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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2007.
OR
[_] 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 Issuer as Specified in its Charter)
DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
21900 BURBANK BOULEVARD, SUITE 270
WOODLAND HILLS, CALIFORNIA 91367
(Address of Principal Executive Offices)
(818) 444-4100
(Registrant's Telephone Number, Including Area Code)
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 is a large accelerated
filer, an accelerated filer or a non-accelerated filer . See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [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 NOVEMBER 14, 2007 THE ISSUER HAD 20,041,433 SHARES OF COMMON STOCK,
$.001 PAR VALUE, ISSUED AND OUTSTANDING.
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TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)
INDEX TO FORM 10-Q
PART I FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements...............................................3
Consdensed Consolidated Balance Sheets as of September 30,
2007 (unaudited) and December 31, 2006 ............................3
Condensed Consolidated Statements of Operations for the
Three Months and the Nine Months Ended September 30, 2007
and 2006 (unaudited)...............................................4
Condensed Consolidated Statement of Stockholders Equity
for the Nine Months Ended September 30, 2007 (unaudited)...........5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2007 and 2006 (unaudited)..........6
Notes to the Condensed Consolidated Financial Statements...........7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................19
Item 3. Quantitative and Qualitative Disclosures about Market Risk........34
Item 4. Controls and Procedures...........................................34
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................35
Item 1A. Risk Factors .....................................................35
Item 4. Submission of Matters to a Vote of Security Holders ..............36
Item 6. Exhibits .........................................................36
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30, December 31,
2007 2006
------------ ------------
Assets
Current assets:
Cash and cash equivalents ............................ $ 2,318,712 $ 2,934,673
Accounts receivable, net ............................. 3,866,355 4,664,766
Note receivable, net ................................. -- 1,378,491
Inventories, net ..................................... 2,710,051 3,051,220
Prepaid expenses and other current assets ............ 449,743 541,034
------------ ------------
Total current assets .................................... 9,344,861 12,570,184
Property and equipment, net ............................. 5,418,095 5,623,040
Fixed assets held for sale .............................. 826,904 826,904
Note receivable, less current portion ................... -- 1,420,969
Due from related party .................................. 736,557 675,137
Intangible assets, net .................................. 4,110,751 4,139,625
Other assets, net ....................................... 592,971 437,569
------------ ------------
Total assets ............................................ $ 21,030,139 $ 25,693,428
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ...................................... $ 5,363,432 $ 4,533,145
Accrued legal costs ................................... 226,507 427,917
Other accrued expenses ................................ 2,246,344 2,832,363
Demand notes payable to related parties ............... 85,176 664,970
Current portion of capital lease obligations .......... 383,090 432,728
Current portion of notes payable ...................... 294,259 1,107,207
Secured convertible promissory notes .................. -- 12,472,622
------------ ------------
Total current liabilities ............................... 8,598,808 22,470,952
Capital lease obligations, less current portion ......... 247,763 474,733
Notes payable, less current portion ..................... 925,104 1,061,514
Revolver note payable ................................... 3,807,806 --
Term note payable, net of discount ...................... 7,289,480 --
Other long term liabilities ............................. 83,651 --
------------ ------------
Total liabilities ....................................... 20,952,612 24,007,199
------------ ------------
Commitments and contingencies ........................... -- --
Stockholders' Equity:
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; 20,041,433 shares issued and
outstanding at September 30, 2007; 18,466,433 at
December 31, 2006 .................................. 20,041 18,466
Additional paid-in capital ............................ 54,394,342 51,792,502
Accumulated deficit ................................... (54,357,221) (50,124,739)
Accumulated other comprehensive income-foreign currency 20,365 --
------------ ------------
Total stockholders' equity .............................. 77,527 1,686,229
------------ ------------
Total liabilities and stockholders' equity .............. $ 21,030,139 $ 25,693,428
============ ============
See accompanying notes to condensed consolidated financial statements.
3
TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2007 2006 2007 2006
------------ ------------ ------------ ------------
Net sales ............................... $ 9,013,135 $ 13,366,945 $ 31,670,234 $ 38,251,248
Cost of goods sold ...................... 6,486,659 9,218,539 22,422,412 27,132,880
------------ ------------ ------------ ------------
Gross profit ......................... 2,526,476 4,148,406 9,247,822 11,118,368
Selling expenses ........................ 722,447 910,996 2,161,666 2,131,515
General and administrative expenses ..... 2,731,665 2,606,936 7,749,445 7,903,435
Reserve for impairment of note receivable 2,127,653 -- 2,127,653 --
------------ ------------ ------------ ------------
Total operating expenses ............. 5,581,765 3,517,932 12,038,764 10,034,950
Income (loss) from operations ........... (3,055,289) 630,474 (2,790,942) 1,083,418
Interest expense, net ................... 647,514 236,500 1,138,088 752,705
------------ ------------ ------------ ------------
Income (loss) before income taxes ....... (3,702,803) 393,974 (3,929,030) 330,713
Provision for income taxes .............. (20,972) 54,857 57,652 66,357
------------ ------------ ------------ ------------
Net income (loss) .................... $ (3,681,831) $ 339,117 $ (3,986,682) $ 264,356
============ ============ ============ ============
Basic income (loss) per share ........... $ (0.18) $ 0.02 $ (0.21) $ 0.01
============ ============ ============ ============
Diluted income (loss) per share ......... $ (0.18) $ 0.02 $ (0.21) $ 0.01
============ ============ ============ ============
Weighted average number of common
shares outstanding:
Basic ................................ 20,041,433 18,440,927 19,060,664 18,347,509
============ ============ ============ ============
Diluted .............................. 20,041,433 19,279,648 19,060,664 18,719,531
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
4
TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
Preferred Stock
Common Stock Series A
--------------------------- ---------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
BALANCE, JANUARY 1, 2007 ................ 18,466,433 $ 18,466 -- $ --
Common stock and warrants issued in
private placement transaction ...... 1,500,000 1,500 -- --
Common stock issued upon exercise of
options and warrants ............... 75,000 75 -- --
Stock based compensation ............. -- -- -- --
Cumulative Effect of Prior Period
Adjustments (FIN 48) .............. -- -- -- --
Accumulated other comprehensive
income: foreign currency translation -- -- -- --
Net loss ............................. -- -- --
------------ ------------ ------------ ------------
BALANCE, SEPTEMBER 30, 2007 ............. 20,041,433 $ 20,041 -- $ --
============ ============ ============ ============
Retained Accumulated
Additional Earnings/ Other Total
Paid-In Accumulated Comprehensive Stockholders'
Capital (Deficit) Income Equity
------------ ------------ ------------ ------------
BALANCE, JANUARY 1, 2007 ................ $ 51,792,502 $(50,124,739) $ -- $ 1,686,229
Common stock and warrants issued in
private placement transaction ...... 2,374,169 -- -- 2,375,669
Common stock issued upon exercise of
options and warrants ............... 42,671 -- -- 42,746
Stock based compensation ............. 185,000 -- -- 185,000
Cumulative Effect of Prior Period
Adjustments (FIN 48) .............. -- (245,800) -- (245,800)
Accumulated other comprehensive
income: foreign currency translation -- -- 20,365 20,365
Net loss ............................. -- -- (3,986,682) (3,986,682)
------------ ------------ ------------ ------------
BALANCE, SEPTEMBER 30, 2007 ............. $ 54,394,342 $(54,357,221) $ 20,365 $ 77,527
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
5
TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30,
----------------------------
2007 2006
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ..................................................... $ (3,986,682) $ 264,356
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization ...................................... 878,834 914,053
Amortization of deferred financing cost and debt discounts ......... 496,264 233,013
Increase (decrease) in allowance for doubtful accounts ............. 2,331,018 (1,046,500)
Decrease in inventory valuation reserves ........................... (52,000) (5,844,532)
Disposal of assets ................................................. -- 108,184
Stock based compensation ........................................... 185,000 283,024
Changes in operating assets and liabilities:
Accounts receivable .............................................. 670,046 1,644,550
Note receivable .................................................. 671,807 317,170
Inventories ...................................................... 393,169 8,267,568
Prepaid expenses and other current assets ........................ 91,291 (63,273)
Due from related party ........................................... (61,420) 86,716
Other assets ..................................................... (22,649) (174,292)
Accounts payable ................................................. 830,287 (1,790,968)
Accrued legal costs .............................................. (306,250) (147,561)
Other accrued expenses ........................................... (795,881) (229,756)
------------ ------------
Net cash provided by operating activities ............................ 1,322,834 2,821,752
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment ............................. (585,470) (325,702)
Proceeds from sale of equipment ................................... -- 2,500
------------ ------------
Net cash used by investing activities ................................ (585,470) (323,202)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and warrants .............. 42,746 --
Proceeds from issuance of stock and warrants, net of issuance costs 2,306,918 --
Revolver note borrowings .......................................... 4,307,806 --
Term note borrowings, net of issuance costs ....................... 6,849,582 --
Payments for capital lease obligations ............................ (334,401) (434,676)
Repayment of demand notes payable to related parties .............. (579,794) --
Repayment of notes payable ........................................ (949,358) (615,037)
Payment of revolver note .......................................... (500,000) --
Payment of secured convertible promissory notes ................... (12,500,000) --
------------ ------------
Net cash from (used by) financing activities ....................... (1,356,501) (1,049,713)
------------ ------------
Net increase (decrease) in cash and cash equivalents .................. (619,137) 1,448,837
Net effect of foreign currency exchange translation on cash ........... 3,176 --
Cash at beginning of period ........................................... 2,934,673 2,277,397
------------ ------------
Cash and cash equivalents at end of period ............................ $ 2,318,712 $ 3,726,234
============ ============
Supplemental disclosures of cash flow information:
Income taxes paid during the period ............................... $ 172,542 $ --
Non-cash financing activities:
Capital lease obligation ........................................ $ 57,793 $ 348,451
Deferred financing cost ......................................... $ 238,491 $ --
Accounts payable & accrued legal converted to notes payable ..... $ -- $ 1,775,000
Effect of foreign currency translation on net assets ............ $ 17,189 $ --
See accompanying notes to condensed consolidated financial statements.
6
TALON INTERNATIONAL, INC.
(FORMERLY TAG-IT PACIFIC, INC.)
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. PRESENTATION OF INTERIM INFORMATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and in accordance with
the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. The accompanying unaudited condensed consolidated financial
statements reflect all adjustments that, in the opinion of the management of
Talon International, Inc. and its consolidated subsidiaries (collectively, the
"Company"), are considered necessary for a fair presentation of the financial
position, results of operations, and cash flows for the periods presented. The
results of operations for such periods are not necessarily indicative of the
results expected for the full fiscal year or for any future period. The
accompanying financial statements should be read in conjunction with the audited
consolidated financial statements and related notes included in the Company's
Annual Report on Form 10-K (and amendments thereto) for the year ended December
31, 2006. The balance sheet as of December 31, 2006 has been derived from the
audited financial statements as of that date but omits certain information and
footnotes required for complete financial statements.
On July 20, 2007 the Company changed its name from Tag-It Pacific, Inc.
to Talon International, Inc.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A complete description of the Company's Significant Accounting Policies
is included in the Company's Annual Report on Form 10-K (and amendments thereto)
for the year ended December 31, 2006, and should be read in conjunction with
these unaudited condensed consolidated financial statements. The Significant
Accounting Policies noted below are only those policies that have changed
materially or have supplemental information included for the periods presented
here.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We are required to make judgments as to the collectability of accounts
receivable based on established aging policy, historical experience and future
expectations. The allowance for doubtful accounts represents amounts for
customer trade accounts receivable that are estimated to be partially or
entirely uncollectible. These allowances are used to reduce gross trade
receivables to their net realizable value. We record these allowances based on
estimates related to the following factors: (i) customer specific allowances;
(ii) amounts based upon an aging schedule; and (iii) an estimated amount, based
on our historical experience, for issues not yet identified. Bad debt expense,
including the impairment of note receivable for the three and nine months ended
September 30, 2007 are $2,307,446 and $2,349,568, respectively, compared to
recoveries of bad debts of $133,780 and $531,121, for the three and nine months
ended September 30, 2006. Total provisions for doubtful accounts during the
third quarter of 2007 includes a provision reserved against the Azteca note
receivable as explained in Note 4.
INTANGIBLE ASSETS
Intangible assets consist of our trade name and exclusive license and
intellectual property rights. Intangible assets acquired in a purchase business
combination and determined to have an indefinite useful life are not amortized,
but instead are tested for impairment at least annually in accordance with the
provisions of FASB Statement No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS.
Intangible assets with estimable useful lives are amortized over their
respective estimated useful lives, which average 5 years, and reviewed for
7
impairment in accordance with the provisions of FASB Statement No. 144,
ACCOUNTING FOR IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. Amortization expense
for these assets for the nine months ended September 30, 2006 was $86,625.
During the first quarter of 2007, the exclusive license and intellectual
property rights became fully amortized with amortization expense of $28,875.
OTHER ACCRUED EXPENSES
Other accrued expenses consist of incurred obligations that are not yet
payable, such as deferred compensation and accrued benefits, interest, and
advance customer payments and deposits. As of September 30, 2007, other accrued
expenses included $582,670 in advance customer payments and deposits (as
compared to $512,339 at December 31, 2006).
CLASSIFICATION OF EXPENSES
COSTS OF SALES - Cost of goods sold primarily includes expenses related
to inventory purchases, customs, duty, freight, overhead expenses and reserves
for obsolete inventory. Overhead expenses primarily consist of warehouse and
operations salaries, and other warehouse expense.
SELLING EXPENSES - Selling expenses primarily include royalty expense,
sales salaries and commissions, travel and entertainment, marketing and other
sales related costs. Marketing and advertising efforts are expensed as incurred
and for the three and nine months ended September 30, 2007 were $17,465 and
$146,551, respectively, compared to $198,319 and $198,393 for the three and nine
months ended September 30, 2006, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES - General and administrative
expenses primarily include administrative salaries, employee benefits,
professional service fees, facility expenses, information technology costs,
investor relations, travel and entertainment, depreciation and amortization, bad
debts and other general corporate expenses.
INTEREST EXPENSE, NET - Interest expense reflects the cost of borrowing
and amortization of deferred financing costs and discounts. Interest expense for
the three and nine months ended September 30, 2007 totaled $677,717 and
$1,354,723, respectively, (compared to $340,965 and $1,017,044 for the three and
nine months ended September 30, 2006, respectively). Interest income consists of
earnings from outstanding amounts due to the Company under notes and other
interest bearing receivables. For the three and nine months ended September 30,
2007 the Company recorded interest income of $30,203 and $216,635 respectively,
compared to $104,465 and $264,339 for the same periods in 2006.
Cash paid for interest charges for the nine months ended September 30,
2007 and 2006 amounted to $1,019,831 and $731,327, respectively. Interest
payments received during the nine months ended September 30, 2007 and 2006
totaled $170,215 and $228,800, respectively.
SHIPPING AND HANDLING COSTS
In accordance with Emerging Issues Task Force (EITF) 00-01, ACCOUNTING
FOR SHIPPING AND HANDLING FEES AND COSTS, the Company records shipping and
handling costs billed to customers as a component of revenue, and shipping and
handling cost incurred by the Company for outbound freight are recorded as a
component of cost of sales. Total shipping and handling costs included as a
component of revenue for the nine months ended September 30, 2007 and 2006 were
$178,435 and $67,426, respectively ($59,383 and $49,006 for the three months
ended September 30, 2007 and 2006, respectively). Total shipping and handling
costs incurred as a component of cost of sales for the nine months ended
September 30, 2007 and 2006 were $622,384 and $500,305, respectively ($194,145
and $161,420 for the three months ended September 30, 2007 and 2006,
respectively).
8
FOREIGN CURRENCY TRANSLATION
The Company has operations and holds assets in various foreign
countries. The local currency is the functional currency for our subsidiaries in
China and India. Assets and liabilities are translated at end-of-period exchange
rates while revenues and expenses are translated at the average exchange rates
in effect during the period. The Chinese yuan was translated at an end-of-period
exchange rate of approximately 7.5176 Chinese yuan per US dollar at September
30, 2007 (7.8175 at December 31, 2006). The Indian rupee was translated at an
end-of-period exchange rate of approximately 44.12 Indian rupees per US dollar
at September 30, 2007 (39.81 at December 31, 2006). Equity is translated at
historical rates and the resulting cumulative translation adjustments are
included as a component of accumulated other comprehensive income (loss) until
the translation adjustments are realized. Included in other accumulated
comprehensive income was a cumulative foreign currency translation adjustment
gain of $20,365 at September 30, 2007 (none at December 31, 2006).
COMPREHENSIVE INCOME
The Company adopted Statement of Financial Standard No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for the
reporting and display of comprehensive income and its components in financial
statements.
Comprehensive income and its components for the three and nine months
ended September 30, 2006 and 2007 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
Net income (loss) ............... $(3,681,831) $ 339,117 $(3,986,682) $ 264,356
Other comprehensive income:
Foreign currency translation .... 20,365 -- 20,365 --
----------- ----------- ----------- -----------
Total comprehensive income (loss) $(3,661,466) $ 339,117 $(3,966,317) $ 264,356
=========== =========== =========== ===========
The foreign currency translation adjustment represents the net currency
translation adjustment gains and losses related to our China and India
subsidiaries, which have not been reflected in net income for the periods
presented.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period financial
statements to conform to the current year presentation. The amortization of
deferred financing costs and discounts are reported as "Interest Expense, net"
on the accompanying unaudited condensed consolidated statement of operations.
These items were previously reported as "General and Administrative Expenses".
Current trade liabilities related to inventory receipts without invoices are
reported as "Accounts payable" on the accompanying unaudited condensed
consolidated balance sheets. These items were previously reported as "Other
accrued expenses".
9
NOTE 3. INCOME (LOSS) PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted income (loss) per share computations:
THREE MONTHS ENDED SEPTEMBER 30, 2007: INCOME (LOSS) SHARES PER SHARE
----------- ----------- -----------
Basic Loss per share:
Available to common stockholders .... $(3,681,831) 20,041,433 $ (0.18)
Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
----------- ----------- -----------
Loss available to common stockholders . $(3,681,831) 20,041,433 $ (0.18)
=========== =========== ===========
THREE MONTHS ENDED SEPTEMBER 30, 2006:
Basic Income per share:
Available to common stockholders .... $ 339,117 18,440,927 $ 0.02
Effect of Dilutive Securities:
Options ............................... -- 838,721 --
Warrants .............................. -- -- --
----------- ----------- -----------
Income available to common stockholders $ 339,117 19,279,648 $ 0.02
=========== =========== ===========
NINE MONTHS ENDED SEPTEMBER 30, 2007:
Basic Loss per share:
Available to common stockholders .... $(3,986,682) 19,060,664 $ (0.21)
Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
----------- ----------- -----------
Loss available to common stockholders . $(3,986,682) 19,060,664 $ (0.21)
=========== =========== ===========
NINE MONTHS ENDED SEPTEMBER 30, 2006:
Basic Income per share:
Available to common stockholders .... $ 264,356 18,347,509 $ 0.01
Effect of Dilutive Securities:
Options ............................... -- 372,022 --
Warrants .............................. -- -- --
----------- ----------- -----------
Income available to common stockholders $ 264,356 18,719,531 $ 0.01
=========== =========== ===========
Warrants to purchase 3,163,813 shares of common stock exercisable at
between $0.95 and $5.06 per share, and options to purchase 4,738,235 shares of
common stock exercisable at between $0.37 and $5.23 per share, were outstanding
for the three and nine months ended September 30, 2007. For the three and nine
months ended September 30, 2007 convertible debt of $12,500,000 convertible at
$3.65 per share was outstanding until July 2007 when the debt was fully repaid.
Other convertible debt of $500,000 convertible at $4.50 per share was
outstanding during the periods until June 27, 2007 when the debt was fully paid.
Warrants issued in July 2004 to purchase 30,000 shares of common stock
exercisable at $4.29 per share, were outstanding during the periods until they
expired in July 2007. These shares were not included in the computation of
diluted loss per share for the three or nine months ended September 30, 2007
because exercise or conversion would have an antidilutive effect on the loss per
share.
10
For the three and nine months ended September 30, 2006 warrants to
purchase 1,243,813 shares of common stock exercisable at between $3.50 and $5.06
per share, options to purchase 4,897,635 shares of common stock exercisable at
between $0.37 and $5.23 per share, convertible debt of $12,500,000 convertible
at $3.65 per share, and other convertible debt of $500,000 convertible at $4.50
per share were outstanding. In connection with the Share-Based Payment ("SFAS
123(R)") calculation (see note 8) 3,435,135 and 2,775,135 shares were included
in the computation of diluted income per share for the three and nine months
ended September 30, 2006, respectively.
NOTE 4. NOTE RECEIVABLE
At September 30, 2007 Azteca Production International, Inc. owes the
Company a balance of $2,127,653 plus accrued and unpaid interest from July 1,
2007, under a Note Payable and Settlement Agreement entered into during February
2006. The note is payable in monthly installments over thirty-one months
beginning March 1, 2006 with payments ranging from $133,000 - $267,000 per month
until paid in full, but not later than July 1, 2008. Azteca failed to make the
scheduled note payments due on July 1, 2007, and all subsequent periods
thereafter, triggering a default and exhausting all cure periods under the note,
resulting in the entire note balance being due and payable. On September 10,
2007 after meeting with and conducting extensive discussions with Azteca, Azteca
failed to provide to the Company certain security interests as required under
the note to make the scheduled note payments. Azteca further expressed its
belief that it would not be able to make any note payments in the foreseeable
future.
Under the terms of the note, a default results in full acceleration of
the balance due, and the maker is also liable for interest accruing and all
costs associated with the collection of the note balance. The Company has
initiated legal actions to secure all legal remedies available to it under the
terms of the note, and is taking legal steps to secure all assets or collateral
available to the Company under the law. The Company will pursue recovery of this
note and all associated costs to the full extent of the law.
Despite the Company's legal remedies, the Company believes the
likelihood of recovery is remote, given the circumstances and current financial
conditions of Azteca Production International, Inc. and Diversified Apparel,
LLC. Accordingly, in the quarter ended September 30, 2007, the Company recorded
a reserve for impairment of note receivable to operations for an amount equal to
the outstanding balance of the note as of September 30, 2007.
NOTE 5. INVENTORIES
Inventories are stated at the lower of cost, determined using the
first-in, first-out ("FIFO") basis, or market value and are all categorized as
finished goods. The costs of inventory include the purchase price, inbound
freight and duties, conversion costs and certain allocated production overhead
costs. Inventory valuation reserves are recorded for damaged, obsolete, excess
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.
Provisions for inventory valuation allowances were $120,654 for the three and
nine months ended September 30, 2007.
11
Inventories consist of the following:
September 30, December 31,
2007 2006
----------- -----------
Finished goods .. $ 3,900,051 $ 4,293,220
Less reserves ... (1,190,000) (1,242,000)
----------- -----------
Total inventories $ 2,710,051 $ 3,051,220
=========== ===========
NOTE 6. FIXED ASSETS HELD FOR SALE
Fixed assets held for sale consist of the North Carolina land and
manufacturing facility that was closed in connection with the Company's 2005
Restructuring Plan. The carrying value of these assets at both September 30,
2007 and December 31, 2006 is $826,904. The assets are financed with a mortgage
note payable with $695,618 outstanding at September 30, 2007 and $712,950 at
December 31, 2006.
Management has the authority to approve the disposal of these assets
and is committed to a plan to sell the facility. The facility is available for
immediate sale in its present condition and the Company has initiated and is
pursuing actions to locate a buyer and list the property with commercial real
estate brokers to complete the sale of the facility. The Company believes the
sale of the facility is probable but has not concluded due to market and
regional conditions. The Company's plan to dispose of the facility is not likely
to be changed or withdrawn and the Company has no future plans to use the
facility.
NOTE 7. DEBT FACILITY
On June 27, 2007 the Company 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 for a three year period
ending June 30, 2010. The revolving credit portion of the facility permits
borrowings based upon a formula including 75% the Company's eligible receivables
and 55% of eligible inventory, and provides for monthly interest payments at the
prime rate 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 the assets of the Company.
Under the terms of the credit agreement the Company is required to meet
certain cash flow and coverage ratios, among other restrictions including a
restriction from declaring or paying a dividend prior to repayment of all the
obligations. The financial covenants require the Company to maintain at the end
of each fiscal quarter "EBITDA" (as defined in the Agreement) for the preceding
four quarters in excess of the Company's principal and interest payments for the
same four-quarter period. In the event that the Company fails to satisfy the
minimum EBITDA requirement for two consecutive quarters, the credit agreement
will be in default and the full amount of the notes outstanding will become due.
For the period ended September 30, 2007 the Company believes that this EBITDA
covenant was satisfied, but also informed the lender that the Company may fail
to satisfy the EBITDA covenant for the quarters ending December 31, 2007 or
March 31, 2008. The Company requested the lender to amend the loan agreement to
allow for additional time to satisfy the covenant. On November 19, 2007 the
Company entered into an agreement with Bluefin Capital, LLC to modify this
financial covenant and to extend until June 30, 2008 (with a further extension
to March 31, 2009 provided certain conditions are met by June 30, 2008) the
application of the EBITDA covenant in exchange for additional common stock of
the Company and a price adjustment to the lenders outstanding warrants issued in
connection with the loan agreement. See Note 13, Subsequent Events.
At closing on June 27, 2007, the proceeds of the term loan ($9.5
million) were deposited into a restricted cash escrow account and $3.0 million
of the borrowings available under the revolving credit note were reserved and
held for payment of the Company's $12.5 million convertible promissory notes
maturing in November 2007. During July 2007 waivers were obtained from all
holders of the convertible promissory notes allowing for early payment of their
notes without penalty, and as of July 31, 2007 all of the note holders had been
paid in full. At closing the Company also borrowed $1,004,306 under the
revolving credit note and used the proceeds to pay the related party note
payable and accrued interest due to Mark Dyne, Chairman of the Board of the
Company. Additionally initial borrowings under the revolving credit note were
used to pay the loan and legal fees due at closing. As of September 30, 2007 the
Company had borrowed $9.5 million under the term note, and $3,807,806 under the
revolving credit note.
12
In connection with the Revolving Credit and Term Loan Agreement, the
Company issued 1,500,000 shares of common stock to the lender for $0.001 per
share, and issued 2,100,000 warrants for the purchase of common stock. The
warrants are exercisable over a five-year period and 700,000 warrants are
exercisable at $0.95 per share; 700,000 warrants are exercisable at $1.05 per
share; and 700,000 warrants are exercisable at $1.14 per share. The relative
fair value of the equity ($2,374,169, which includes a reduction for financing
costs) of the equity 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 will be 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 in other assets as deferred financing costs and are being amortized
over the term of the notes.
Interest expense related to the Revolving Credit and Term Loan Agreement
for the three and nine months ended September 30, 2007 were $467,360 and
$484,006, respectively, which includes $220,503 and $230,382 in amortization of
discounts and deferred financing costs, respectively.
NOTE 8. STOCK BASED COMPENSATION
The Company accounts for stock-based awards to employees and directors
in accordance with Statement of Financial Accounting Standards No. 123 revised,
Share-Based Payment, ("SFAS 123(R)") which requires the measurement and
recognition of compensation expense for all share-based payment awards made to
employees and directors based on estimated fair values. Options issued to
consultants are accounted for in accordance with the provisions of Emerging
Issues Task Force (EITF) No. 96-18, "Accounting for Equity Instruments that are
Issued to Others than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services". There were 46,600 options granted to employees during the
nine months ended September 30, 2007 (none during the three months ended
September 30, 2007) at a weighted average exercise price of $1.02 per share. The
estimated fair value of options granted in the nine months ended September 30,
2007 was $31,700. Common shares of 1,500,000 and warrants to acquire 2,100,000
shares of common stock were issued on June 27, 2007 to a non-employee in
connection with a debt financing facility at a weighted average exercise price
of $1.05 per share for the warrants and $0.001 per share for the common shares
issued. The estimated total fair value of the warrants and shares of common
stock granted during the three and nine months ended September 30, 2007 was
$2,879,020. The relative fair value of warrants and shares of common stock
issued, less financing costs, is accounted for as debt discount related to the
$9.5 million term note entered into in June 2007. Assumptions used to value
options granted to employees were expected volatility of 69%, expected term of
6.1 years, risk-free interest rate of approximately 5.0%, and an expected
dividend yield of zero. Assumptions used to value warrants granted to
non-employees were expected volatility of 78%, expected term of 5 years
(contractual life), risk-free interest rate of 5.0%, and expected dividend yield
of zero. In January, 2007, a consultant exercised options to acquire 75,000
shares of common stock. Cash received upon exercise was $42,750 or $0.57 per
share. At the time of exercise, the total intrinsic value of the options
exercised was approximately $72,000 (or $0.96 per share). Because the option
exercised was a non-qualified stock option, the Company will receive a tax
deduction based upon the intrinsic value amount.
As of September 30, 2007, the Company had approximately $467,000 of
unamortized stock-based compensation expense related to options issued to
employees and directors, which will be recognized over the weighted average
period of 2.2 years. This expected expense will change if any stock options are
granted or cancelled prior to the respective reporting periods or if there are
any changes required to be made for estimated forfeitures.
During the three months ended September 30, 2006, the Company granted
options to acquire 660,000 common shares at an exercise price of $0.69 per
share. During the nine months ended September 30, 2006, the Company granted
awards of stock for 225,388 shares at an average market price of $0.45 per share
and granted options to acquire 3,345,135 shares at an average exercise price of
$0.47 per share. Awards to acquire 1,625,000 shares were granted to employees
13
outside of the 1997 Plan, and awards of stock and options to acquire 165,253
shares were granted to a consultant. The estimated fair value of awards granted
during the three months ended September 30, 2006 was $43,756 and the estimated
fair value of all awards granted during the nine months ended September 30, 2006
was $353,024 of which $70,000 was accrued for as of December 31, 2005.
Assumptions used to value options granted to employees during the nine months
ended September 30, 2006 were expected volatility of 57% to 64%, expected term
of 5.0 years to 6.1 years, risk-free interest rate of approximately 4.8%, and an
expected dividend yield of zero. Assumptions used to value options granted to
consultants were expected volatility of 65%, expected term of 10 years
(contractual life), risk-free interest rate of 4.5%, and expected divided yield
of zero.
The following table summarizes the activity in the Company's share
based plans during the three and nine months ended September 30, 2007. At
September 30, 2007 the 1997 Stock Plan expired and no further awards may be
issued under this Plan.
Weighted
Average
Number of Exercise
Shares Price
---------- ----------
EMPLOYEES AND DIRECTORS
Options and warrants outstanding - January 1, 2007 ....... 5,002,635 $ 1.41
Granted ............................................. -- --
Exercised ........................................... -- --
Cancelled ........................................... (299,500) $ 1.03
---------- ----------
Options and warrants outstanding - March 31, 2007 ........ 4,703,135 $ 1.44
Granted ............................................. 46,600 $ 1.02
Exercised ........................................... -- --
Cancelled ........................................... (3,000) $ 1.27
---------- ----------
Options and warrants outstanding - June 30, 2007 ......... 4,746,735 $ 1.44
Granted ............................................. -- --
Exercised ........................................... -- --
Cancelled ........................................... (8,500) $ 1.27
---------- ----------
Options and warrants outstanding - September 30, 2007 .... 4,738,235 $ 1.44
========== ==========
NON-EMPLOYEES
Options and warrants outstanding - January 1, 2007 ....... 1,318,813 $ 4.13
Granted ............................................. -- --
Exercised ........................................... (75,000) $ .57
Cancelled ........................................... (150,000) $ 3.50
---------- ----------
Options and warrants outstanding - March 31, 2007 ........ 1,093,813 $ 4.46
Granted ............................................. 2,100,000 $ 1.05
Exercised ........................................... -- --
Cancelled ........................................... -- --
---------- ----------
Options and warrants outstanding - June 30, 2007 ......... 3,193,813 $ 2.22
Granted ............................................. -- --
Exercised ........................................... -- --
Cancelled ........................................... (30,000) $ 4.29
---------- ----------
Options and warrants outstanding - September 30, 2007 .... 3,163,813 $ 2.20
========== ==========
14
On July 31, 2007, at the Company's annual meeting of stockholders, the
2007 Stock Plan was approved which replaced the 1997 Stock Plan. The 2007 Stock
Plan authorizes up to 2,600,000 shares of common stock for issuance pursuant to
awards granted to individuals under the plan. At September 30, 2007 no awards
under the 2007 Stock Plan had been granted.
NOTE 9. INCOME TAXES
On January 1, 2007 the Company adopted the provisions of Financial
Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes-an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements and prescribes a recognition threshold and
measurement process for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on the recognition, classification, interest and penalties, accounting
in interim periods, disclosure and transition associated with income tax
liabilities.
As a result of the implementation of FIN 48, the Company recognized an
increase in liabilities for unrecognized tax benefits of approximately $245,800,
which was accounted for as an increase in the January 1, 2007 accumulated
deficit.
The Company recognizes interest accrued related to unrecognized tax
benefits in interest expense and penalties in income tax expense. For the three
and nine months ended September 30, 2007 the Company recognized accrued interest
for unrecognized tax benefits of approximately $4,000 and $8,000, respectively.
There were no interest or penalties recognized during the three months or nine
months ended September 30, 2006 for unrecognized tax benefits due to the
provisions of FIN 48 not becoming effective until January 2007. At September 30,
2007 the Company had approximately $41,875 accrued in interest and penalties
associated with the unrecognized tax liabilities.
NOTE 10. CONTINGENCIES AND GUARANTEES
In May, 2006, the Company received notice from the American Stock
Exchange ("AMEX") that it was not in compliance with certain of the continued
listing standards as set forth in the AMEX Company Guide due to the failure to
comply with Section 1003(a)(i) and Section 1003(a)(ii) of the Company Guide,
which effectively required that the Company maintain shareholders' equity of at
least $4,000,000. Following the notice from AMEX the Company was afforded the
opportunity to submit a "plan of compliance" to AMEX outlining in detail how the
Company expected to achieve the minimum equity requirements and to regain
compliance. On August 3, 2006 the Company received notification from AMEX that
the Company's plan to regain compliance with the minimum shareholders' equity
requirements of the AMEX Company Guide had been accepted and the Company has
been granted an extension until November 16, 2007 to achieve the AMEX continued
listing requirements.
The Company has not achieved the AMEX minimum equity requirements as of
this filing and the extension period granted by AMEX has expired. Accordingly,
the Company expects the AMEX to begin delisting proceedings shortly thereafter
and to remove the Company's shares from trading on AMEX.
On October 12, 2005, a shareholder class action complaint -- HUBERMAN
V.TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex) -- was filed against
the Company and certain of its current and former officers and directors in the
United States District Court for the Central District of California, alleging
claims under Section 10(b) and Section 20 of the Securities Exchange Act of
1934. A lead plaintiff was appointed, and his amended complaint alleged that
defendants made false and misleading statements about the Company's financial
situation and its relationship with certain of its large customers. The action
was brought on behalf of all purchasers of the Company's publicly-traded
securities during the period from November 13, 2003 to August 12, 2005. On
February 20, 2007, the Court denied class certification. On April 2, 2007 the
Court granted defendants' motion for summary judgment, and on or about April 5,
2007, the Court entered judgment in favor of all defendants. On or about April
30, 2007, plaintiff filed a notice of appeal, and his opening appellate brief
15
was filed on October 15, 2007. Our brief is currently due November 28, 2007. The
Company believes that this matter will be resolved favorably on appeal, or in a
later trial or in settlement within the limits of its insurance coverage.
However, the outcomes of this action or an estimate of the potential losses, if
any, related to the lawsuit cannot be reasonably predicted, and an adverse
resolution of the lawsuit could potentially have a material adverse effect on
the Company's financial position and results of operations.
On April 16, 2004 the Company filed suit against Pro-Fit Holdings,
Limited ("Pro-Fit") 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 the Company's
exclusive license and intellectual property agreement with Pro-Fit, seeking
declaratory relief, injunctive relief and damages. It is the Company's position
that the agreement with Pro-Fit gives the Company the exclusive rights in
certain geographic areas to Pro-Fit's stretch and rigid waistband technology. On
June 5, 2006 the Court denied the Company's motion for partial summary judgment,
but did not find that the Company breached its agreement with Pro-Fit and a
trial is required to determine issues concerning our activities in Columbia and
whether other actions by Pro-Fit constituted an unwillingness or inability to
fill orders. The Court also held that Pro-Fit was not "unwilling or unable" to
fulfill orders by refusing to fill orders with goods produced in the United
States. The Court has not yet set a date for trial of this matter. The Company
has historically derived a significant amount of revenue from the sale of
products incorporating the stretch waistband technology and the Company's
business, results of operations and financial condition could be materially
adversely affected if the dispute with Pro-Fit is not resolved in a manner
favorable to the Company. Additionally, the Company has incurred significant
legal fees in this litigation, and unless the case is settled, the Company will
continue to incur additional legal fees in increasing amounts as the case
accelerates to trial.
A subsidiary, Tag-It de Mexico, S.A. de C.V., operated under the
Mexican government's Maquiladora Program, which entitled Tag-It de Mexico to
certain favorable treatment as respects taxes and duties regarding certain
imports. In July of 2005, the Mexican Federal Tax Authority asserted a claim
against Tag-It de Mexico alleging that certain taxes had not been paid on
imported products during the years 2000, 2001, 2002 and 2003. In October of
2005, the Company filed a procedural opposition to the claim and submitted
documents to the Mexican Tax Authority in opposition to this claim, supporting
the Company's position that the claim was without merit. The Mexican Federal Tax
Authority failed to respond to the opposition filed, and the required response
period by the Tax Authority has lapsed. In addition, a controlled entity
incorporated in Mexico (Logistica en Avios, S.A. de C.V.) through which the
Company conducted its operations in 2005, may be subjected to a claim or claims
from the Mexican Tax Authority, as identified directly above, and additionally
to other tax issues, including those arising from employment taxes. The Company
believes that any such claim is defective on both procedural and documentary
grounds and is without merit. An estimate of the possible loss or range of loss
if any associated with these matters cannot be made at this time. The Company
does not believe these matters will have a material adverse effect on the
Company.
The Company currently has pending a number of other claims, suits and
complaints that arise in the ordinary course of our business. The Company
believes 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 the Company's consolidated financial
condition if adversely determined against the Company.
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34." The following is a summary of the Company's
agreements that it has determined are within the scope of FIN 45:
In accordance with the bylaws of the Company, officers and directors
are indemnified for certain events or occurrences arising as a result of the
officer or director's serving in such capacity. The term of the indemnification
period is for the lifetime of the officer or director. The maximum potential
amount of future payments the Company could be required to make under the
indemnification provisions of its bylaws is unlimited. However, the Company has
a director and officer liability insurance policy that reduces its exposure and
16
enables it to recover a portion of any future amounts paid. As a result of its
insurance policy coverage, the Company believes the estimated fair value of the
indemnification provisions of its bylaws is minimal and therefore, the Company
has not recorded any related liabilities.
The Company enters into indemnification provisions under its agreements
with investors and its agreements with other parties in the normal course of
business, typically with suppliers, customers and landlords. Under these
provisions, the Company generally indemnifies and holds harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
the Company's activities or, in some cases, as a result of the indemnified
party's activities under the agreement. These indemnification provisions often
include indemnifications relating to representations made by the Company with
regard to intellectual property rights. These indemnification provisions
generally survive termination of the underlying agreement. The maximum potential
amount of future payments the Company could be required to make under these
indemnification provisions is unlimited. The Company has not incurred material
costs to defend lawsuits or settle claims related to these indemnification
agreements. As a result, the Company believes the estimated fair value of these
agreements is minimal. Accordingly, the Company has not recorded any related
liabilities.
NOTE 11. NEW ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115," ("SFAS No. 159") which expands the use of fair value. Under
SFAS No. 159 a company may elect to use fair value to measure accounts and loans
receivable, available-for-sale and held-to-maturity securities, equity method
investments, accounts payable, guarantees, issued debt and other eligible
financial instruments. SFAS No. 159 is effective for years beginning after
November 15, 2007. The Company does not believe that SFAS No. 159 will have a
material impact on the Company's financial position, results of operations or
cash flows.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements", ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles
(GAAP), and expands disclosures about fair value measurements. This Statement
applies under other accounting pronouncements that require or permit fair value
measurements, and does not require any new fair value measurements. The
application of SFAS No. 157, however, may change current practice within an
organization. SFAS No. 157 is effective for all fiscal years beginning after
November 15, 2007, with earlier application encouraged. The Company does not
believe that SFAS No. 157 will have a material impact on the Company's financial
position, results of operations or cash flows.
NOTE 12. GEOGRAPHIC INFORMATION
The Company specializes in the distribution of a full range of apparel
zipper and trim items to manufacturers of fashion apparel, specialty retailers
and mass merchandisers. There is not enough difference between the types of
products developed and distributed by the Company to account for these products
separately or to justify segmented reporting by product type. The Company
believes that revenue by each major product class is a valuable business
measurement. The net revenues for the three primary product groups are as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
Product Group net
Revenue: 2007 2006 2007 2006
----------- ----------- ----------- -----------
Talon zipper ... $ 4,280,168 $ 4,136,425 $17,471,285 $13,321,301
Trim ........... 4,690,037 5,674,366 13,517,895 16,969,322
Tekfit ......... 42,930 3,556,154 681,054 7,960,625
----------- ----------- ----------- -----------
$ 9,013,135 $13,366,945 $31,670,234 $38,251,248
=========== =========== =========== ===========
17
The Company distributes its products internationally and has reporting
requirements based on geographic regions. The net book value of long-lived
assets (consisting of property and equipment, intangible assets and property
held for sale) is attributed to countries based on the location of the assets
and revenues are attributed to countries based on customer delivery locations,
as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
Country / Region 2007 2006 2007 2006
----------- ----------- ----------- -----------
United States .... $ 944,190 $ 1,205,357 $ 2,835,124 $ 3,143,816
Asia ............. 7,466,034 7,206,857 26,020,853 21,940,718
Mexico ........... 51,643 722,502 651,069 3,302,242
Dominican Republic 44,119 3,423,416 698,789 7,695,516
Other ............ 507,149 808,813 1,464,399 2,168,956
----------- ----------- ----------- -----------
$ 9,013,135 $13,366,945 $31,670,234 $38,251,248
=========== =========== =========== ===========
September 30, December 31,
2007 2006
----------- -----------
LONG-LIVED ASSETS, NET:
United States ...................... $ 9,180,524 $ 9,531,659
Asia ............................... 587,937 386,516
Mexico ............................. 1,250 5,078
Dominican Republic ................. 586,184 668,067
----------- -----------
Net book value of long-lived assets $10,355,895 $10,591,320
=========== ===========
NOTE 13. SUBSEQUENT EVENTS
On November 19, 2007, the Company entered into an amendment to its
Revolving Credit and Term Loan agreement with Bluefin Capital, LLC (See Note 7).
The amendment includes a modification to the loan agreement that extends until
June 30, 2008 (with a further extension to March 31, 2009 provided certain
conditions are met by June 30, 2008) the application of the EBITDA covenant and
provides additional time to meet other non-performance related covenants. In
consideration for the covenant waiver the Company agreed to (a) issue Bluefin
Capital, LLC 250,000 shares of the Company's common stock; and (b) to re-price
warrants for 2,100,000 shares of the Company's common stock issued on June 27,
2007 in connection with the loan agreement from a weighted average exercise
price of $1.05 to $0.75 per share. In the event the Company completes an equity
offering prior to June 30, 2008, Bluefin Capital agreed to accept 25% of the net
proceeds of the equity offering as a prepayment on the term note, in lieu of a
prepayment of 50% as provided for under the loan agreement, and to further
extend until March 31, 2009 the application of the EBITDA covenant. In
consideration for these changes the Company agreed, if it completes an equity
offering, to issue Bluefin Capital an additional 500,000 shares of the Company's
common stock, and to re-price their warrants to the price of warrants issued in
the offering, if lower.
Under the provisions of Statement of Financial Accounting Standard, No.
123(R), the fair value of the common stock issued in exchange for this
modification, together with the difference in the fair value of the warrants
measured at the date of the re-pricing and the fair value of the warrants before
the re-pricing, is recognized as an expense in the period the shares are issued
and the price of the warrants is changed. Accordingly, the Company estimates the
loan modification will result in a charge to earnings during the fourth quarter
of 2007 of approximately $212,000 for the fair value of the equity components,
plus approximately $110,000 in legal and other associated costs, for a total
estimated charge of $322,000.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. 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. 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 below. 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
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.
OVERVIEW
The following management's discussion and analysis is intended to
assist the reader in understanding our consolidated financial statements. This
management's discussion and analysis is provided as a supplement to, and should
be read in conjunction with, our consolidated financial statements and
accompanying notes.
On July 20, 2007, we changed our corporate name from Tag-It Pacific,
Inc. to Talon International, Inc. in order to reflect our core marketing
strategy of focusing on growth opportunities in the global zipper market with
our Talon(R) brand zippers.
Talon International, Inc. designs, sells 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 plan to increase our global expansion of Talon zippers through the
establishment of a network of Talon locations, distribution relationships, and
joint ventures. The network of global manufacturing and distribution locations
are expected to improve our global footprint and allow us to more effectively
serve apparel brands and manufacturers globally.
Our Trim business focus is 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
development, design 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.
Our Tekfit services provide manufacturers with the patented technology,
manufacturing know-how and materials required to produce garments incorporating
an expandable waistband. These products historically have been produced by
several manufacturers for one single brand under an exclusive supply contract.
This contract expired in October 2006 and we now intend to expand this product
to other brands. Our expansion has been limited to date due to the exclusive
contract as well as licensing dispute. As described more fully in this report
under Contingencies and Guarantees (see Note 10 to our unaudited condensed
consolidated financial statements), we are presently in litigation with Pro-Fit
Holdings Limited regarding our exclusively licensed rights to sell or sublicense
stretch waistbands manufactured under Pro-Fit's patented technology. As we have
derived a significant amount of revenue from the sale of products incorporating
the stretch waistband technology, our business, results of operations and
financial condition could be materially adversely affected if our dispute with
Pro-Fit is not resolved in a manner favorable to us.
19
Under the terms of our credit agreement we are required to meet certain
cash flow and coverage ratios. The financial covenant requires us to maintain at
the end of each fiscal quarter "EBITDA" (as defined in the Agreement) for the
preceding four quarters in excess of our principal and interest payments for the
same four-quarter period. In the event that we fail to satisfy the minimum
EBITDA requirement for two consecutive quarters, the credit agreement will be in
default and the full amount of the notes outstanding will become due. For the
period ended September 30, 2007 we believed that this EBITDA covenant was
satisfied, but also informed the lender that we may fail to satisfy the EBITDA
covenant for the quarters ending December 31, 2007 or March 31, 2008. We
requested the lender to amend the loan agreement to allow for additional time to
satisfy the covenant. On November 19, 2007 we entered into an agreement with
Bluefin Capital, LLC to modify this financial covenant and to extend until June
30, 2008 (with a further extension to March 31, 2009 provided certain conditions
are met by June 30, 2008) the application of the EBITDA covenant in exchange for
additional shares of our common stock and a price adjustment to the lender's
outstanding warrants. See Note 13, Subsequent Events.
RESULTS OF OPERATIONS
The following table sets forth selected statements of operations data
shown as a percentage of net sales for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2007 2006 2007 2006
-------- -------- -------- --------
Net sales ................................ 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ....................... 72.0 69.0 70.8 70.9
-------- -------- -------- --------
Gross profit ............................. 28.0 31.0 29.2 29.1
Selling expenses ......................... 8.0 6.8 6.8 5.6
General and administrative expenses ...... 30.3 19.5 24.5 20.7
Impairment of note receivable ............ 23.6 -- 6.7 --
Interest & taxes ......................... 7.0 2.2 3.8 2.1
-------- -------- -------- --------
Net income (loss) ........................ (40.9)% 2.5% (12.6)% 0.7%
======== ======== ======== ========
SALES
For the three and nine months ended September 30, 2007 and 2006, sales
by geographic region based on the location of the customer as a percentage of
sales were:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
REGION 2007 2006 2007 2006
-------- -------- -------- --------
United States .................. 10.5% 9.0% 9.0% 8.2%
Asia ........................... 82.8% 53.9% 82.1% 57.4%
Mexico ......................... 0.6% 5.4% 2.1% 8.6%
Dominican Republic ............. 0.5% 25.6% 2.2% 20.1%
Other .......................... 5.6% 6.1% 4.6% 5.7%
-------- -------- -------- --------
100.0% 100.0% 100.0% 100.0%
======== ======== ======== ========
Sales for the nine months ended September 30, 2007 were $31.7 million
or $6.6 million (17.2%) less than sales for the same period in 2006. The
reduction in sales for the nine months ended September 30, 2007 as compared to
the same period in 2006 is the net result of an increase of $4.1 million (31.2%)
in our Talon zipper sales as we expand our operations throughout China and
southeast Asia, offset by lower sales of waistband products as a result of the
expiration in October of 2006 of our exclusive contract for these products ($7.2
20
million); reduced operations in Mexico as production shifted from this area to
Asia and we closed our operations in 2005 and 2006 ($2.0 million); as a result
of sales ($0.7 million) recognized in the second quarter of 2006 associated with
a revenue restatement from a 2005 agreement; and lower trim sales due to fewer
and smaller programs with our customers ($0.8 million).
Sales for the three months ended September 30, 2007 were $9.0 million
or $4.4 million (32.6%) less than sales for the three months ended September 30,
2006. The reduction in sales for the three months ended September 30, 2007 as
compared to the same period in 2006 is principally the result of lower sales of
waistband products from the expiration of our exclusive contract for these
products ($3.5 million); a result of sales ($0.7 million) from Mexico in 2006
and our closure of the Mexican operations; and lower trim sales due to fewer and
smaller programs with our customers ($0.3 million); offset by an increase in
Talon zipper sales ($0.1 million). Talon zipper sales for the three months ended
September 30, 2007 were partially impacted by the acceleration of zipper
deliveries into the second quarter of 2007 as manufacturers worked to avoid
additional VAT taxes in China effective July 31, 2007, and by expiring Chinese
export quotas limiting the exportation of products manufactured in China for our
customers. Talon zipper sales for the balance of 2007 will continue to be
impacted by limited export quotas until 2008, and our continued expansion
throughout Southeast Asia into Thailand, Vietnam and Indonesia is intended to
partially offset these restrictions.
GROSS MARGIN
Gross margin for the three months ended September 30, 2007 was $2.5
million, as compared to $4.1 million for the same period in 2006. Gross margin
for the nine months ended September 30, 2007 was $9.2 million as compared to
$11.1 million for the same period in 2006. The reduction in gross margin for the
three and nine months ended September 30, 2007 as compared to the same periods
in 2006 was principally attributable to lower overall sales volumes and lower
direct margin resulting from a change in the mix in sales by product group,
partially offset by reduced distribution charges since more products are now
sourced and delivered within the same marketplace, reduced manufacturing and
assembly overhead costs and lower inventory obsolescence and management charges
as inventory levels have been reduced and turns accelerated.
A brief recap of the change in gross margin for the three and nine
months ended September 30, 2007 as compared with the same periods in 2006 is as
follows:
(Amounts in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
Amount %(1) Amount %(1)
---------- ---------- ---------- ----------
Gross margin (decrease) increase as a result of:
Lower volumes .................................. $ (1,614) (38.9) $ (2,343) (21.1)
Product margin mix ............................. (265) (6.4) (756) (6.8)
Reduced freight and duty costs ................. 163 3.9 480 4.3
Lower manufacturing & assembly costs ........... 118 2.8 248 2.2
Reduced obsolescence & inventory costs ......... 6 .2 646 5.8
Other cost of sales charges .................... (30) (.7) (145) (1.2)
---------- ---------- ---------- ----------
Gross margin (decrease) ........................ $ (1,622) (39.1) $ (1,870) (16.8)
========== ========== ========== ==========
(1) Represents the percentage change in the 2007 period, as compared to the same
period in 2006.
21
SELLING EXPENSES
Selling expenses for the three months ended September 30, 2007 were
$0.7 million, or 8.0% of sales compared to $0.9 million or 6.8% of sales for the
same period in 2006. The change in selling expense is principally due to reduced
spending for marketing programs, lower sales commissions on the lower volumes
and lower royalty fees on Tekfit sales ($0.3 million), partially offset by
increased salaries, facilities and other costs associated with new employees and
offices within Asia ($0.1 million).
Selling expenses for the nine months ended September 30, 2007 were $2.2
million or 6.8% of sales compared to $2.1 million or 5.6% of sales for the same
period in 2006. The increase in selling expense is principally due to the
increased number of sales offices and employees within China and their
associated compensation, facilities travel and administrative costs ($0.4
million) offset by lower marketing costs, lower royalty fees on waistband
products, and reduced commissions on lower volumes ($0.3 million).
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the three months ended
September 30, 2007 were $2.7 million or $0.1 million more than $2.6 million for
the comparable period in 2006. General and administrative expenses for the nine
months ended September 30, 2007 were $7.7 million or $0.2 million less than $7.9
million for the comparable period in 2006.
General and administrative expense for the three month period ended
September 30, 2007 increased by approximately $0.2 million from increased
employee costs and by $0.3 million as a result of $0.2 million in bad debt
provisions in 2007 compared to bad debt recoveries of $0.1 million in 2006.
General and administrative expenses decreased by approximately $0.3 million as a
result of reduced legal and professional fees, lower facility costs and other
lower overall general and administrative expenses.
For the nine months ended September 30, 2007 general and administrative
expenses increased by approximately $0.1 million from increased employee costs
and by $0.6 million as a result of $0.1 million in bad debt provisions in 2007
compared to bad debt recoveries of $0.5 million in 2006. Reduced legal and
professional fees ($0.6 million) and lower facility and other overall general
and administrative expenses ($0.6 million) offset the cost increases and
resulted in the net reduction of costs.
IMPAIRMENT OF NOTE RECEIVABLE
Operating expenses for the three and nine months ended September 30,
2007 include $2.1 million in bad debt reserve provisions associated with the
note receivable due the Company from Azteca Production International, Inc. See
Note 4 of the unaudited condensed consolidated financial statements.
INTEREST EXPENSE AND INTEREST INCOME
Interest expense for the three months ended September 30, 2007
increased $337,000 from the same period in 2006. Interest expense for the nine
months ended September 30, 2007 increased $338,000 from the same period in 2006.
The increase for the quarter and nine months ended September 30, 2007 over the
same periods in 2006 was principally as a result of increased amortization of
deferred financing costs and discounts, and higher interest costs on the
revolving credit and term notes as compared to the previous secured convertible
notes payable. During the third quarter 2007, we charged off approximately
$111,000 in unamortized deferred financing costs and discounts related to and in
conjunction with the early payment of the secured convertible promissory notes
in July 2007.
Interest income for the three months and nine months ended September
30, 2007 decreased from the same period in 2006, primarily related to the note
receivable discussed in Note 4 to the unaudited condensed consolidated financial
statements.
22
A brief summary of interest expense and interest income is presented
below:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
Interest expense ....................... $ 345,045 $ 263,206 $ 858,458 $ 784,031
Amortization of deferred financing costs
& debt discounts .................... 332,672 77,759 496,265 233,013
----------- ----------- ----------- -----------
Interest expense ................... 677,717 340,965 1,354,723 1,017,044
Interest income ........................ (30,203) (104,465) (216,635) (264,339)
----------- ----------- ----------- -----------
Interest expense, net .................. $ 647,514 $ 236,500 $ 1,138,088 $ 752,705
=========== =========== =========== ===========
INCOME TAXES
Income tax provisions for the three and nine months ended September 30
2007 reflected a tax benefit of $20,972 and a tax expense of $57,652,
respectively. For the three and nine months ended September 30, 2006, income tax
expense was $54,857 and $66,357, respectively. The tax expense in both 2007 and
2006 is associated with foreign income taxes from earnings of our Asian
facilities. Due to prior operating losses incurred within the year no benefit
for domestic income taxes has been recorded since there is not sufficient
evidence to determine that we will be able to utilize our net operating loss
carry-forwards to offset future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes selected financial data (amounts in
thousands) at:
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------ ------------
Cash and cash equivalents ........................ $ 2,319 $ 2,935
Total assets ..................................... $ 21,030 $ 25,693
Current debt ..................................... $ 8,599 $ 22,471
Non-current debt ................................. $ 12,354 $ 1,536
Stockholders' equity ............................. $ 78 $ 1,686
CASH AND CASH EQUIVALENTS
Cash provided by operating activities is our primary recurring source
of funds, and was approximately $1.3 million for the nine months ended September
30, 2007. The cash provided by operating activities during the nine months
resulted principally from a net loss before non-cash charges of $148,000;
collections on the note receivable of $672,000; an decrease in operating capital
(accounts receivable, inventories, accounts payable and other accrued expenses)
of $1,098,000; and other increases in operating assets and liabilities of
$299,000.
Net cash used in investing activities for the nine months ended
September 30, 2007 was $585,000 as compared to $323,000 for the nine months
ended September 30, 2006. These expenditures were principally associated with
leasehold improvements in new facilities, office equipment for new employees,
improvements in our technology systems and a marketing website acquisition. In
2006 the cash used for investing activities consisted primarily of capital
expenditures for replacing computer equipment.
Net cash of $1,356,000 was used in financing activities for the nine
months ended September 30, 2007. $13,507,000 (net of issuance costs) was
provided by the issuance of common stock and warrants, and by borrowings under a
new debt facility (see Note 7) designated to pay off our existing convertible
23
promissory notes and to provide funds for future growth. The proceeds from this
debt facility were used to pay the $12,500,000 of secured convertible promissory
notes, and $1,004,000 was used to pay a related party note ($580,000) and
associated accrued interest. Approximately $1,284,000 was used primarily for the
repayment of borrowings under capital leases and notes payable and during the
quarter ended September 30, 2007 $500,000 in initial borrowings under the
revolving note were repaid.
Our Revolving Credit and Term Loan Agreement with Bluefin Capital, LLC
requires us to maintain at the end of each fiscal quarter, "EBITDA" (as defined
in the Agreement) for the preceding four quarters in excess of our principal and
interest payments for the same four-quarter period. In the event that we fail to
satisfy the minimum EBITDA requirement for two consecutive quarters, the credit
agreement will be in default and the full amount of the notes outstanding will
become due. For the period ended September 30, 2007 we believe that this EBITDA
covenant was satisfied.
We have also informed our lender that we may not satisfy the EBITDA
covenant for the quarters ending December 31, 2007 or March 31, 2008, and
accordingly we requested our lender to amend the loan agreement to allow for
additional time to satisfy the covenant. On November 19, 2007 we entered into an
agreement with Bluefin Capital, LLC to modify this financial covenant and to
extend until June 30, 2008 (with a further extension to March 31, 2009 provided
certain conditions are met by June 30, 2008) the application of the EBITDA
covenant in exchange for additional shares of our common stock and a price
adjustment to the lender's outstanding warrants. See Note 13, Subsequent Events.
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 as well as provide for
our scheduled debt service requirements for at least the next twelve months.
This conclusion is based on the belief that our operating assets, strategic
plan, operating expectations and operating expense structure will provide for
sufficient profitability from operations before non-cash charges to fund our
operating capital requirements and to achieve our debt service requirements, and
that our existing cash and cash equivalents will be sufficient to fund our
expansion and capital requirements.
We have historically satisfied our working capital requirements
primarily through cash flows generated from operations, and 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, are increasing. 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 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 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.
We have incurred significant legal fees in our litigation with Pro-Fit
Holdings Limited. Unless the case is settled, we will continue to incur
additional legal fees in increasing amounts as the case accelerates to trial.
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, Central and South American and Caribbean markets and the further
development of our waistband technology. If our cash from operations is less
than anticipated or our working capital requirements and capital expenditures
are greater than we expect, we may need to raise additional debt or equity
financing in order to provide for our operations. We are continually evaluating
various financing strategies to be used to expand our business and fund future
growth or acquisitions. There can be no assurance that additional debt or equity
24
financing will be available on acceptable terms or at all. If we are unable to
secure additional financing, we may not be able to execute our plans for
expansion, including expansion into foreign markets to promote our Talon brand
trade name, and we may need to implement additional cost savings initiatives.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at September 30,
2007 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:
PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------
LESS THAN 1 TO 3 4 TO 5 AFTER
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
------------------------------- ----------- ----------- ----------- ----------- -----------
Demand notes payable to related
parties (1) ................ $ 211,300 $ 211,300 -- -- --
Capital lease obligations ..... $ 694,900 $ 419,000 $ 275,900 -- --
Operating leases .............. $ 1,331,800 $ 574,600 $ 753,300 $ 3,900 --
Revolving Credit & Term notes . $16,601,800 $ 1,197,800 $15,404,000 -- --
Other Notes payable ........... $ 1,511,200 $ 461,000 $ 1,050,200 -- --
----------- ----------- ----------- ----------- -----------
Total Obligations ...... $20,351,000 $ 2,863,700 $17,483,400 $ 3,900 --
=========== =========== =========== =========== ===========
(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 September 30, 2007.
At September 30, 2007 and 2006, 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
Todd Kay, a director and significant shareholder of Tarrant Apparel
Group is also a stockholder of the Company. Sales to Tarrant for the three
months and nine months ended September 30, 2007 were $1,800, and $141,800,
respectively. Sales to Tarrant for the three and nine months ended September 30,
2006 were $300 and $1,300 respectively. As of September 30, 2007 and at December
31, 2006 there were no amounts due from Tarrant.
Colin Dyne, a director and stockholder of the Company is also a
director, officer and significant stockholder in People's Liberation, Inc.
During the three and nine months ended September 30, 2007 we had sales of
$115,500 and $323,000, respectively, to subsidiaries of People's Liberation,
Inc. For the three and nine months ended September 30, 2006 we had sales of
$22,100 and $55,100, respectively, to subsidiaries of Peoples Liberation, Inc.
At September 30, 2007, accounts receivable included $94,800 outstanding from
People's Liberation subsidiaries. At December 31, 2006, accounts receivable of
$83,400 was outstanding from subsidiaries of People's Liberation, Inc.
Jonathan Burstein, a former director of the Company, purchases products
from the Company through an entity operated by his spouse. For the three and
nine months ended September 30, 2007 sales to this entity were $24,800 and
$58,500, respectively. Sales to this entity for the three and nine months ended
25
September 30, 2006 were $10,500 and $21,100, respectively. At September 30,
2007, $7,700 was included in accounts receivable from this entity and at
December 31, 2006 accounts receivable included $18,400 due from this entity. On
October 25, 2007, Mr. Burstein resigned as a director of the Company.
Due from related parties at September 30, 2007 includes $736,600 and at
December 31, 2006 includes $675,100 of unsecured notes, advances and accrued
interest receivable from Colin Dyne. The notes and advances bear interest at
7.5% and are due on demand.
Demand notes payable to related parties includes notes and advances to
parties related to or affiliated with Mark Dyne, Chairman of the Board of the
Company. The principal balance of Demand notes payable to related parties at
September 30, 2007 was $85,200 and at December 31, 2006 was $665,000. On June
27, 2007 a note payable to Mark Dyne in the principal amount of $579,795, plus
accrued interest of $424,511, was paid in full.
Consulting fees paid to Diversified Investments, a company owned by
Mark Dyne, amounted to $37,500 for the three months ended September 30, 2007 and
2006. Consulting fees paid for the nine months ended September 30, 2007 and 2006
were $112,500.
Consulting fees of $75,000 and $ 200,100 were paid for services
provided by Colin Dyne for the three months and nine months ended September 30,
2007, respectively. For the three and nine months ended September 30, 2006
consulting fees of $36,000 and $108,000, respectively were paid to Colin Dyne.
Consulting fees of $73,800 and $221,000 were paid for services provided by
Jonathan Burstein, for the three months and nine months ended September 30,
2007, respectively. No consulting fees were paid to Jonathan Burstein in 2006.
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, 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 condensed consolidated financial statements:
o Accounts receivable balances are evaluated on a continual
basis and allowances are provided for potentially
uncollectible accounts based on management's estimate of the
collectibility of customer accounts. If the financial
condition of a customer were to deteriorate, resulting in an
impairment of its ability to make payments, an additional
allowance may be required. Allowance adjustments are charged
to operations in the period in which the facts that give rise
to the adjustments become known.
o 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. 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 and slow-moving
inventory. We use estimates to record these reserves.
Slow-moving inventory is reviewed by category and may be
26
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.
o 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.
o 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 are evaluated on a
continual basis and impairment adjustments are made based upon
management's valuations.
o Sales are recognized when persuasive evidence of an
arrangement exists, product delivery has occurred, 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.
o Upon approval of a restructuring plan by management, we record
restructuring reserves for certain costs associated with
facility closures and business reorganization activities as
they are incurred or when they become probable and estimable.
Such costs are recorded as a current liability. We record
restructuring reserves in compliance with SFAS 146 "Accounting
for Costs Associated with Exit or Disposal Activities",
resulting in the recognition of employee severance and related
termination benefits for recurring arrangements when they
became probable and estimable and on the accrual basis for
one-time benefit arrangements. We record other costs
associated with exit activities as they are incurred. Employee
severance and termination benefits are estimates based on
agreements with the relevant union representatives or plans
adopted by us that are applicable to employees not affiliated
with unions. These costs are not associated with nor do they
benefit continuing activities. Inherent in the estimation of
these costs are assessments related to the most likely
expected outcome of the significant actions to accomplish the
restructuring. Changing business conditions may affect the
assumptions related to the timing and extent of facility
27
closure activities. We review the status of restructuring
activities on a quarterly basis and, if appropriate, record
changes based on updated estimates.
o 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 SFAS No. 5, "Accounting for
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 September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value
measurements, and does not require any new fair value measurements. The
application of SFAS No. 157 however may change current practice within an
organization. SFAS No. 157 is effective for all fiscal years beginning after
November 15, 2007, with earlier application encouraged. We do not believe that
SFAS No. 157 will have a material impact on our financial position, results of
operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115," ("SFAS No. 159") which expands the use of fair value. Under
SFAS No. 159 a company may elect to use fair value to measure accounts and loans
receivable, available-for-sale and held-to-maturity securities, equity method
investments, accounts payable, guarantees, issued debt and other eligible
financial instruments. SFAS No. 159 is effective for years beginning after
November 15, 2007. We do not believe that SFAS No. 159 will have a material
impact on our financial position, results of operations or cash flows.
CAUTIONARY STATEMENTS AND RISK FACTORS
Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In addition to other information contained in this report, readers should
carefully consider the following cautionary statements and risk factors.
WE DO NOT EXPECT TO REGAIN COMPLIANCE WITH AMEX LISTING REQUIREMENTS,
AND WE EXPECT TO BE DELISTED BY THE AMEX AND THAT OUR SHARES WILL NO LONGER BE
TRADED ON THIS EXCHANGE. In May 2006 we were advised by AMEX that we were
non-compliant with the minimum net equity listing requirements and we were
afforded an opportunity to submit a plan to AMEX that provided for increases in
our equity beyond the minimum $4.0 million equity requirement within an
eighteen-month timeframe from the date of the notice from AMEX. On August 3,
2006 AMEX accepted our plan to regain compliance and has given us an extension
until November 16, 2007 to become compliant with the AMEX continued listing
standards. We have suffered substantial operating losses and as of this filing
we have not met the minimum listing requirements of AMEX. As a result, our
shares of common stock may be removed from listing on AMEX.
WE DO NOT EXPECT TO BE ABLE TO COLLECT OUR NOTE RECEIVABLE. On April
11, 2007 a favorable verdict was awarded to the plaintiff in a trademark
infringement lawsuit in which Azteca Production International, Inc. is a
defendant. We have an outstanding note from Azteca of $2.1 million and this
adverse ruling against them has impacted their ability to repay our note
receivable. On September 10, 2007 we obtained further information from the maker
that further evidenced their inability to pay the note, and accordingly we
recorded an impairment reserve for the full value outstanding of $2.1 million.
We will continue to pursue collection through all legal resources available to
us. The failure to collect payments under this note as scheduled will have a
material adverse effect on our financial position, results of operations and
cash flow.
28
OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, 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 Part II, Item 1, "Legal Proceedings" for discussion of this litigation. We
have derived a significant amount of revenues from the sale of products
incorporating the stretch waistband technology. Our business, results of
operations and financial condition could be materially adversely affected if we
are unable to 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 will continue to incur additional legal fees in increasing amounts
as the case accelerates to trial.
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 terminates, it may
have an adverse effect on our results because:
o We will lose a primary source of revenue if these customers
choose not to purchase our products or services;
o We may not be able to reduce fixed costs incurred in
developing the relationship with these customers in a timely
manner;
o We may not be able to recoup setup and inventory costs;
o We may be left holding inventory that cannot be sold to other
customers; and
o We may not be able to collect our receivables from them.
In October 2006, our exclusive supply agreement with Levi Strauss &
Co., pursuant to which we supplied Levi with TEKFIT waistbands for their Dockers
programs, expired. With the expiration of this contract we now have broader
access to other customers and we intend to actively expand this product offering
to other brands. Sales of this product to Levi ended during the third quarter of
2007 and are significantly lower than in the previous year, and orders from new
brands are not expected to fully offset these declines for several quarters, if
at all. The revenues we derived from the sale of products incorporating the
stretch waistband technology represented approximately 19% of our consolidated
revenues for the years ended December 31, 2005 and 2006. A failure to attract
new customers for our TEKFIT waistbands could have a material adverse effect on
our sales and results of operations.
IF CUSTOMERS DEFAULT ON INVENTORY PURCHASE COMMITMENTS WITH US, WE
WILL BE LEFT HOLDING NON-SALABLE INVENTORY. We hold significant 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 significant amounts of non-salable
inventory and this would have a negative impact on our operations and cash flow.
OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS WORSEN. Our
revenues depend on the health of the economy and the growth of our customers and
potential future customers. When economic conditions weaken, certain apparel
manufacturers and retailers, including some of our customers 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 vendors. There can be no assurance
that we will remain a preferred vendor to our existing customers. A decrease in
business from or loss of a major customer could have a material adverse effect
on our results of operations. Further, if the economic conditions in the United
States worsen or if a wider or global economic slowdown occurs, we may
experience a material adverse impact on our business, operating results, and
financial condition.
BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, WE MAY NOT BE ABLE
TO ALWAYS OBTAIN MATERIALS WHEN WE NEED THEM AND WE MAY LOSE SALES AND
CUSTOMERS. Lead times for materials we order can vary significantly and depend
on many factors, including the specific supplier, the contract terms and the
29
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.
WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS
IN OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND
STOCK PRICE VOLATILITY. We operate in an industry that is subject to significant
fluctuations in operating results from quarter to quarter, which may lead to
unexpected reductions in revenues and stock price volatility. Factors that may
influence our quarterly operating results include:
o The volume and timing of customer orders received during the
quarter;
o The timing and magnitude of customers' marketing campaigns;
o The loss or addition of a major customer;
o The availability and pricing of materials for our products;
o The increased expenses incurred in connection with the
introduction of new products;
o Currency fluctuations;
o Delays caused by third parties; and
o Changes in our product mix or in the relative contribution to
sales of our subsidiaries.
Due to these factors, it is possible that in some quarters our
operating results may be below our stockholders' expectations and those of
public market analysts. If this occurs, the price of our common stock 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 Part II, Item 1, "Legal Proceedings"
for a detailed description of this lawsuit.
THE OUTCOME OF 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 a number of 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
intend to contest each lawsuit vigorously, no assurances can be given that the
results of these matters will be favorable to us. An adverse resolution of any
of these lawsuits could have a material adverse effect on our financial position
and results of operations.
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.
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
30
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 adverse effects on
the information reported.
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.
IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL
NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently,
we do not operate duplicate facilities in different geographic areas. Therefore,
in the event of a regional disruption where we maintain one or more of our
facilities, it is unlikely that we could shift our operations to a different
geographic region and we may have to cease or curtail our operations. This may
cause us to lose sales and customers. The types of disruptions that may occur
include:
o Foreign trade disruptions;
o Import restrictions;
o Labor disruptions;
o Embargoes;
o Government intervention;
o Natural disasters; or
o Regional pandemics.
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.
THE REQUIREMENTS OF THE SARBANES-OXLEY ACT, INCLUDING SECTION 404, ARE
BURDENSOME, AND OUR FAILURE TO COMPLY WITH THEM COULD HAVE A MATERIAL ADVERSE
AFFECT ON OUR BUSINESS AND STOCK PRICE. Effective internal control over
financial reporting is necessary for us to provide reliable financial reports
and effectively prevent fraud and safeguard Company assets. Section 404 of the
Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal
control over financial reporting beginning with our annual report on Form 10-K
for the fiscal year ending December 31, 2007. Our independent registered public
accounting firm will need to annually attest to our evaluation, and issue their
own opinion on our internal control over financial reporting beginning with our
annual report on Form 10-K for the fiscal year ending December 31, 2008. We are
preparing for compliance with Section 404 by strengthening, assessing and
testing our system of internal control over financial reporting to provide the
basis for our report. The process of strengthening our internal control over
financial reporting and complying with Section 404 is expensive and time
consuming, and requires significant management attention. Failure to implement
required controls, or difficulties encountered in their implementation, could
cause us to fail to meet our reporting obligations. If we or our auditors
discover a material weakness in our internal control over financial reporting,
the disclosure of that fact, even if the weakness is quickly remedied, could
diminish investors' confidence in our financial statements and harm our stock
price. In addition, non-compliance with Section 404 could subject us to a
variety of administrative sanctions, including the suspension of trading,
ineligibility for listing on one of the national securities exchanges, and the
inability of registered broker-dealers to make a market in our common stock,
which would further reduce our stock price.
31
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 AND WE
MAY BE ADVERSELY IMPACTED BY THESE FALSE CLAIMS. Counterfeiting of valuable
trade names is commonplace in the apparel industry and while there are industry
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, or we may have to pay for false claims.
OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS
AND CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES. The following factors
could cause the market price of our common stock to decrease, perhaps
substantially:
o The failure of our quarterly operating results to meet
expectations of investors or securities analysts;
o Adverse developments in the financial markets, the apparel
industry and the worldwide or regional economies;
o Interest rates;
o Changes in accounting principles;
o Intellectual property and legal matters;
o Sales of common stock by existing shareholders or holders of
options;
o Announcements of key developments by our competitors; and
o 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 INCUR
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
32
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.
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 September 30, 2007, our officers and directors and their affiliates
beneficially owned approximately 20% of the outstanding shares of our common
stock. The Dyne family, which includes Mark Dyne and Colin Dyne who are also our
directors; Jonathan Burstein, Larry Dyne and the estate of Harold Dyne;
beneficially owned approximately 13% of the outstanding shares of our common
stock at September 30, 2007. Additionally, at September 30, 2007 our lender
Bluefin Capital, LLC beneficially owned approximately 16.3% 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.
33
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
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, Chinese yuans and
British pounds. There were no hedging contracts outstanding as of September 30,
2007 or December 31, 2006. 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 September
30, 2007 the Revolving Credit Note of $3.8 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 $38,000 on our
variable rate borrowings.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under the
Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities Exchange Commission's rules and forms, including to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is accumulated and communicated to our management,
including our principal executive and principal financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange
Act.
As of September 30, 2007, we conducted an evaluation, with the
participation of our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that as of September 30, 2007, our disclosure
controls and procedures were effective.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
During the fiscal quarter ended September 30, 2007 there were no
changes in our internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
34
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On October 12, 2005, a shareholder class action complaint -- HUBERMAN
V.TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex) -- was filed against us
and certain of our current and former officers and directors in the United
States District Court for the Central District of California, alleging claims
under Section 10(b) and Section 20 of the Securities Exchange Act of 1934. A
lead plaintiff was appointed, and his amended complaint alleged 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. On February 20, 2007, the Court
denied class certification. On April 2, 2007 the Court granted defendants'
motion for summary judgment, and on or about April 5, 2007, the Court entered
judgment in favor of all defendants. On or about April 30, 2007, plaintiff filed
a notice of appeal, and his opening appellate brief was filed on October 15,
2007. Our brief is currently due November 28, 2007. We believe that this matter
will be resolved favorably on appeal, or in a later trial or in settlement
within the limits of its insurance coverage. However, the outcomes of this
action or an estimate of the potential losses, if any, related to the lawsuit
cannot be reasonably predicted, and an adverse resolution of the lawsuit could
potentially have a material adverse effect on our financial position and results
of operations.
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 the
exclusive rights in certain geographic areas to Pro-Fit's stretch and rigid
waistband technology. On June 5, 2006 the Court denied our motion for partial
summary judgment, but did not find that we breached our agreement with Pro-Fit
and a trial is required to determine issues concerning our activities in
Columbia and whether other actions by Pro-Fit constituted an unwillingness or
inability to fill orders. The Court also held that Pro-Fit was not "unwilling or
unable" to fulfill orders by refusing to fill orders with goods produced in the
United States. The Court has not yet set a date for trial of this matter. We
have historically derived a significant amount of revenue from the sale of
products incorporating the stretch waistband technology and our business,
results of operations and financial condition could be materially adversely
affected if the dispute with Pro-Fit 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 will continue to incur additional legal fees
in increasing amounts as the case accelerates to trial.
We currently have pending a number of other claims, suits and
complaints that arise in the ordinary course of its business. We believe that we
has meritorious defenses to these claims and that the claims are either covered
by insurance or, after taking into account the insurance in place, would not
have a material effect on our consolidated financial condition if adversely
determined against us.
ITEM 1A. RISK FACTORS
A restated description of the risk factors associated with our Company
is included under "Cautionary Statements and Risk Factors" in Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
contained in Item 2 of Part I of this report. This description includes any
material changes to and supersedes the description of the risk factors
associated with an investment in the Company previously disclosed in our Annual
Report on Form 10-K for 2006 as amended and is incorporated herein by reference.
35
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 31, 2007, we held our 2007 annual meeting of stockholders. For
the results of voting at the 2007 annual meeting of stockholders, see Item 8.01
of our Current Report on Form 8-K filed with the Securities and Exchange
Commission on August 3, 2007.
ITEM 6. EXHIBITS
3.1 Certificate of Incorporation of Registrant. Incorporated by
reference to Exhibit 3.1 to Form SB-2 filed on October 21,
1997, and the amendments thereto.
3.1.2 Certificate of Designation of Rights, Preferences and
Privileges of Series A Preferred Stock. Incorporated by
reference to Exhibit A to the Rights Agreement filed as
Exhibit 4.1 to Current Report on Form 8-K filed on November 4,
1998.
3.1.3 Certificate of Amendment of Certificate of Incorporation of
Registrant. Incorporated by reference to Exhibit 3.4 to Annual
Report on Form 10-KSB, filed March 28, 2000.
3.1.4 Certificate of Amendment of Certificate of Incorporation of
Registrant. Incorporated by reference to Exhibit 3.1.3 to Form
8-K filed on August 4, 2006.
3.1.5 Certificate of Ownership and Merger. Incorporated by reference
to Exhibit 3.1 to Form 8-K filed on July 20, 2007.
31.1 Certificate of Chief Executive Officer pursuant to Rule
13a-14(a) under the Securities and Exchange Act of 1934, as
amended.
31.2 Certificate of Chief Financial Officer pursuant to Rule
13a-14(a) under the Securities and Exchange Act of 1934, as
amended.
32.1 Certificate of Chief Executive Officer and Chief Financial
Officer pursuant to Rule 13a-14(b) under the Securities and
Exchange Act of 1934, as amended.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 19, 2007
TALON INTERNATIONAL, INC.
` /S/ LONNIE D. SCHNELL
-----------------------------------------
By: Lonnie D. Schnell
Its: Chief Financial Officer
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