shares of our common stock.  The Dyne family, which includes Mark Dyne and Colin Dyne, who are also our directors, and Larry Dyne who is our President; beneficially owned approximately 13.4% of the outstanding shares of our common stock at March 29, 2010.  Additionally, at March 29, 2010, CVC California, LLC, our lender, beneficially owned approximately 8.6% of the outstanding shares of our common stock.  As a result, our lender, officers and directors and the Dyne family are able to exert considerable influence over the outcome of any matters submitted to a vote of the holders of our common stock, including the election of our Board of Directors.  The voting power of these stockholders could also discourage others from seeking to acquire control of us through the purchase of our common stock, which might depress the price of our common stock.
 
We may face interruption of production and services due to increased security measures in response to terrorism.
 
Our business depends on the free flow of products and services through the channels of commerce.  In response to terrorists’ activities and threats aimed at the United States, transportation, mail, financial and other services may be slowed or stopped altogether.  Extensive delays or stoppages in transportation, mail, financial or other services could have a material adverse effect on our business, results of operations and financial condition.  Furthermore, we may experience an increase in operating costs, such as costs for transportation, insurance and security as a result of the activities and potential delays.  We may also experience delays in receiving payments
 

from payers that have been affected by the terrorist activities.  The United States economy in general may be adversely affected by the terrorist activities and any economic downturn could adversely impact our results of operations, impair our ability to raise capital or otherwise adversely affect our ability to grow our business.
 

 
 
Not applicable.
 

16

 
 
 
Our headquarters are located in the greater Los Angeles area, in Woodland Hills, California, where we lease approximately 8,800 square feet of administrative and product development space.  In addition to the Woodland Hills facility, we lease 120 square feet of office space in New York, New York; 1,400 square feet of office space in Columbus, Ohio; 7,000 square feet of warehouse in Grover, North Carolina; 450 square feet of office in Mt. Holly, North Carolina; 3,400 square feet of warehouse space in Simi Valley, California; 23,809 square feet of office and warehouse space in Kwun Tong, Hong Kong; 10,168 square feet of office and showroom space in Shenzhen, China; office space square footage totaling 4,800  in various other cities in China; 1,000 square feet of office space in Bangalore, India; and 4,100 square feet of warehouse space in Santiago, Dominican Republic. The lease agreements related to these properties expire at various dates through September 2010.  The building we owned in Kings Mountain, North Carolina was sold on October 22, 2008. We believe our existing facilities are adequate to meet our needs for the foreseeable future.
 

 
 
In October 2005, a shareholder class action complaint was filed in the United States District Court for the Central District of California ("District Court") against us, Colin Dyne, Mark Dyne, Ronda Ferguson and August F. Deluca (collectively, the "Individual Defendants" and, together with us, the "Defendants").  The action was styled Huberman v. Tag-It Pacific, Inc., et al., Case No. CV05-7352 R(Ex). On January 23, 2006, the District Court appointed Seth Huberman as the lead plaintiff ("Plaintiff") and in March 2006, Plaintiff filed an amended complaint alleging that defendants made false and misleading statements about our financial situation and our relationship with certain of our large customers. The action was brought on behalf of all purchasers of our publicly-traded securities during the period from November 13, 2003, to August 12, 2005. In August 2006, Defendants filed denying any material allegations of wrongdoing. On February 20, 2007, the District Court denied the Plaintiff class certification and in April 2007, the District Court granted Defendants’ motion for summary judgment and entered judgment in favor of all Defendants. On or about April 30, 2007, Plaintiff filed a notice of appeal with the United States Court of Appeals for the Ninth Circuit and on January 16, 2009, the Ninth Circuit issued instructions to the District Court to certify a class, and reversed the District Court’s grant of summary judgment.  The District Court thereafter certified a class and adopted a schedule for the case. On July 31, 2009, the parties entered into a stipulation of settlement and dismissal of the matter with prejudice.
 
Thereafter, total settlement proceeds of $5.75 million were paid in full by our insurers without any contribution from us or individual defendants.  On December 7, 2009, the Court gave final approval to the settlement and the case was dismissed with prejudice per the terms of the settlement. 
 
On April 16, 2004, we 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) -- asserting various contractual and tort claims relating to our exclusive license and intellectual property agreement with Pro-Fit, seeking declaratory relief, injunctive relief and damages.  It is our position that the agreement with Pro-Fit gives us exclusive rights in certain geographic areas to Pro-Fit’s stretch and rigid waistband technology.  We also filed a second civil action against Pro-Fit and related companies in the California Superior Court which was removed to the United States District Court, Central District of California.  In the second quarter of 2008, Pro-Fit and certain related companies were placed into administration in the United Kingdom and filed petitions under Chapter 15 of Title 11 of the United States Code.  As a consequence of the chapter 15 filings, all litigation by us against Pro-Fit has been stayed.  We have incurred significant legal fees in this litigation, and unless the case is settled or resolved, may continue to incur additional legal fees in order to assert its rights and claims against Pro-Fit and any successor to those assets of Pro-Fit that are subject to our exclusive license and intellectual property agreement with Pro-Fit and to defend against any counterclaims.
 
 
17

 
 
We currently have pending various 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 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.
 

 
PART II
 
 
Common Stock
 
Our common stock has been quoted on the OTC Bulletin Board under the symbol “TALN” since December 28, 2007.  The following table sets forth the high and low sales prices for the Common Stock as reported by the OTC Bulletin Board during the periods indicated. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.
 
   
High
 
Low
Year ended December 31, 2009
       
1st Quarter. 
 
$  0.14
 
$0.06
2nd Quarter 
 
   0.20
 
0.07
3rd Quarter 
 
0.11
 
0.05
4th Quarter 
 
0.09
 
0.05
 
 
Year ended December 31, 2008
       
1st Quarter. 
 
$  0.50
 
$0.22
2nd Quarter 
 
   0.38
 
0.19
3rd Quarter 
 
0.29
 
0.10
4th Quarter 
 
0.25
 
0.10
         
 
On March 26, 2010 the closing sales price of our common stock as reported on OTC Bulletin Board was $0.13 per share.  As of March 26, 2010, there were 23 record holders of our common stock and approximately 81.6% of our outstanding shares are held by brokers and dealers.
 
Dividends
 
We have never paid dividends on our common stock.  We are restricted from paying dividends under our senior secured credit facility.  It is our intention to retain future earnings for use in our business.
 
Performance Graph
 
The following graph sets forth the percentage change in cumulative total stockholder return of our common stock during the period from December 31, 2004 to December 31, 2009, compared with the cumulative returns of the American Stock Exchange Market Value (U.S. & Foreign) Index and The Dow Jones U.S. Clothing & Accessories Index.  The comparison assumes $100 was invested on December 31, 2004 in our common stock and in each of the foregoing indices.  The stock price performance on the following graph is not necessarily indicative of future stock price performance.
 
 
18

 
 


 
    Cumulative Total Return
   
12/04
12/05
12/06
12/07
12/08
12/09
               
Talon International, Inc.
 
100.00
8.00
22.89
9.00
2.44
2.00
AMEX Composite
 
100.00
125.80
150.40
178.95
108.56
147.27
Dow Jones US Clothing & Accessories
 
100.00
104.43
129.44
97.40
58.68
100.09

 
The information under this “Performance Graph” subheading shall not be deemed to be “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liabilities of such section, nor shall such information or exhibit be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Exchange Act, except as shall be expressly set forth by specific reference in such a filing.
 
 
19

 
 
 
 
The following selected financial data is not necessarily indicative of our future financial position or 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 Annual Report on Form 10-K.
 
 
   
(In thousands except per share data)
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
Consolidated Statement of Operations Data:
                             
  Talon zippers net sales
  $ 21,341     $ 28,429     $ 21,160     $ 17,005     $ 13,594  
  Trim net sales
    17,274       19,537       18,689       22,503       24,788  
  Tekfit net sales
    61       205       681       9,317       8,949  
Total net sales
  $ 38,676     $ 48,171     $ 40,530     $ 48,825     $ 47,331  
Income (loss) from operations (1)
  $ 289     $ (5,962 )   $ (3,171 )   $ 1,331     $ (27,098 )
Net income (loss)
  $ (2,693 )   $ (8,359 )   $ (4,922 )   $ 309     $ (29,538 )
Net income (loss) per share – basic
  $ (0.13 )   $ (0.41 )   $ (0.24 )   $ 0.02     $ (1.62 )
Net income (loss) per share – diluted
  $ (0.13 )   $ (0.41 )   $ (0.24 )   $ 0.02     $ (1.62 )
Weighted average shares outstanding – basic
    20,291       20,291       20,156       18,377       18,226  
Weighted average shares outstanding – diluted
    20,291       20,291       20,156       18,956       18,226  
Consolidated Balance Sheet Data:
                                       
Cash and cash equivalents
  $ 2,265     $ 2,400     $ 2,919     $ 2,935     $ 2,277  
Total assets
  $ 13,834     $ 15,603     $ 21,684     $ 25,694     $ 30,321  
Capital lease obligations, line of credit and notes payable
  $ 15,270     $ 13,316     $ 12,696     $ 16,214     $ 16,001  
Stockholders’ equity (deficit)
  $ (11,179 )   $ (8,762 )   $ (717 )   $ 1,686     $ 912  
Total liabilities and stockholders’ equity
  $ 13,834     $ 15,603     $ 21,684     $ 25,694     $ 30,321  
Per Share Data:
                                       
Net book value per common share
  $ (0.55 )   $ (0.43 )   $ (0.04 )   $ 0.09     $ 0.05  
Common shares outstanding
    20,291       20,291       20,291       18,466       18,241  
 
(1) Income (loss) from operations for each fiscal year includes the following items (in thousands):
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
Restructuring Charges
  $ -     $ -     $ -     $ -     $ (2,924 )
Inventory Impairment
  $ -     $ (692 )   $ -     $ -     $ (3,447 )
Losses from a former customer and impairment of related marketable securities
  $ -     $ (1,040 )   $ (1,088 )   $ -     $ -  
Executive severance
  $ -     $ (724 )   $ -     $ -     $ -  
Related Party Note Impairment
  $ (200 )   $ (474 )   $ -     $ -     $ -  
Prior years consulting fees
  $ (201 )   $ -     $ -     $ -     $ -  
Impairment charges Idle Equipment and Building
  $ -     $ (2,430 )   $ (127 )   $ -     $ -  
                   Combined
  $ (401 )   $ (5,360 )   $ (1,215 )   $ -     $ (6,371 )
 
 
 
20


 
 
Overview
 
The following management’s discussion and analysis is intended to assist the reader in understanding our consolidated financial statements.  This discussion is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and accompanying notes.
 
Talon International, Inc. designs, sells, manufactures and distributes apparel zippers, specialty waistbands and various apparel trim products to manufacturers of fashion apparel, specialty retailers and mass merchandisers. We sell and market these products under various branded names including Talon and Tekfit.  We operate the business globally under three product groups.
 
We pursue the global expansion of Talon zippers through the establishment of Talon owned sales, distribution and manufacturing locations, strategic distribution relationships and joint ventures.   These distributors and manufacturing joint ventures, in combination with Talon owned and affiliated facilities under the Talon brand, improve our time-to-market by eliminating the typical setup and build-out phase for new manufacturing capacity throughout the world by sourcing, finishing and distributing to apparel manufacturers in their local markets.
 
We have structured our trim business to focus as an outsourced product development, sourcing and sampling department for the most demanding brands and retailers.  We believe that trim design differentiation among brands and retailers has become a critical marketing tool for our customers.  By assisting our customers in the design, development, sampling and sourcing of trim, we expect to achieve higher margins for our trim products, create long-term relationships with our customers, grow our sales to a particular customer by supplying trim for a larger proportion of their brands and better differentiate our trim sales and services from those of our competitors.   We are expanding our trim business globally, so we may better serve our apparel factory customers in the field, in addition to our brand and retail customer.  We believe we can lead the industry in trim sourcing by having both an intimate relationship with our brand and retail customers and having a distributed service organization to serve our factory customers (those that manufacture for the apparel brand and retailers) globally.
 
Our Tekfit business provides manufacturers with the patented technology, manufacturing know-how and materials required to produce pants incorporating an expandable waistband.    Our efforts to expand this product offering to other customers have been limited by a licensing dispute.  As described more fully in this report under Item 3. “Legal Proceedings”, we are presently in litigation with Pro-Fit Holdings Limited related to our exclusively licensed rights to sell or sublicense stretch waistbands manufactured under Pro-Fit’s patented technology.  The revenues we derive from the sale of products incorporating the stretch waistband technology represented less than 2% of our consolidated revenues for the years ended December 31, 2009, 2008 and 2007. Our business prospects for this group could be adversely affected if our dispute with Pro-Fit is not resolved in a manner favorable to us.
 
Effects of the Global Economic Recession
 
During 2009, we experienced a general decrease in sales which reflected the impact of the global recession on the apparel industry and the corresponding lower demand for all apparel products including our Talon zipper and trims products.  The apparel industry and our customers are expected to continue to be adversely impacted by this recession in early 2010 and perhaps beyond, depending upon the global economic trends. During 2009 the year-to-year comparative sales performance by quarter with 2008 reflected improvements throughout the year after the sharp retail industry decline that began late in 2008.  The first quarter of 2009 reflected a sales decline from the same quarter in 2008 by more than 34%.  The sales shortfall from the second quarter of 2009 as compared to 2008 reduced to 26% and the sales shortfall from the third quarter of 2009 as compared to 2008 reduced again to 18%.
 
 
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These declines from our sales levels in 2008 reflect the severe impact of the global decline in retail purchases and a sharp reduction in retail inventories by our customers as a consequence of the falling consumer demand.  We believe the modest improvements in our quarter to quarter sales performance during the year evidence improved consumer and customer confidence in the overall economy and our ability to retain preferred supplier positions with customers as the industry sharply reduced its supplier base.  Our fourth quarter sales in 2009 reflected an increase of 9.0% over the fourth quarter in 2008.  This was attributable to the improving trend in consumer and customer confidence, the rebuilding of retail inventories across the industry, and from sales with customers where we have secured preferred positions. Early in 2010, consumer confidence remains weak, however retail inventories are still near historic lows and as these rebuild to more normal levels, our expectation is that sales of our products should exceed the overall retail growth.
 
Results of Operations
 
Net Sales
 
For the years ended December 31, 2009, 2008 and 2007, total sales by geographic region based on customer delivery locations were as follows:
 
   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
Sales:
                 
United States
  $ 3,396,705     $ 3,332,257     $ 3,692,468  
Hong Kong
    13,131,762       15,181,280       14,178,421  
China
    8,990,718       13,614,709       11,159,726  
       India
    1,650,990       2,536,929       2,187,684  
       Bangladesh
    2,008,869       2,434,382       1,924,943  
Other
    9,496,746       11,071,423       7,386,313  
Total
  $ 38,675,790     $ 48,170,980     $ 40,529,555  
 
 
 The net revenues for the three primary product groups are as follows:
 
   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
Product Group Net Revenue:
                 
Talon zipper
  $ 21,341,132     $ 28,428,885     $ 21,159,595  
Trim
    17,274,158       19,537,302       18,688,698  
Tekfit
    60,500       204,793       681,262  
Total
  $ 38,675,790     $ 48,170,980     $ 40,529,555  

 
Sales are influenced by a number of factors, including demand, pricing strategies, foreign exchange effects, new product launches and indications, competitive products, product supply and acquisitions.  See Item 1 “Business” for a discussion of our principal products.
 
The net reduction in sales in 2009 versus 2008 ($9.5 million or 19.7%) was due mainly to the impact of the global recession on the apparel industry and the related lower demand for Talon products.
 
 
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The net increase of sales in 2008 versus 2007 was primarily due to an increase in Talon zipper sales ($7.3 million or 34.4%) as a result of new brand nominations and sales within Southeast Asia, together with new and increased program sales in the Trim division ($0.8 million or 4.5% increase) partially offset by a decline in sales of Tekfit products.
 
Cost of goods sold and selected operating expenses
 
The following table summarizes cost of goods sold and selected operating expenses for the years ended December 31, 2009, 2008 and 2007 (amounts in thousands) and the percentage change in such operating expenses as compared to the previous year:
 
   
2009
   
Change
   
2008
   
Change
   
2007
 
                               
Sales
  $ 38,676       (20 ) %   $ 48,171       19 %   $ 40,530  
Cost of goods sold
    27,363       (23 ) %     35,554       25 %     28,423  
    % of sales
    71 %             74 %             70 %
Sales and marketing expenses
    2,713       (32 ) %     3,982       1 %     3,931  
    % of sales
    7 %             8 %             10 %
General and administrative expense
    8,311       (25 ) %     11,127       10 %     10,132  
    % of sales
    22 %             23 %             25 %
Impairment of note receivable and related loss on marketable securities
    -       - %     1,040       (4 ) %     1,088  
    % of sales
    - %             2 %             3 %
Impairment loss on fixed assets
    -       - %     2,430       1,813 %     127  
    % of sales
    - %             5 %             .3 %

 
Cost of goods sold
 
Cost   of goods sold for the year ended December 31, 2009 declined $8.2 million, to 71% of sales versus 74% of sales in the year ended December 31, 2008.  The reduction in the cost of goods sold reflected lower overall sales volumes of $6.2 million due to the impact of the global recession on the apparel industry and the related lower demand for Talon products, lower direct costs associated with a greater mix of Trim product sales of $0.8 million, lower product obsolescence in amount of $0.8 million, lower freight and duty costs of $0.3 million and lower contract service of $0.1 million.
 
Cost of goods sold for the year ended December 31, 2008 increased $7.1 million, to 74% of sales versus 70% of sales in the year ended December 31, 2007.  Our increased sales volumes and a product sales mix change to a higher proportion of lower margin Talon zipper products versus Trim components primarily increased costs of goods sold for 2008 by about $6.2 million. In addition, we also recorded an additional $0.7 million charge for inventory valuation reserves in 2008 versus $0.1 million in 2007 and also experienced $0.3 million in 2008 in increased freight and manufacturing costs.
 
 
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Sales and marketing expenses
 
Sales and marketing expenses for the year ended December 31, 2009 decreased $1.3 million as compared to 2008 and decreased as a percentage of sales by 1.3% to 7.0%.  The lower selling costs reflect lower salaries and benefits of $0.8 million and related travel and communications expense of $0.2 million, along with lower production development supplies and samples of $0.3 million primarily associated with reduced sales volumes.
 
Sales and marketing expenses for the year ended December 31, 2008 remained relatively unchanged in dollar terms as compared to 2007 but decreased as a percentage of sales by 1.4% to 8.3%.  Our production samples increased as we targeted new customers and programs within the industry for growth offset by lower marketing costs.
 
General and administrative expenses
 
General and administrative expenses for the year ended December 31, 2009 of $8.3 million were 21.5% of sales and were $2.8 million lower than 2008. General and administrative expenses for the year ended December 31, 2008, were 23.1% of sales. The general and administrative expenses in 2008 included $0.7 million in compensation and related costs mainly associated with the severance of the former chief executive officer and chief operating officer.  The reduction in the general and administrative expenses, in addition to the severance charges, reflects lower salaries and benefit costs of $0.5 million principally associated with reduced staffing in Asia and the U.S. due to a reduction in sales volume, reduced facility, maintenance and insurance costs of $0.5 million due to a reduction in our leased facilities, lower professional and other outside services of $0.4 million primarily resulting from the termination of a related party consulting contract, lower depreciation charges of $0.4 million, lower bad debt expense in amount of $0.2 million mainly due to related party note receivable allowance and lower stock-based compensation of $0.1 million.
 
General and administrative expenses for the year ended December 31, 2008, was $11.1 million; $1.0 million higher than in 2007.  The general and administrative expenses in 2008 include $0.7 million in compensation and related costs mainly associated with the severance of our former chief executive officer and chief operating officer while the 2007 expenses included $0.9 million of professional costs related to consulting contracts with two former directors. Other major factors affecting general and administrative expenses in 2008 were higher salaries, benefits, travel and facility costs of $.3 million from expanded operations in Asia which supported the higher sales; higher depreciation of $0.2 million primarily from idle equipment; higher bad debt expense of $0.4 million primarily due to the impairment of a related party note receivable; higher stock based compensation of $0.2 million associated with new incentive option grants and $0.1 million of higher sampling costs associated with new programs.
 
Impairment of note receivable and related loss on marketable securities

Loss on marketable securities for the year ended December 31, 2008 includes $1.0 million in a valuation reserve for the full value of our investment in marketable securities that we received in exchange for the Azteca Production International, Inc. note receivable. Operating expense in 2007 included $1.1 million in bad debt reserve provisions associated with the note receivable due from Azteca Production International, Inc.
 
As of December 31, 2006 a note receivable from Azteca Productions International, Inc. (“Azteca”) was outstanding in the amount of $2,799,460. The note provided for payment in monthly installments over thirty-one months beginning March 1, 2006.
 

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Azteca failed to make the scheduled note payments due on July 1, 2007 and all subsequent periods thereafter, triggering a default, and resulting in the entire note balance becoming immediately due and payable.  In September 2007, after meeting with and conducting extensive discussions with Azteca, Azteca failed to provide to us certain security interests as required under the note or to make the scheduled note payments and Azteca further expressed its belief that it would be unable to make note payments in the foreseeable future.  As a result, in the third quarter of 2007, we recorded a charge of $2,127,653 to write-off the remaining outstanding note balance from Azteca as a bad debt.  With continued discussions however, in December 2007, an agreement was reached whereby Azteca delivered to us 2,000,000 shares of unrestricted common stock of a separate public corporation with a value of $1,040,000, in exchange for cancellation of the Azteca note receivable. Accordingly, in the fourth quarter of 2007, we reversed a portion of the impairment recorded in September 2007, reflecting income of $1,040,000 as a reversal of the previously recorded bad debt.
 
No sales of these securities occurred in 2008 and on September 30, 2008, this public company issued its quarterly SEC filing stating it had no customers, cash flow, or new orders and that it was in violation of its financial covenants to its lender. Consequently, we concluded that the marketable securities were permanently impaired and as a result, recognized a loss on these securities for the full value of the investment of $1,040,000 at September 30, 2008.
 
Impairment loss on property and equipment
 
Operating expenses for the years ended 2008 and 2007 include $2.4 million and $0.1 million, respectively, in impairment valuations for certain equipment and building. See Note 1 of the Notes to Consolidated Financial Statements. During 2009 no impairment valuations were recorded for property and equipment.
 
Interest expense and interest income
 
Interest expense for the year ended December 31, 2009 increased approximately $0.2 million or 7.4% to $2.7 million, as compared to $2.5 million in 2008. In 2009, our interest increased as a result of higher amortization of financing costs and debt discount amortization related to our revolving credit and term notes offset by the decrease in interest as a result of the sale of the North Carolina property and subsequent payoff of the mortgage on this property. Interest income for the year ended December 31, 2009 decreased about $57,000 to $8,000 as compared to $64,000 in 2008 primarily due to the interest income on the related party note receivable was recorded against the note receivable reserve in 2009.
 
Interest expense for the year ended December 31, 2008 increased approximately $0.6 million or 30.1% to $2.5 million, as compared to $1.9 million in 2007. In 2008, we recorded a full year of interest expense and amortization of deferred financing costs for our revolving credit and term notes, which carry a higher cost, as compared to 2007 which included only a partial year of interest related to our revolving credit and term notes and a partial year of our previous secured convertible notes payable. These secured convertible notes payable were paid off early in the third quarter of 2007. Interest expense also included $1.2 million in amortized deferred financing charges, compared to $0.7 million in 2007, associated with the fair value of equity components issued in connection with the debt facility. Interest income for the year ended December 31, 2008 decreased about $178,000 to $64,000 as compared to $242,000 in 2007 primarily due to the write-off of the Azteca note receivable. See Note 1 of the Notes to Consolidated Financial Statements.
 
Income taxes
 
The provision for income tax was approximately $254,000 in 2009, which includes a charge for foreign withholding taxes arising from our domestic royalty charges to our foreign operations, domestic state income taxes, tax provision for our profitable operations in Hong Kong offset by adjustments to deferred tax assets in Hong Kong and India. There is not sufficient evidence to determine that it is more likely than not that we will be able to utilize its domestic and part of our foreign net operating loss carry forwards to offset future taxable income and as a result, these losses have a full valuation reserve against them.
 
 
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The net tax benefit for income taxes was approximately $40,000 in 2008.  It includes a charge for foreign withholding taxes arising from our domestic royalty charges to our foreign operations and domestic state income taxes offset by a tax benefit from our operating loss carry forwards in Hong Kong and India.
 
The provision for income taxes was $0.1 million for the year ended December 31, 2007.  It principally includes income tax provisions from operations in China and India; offset by an income tax benefit from net operating loss carry forward in Hong Kong.
 
Liquidity and Capital Resources
 
The following table summarizes selected fina ncial data (amounts in thousands):
 
   
December 31,
2009
   
December 31,
2008
 
Cash and cash equivalents
  $ 2,265     $ 2,400  
Total assets
  $ 13,834     $ 15,603  
Current liabilities
  $ 24,262     $ 10,899  
Non-current liabilities
  $ 751     $ 13,466  
Stockholders’ deficit
  $ (11,179 )   $ (8,762 )

 
We believe that our existing cash and cash equivalents and our anticipated cash flows from our operating activities will be sufficient to fund our minimum working capital and capital expenditure needs for operating activities for at least the next twelve months.
 
Our existing cash and cash equivalents and our anticipated cash flows from operating activities will not be sufficient to satisfy the CVC debt facility due at June 30, 2010.  Accordingly an extension or modification of the CVC debt will be required prior to the due date or it will be necessary for us to raise additional debt or equity financing in order to satisfy the CVC debt. If we cannot obtain an extension or modification of the CVC debt, or raise additional equity or debt to satisfy this requirement we will default on our credit agreement. 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 or restructure our existing debt, CVC will have the right to exercise its remedies including enforcement of its lien on substantially all of our assets.  See Note 6 of the Notes to the Consolidated Financial Statements.
 
 
Cash and cash equivalents
 
Our cash is held with financial institutions.  Substantially all of the balances at December 31, 2009 and 2008 are in excess of federally insured limits, and there is no restricted cash. We have pledged cash of $252,324 as a compensating balance in a legal dispute with a trade supplier in China. The pledge will be eliminated upon settlement of the dispute or upon our payment of the trade payable of the same amount.
 
Cash and cash equivalents for the year ended December 31, 2009 decreased by $0.1 million from December 31, 2008 due to a decrease in cash generated by operating activities and increased cash used in investment activities, offset by increased revolver note borrowing and term note borrowing in financing activities.
 
Cash and cash equivalents for the year ended December 31, 2008 decreased by $0.5 million from December 31, 2007 due to a decrease in cash generated by operating activities, net of proceeds from the disposition of the building in North Carolina and lower overall net cash used in financing activities.
 
 
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Cash flows
 
The following table summarizes our cash flow activity for the years ended December 31, 2009, 2008 and 2007 (amounts in thousands):
 
   
2009
   
2008
   
2007
 
Net cash provided by operating activities
  $ 186     $ 363     $ 2,137  
Net cash used in investing activities
    (487 )     (133 )     (725 )
Net cash provided by (used in) financing activities
    193       (779 )     (1,433 )
Net effect of foreign currency translation on cash
    (27 )     30       5  
Net decrease in cash and cash equivalents
  $ (135 )   $ (519 )   $ (16 )

Operating Activities

Cash provided by operating activities is our primary recurring source of funds, and reflects net income from operations excluding non cash charges, and changes in operating capital. Cash provided by operating activities was $0.2 million for the year ended December 31, 2009 resulted principally from:
 
Net income before non-cash expenses
  $ 183,000  
Increased Inventory
    (71,000 )
Accounts receivable reduction
    722,000  
Accounts payable and accrued expense reduction
    (1,014,000 )
Other increases in operating capital
    366,000  
Cash provided by operating activities
  $ 186,000  

Cash provided by operating activities was $0.4 million for the year ended December 31, 2008.  The cash generated by operating activities during 2008 resulted primarily from reductions in inventory net of reserves of $0.8 million, prepaid expenses of $0.5 million and an increase in accounts payables and accrued expenses of $1.3 million.
 
Cash provided by operating activities was $2.1 million for the year ended December 31, 2007.  The cash generated by operating activities during 2007 resulted primarily from reductions in accounts receivable net of applied reserves of $3.3 million, $0.6 million in reductions in inventory net of reserves applied, $0.6 million in collections on the note receivable and increases in accounts payable of $2.1 million offset by increases in prepaid assets and other assets of approximately $0.5 million.  Included in the net reserves was the write-off of the Azteca note and subsequent payment in shares as discussed in Note 1 of the Notes to Consolidated Financial Statements.
 
 
Investing Activities
 
Net cash used in investing activities for the year ended December 31, 2009 was approximately $487,000 resulting in expenditures in amount of approximately $543,000 principally associated with the development of our new ERP system that was implemented in March 2009 and leasehold improvements for our new facility in China and proceeds from sale of equipment mainly associated with equipment held for sale as of December 31, 2008.
 
Cash flows from investing activities for the year ended December 31, 2008 include the sale of the North Carolina property with proceeds of $0.7 million offset by capital expenditures of $0.8 million primarily for new office space in Asia and improvements in our technology systems.
 
Net cash used in investing activities for the year ended December 31, 2007 consisted of capital expenditures of $0.7 million for leasehold improvements, office equipment for new employees, improvements in our technology systems and a marketing website acquisition.
 
 
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Financing Activities

Net cash provided by financing activities for the year ended December 31, 2009 was approximately $193,000 and primarily reflects additional borrowings under our revolver line of credit, offset by the repayment of borrowings under capital leases and notes payable.
 
Net cash used in financing activities for the year ended December 31, 2008 was $0.8 million with $1.2 million in revolver note borrowings and $2.0 million used for repayment of the revolver, term note and other notes payable and capital lease obligations.
 
Net cash used in financing activities for the year ended December 31, 2007 was $1.4 million.  During 2007, $13.8 million (net of issuance costs) was provided by the issuance of common stock and warrants and by borrowings, under a new debt facility (see below), designated to pay off our previously existing convertible promissory notes and to provide funds for future growth. The proceeds from this debt facility were used to pay the $12.5 million of secured convertible promissory notes, and $1.0 million was used to pay a related party note of $0.6 million and associated accrued interest.  Approximately $1.2 million was used for the repayment of borrowings under capital leases and notes payable and $0.5 million in initial borrowings under the revolving note were repaid.

On June 27, 2007, we entered into a Revolving Credit and Term Loan Agreement with Bluefin Capital, LLC that provides for a $5.0 million revolving credit loan and a $9.5 million term loan with a three year term maturing June 30, 2010. Bluefin Capital subsequently assigned its rights and obligations under the credit facility agreements to an affiliate, CVC California, LLC (“CVC”).  The revolving credit portion of the facility, as amended, permits borrowings based upon a formula including 85% of eligible receivables and 55% of eligible inventory and provides for monthly interest payments at the U.S.A. prime rate (3.25% at December 31, 2009) plus 2.0%.  The term loan bears interest at 8.5% annually with quarterly interest payments and repayment in full at maturity.
 
Borrowings under both credit facilities are secured by all of our assets. As of December 31, 2009 our borrowing base ($4,546,996) was lower than our actual borrowing ($4,988,988) by $441,992, therefore we did not have available borrowing at that date. There was $3,000 in available borrowings at December 31, 2008.
 
Our cash flows from operating activities will not be sufficient to satisfy the CVC debt facility when it becomes due on June 30, 2010.  Accordingly, we are seeking an extension or modification of the CVC debt prior to the due date and also exploring raising additional debt or equity financing in order to satisfy the CVC debt. There can be no assurance that additional debt or equity financing will be available on acceptable terms or at all. If we cannot obtain an extension or modification of the CVC debt, or raise additional equity or debt to satisfy this requirement we will default on our credit agreement. If we are unable to secure additional financing or restructure our existing debt, CVC will have the right to exercise its remedies including enforcement of its lien on substantially all of our assets.  See Note 1 of the Notes to Consolidated Financial Statements
 
In connection with the Revolving Credit and Term Loan Agreement, we issued 1,500,000 shares of common stock to the lender for $0.001 per share, and issued warrants to purchase 2,100,000 shares of common stock.  The warrants were exercisable over a five-year period and initially 700,000 warrants were exercisable at $0.95 per share; 700,000 warrants were exercisable at $1.05 per share; and 700,000 warrants were exercisable at $1.14 per share.  The warrants did not require cash settlements. The relative fair value of the equity ($2,374,169, which includes a reduction for financing costs) issued with this debt facility was allocated to paid-in-capital and reflected as a debt discount to the face value of the term note.
 
This discount is being amortized over the term of the note and recognized as additional interest cost as amortized.  Costs associated with the debt facility included debt fees, commitment fees, registration fees and legal and professional fees of $486,000.  The costs allocable to the debt instruments are reflected as a reduction to the face value of the note on the balance sheet.
 
 
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On November 19, 2007, we entered into an amendment of the credit agreement with the lender to modify the original financial covenants and to extend until June 30, 2008 the application of the original EBITDA covenants in exchange for additional common stock and a price adjustment to the lenders outstanding warrants issued to the lender in connection with the loan agreement.  In connection with this amendment we issued an additional 250,000 shares of common stock to the lender for $0.001 per share, and the exercise price for all of the previously issued warrants for the purchase of 2,100,000 shares of common stock was amended to an exercise price of $0.75 per share.   The new relative fair value of the equity issued with this debt of $2,430,000, including the modifications in this amendment and a reduction for financing costs, is being amortized over the term of the note.
 
On April 3, 2008, we executed a further amendment to the credit agreement.  The amendment included a redefining of the EBITDA covenants, and the cancellation of the common stock warrants previously issued to the lender in exchange for our issuance of an additional note payable to the lender for $1.0 million.  The note bears interest at 8.5% and both the note and accrued interest are payable at maturity on June 30, 2010.  In addition, our borrowing base was modified in this amendment by  increasing the allowable portion of inventory held by third party vendors to $1.0 million with no more than $500,000 held at any one vendor and increasing the percentage of accounts receivable to be included in the borrowing base to 85%. We incurred a one-time modification fee of $145,000 to secure the amendment of the agreement.  The new relative fair value of the equity issued with this debt of $2,542,000, including the modifications in this amendment and a reduction for financing costs, is being amortized over the term of the note.
 
Under the terms of the credit agreement, as amended, we are required to meet certain coverage ratios, among other restrictions including a restriction from declaring or paying a dividend prior to repayment of all the obligations. The financial covenants, as amended, require that we maintain at the end of each fiscal quarter “EBITDA” (as defined in the agreement) in excess of the principal and interest payments for the same period of not less than $1.00 and in excess of ratios set out in the agreement for each quarter.
 
We failed to satisfy the minimum EBITDA requirement for quarter ended December 31, 2008 as well as the quarter ended March 31, 2009, and in connection with such failures, on March 31, 2009 we entered into a further amendment to the credit agreement with CVC. This amendment provided for the issuance of an additional term note to CVC in the principal amount of $225,210 in lieu of paying a cash waiver fee in connection with our failures to satisfy the EBITDA requirements for the quarters ended December 31, 2008 and March 31, 2009; deferral of the term note quarterly interest payment of $215,000 due April 1, 2009; a temporary increase to the borrowing base formulas and calculations under the revolving credit facility; the re-lending by CVC of $125,000 under the term loan portion of credit facility; a consent to allow us to sell equipment that has been designated as held for sale more fully described in Note 6 of the Notes to Consolidated Financial Statements; and the granting to CVC of the right to designate a non-voting observer to attend all meetings of our Board of Directors.
 
We financed building, land and equipment purchases through notes payable and capital lease obligations expiring through June 2011.  The building and land mortgage were fully paid when the property was sold in October 2008. The remaining equipment obligations bear interest at rates of 6.6% and 12.1% per annum, and under these obligations, we are required to make monthly payments of principal and interest.
 
The outstanding balance including accrued interest of our notes payable to related parties at December 31, 2009 and December 31, 2008 was $266,000 and $222,000, respectively.  Included in this balance are demand notes of $85,000 which bear interest at 10% (total balance as of December 31, 2009 of $230,000) have no scheduled monthly payments and are due within fifteen days following demand. The remainder of the notes payable to related parties includes our note payable to an officer for $36,000. The note bears 6% interest annually and the maturity date is the earlier of December 31, 2011 or ten days following employment termination date. The note is fully presented as part of current liabilities as of December 31, 2009.
 
 
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We have historically satisfied our working capital requirements primarily through cash flows generated from operations and borrowings under our credit facility.  As we continue to expand globally with our apparel manufacturing in offshore locations, our customers (some of which are backed by U.S. brands and retailers) are substantially all foreign based entities.  Our revolving credit facility provides limited financing secured by our accounts receivable, and our current borrowing capability may not provide the level of financing we need to continue in or to expand into additional foreign markets.  We are continuing to evaluate non-traditional financing of our foreign assets and equity transactions to provide capital needed to fund our expansion and on-going operations. If we experience greater than anticipated reductions in sales, we may need to raise additional capital, or further reduce the scope of our business in order to fully satisfy our future short-term operating requirements.  The extent of our future long-term capital requirements will depend on many factors, including our results of operations, future demand for our products, the size and timing of future acquisitions, our borrowing base availability limitations related to eligible accounts receivable and inventories and our expansion into foreign markets.  Our need for additional long-term financing includes the integration and expansion of our operations to exploit our rights under our Talon trade name, the expansion of our operations in the Asian and European markets. 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.
 
Contractual Obligations
 
The following summarizes our contractual obligations at December 31, 2009 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
 
Demand notes payable to related parties (1)
  $ 229,400     $ 229,400     $ -     $ -     $ -  
Note Payable to Related Party
    36,500       36,500       -       -       -  
Capital lease obligations
    88,400       58,400       27,400       2,600       -  
Operating leases
    821,300       551,700       269,600       -       -  
Revolver & Term Note
    16,301,000       16,301,000       -       -       -  
Other notes payable
    61,100       61,100       -       -       -  
     Total Obligations
  $ 17,537,700     $ 17,238,100     $ 297,000     $ 2,600     $ -  

 
(1)
The majority of notes payable to related parties is due on demand with the remainder due and payable on the fifteenth day following the date of delivery of written demand for payment and includes accrued interest payable through December 31, 2009.


Off-Balance Sheet Arrangements
 
At December 31, 2009 and 2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.  As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
 
Related Party Transactions
 
For a description of certain transactions to which we were or will be a party, and in which any director, executive officer, or 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 Item 13, “Certain Relationships and Related Transactions and Director Independence,” of this Report.
 
 
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Application of Critical Accounting Policies and Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions for the reporting period and as of the financial statement date. 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.  These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenue and expense. Actual results could differ from those estimates.
 
Critical accounting policies are those that are important to the portrayal of our financial condition and results of operations, and which require us to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:
 
 
·
Accounts and note receivable balances are evaluated on a continual basis and allowances are provided for potentially uncollectible accounts based on management’s estimate of the collectability of customer accounts.  If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments, an additional allowance may be required.  Allowance adjustments are charged to operations in the period in which the facts that give rise to the adjustments become known.
 
The bad debt expenses, recoveries and allowances for the twelve months ended December 31, 2009, 2008 and 2007 are as follows:
 
 
   
Twelve Months Ended
 
   
December 31,
 
   
2009
   
2008
   
2007
 
Bad debt expenses for accounts receivable
  $ 120,701     $ 77,558     $ 206,253  
Bad debt expense for notes receivable, including related party
  $ 200,000     $ 474,010     $ 1,087,653  
Recoveries
  $ (1,016 )   $ (3,049 )   $ (19,500 )
Allowance for doubtful accounts
  $ 232,329     $ 217,323     $ 140,420  
Allowance for doubtful accounts, related party
  $ 740,417     $ 474,010     $ -  
                         

 
31



 
·
Inventories are stated at the lower of cost, determined using the first-in, first-out basis or market value and are all substantially finished goods.  The costs of inventory include the purchase price, inbound freight and duties, conversion costs and certain allocated production overhead costs.  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.  Inventory reserves are recorded for damaged, obsolete, excess, impaired and slow-moving inventory. We use estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory. 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 these adjustments become known.  Market value of inventory is estimated based on the impact of market trends, an evaluation of economic conditions and the value of current orders relating to the future sales of this type of inventory.
 
The inventory reserve expenses and allowances for the years ended December 31, 2009, 2008 and 2007 are as follows:
 
   
Twelve Months Ended
December 31,
 
   
2009
   
2008
   
2007
 
Inventory valuation expense
  $ 60,612     $ 692,382     $ 148,000  
Allowance for inventory valuation reserves
  $ 1,184,621     $ 1,211,170     $ 1,019,000  
 

 
 
·
We record deferred tax assets arising from temporary timing differences between recorded net income and taxable net income when and if we believe that future earnings will be sufficient to realize the tax benefit.  For those jurisdictions where the expiration date of tax benefit carry-forwards or the projected taxable earnings indicate that realization is not likely, a valuation allowance is provided.  If we determine that we may not realize all 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.  We believe that our estimate of deferred tax assets and determination to record a valuation allowance against such assets are critical accounting estimates because they are subject to, among other things, an estimate of future taxable income, which is susceptible to change and dependent upon events that may or may not occur, and because the impact of recording a valuation allowance may be material to the assets reported on the balance sheet and results of operations.  See Note 10 of the Notes to Consolidated Financial Statements.
 
 
 
·
We record impairment charges when the carrying amounts of long-lived assets are determined not to be recoverable. Impairment is measured by assessing the usefulness of an asset or by comparing the carrying value of an asset to its fair value. Fair value is typically determined using quoted market prices, if available, or an estimate of undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. The amount of impairment loss is calculated as the excess of the carrying value over the fair value. Changes in market conditions and management strategy have historically caused us to reassess the carrying amount of our long-lived assets. Long-lived assets were evaluated, and we determined that certain components of idle equipment would not either be effectively redeployed or would be sold or disposed.  Accordingly, we took $2,430,000 in impairment charges for the period ending December 31, 2008. See Note 1 of the Notes to Consolidated Financial Statements.
 
 
32

 
 
 
·
Sales are recognized when persuasive evidence of an arrangement exists, product title has passed, pricing is fixed or determinable and collection is reasonably assured. Sales resulting from customer buy-back agreements, or associated inventory storage arrangements are recognized upon delivery of the products to the customer, the customer’s designated manufacturer, or upon notice from the customer to destroy or dispose of the goods. Sales, provisions for estimated sales returns and the cost of products sold are recorded at the time title transfers to customers. Actual product returns are charged against estimated sales return allowances, which returns have been insignificant.
 
 
·
We are currently involved in various lawsuits, claims and inquiries, most of which are routine to the nature of the business and in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No 450, “Contingencies”, we accrue estimates of the probable and estimable losses for the resolution of these claims. The ultimate resolution of these claims could affect our future results of operations for any particular quarterly or annual period should our exposure be materially different from our earlier estimates or should liabilities be incurred that were not previously accrued.
 
New Accounting Pronouncements
 
In June 2009, the Financial FASB issued ASC 105-10, “Generally Accepted Accounting Principles” (“ASC 105-10”). Effective for our financial statements issued for interim and annual periods commencing with the quarterly period ended September 30, 2009, the FASB Accounting Standards Codification (“Codification” or “ASC”) is the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification supersedes all then-existing, non-SEC accounting and reporting standards. In the FASB’s view, the Codification does not change GAAP, and therefore the adoption of ASC 105-10, Generally Accepted Accounting Principles, did not have an effect on our consolidated financial position, results of operations or cash flows. However, where we have referred to specific authoritative accounting literature, the Codification literature is disclosed.
 
In April 2009, the FASB issued ASC 820-10, “Fair Value Measurements and Disclosures” (Topic 820). ASC 820-10 provides guidance on how to determine the fair value of assets and liabilities when the volume and level of activity for the asset/liability has significantly decreased. ASC 820-10 also provides guidance on identifying circumstances that indicate a transaction is not orderly. In addition, ASC 820-10 requires disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques. ASC 820-10 was effective beginning in the second quarter of fiscal year 2009. The adoption of ASC 820-10 did not have a material impact on the consolidated financial statements.
 
In April 2009, the FASB issued ASC 320-10, “Investments - Debt and Equity Securities” (“ASC 320-10”). ASC 320-10 amends the requirements for the recognition and measurement of other-than-temporary impairments for debt securities by modifying the pre-existing “intent and ability” indicator. Under ASC 320-10, other-than-temporary impairment is triggered when there is intent to sell the security, it is more likely than not that the security will be required to be sold before recovery, or the security is not expected to recover the entire amortized cost basis of the security. Additionally, ASC 320-10 changes the presentation of other-than-temporary impairment in the income statement for those impairments involving credit losses. The credit loss component will be recognized in earnings and the remainder of the impairment will be recorded in other comprehensive income. ASC 320-10 was effective beginning in the second quarter of fiscal year 2009. The implementation of ASC 320-10 did not have a material impact on the consolidated financial statements.
 
In April 2009, the FASB issued ASC 825-10, “Financial Instruments” (“ASC 825-10”). ASC 825-10 requires interim disclosures regarding the fair values of financial instruments. Additionally, ASC 825-10 requires disclosure of the methods and significant assumptions used to estimate the fair value of financial instruments on an interim basis as well as changes of the methods and significant assumptions from prior periods. ASC 825-10 does not change the accounting treatment for these financial instruments and did not have a material impact on the consolidated financial statements.
 
 
33

 
 
In April 2009, the FASB issued ASC 805, “Business Combinations” (“ASC 805”). ASC 805 amends the original guidance relating to the initial recognition and measurement, subsequent measurement and accounting and disclosures of assets and liabilities arising from contingencies in a business combination which were adopted by us as of the beginning of fiscal 2009 and it did not have a material impact on the consolidated financial statements. We will apply the requirements of ASC 805 prospectively to any future acquisitions.
 
In May 2009, the FASB issued ASC 855-10, “Subsequent Events” (“ASC 855-10”). ASC 855-10 provides general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855-10 was adopted by us in the second quarter of 2009 and did not have a material impact on the consolidated financial statements. The implementation of ASC 855-10 did not have a material impact on the consolidated financial statements. See Note 16 of the Notes to Consolidated Financial Statements for the disclosures regarding ASC 855-10.
 
In June 2009, the FASB issued ASC 860, “Transfers and Servicing” (”ASC 860”). ASC 860 seeks to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows  and a transferor’s continuing involvement, if any, in transferred financial assets. ASC 860 is applicable for annual periods beginning after November 15, 2009. The implementation of ASC 860 is not expected to have a material impact on the consolidated financial statements.
 
In June 2009, the FASB issued accounting guidance contained within ASC 810, “Consolidations”, which pertains to the consolidation of variable interest entities, “Amendments to FASB Interpretation No. 46R”, (“ASC 810”). This guidance within ASC 810 requires an analysis to be performed to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. This standard requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. This standard is effective for fiscal years beginning after November 15, 2009. The implementation of ASC 810 is not expected to have an impact on the consolidated financial statements.
 
In August 2009, the FASB issued ASC 820-10-35, “Fair Value Measurements and Disclosures” (“ASC 820-10-35”), which provides amendments to Topic 820. ASC 820-10-35 provides additional guidance clarifying the measurement of liabilities at fair value. ASC 820-10-35 is effective in the fourth quarter 2009 for a calendar year entity. ASC 820-10-35 did not have a material impact on the consolidated financial statements.
 
In January 2010, the FASB issued Accounting Standards Update 2010-06, “Fair Value Measurements and Disclosures” (Topic 820): Improving Disclosures about Fair Value Measurements.  This guidance amends the disclosure requirements related to recurring and nonrecurring fair value measurements and requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance will become effective for the reporting period beginning January 1, 2010, except for the disclosure on the roll forward activities for Level 3 fair value measurements, which will become effective for the reporting period beginning January 1, 2011. Other than requiring additional disclosures, adoption of this new guidance will not have a material impact on the consolidated financial statements.
 

 
34


 
 
All of our sales are denominated in United States dollars or the currency of the country in which our products originate.  We are exposed to market risk for fluctuations in the foreign currency exchange rates for certain product purchases that are denominated in Hong Kong dollars and Chinese Yuan.   We do not intend to purchase contracts to hedge the exchange exposure for future product purchases. There were no hedging contracts outstanding as of December 31, 2009.  Currency fluctuations can increase the price of our products to foreign customers which can adversely impact the level of our export sales from time to time.  The majority of our cash equivalents are held in United States dollars in various bank accounts and we do not believe we have significant market risk exposure with regard to our investments.  At December 31, 2009, the Revolving Credit Note of $5.0 million was subject to interest rate fluctuations.  A one percentage point increase in interest rates would result in an annualized increase to interest expense of approximately $50,000 on our variable rate borrowings.
 

 
ITEM 8.              FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
 
TABLE OF CONTENTS
 
   
Page
     
Report of Independent Registered Public Accounting Firm                                                                                                                              
 
36
Consolidated Balance Sheets                                                                                                                              
 
37
Consolidated Statements of Operations                                                                                                                              
 
38
Consolidated Statements of Stockholders’ Deficit                                                                                                                              
 
39
Consolidated Statements of Cash Flows                                                                                                                              
 
40
Notes to Consolidated Financial Statements                                                                                                                              
 
42
     
 
 
 
35

 
 
 
 
To the Board of Directors and Stockholders
Talon International, Inc.
Woodland Hills, California

We have audited the accompanying consolidated balance sheets of Talon International, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders' deficit, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedule of Talon International, Inc. and subsidiaries, listed in Item 15(a). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Talon International, Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
 
We were not engaged to examine management's assessment of the effectiveness of Talon International, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2009, included in the accompanying Management's Report on Internal Control Over Financial Reporting and,  accordingly, we do not express an opinion thereon.
 
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, for the year ended December 31, 2009, the Company incurred a net loss of $2,692,977. In addition, the Company had an accumulated deficit of $66,344,009 and a working capital deficit of $17,056,232 at December 31, 2009. These factors, among others, as discussed in Note 2 to the financial statements, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 

 
/s/ SingerLewak  LLP                     
SINGERLEWAK  LLP
 
Los Angeles, California
March 29, 2010
 

 
36


 
TALON INTERNATIONAL, INC.
 
 
   
December 31,
2009
   
December 31,
2008
 
Assets
           
Current Assets:
           
Cash and cash equivalents
  $ 2,264,606     $ 2,399,717  
Accounts receivable, net
    3,021,642       3,856,613  
Inventories, net
    1,679,302       1,669,149  
Prepaid expenses and other current assets
    240,554       473,955  
Total current assets                                                                                               
    7,206,104       8,399,434  
                 
Property and equipment, net
    2,280,586       2,491,899  
Note receivable from related party, net
    -       200,000  
Intangible assets, net
    4,110,751       4,110,751  
Other assets
    236,386       400,494  
Total assets                                                                                               
  $ 13,833,827     $ 15,602,578  
                 
Liabilities and Stockholders’ Deficit
               
Current liabilities:
               
Accounts payable
  $ 6,337,368     $ 7,674,768  
Accrued expenses
    2,678,659       2,617,166  
Revolver note payable
    4,988,988       -  
Term notes payable, net of discounts
    9,876,114       -  
Notes payable to related parties
    265,871       222,264  
Current portion of long term obligations
    115,336       385,098  
Total current liabilities
    24,262,336       10,899,296  
                 
Revolver note payable, net of current portion
    -       4,638,988  
Term notes payable, net of discounts and current portion
    -       8,067,428  
Capital lease obligations, net of current portion
    23,477       1,910  
Other liabilities
    726,875       756,888  
Total liabilities
    25,012,688       24,364,510  
                 
Commitments and contingencies (Note 11)
               
                 
Stockholders’ Deficit:
               
Preferred stock Series A, $0.001 par value; 250,000 shares authorized; no shares issued or outstanding
    -       -  
                 
Common stock, $0.001 par value, 100,000,000 shares authorized;
20,291,433 shares issued and outstanding at December 31, 2009
and 2008
    20,291       20,291  
Additional paid-in capital
    55,070,568       54,769,072  
Accumulated deficit
    (66,344,009 )     (63,651,032 )
Accumulated other comprehensive income
    74,289       99,737  
Total stockholders’ deficit                                                                                               
    (11,178,861 )     (8,761,932 )
Total liabilities and stockholders’ deficit
  $ 13,833,827     $ 15,602,578  
 

 
See accompanying notes to consolidated financial statements.
 

37

 
 
TALON INTERNATIONAL, INC.
 
 

 
   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
Net sales                                                                
  $ 38,675,790     $ 48,170,980     $ 40,529,555  
Cost of goods sold                                                                
    27,363,216       35,553,857       28,422,820  
Gross profit                                                                
    11,312,574       12,617,123       12,106,735  
                         
Sales and marketing expenses                                                                
    2,712,814       3,982,124       3,930,815  
                         
General and administrative expenses
    8,310,684       11,127,376       10,132,042  
                         
Impairment loss of marketable securities and related note receivable
    -       1,040,000       1,087,653  
                         
Impairment loss on property and equipment
    -       2,429,506       126,904  
Total operating expenses                                                             
    11,023,498       18,579,006       15,277,414  
                         
Income (loss) from operations                                                                
    289,076       (5,961,883 )     (3,170,679 )
                         
Interest expense, net                                                                
    2,727,919       2,436,675       1,680,079  
Net loss before provision for (benefit from) income taxes
    (2,438,843 )     (8,398,558 )     (4,850,758 )
                         
Provision for (benefit from) income taxes
    254,134       (39,772 )     70,949  
 
Net loss                                                                
  $ (2,692,977 )   $ (8,358,786 )   $ (4,921,707 )
 
 
See accompanying notes to consolidated financial statements.


38


 
TALON INTERNATIONAL, INC.
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007


 
                                           
               
Preferred Stock
   
Additional
   
Other
             
   
Common Stock
   
Series A
   
Paid-In
   
Comprehensive
             
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Income (losses)
   
(Deficit)
   
Total
 
 
Balance, January 1, 2007
    18,466,433     $ 18,466       -     $ -     $ 51,792,502     $ -     $ (50,124,739 )   $ 1,686,229  
Common stock issued upon exercise of options
    75,000       75                       42,671                       42,746  
Common stock warrants issued in private placement transaction
    1,750,000       1,750                       2,429,988                       2,431,738  
Stock based compensation
                                    245,000                       245,000  
Foreign currency translation
                                            44,444               44,444  
Adoption of ASC 850
                                                    (245,800 )     (245,800 )
Net  loss
                                                    (4,921,707 )     (4,921,707 )
Balance, December 31, 2007
    20,291,433       20,291       -       -       54,510,161       44,444       (55,292,246 )     (717,350 )
Warrant fair value adjustment
                                    (148,302 )                     (148,302 )
Stock based compensation
                                    407,213                       407,213  
Foreign currency translation
                                            55,293               55,293  
Net loss
                                                    (8,358,786 )     (8,358,786 )
Balance, December 31, 2008
    20,291,433       20,291       -       -       54,769,072       99,737       (63,651,032 )     (8,761,932 )
Stock based compensation
                                    301,496                       301,496  
Foreign currency translation
                                            (25,448 )             (25,448 )
Net loss
                                                    (2,692,977 )     (2,692,977 )
Balance, December 31, 2009
    20,291,433     $ 20,291       -     $ -     $ 55,070,568     $ 74,289     $ (66,344,009 )   $ (11,178,861 )


See accompanying notes to consolidated financial statements.
 

 
39

 
 
TALON INTERNATIONAL, INC.
 
 

   
Year ended December 31, 2009
   
Year ended December 31, 2008
   
Year ended December 31, 2007
 
                   
Cash flows from operating activities:
                 
Net loss
  $ (2,692,977 )   $ (8,358,786 )   $ (4,921,707 )
Adjustments to reconcile net loss to net cash
    provided by operating activities:
                       
Depreciation and amortization
    725,979       1,079,441       1,168,434  
Amortization of deferred financing cost and debt discounts
    1,462,563       1,186,837       736,042  
Stock based compensation 
    301,496       407,213       245,000  
Bad debt expense
    119,685       74,509       186,753  
Related party note impairment
    200,000       474,010       -  
Additions to inventory valuation reserve
    60,612       692,382       148,000  
Impairment of marketable securities and related note
 receivable
    -       1,040,000       1,087,653  
Impairment loss on property and equipment
    -       2,429,506       126,904  
Loss from disposal of assets
    5,462       49,000       58,076  
   Changes in operating assets and liabilities:
                       
Accounts and notes receivable, including related parties
    721,841       (419,891 )     1,048,662  
Note receivable collections
    -       -       596,491  
Inventories
    (70,768 )     125,896       415,793  
Prepaid expenses and other current assets
    234,340       474,317       (404,532 )
Other assets
    165,613       (302,735 )     (202,150 )
Accounts payable and accrued expenses
    (1,013,856 )     1,358,483       1,764,148  
       Other liabilities                                                                             
    (34,100 )     53,026       83,651  
   Net cash provided by operating activities
    185,890       363,208       2,137,218  
Cash flows from investing activities:
                       
Proceeds from sale of equipment                                                                           
    56,058       686,510       -  
Acquisition of property and equipment
    (543,117 )     (819,876 )     (725,498 )
Net cash used in investing activities                                                                           
    (487,059 )     (133,366 )     (725,498 )
Cash flows from financing activities:
                       
Proceeds from exercise of stock options and warrants
    -       -       42,746  
Proceeds from issuance of stock options and warrants, net of issuance costs
    -       -       2,463,017  
Revolver note borrowings
    350,000       1,200,000       4,307,806  
Repayment of revolver note borrowings
    -       (521,722 )     (500,000 )
Term note borrowings, net of issuance costs
    125,000       -       7,131,720  
Payments on term note
    -       (125,000 )     (449,840 )
Proceeds from other notes including related party
    -       -       291,753  
Payments of demand note payable to related party
    -       -