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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of The Securities
Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-13669
TAG-IT PACIFIC, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
21900 BURBANK BLVD., SUITE 270
WOODLAND HILLS, CALIFORNIA 91367
(Address of Principal Executive Offices) (Zip Code)
(818) 444-4100
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
COMMON STOCK, $.001 PAR VALUE AMERICAN STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [_] No [X]
Indicate by check mark if the registration is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [_] No [X]
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
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 June 30, 2005 the aggregate market value of the voting and non-voting common
stock held by non-affiliates of the registrant was $42,684,045. At March 31,
2006 the issuer had 18,376,180 shares of Common Stock, $.001 par value, issued
and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the issuer's proxy statement with respect to its 2006 annual meeting
of stockholders are incorporated by reference into Part III of this report.
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TAG-IT PACIFIC, INC.
INDEX TO FORM 10-K
PART I PAGE
Item 1. Business................................................... 1
Item 1A. Risk Factors .............................................. 7
Item 1B. Unresolved Staff Comments ................................. 12
Item 2. Properties................................................. 13
Item 3. Legal Proceedings.......................................... 13
Item 4. Submission of Matters to a Vote of Security Holders........ 14
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities....................................... 15
Item 6. Selected Financial Data.................................... 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 18
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk ............................................ 32
Item 8. Financial Statements and Supplementary Data.............. 33
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................... 70
Item 9A. Controls and Procedures.................................... 70
Item 9B. Other Information.......................................... 71
PART III
Item 10. Directors and Executive Officers of the Registrant......... 72
Item 11. Executive Compensation..................................... 72
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.............. 72
Item 13. Certain Relationships and Related Transactions............. 72
Item 14. Principal Accountant Fees and Services..................... 72
PART IV
Item 15. Exhibits and Financial Statement Schedules................. 72
PART I
ITEM 1. BUSINESS
GENERAL
Tag-It Pacific is an apparel company that specializes in the
distribution of a full range of apparel zippers and trim items to manufacturers
of fashion apparel, specialty retailers and mass merchandisers. We manufacture
and distribute zippers under our TALON brand name to manufacturers for apparel
brands and retailers such as Levi Strauss & Co., Wal-Mart and JC Penny, among
others. We act as a full service outsourced trim design, sourcing and management
department for manufacturers of fashion apparel such as Abercrombie & Fitch and
Kellwood. We also serve as a specified supplier of trim items to owners of
specific brands, brand licensees and retailers, including Levi Strauss & Co.,
Express, The Limited, Lerner, Mother's Work and Miller's Outpost, among others.
In our TEKFIT division, we develop and sell apparel components that utilize the
patented Pro-Fit technology, including a stretch waistband sold to Levi Strauss
& Co.
We were incorporated in the State of Delaware in 1997. We were formed
to serve as the parent holding company of Tag-It, Inc., a California
corporation, Tag-It Printing & Packaging Ltd., which changed its name in 1999 to
Tag-It Pacific (HK) LTD, a BVI corporation, Tagit de Mexico, S.A. de C.V.,
A.G.S. Stationery, Inc., a California corporation, and Pacific Trim & Belt,
Inc., a California corporation. All of these companies were consolidated under a
parent limited liability company in October 1997. These companies became our
wholly owned subsidiaries immediately prior to the effective date of our initial
public offering in January 1998. In 2000, we formed two wholly owned
subsidiaries of Tag-It Pacific, Inc: Tag-It Pacific Limited, a Hong Kong
corporation, and Talon International, Inc., a Delaware corporation. Our Web site
is WWW.TAGITPACIFIC.COM. Our Web site address provided in this Annual Report on
Form 10-K is not intended to function as a hyperlink and the information on our
website is not and should not be considered part of this report and is not
incorporated by reference in this document.
BUSINESS SUMMARY
We operate our business within three product groups, Talon, Trim, and
Tekfit. In our Talon group, we design, engineer, test and distribute zippers
under our TALON trademark and trade names to apparel brands and manufacturers.
TALON enjoys brand recognition in the apparel industry worldwide. TALON is a
100-year-old brand, which is well known for quality and product innovation.
TALON was the original pioneer of the formed wire metal zipper for the jeans
industry and is a specified zipper brand for manufacturers in the sportswear and
outerwear markets. We have introduced a revised line of high quality zippers,
broadened distribution to Asia, Mexico and Central America and initiated a new
sales and marketing effort for this brand. We have also developed, and are now
implementing, what we refer to as our TALON franchise strategy, whereby we
appoint suitable distributors in various geographic international regions to
finish and sell zippers under the TALON brand name. Our distributors purchase
and install locally equipment for dying and producing finished zippers. We
expect this program to significantly expand the geographic footprint of our
TALON products. TALON is promoted both within our trim packages, as well as a
stand-alone product line.
In our Trim products group, we have positioned ourselves as a fully
integrated single-source supplier, designer and sourcing agent of a full range
of trim items for manufacturers of fashion apparel. Our business focuses on
servicing all of the trim requirements of our customers at the manufacturing and
retail brand level of the fashion apparel industry. Trim items include labels,
buttons, rivets, printed marketing material, polybags, packing cartons, and
hangers. Trim items comprise a relatively small part of the cost of most apparel
products but comprise the vast majority of components necessary to fabricate a
typical apparel product. We offer customers a one-stop outsourced service for
all trim related matters. Our teams work with the apparel designers, and
function as an extension of their staff. We are responsible for creating sample
designs for all the trim our clients require.
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For example, if one of our customers is creating a new pair of cargo
pants for their fall collection, we will collaborate with them on their design
vision, then present several examples of their vision in graphic form for all
trim components. We will design the buttons, snaps, hang tags, labels, zipper
pullers and other items. Once our customer selects the designs they like, our
sourcing team will review our proprietary database of manufacturers worldwide to
find the best manufacturers for the type of items being produced. The sourcing
is a critical part of our service. Knowing exactly where to go for proper paper
finishes, distressing or other types of material needs and manufacturing
techniques is critical. Because we perform this function for many different
global projects and apparel brands, we have a depth and breadth of knowledge in
sourcing that our customers can not achieve, and therefore offer a significant
value to our customers. In addition, because we are consistently innovating new
items, manufacturing techniques and finishes, we bring many new, fresh and
unique trim ideas to our customers. Once we find the appropriate manufacturers,
we create production samples of all of our designs, and review the samples with
our customers so they can make a final decision while looking at the actual
items that will be used on the garments. Once our customer selects the
appropriate items, we are nominated as the sole-source trim supplier for the
project, and all of our customer's factories are then required to purchase their
trim from us. Throughout the garment manufacturing process, Tag-It is
consistently monitoring the timing and accuracy of the production items to
ensure the production items exactly match all samples when delivered to our
customer's apparel factories.
We also serve as a specified supplier for a variety of major retail
brand and private label oriented companies. A specified supplier is a supplier
that has been approved for quality and service by a major retail brand or
private label company. Contractors manufacturing for the retail brand or private
label company must purchase their trim requirements from a supplier that has
been specified. We seek to expand our services as a vendor of select lines of
trim items for such customers, to being a preferred or single source provider of
all of such brand customer's authorized trim requirements. Our ability to offer
brand name and private label oriented customers a full range of trim products is
attractive because it enables our customers to address their quality and supply
needs for all of their trim requirements from a single source, avoiding the time
and expense necessary to monitor quality and supply from multiple vendors and
manufacturer sources. Becoming a specified supplier to brand customers gives us
an advantage to become the preferred or sole vendor of trim items for all
manufacturers of apparel under that brand name.
Our team of sales representatives, program managers, creative design
personnel and global production and distribution coordinators at our facilities
located in the United States, China and the Caribbean enable us to take
advantage of and address the increasingly complicated requirements of the large
and expanding demand for complete trim packages. We plan to continue to expand
operations in Asia, Europe, Central and South America and the Caribbean to take
advantage of the large apparel manufacturing markets in these regions.
PRODUCTS
TALON BRAND ZIPPERS. We offer a full line of metal and synthetic
zippers bearing the TALON brand name. TALON zippers are used primarily by
manufacturers in the apparel industry and are distributed through our
distribution facilities in the United States, Mexico and China and through
distributors, who we refer to as franchisees, in other international markets.
We are negotiating with several distributors and agents that service
local markets in Asia, Africa and the Middle East, and are establishing several
non-exclusive relationships to service these markets. Previously, we had
established franchises with specific geographic territories. However, in the
fourth quarter of 2005 we modified our strategy to a non-exclusive model,
allowing our agents and franchises to operate on a non-exclusive basis. We are
continuing to negotiate with distributors that service local apparel
manufacturing regions in the United States and overseas, and this strategy will
be a significant focus in 2006. We offer manufacturers technologically advanced
equipment for efficiently handling TALON zippers and applying them into
garments. The branded apparel zipper market is dominated by one company and we
are positioning TALON to be a viable global alternative to this competitor and
capture an increased market share position. We
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plan to leverage the brand awareness of the TALON name by branding other
products in our line with the TALON name.
MANAGED TRIM SOLUTION. We consider a high level of customer service
essential to our success. We combine our high level of customer service with our
MANAGED TRIM SOLUTION to offer our customers a complete trim service product. We
believe this full-service product gives us a competitive edge over companies
that only offer selected trim components because our MANAGED TRIM SOLUTION saves
our customers time and work hours in ordering, designing, sampling and managing
trim orders from several different suppliers. Our MANAGED TRIM SOLUTION is a
trim development system that allows us to provide our customers with a
customized, comprehensive system for the management of virtually all aspects of
their trim programs. Our proprietary TRIMNET software, a web based e-sourcing
system, has allowed us to seamlessly supply complete trim packages to apparel
brands, retailers and manufacturers around the world over the past several
years.
We produce customized woven, leather, synthetic, embroidered and
novelty labels and tapes, which can be printed on or woven into a wide range of
fabrics and other materials using various types of high-speed equipment. As an
additional service, we may lease to our customers the machinery used to attach
the buttons, rivets and snaps we distribute.
In 2005 we marketed and supplied our customers with complete trim
packages on a per-garment basis which we assembled on behalf of our customers.
Each trim package included all items of trim that a customer needed in the
manufacture of a particular item of apparel. Our complete trim packages included
a variety of trim items including thread, zippers, labels, buttons, rivets,
polybags, packing cartons and hangers. We also included in our trim packages
printed marketing materials including hang tags, bar-coded hang tags, pocket
flashers, waistband tickets and size stickers that were attached to products to
identify and promote the products, permit automated data collection, provide
brand identification and communicate consumer information such as a product's
retail price, size, fabric content and care instructions. We plan to continue to
sell the trim package components separately, but phase-out the offering as a
complete kit as our cost of labor for the assembly is no longer competitive, and
the market is not willing to pay the premium for pre-assembly of the trim
material. In 2005 we also decided to discontinue offering thread as a portion of
our trim products and we negotiated an agreement with our major supplier for the
return of substantially all of the company's thread products. We instead, are
sharpening our focus on the market opportunity in which we add the most value,
our MANAGED TRIM SOLUTION.
TEKFIT. We distribute a proprietary stretch waistband under our
Exclusive License and Intellectual Property Rights agreement with Pro-Fit
Holdings, Limited ("Pro-Fit"). The agreement gives us the exclusive rights to
sell or sublicense stretch waistbands manufactured under the patented technology
developed by Pro-Fit for garments manufactured anywhere in the world for the
U.S. market and for all U.S. brands for the life of the patent and its related
know-how. We offer apparel manufacturers advanced, patented fabric technologies
to utilize in their garments under the TEKFIT name. This technology allows
fabrics to be altered through the addition of stretch characteristics resulting
in greatly improved fit and comfort. Currently, we are supplying Levi Strauss &
Co. with TEKFIT waistbands for their Dockers(R) programs. Our exclusive supply
arrangement with Levi Strauss & Co. is for twill type pants only. This
technology allows pant manufacturers to build in a stretch factor into standard
waistbands that does not alter the appearance of the garment, but will allow the
waist to stretch out and back by as much as two waist sizes.
We are presently in litigation with Pro-Fit relating to our rights
under the agreement, as described more fully in Item 3 "Legal Proceedings"
below. As we derive a significant amount of revenue from the sale of products
incorporating the stretch waistband technology, our business, results of
operations and financial condition could be materially adversely affected if our
dispute with Pro-Fit is not resolved in a manner favorable to us.
DESIGN AND DEVELOPMENT
Our in-house creative team produces products with innovative technology
and designs that we believe distinguish our products from those of our
competitors. We support our skills and expertise in
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material procurement and product-manufacturing coordination with product
technology and designs intended to meet fashion demands, as well as functional
and cost parameters. Many specialty design companies with which we compete have
limited sourcing or manufacturing experience. These companies create designs
that often cannot be implemented due to difficulties in the manufacturing
process, the expenses of required materials, or a lack of functionality in the
resulting product. We design products to function within the limitations imposed
by the applicable manufacturing framework. Using our manufacturing and sourcing
experience, we minimize the time-consuming delays that often arise in
coordinating the efforts of independent design houses and manufacturing
facilities. By supporting our material procurement and product manufacturing
services with design services, we believe that we reduce development and
production costs and deliver products to our customers sooner than many of our
competitors. Our development costs are low, most of which are borne by our
customers. Our design teams are based out of our California and Hong Kong
facilities.
CUSTOMERS
We have more than 300 active customers. Our customers include the
designated suppliers of well-known apparel manufacturers, such as Levi Strauss &
Co., The Limited Group, Mother's Work, Kellwood, and VF Corporation, among
others. Our customers also include contractors for specialty retailers such as
Miller's Outpost and mass merchant retailers such as Wal-Mart.
In 2002, we entered into an exclusive supply contract with Levi Strauss
& Co. Under the terms of the supply agreement, Levi Strauss & Co. agreed to
purchase a minimum of $10 million of TEKFIT stretch waistbands, various other
trim products, garment components and services over the two-year term of the
agreement. On July 16, 2004, we amended our exclusive supply agreement with Levi
Strauss & Co. to provide for an additional two-year term through November 2006.
Levi Strauss & Co. also appointed TALON as an approved zipper supplier.
For the year ended December 31, 2005, no single customer represented
more than 10% of our consolidated net sales; however, our three largest
customers represented approximately 22% of our consolidated net sales. Two major
customers accounted for approximately 22% of our net sales for the year ended
December 31, 2004. Three major customers, two of which were related parties,
accounted for approximately 64% of our consolidated net sales for the year ended
December 31, 2003.
Our results of operations will depend to an extent upon the commercial
success of these customers. If these customers fail to purchase trim products at
anticipated levels, or the relationship terminates, it may have an adverse
affect on our results of operations. If the financial condition of these
customers were to deteriorate, resulting in an impairment of their ability to
purchase inventories or repay receivables, it may also have an adverse affect on
our results of operations. The financial position and operations of these
customers are monitored on an ongoing basis. United States export sales are not
a significant part of our business. Backlogs are not considered material in the
industries in which we compete.
SALES AND MARKETING
We sell our principal products through our own sales force based in Los
Angeles, California, various other cities in the United States, Hong Kong,
China, Taiwan and Mexico. We also employ customer service representatives who
are assigned to key customers and provide in-house customer service support. Our
senior executives have developed relationships with our major customers at
senior levels. These executives actively participate in marketing and sales
functions and the development of our overall marketing and sales strategies.
When we become the outsourcing vendor for a customer's packaging or trim
requirements, we position ourselves as if we are an in-house department of the
customer's trim procurement operation.
SOURCING AND ASSEMBLY
We have developed expertise in identifying high quality materials,
competitive prices and approved vendors for particular products and materials.
This expertise enables us to produce a broad range of
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packaging and trim products at various price points. The majority of products
that we procure and distribute are purchased on a finished good basis. Raw
materials, including paper products and metals used to manufacture zippers, used
in the assembly of our trim kits are available from numerous sources and are in
adequate supply. We purchase products from several qualified material suppliers.
We create most product artwork and any necessary dies and molds used to
design and manufacture our products. All other products that we design and sell
are produced by third party vendors. We are confident in our ability to secure
high quality alternative manufacturing sources. We intend to continue to
outsource production to qualified vendors, particularly with respect to
manufacturing activities that require substantial investment in capital
equipment.
Through our Hong Kong facility, we distribute TALON zippers, trim items
and apparel packaging and coordinate the manufacture and distribution of the
full range of our products. Our Hong Kong facility supplies several significant
packaging programs, services customers located in Asia and the Pacific Rim and
sources products for our Los Angeles and Mexico based operations.
INTELLECTUAL PROPERTY RIGHTS AND LICENSES
We have trademarks as well as copyrights, software copyrights and trade
names for which we rely on common law protection, including the TALON trademark.
Several of our other trademarks are the subject of applications for federal
trademark protection through registration with the United States Patent and
Trademark Office, including "Tag-It", "Managed Trim Solution" and "TekFit". We
also rely on our Exclusive License and Intellectual Property Rights agreement
with Pro-Fit to sell our TEKFIT Stretch waistbands. The agreement gives us the
exclusive rights to sell or sublicense stretch waistbands manufactured under the
patented technology developed by Pro-Fit for garments manufactured anywhere in
the world for the U.S. market and for all U.S. brands, for an indefinite term
that extends for the duration of the patent and trade secrets licensed under the
agreement. We are presently in litigation with Pro-Fit relating to our rights
under the agreement, as described more fully elsewhere in this report.
SEASONALITY
We typically experience seasonal fluctuations in sales volume. These
seasonal fluctuations result in sales volume decreases in the first and fourth
quarters of each year due to the seasonal fluctuations experienced by the
majority of our customers. The apparel industry typically experiences higher
sales volume in the second quarter in preparation for back-to-school purchases,
and the third quarter in preparation for year-end holiday purchases.
INVENTORIES
In order to meet the rapid delivery requirements of our customers, we
may be required to purchase inventories based upon projections made by our
customers. In these cases we may carry a substantial amount of inventory on
their behalf. We attempt to manage this risk by obtaining customer commitments
to purchase any excess inventories. These buyback arrangements provide that in
the event that inventories remain with us in excess of six to nine months from
our receipt of the goods from our vendors or the termination of production of a
customer's product line related to the inventories, the customer is required to
purchase the inventories from us under normal invoice and selling terms. While
these agreements provide us some advantage in the negotiated disposition of
these inventories, we cannot be assured that our customers will complete these
agreements or that we can enforce these agreements without adversely affecting
our business operations.
COMPETITION
We compete in highly competitive and fragmented industries that include
numerous local and regional companies that provide some or all of the products
we offer. We also compete with United States and international design companies,
distributors and manufacturers of tags, trim, packaging products and
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zippers. Some of our competitors, including Paxar Corporation, YKK (R),
Universal Button, Inc., Avery Denison Corporation and Scovill Fasteners, Inc.
have greater name recognition, longer operating histories and greater financial
and other resources.
Because of our integrated materials procurement and assembly
capabilities and our full service MANAGED TRIM SOLUTION, we believe that we are
able to effectively compete for our customers' business, particularly where our
customers require coordination of separately sourced production functions. We
believe that to successfully compete in our industry we must offer superior
product pricing, quality, customer service, design capabilities, delivery lead
times and complete supply-chain management. We also believe the TALON brand name
and the quality of our TALON brand zippers will allow us to gain market share in
the zipper industry. The unique stretch quality of our TEKFIT waistbands will
also allow us to compete effectively in the market for waistband components.
SEGMENT INFORMATION
We operate primarily in one industry segment, the distribution of a
full range of apparel zipper and trim products to manufacturers of fashion
apparel, specialty retailers and mass merchandisers.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREA
We sell the majority of our products to U.S. based brands, retailers
and manufacturers. The majority of these customers produce their products or
outsource the production of their products in manufacturing facilities located
outside of the U.S., primarily in Asia, Mexico, the Dominican Republic and
Central and South America.
A summary of our domestic and international net sales and long-lived
assets is set forth in Item 8, "Notes to consolidated financial statements",
Note 15. Approximately 81% of our overall net sales came from sales to U.S.
based or contract manufacturers' facilities located outside of the United States
during the year ended December 31, 2005.
We are subject to certain risks referred to in Item 1A, "Risk Factors"
and Item 3, "Legal Proceedings", including those normally attending
international and domestic operations, such as changes in economic or political
conditions, currency fluctuations, foreign tax claims or assessments, exchange
control regulations and the effect of international relations and domestic
affairs of foreign countries on the conduct of business, legal proceedings, and
the availability and pricing of raw materials.
EMPLOYEES
As of December 31, 2005, we had approximately 131 full-time employees
including 41 in the United States, 65 employees in Hong Kong, 6 employees in the
Dominican Republic, and 19 employees in Mexico. Our labor forces are non-union.
We believe that we have satisfactory employee and labor relations.
CORPORATE GOVERNANCE AND INFORMATION RELATED TO SEC FILINGS
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and amendments to those reports filed with, or
furnished to, the Securities and Exchange Commission ("SEC") pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of
charge through our Web site, www.tagitpacific.com (in the "Investor Relations"
section, as soon as reasonably practical after electronic filing with or
furnishing of such material to the SEC.) We make available at the Web site our
(i) shareholder communications policies, (ii) Code of Ethical Conduct, (iii) the
charters of the Audit and Nominating Committees of our Board of Directors, and
(iv) Employee Complaint Procedures for Accounting and Auditing Matters. These
materials are also available free of charge in print to stockholders who request
them by writing to: Investor Relations, Tag-It Pacific, Inc., 21900 Burbank
Boulevard, Suite 270, Woodland Hills, CA 91367. Our Web site address provided in
this Annual Report on
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Form 10-K is not intended to function as a hyperlink and the information on our
website is not and should not be considered part of this report and is not
incorporated by reference in this document.
ITEM 1A. RISK FACTORS
Several of the matters discussed in this document contain
forward-looking statements that involve risks and uncertainties. Factors
associated with the forward-looking statements that could cause actual results
to differ from those projected or forecast are included in the statements below.
In addition to other information contained in this report, readers should
carefully consider the following cautionary statements and risk factors.
OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY
EFFECTED IF WE ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING
OUR RIGHTS UNDER OUR EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY AGREEMENT
("AGREEMENT") WITH PRO-FIT. Pursuant to our agreement with Pro-Fit Holdings,
Limited, we have exclusive rights in certain geographic areas to Pro-Fit's
stretch and rigid waistband technology. We are in litigation with Pro-Fit
regarding our rights. See Item 3, "Legal Proceedings" for discussion of this
litigation. We derive a significant amount of revenues from the sale of products
incorporating the stretch waistband technology. Our business, results of
operations and financial condition could be materially adversely affected if we
are unable to conclude our present negotiations in a manner acceptable to us and
ensuing litigation is not resolved in a manner favorable to us. 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.
FAILURE TO MANAGE OUR CORPORATE RESTRUCTURING COULD IMPAIR OUR
BUSINESS. In an effort to better align our organizational and cost structures
with our future growth opportunities, in August 2005 our Board of Directors
adopted a restructuring plan for our company that we believe was substantially
completed by December 31, 2005. The plan included restructuring our global
operations by eliminating redundancies in our Hong Kong operation, closing our
Mexican facilities, converting our Guatemala facility from a manufacturing site
to a distribution center, and closing our North Carolina manufacturing facility.
We have also refocused our sales efforts on higher margin products, which may
result in lower net sales over the next twelve months.
While we expect that the restructuring will result in reduced operating
costs and improved operating results and cash flows, there can be no assurance
that these results will be achieved. We recorded restructuring costs during 2005
of $6.4 million. We face many challenges related to our decision to implement
this restructuring plan, including that we may not execute the restructuring
effectively, and our expectation that we will benefit from greater efficiencies
may not be realized. Any failure on our part to successfully manage these
challenges or other unanticipated consequences may result in the loss of
customers and sales, which could cause our results to differ materially from our
current expectations. The challenges we face include:
o Our ability to execute successfully through business cycles
while we continue to implement the restructuring plan and cost
reductions;
o Our ability to meet and achieve the benefits of our
cost-reduction goals and otherwise successfully adapt our cost
structures to continuing changes in business conditions;
o The risk that our cost-cutting initiatives will impair our
ability to develop products and remain competitive and to
operate effectively;
o We may experience delays in implementing our restructuring
plan and incur additional costs;
o We may experience decreases in employee morale; and
o We may experience unanticipated expenses winding down
manufacturing operations, including labor costs, which may
adversely affect our results of operations in the short term.
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WE MAY BE UNABLE TO CONTINUE AS A GOING CONCERN IF WE DO NOT
SUCCESSFULLY ACHIEVE CERTAIN OBJECTIVES. If we are unable to successfully fully
implement our restructuring initiative, or collect the note receivable, or
experience greater than anticipated reductions in sales, we may need to raise
additional capital or further reduce the scope of our business 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 our failure to
implement our restructuring initiative in accordance with our plan, or fail to
achieve other operating objectives, we may be otherwise unable to achieve our
goals or continue our operations. Our auditors have included in their report on
our financial statements for the year ending December 31, 2005 an explanatory
paragraph expressing substantial doubt about our ability to continue as a going
concern.
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 affect on our results because:
o We will lose a primary source of revenue if these customers
choose not to purchase our products or services;
o We may not be able to reduce fixed costs incurred in
developing the relationship with these customers in a timely
manner;
o We may not be able to recoup setup and inventory costs;
o We may be left holding inventory that cannot be sold to other
customers; and
o We may not be able to collect our receivables from them.
CONCENTRATION OF RECEIVABLES FROM OUR LARGER CUSTOMERS MAKES RECEIVABLE
BASED FINANCING DIFFICULT AND INCREASES THE RISK THAT IF OUR LARGER CUSTOMERS
FAIL TO PAY US, OUR CASH FLOW COULD BE SEVERELY AFFECTED. Our business relies
heavily on a relatively small number of customers. This concentration of our
business reduces the amount we can borrow from our lenders under receivables
based financing agreements. If we are unable to collect any large receivables
due us, our cash flow would be severely impacted.
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
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
8
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 Item 3, "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 AFFECT 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 affect 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. 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
integrate the information systems of our Hong Kong facility with the
9
information systems of our principal offices in California. Our failure to do so
could result in lost revenues, delay financial reporting or adversely affect
availability of funds under our credit facilities.
THE LOSS OF KEY MANAGEMENT AND SALES PERSONNEL COULD ADVERSELY AFFECT
OUR BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE
SALES. Our success has and will continue to depend to a significant extent upon
key management and sales personnel, many of whom would be difficult to replace.
In connection with our restructuring, we significantly reduced the number of
employees within our company, which has increased our reliance on those
employees that have remained with the company. 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 HOST OUR MANAGED TRIM SOLUTION MAY
EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. Our
MANAGED TRIM SOLUTION is an Internet-based business-to-business e-commerce
system. To the extent that we fail to adequately continue to update and maintain
the hardware and software implementing the system, our customers may experience
interruptions in service 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 customers' ability to use the
MANAGED TRIM SOLUTION to monitor and manage various aspects of their trim needs.
Such defects or interruptions could result in lost revenues and lost customers.
THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND
SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL
BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented
industries with numerous local and regional companies that provide some or all
of the products and services we offer. We compete with national and
international design companies, distributors and manufacturers of tags,
packaging products, zippers and other trim items. Some of our competitors 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
10
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.
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 ASSUME
ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE
DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may
include expansion through internal growth, by acquiring complementary businesses
or by establishing strategic relationships with targeted customers and
suppliers. In order to do so or to fund our other activities, we may issue
additional equity securities that could dilute our stockholders' value. We may
also assume additional debt and incur impairment losses to our intangible assets
if we acquire another company.
IF WE ARE NOT ABLE TO REGAIN COMPLIANCE WITH LISTING REQUIREMENTS, OUR
SHARES MAY BE REMOVED FROM LISTING ON AMEX. We have been advised by AMEX that we
are non-compliant with certain listing requirements related to the number of
independent board members, and the number of members on our audit committee. The
AMEX has allowed the company until July 28, 2006 to regain compliance with these
matters. We have also suffered substantial recurring losses and may fail to
comply with other listing requirements of AMEX. We may not be able to regain
compliance with these matters within the time allowed by the exchange, and our
shares of common stock may be removed from the listing on AMEX.
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.
11
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. See Item 3
"Legal Proceedings" for discussion of certain tax claims.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE
PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue
additional shares of preferred stock and some provisions of our certificate of
incorporation and bylaws and of Delaware law could make it more difficult for a
third party to make an unsolicited takeover attempt of us. These anti-takeover
measures may depress the price of our common stock by making it more difficult
for third parties to acquire us by offering to purchase shares of our stock at a
premium to its market price.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD
LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As
of March 31, 2006, our officers and directors and their affiliates beneficially
owned approximately 10.5% of the outstanding shares of our common stock. The
Dyne family, which includes Mark Dyne, Colin Dyne, and Jonathan Burstein, who
are also our directors; Larry Dyne and the estate of Harold Dyne; beneficially
owned approximately 12.7% of the outstanding shares of our common stock at March
31, 2006. As a result, our 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
12
ITEM 2. PROPERTIES
Our headquarters are located in the greater Los Angeles area, in
Woodland Hills, California, where we lease approximately 8,800 square feet of
administrative and product development space. In addition to the Woodland Hills
facility, we lease 675 square feet of office space in Columbus, Ohio; 54,000
square feet of warehouse space in Gastonia, North Carolina; 5,400 square feet of
office and warehouse space in Kwun Tong, Hong Kong; 4,100 square feet of
warehouse space in Santiago, Dominican Republic; and 50,000 square feet of
warehouse, distribution and administration space in Puebla, Mexico. The lease
agreements related to these properties expire at various dates through September
2010. We also own a building with 41,650 square feet of manufacturing and
warehouse space in Kings Mountain, North Carolina, which is being held for sale.
We believe our existing facilities are adequate to meet our needs for the
foreseeable future.
ITEM 3. 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, as amended,
and Rule 10b-5 promulgated thereunder. The action is brought on behalf of all
purchasers of our publicly-traded securities during the period from November 14,
2003 to August 12, 2005. On January 23, 2006 the court heard competing motions
for appointment of lead plaintiff/counsel and appointed Seth Huberman as lead
plaintiff. The lead plaintiff thereafter filed an amended complaint on March 13,
2006. The amended complaint alleges that defendants made false and misleading
statements about the company's financial situation and its relationship with
certain of its large customers during a purported class period between November
13, 2003 and August 12, 2005. It purports to state claims under Section
10(b)/Rule 10b-5 and Section 20(a) of the Securities Exchange Act of 1934. We
intend to file a motion to dismiss the amended complaint, which motion is
scheduled to be heard on June 19, 2006. Pursuant to the Private Securities
Litigation Reform act, discovery is stayed in the case. Although we believe that
we and the other defendants have meritorious defenses to the class action
complaint and intend to contest the lawsuit vigorously, an adverse resolution of
any of the lawsuit could have a material adverse effect on our financial
position and results of operations. At this early stage of the litigation, we
are not able to reasonably predict the outcome of this action or estimate
potential losses, if any, related to the lawsuit.
We have filed suit against Pro-Fit Holdings, Limited in the U.S.
District Court for the Central District of California -- TAG-IT PACIFIC, INC. V.
PRO-FIT HOLDINGS, LIMITED, CV 04-2694 LGB (RCx) -- based on various contractual
and tort claims relating to our exclusive license and intellectual property
agreement, seeking declaratory relief, injunctive relief and damages. The
agreement with Pro-Fit gives us the exclusive rights in certain geographic areas
to Pro-Fit's stretch and rigid waistband technology. Pro-Fit filed an answer
denying the material allegations of the complaint and filed a counterclaim
alleging various contractual and tort claims seeking injunctive relief and
damages. We filed a reply denying the material allegations of Pro-Fit's
pleading. Pro-Fit has since purported to terminate the exclusive license and
intellectual property agreement based on the same alleged breaches of the
agreement that are the subject of the parties' existing litigation, as well as
on an additional basis unsupported by fact. In February 2005, we amended our
pleadings in the litigation to assert additional breaches by Pro-Fit of its
obligations us under the agreement and under certain additional letter
agreements, and for a declaratory judgment that Pro-Fit's patent No. 5,987,721
is invalid and not infringed by us. Thereafter, Pro-Fit filed an amended answer
and counterclaim denying the material allegations of the amended complaint and
alleging various contractual and tort claims seeking injunctive relief and
damages. Pro-Fit further asserted that we infringed its United States Patent
Nos. 5,987,721 and 6,566,285. We filed a reply denying the substantive
allegations of the reply. At our request, the Court bifurcated the contract
issues for trial which was scheduled to commence on January 10, 2006 but has
since been postponed by the Court. The parties have filed summary judgment
motions which may dispose of some of the issues in this case prior to trial. The
remaining issues will be tried at a later date. We derive a significant amount
of revenue from the sale of products incorporating the stretch waistband
technology, our business, results of operations and financial condition could be
materially adversely affected if the dispute
13
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.
In December 2005 a lawsuit was filed against us in the United States
District Court, Central District of California -- TODO TEXTIL, S.A. V. TAG-IT
PACIFIC, INC., TALON INTERNATIONAL, INC., COLIN DYNE, JONATHAN MARKILES, ET AL.,
Case No. CV05-8498 MMM (RCx) in which the claimant alleges we breached an
operating contract with the plaintiff. This matter is in the initial stages of
litigation and we believe it is without merit and that there will not be a
material affect on us.
A subsidiary, Tag-It de Mexico, S.A. de C.V., was operating 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, Tag-It filed a procedural opposition to the claim and, in December of
2005, 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 has failed to respond to the opposition filed, and
the required response period has lapsed. In addition, a controlled entity
incorporated in Mexico (Logistica en Avios, S.A. de C.V.) through which Tag-It
conducts its operations, 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. Tag-It believes that the
claim is defective on both procedural and documentary grounds and does not
believe there will be a material adverse affect on us.
We currently have pending a number of other claims, suits and
complaints that arise in the ordinary course of our business. We believe that we
have meritorious defenses to these claims and that the claims are either covered
by insurance or, after taking into account the insurance in place, would not
have a material effect on our consolidated financial condition if adversely
determined against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
fourth quarter of 2005.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
COMMON STOCK
Tag-It Pacific's Common Stock is traded on the American Stock Exchange
under the symbol "TAG." The following table sets forth the high and low sales
prices for the Common Stock as reported by the American Stock Exchange.
HIGH LOW
---- ---
YEAR ENDED DECEMBER 31, 2005
1st Quarter..................... $ 5.45 $ 4.24
2nd Quarter...................... 4.10 2.11
3rd Quarter...................... 2.11 0.79
4th Quarter...................... 0.89 0.29
YEAR ENDED DECEMBER 31, 2004
1st Quarter..................... $ 6.14 $ 4.30
2nd Quarter..................... 5.99 4.20
3rd Quarter..................... 4.35 3.09
4th Quarter..................... 4.58 2.81
On March 31, 2006, the closing sales price of our Common Stock as
reported on the American Stock Exchange was $0.81 per share. As of March 31,
2006, there were 1,333 record holders of our Common Stock.
DIVIDENDS
We have never paid dividends on our Common Stock. We are restricted
from paying dividends under our Secured Convertible Promissory Notes until such
notes are fully paid or converted to Common Stock. It is our intention to retain
any future earnings for use in our business.
UNREGISTERED SALES OF EQUITY SECURITIES
During the first quarter of 2006, we granted non-qualified options to
purchase shares of our commons stock to the following executive officers:
o As of January 16, 2006, we granted Stephen P. Forte, our Chief
Executive Officer, an option to purchase 900,000 shares of
common stock at an exercise price of $0.37 per share, which
vests over a period of three years;
o As of January 26, 2006, we granted Lonnie D. Schnell, our
newly appointed Chief Financial Officer, an option to purchase
400,000 shares of common stock at an exercise price of $0.59
per share, which vests over a period of four years; and
o As of March 1, 2006, we granted Wouter van Biene, our newly
appointed Chief Operating Officer, an option to purchase
325,000 shares of common stock at an exercise price of $0.53
per share, which vests over a period of three years.
15
Each of the foregoing option grants were issued as an inducement to
employment pursuant to AMEX Company Guide Section 711(a), and were approved by
our Board of Directors, including a majority of the independent directors. The
issuances of these options were exempt from the registration and prospectus
delivery requirements of the Securities Act pursuant to Section 4(2) of the
Securities Act.
16
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is not necessarily indicative of
our future financial position or results of future operations, and should be
read in conjunction with Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Consolidated Financial
Statements and Notes thereto included in Item 8, "Financial Statements and
Supplementary Data" of this Report on Form 10-K.
YEARS ENDED DECEMBER 31,
(In thousands except per share data)
2001(1) 2002 2003(1) 2004(1,2) 2005(1)
-------- -------- -------- -------- --------
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenue ............................... $ 43,568 $ 60,073 $ 64,443 $ 55,109 $ 47,331
Income (loss) from operations ............... $ (253) $ 3,044 $ (5,881) $(14,527) $(27,409)
Net income (loss) ........................... $ (1,226) $ 1,496 $ (4,745) $(17,609) $(29,538)
Net income (loss) per share - basic ......... $ (0.16) $ 0.14 $ (0.46) $ (1.02) $ (1.62)
Net income (loss) per share - diluted ....... $ (0.16) $ 0.14 $ (0.46) $ (1.02) $ (1.62)
Weighted average shares outstanding - basic . 8,017 9,232 10,651 17,316 18,226
Weighted average shares outstanding - diluted 8,017 9,531 10,651 17,316 18,226
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents ................... $ 47 $ 285 $ 14,443 $ 5,461 $ 2,277
Total assets ................................ $ 40,794 $ 54,055 $ 67,770 $ 56,448 $ 30,321
Capital lease obligations, line of credit and
notes payable ............................ $ 15,685 $ 21,263 $ 11,759 $ 18,792 $ 16,001
Convertible redeemable preferred stock ...... $ 2,895 $ 2,895 $ 2,895 $ -- $ --
Stockholders' equity ........................ $ 15,428 $ 18,467 $ 43,564 $ 30,195 $ 912
Total liabilities and stockholders' equity .. $ 40,794 $ 54,055 $ 67,770 $ 56,448 $ 30,321
PER SHARE DATA:
Net book value per common share ............. $ 1.76 $ 1.98 $ 3.79 $ 1.66 $ 0.05
Common shares outstanding ................... 8,770 9,320 11,508 18,171 18,241
----------
(1) We incurred restructuring costs of $6.4 million, $.4 million, $7.7 million,
and $1.6 million during the years ended December 31, 2005, 2004, 2003 and 2001,
respectively.
(2) We incurred net charges of $4.3 million from the write-off of obligations
due from a former major customer and other fourth quarter adjustments totaling
$9.5 million during the year ended December 31, 2004.
17
ITEM 7. 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. In addition, we, or others
on our behalf, may make forward looking statements in press releases or written
statements, or in our communications and discussions with investors and analysts
in the normal course of business through meetings, webcasts, phone calls, and
conference calls. Words such as "expect," "anticipate," "outlook," "could,"
"target," "project," "intend," "plan," "believe," "seek," "estimate," "should,"
"may," "assume," "continue," variations of such words and similar expressions
are intended to identify such forward looking statements. These statements are
not guarantees of future performance and involve certain risks, uncertainties,
and assumptions that are difficult to predict. We describe our respective risks,
uncertainties, and assumptions that could affect the outcome or results of
operations in "Item 1A. Risk Factors." We have based our forward looking
statements on our management's beliefs and assumptions based on information
available to our management at the time the statements are made. We caution you
that actual outcomes and results may differ materially from what is expressed,
implied, or forecast by our forward looking statements. Reference is made in
particular to forward looking statements regarding projections or estimates
concerning our 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. Except as required under the federal
securities laws and the rules and regulations of the SEC, we do not have any
intention or obligation to update publicly any forward looking statements after
the distribution of this report, whether as a result of new information, future
events, changes in assumptions, or otherwise.
OVERVIEW
The following management's discussion and analysis (or "MD&A") is
intended to assist the reader in understanding our consolidated financial
statements. This MD&A is provided as a supplement to, and should be read in
conjunction with, our consolidated financial statements and accompanying notes.
Tag-It Pacific, Inc. 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, Tekfit, and Trimfit. 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 distribution relationships. These
distribution partners will be required to maintain excellent zipper
manufacturing capabilities and will adopt quality manufacturing procedures to
meet our high manufacturing standards. The network of these manufacturers under
the Talon brand is expected to improve the time-to-market by eliminating the
typical setup and build-out phase for new manufacturing capacity throughout the
world. In 2005 several of our initial distribution partners experienced delays
in their acquisition of necessary zipper equipment, and this in turn delayed the
distribution of Talon zippers within their respective territories. As a result
of these delays, and other performance deficiencies, the initial distribution
agreements were terminated. We are in the process of changing our distribution
agreements to better serve the local and regional markets and to provide more
guidance and flexibility in meeting our manufacturing standards.
We have restructured our trim business to become an outsourced product
development, sourcing and sampling department for the most demanding brands and
retailers. We believe that trim design
18
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 a customer by supplying trim for a larger proportion of their brands,
and better differentiate our trim sales and services from those of our
competitors. We expect our trim kits to have less of a material contribution to
our trim business. We will continue to supply trim to customers who do not
engage us to serve as an outsourced development, sourcing and sampling
department; however, we will not provide this trim in a preassembled kit.
Our Tekfit services provide manufacturers with the patented technology,
manufacturing know-how and materials required to produce pants incorporating an
expandable waistband. These products are currently produced by several
manufacturers for one single brand. We intend to expand this product to other
brands; however our expansion has been limited to date due to a licensing
dispute. See Item 3 "Legal Proceedings" for details of this matter.
In an effort to better align our organizational and cost structures
with its future growth opportunities, in August 2005 our Board of Directors
adopted a restructuring plan that was substantially completed by December 31,
2005. The plan included restructuring our global operations by eliminating
redundancies in our Hong Kong operation, closing our facilities in Mexico,
converting our Guatemala facility from a manufacturing site to a distribution
center, and closing our North Carolina manufacturing facility. The Company has
also refocused its sales efforts on higher margin products, which may result in
lower net sales over the next twelve months. As a result of this restructuring,
we will operate with fewer employees and will have lower associated operating
and distribution expenses.
During 2005, we recorded charges in connection with its restructuring
plan in accordance with SFAS No. 146 (as amended), "Accounting for Costs
Associated with Exit or Disposal Activities." In addition, the restructuring
plan has resulted in the carrying value of certain long-lived assets, primarily
equipment, being impaired. Accordingly, we recorded a charge to recognize the
impairment of these assets in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets."
Our North Carolina manufacturing facility has been classified as "Fixed
assets held for sale" in our consolidated financial statements. Management has
committed to sell the asset; and is listing the property for sale with a
commercial real estate agent. We believe the sale of the asset is probable and
that the sale is expected to be completed within one year. The major components
of manufacturing equipment used in this plant to manufacture zippers are not
classified as assets held for sale since management intends to re-deploy this
equipment in the manufacture of Talon zippers through investment or sale of this
equipment to distributors of Talon zippers. This equipment is separately
identified as idle equipment as a component of "Property and Equipment". See
"Notes to consolidated financial statements," Note 1.
Restructuring costs recorded in the third quarter of 2005 were $6.2
million. Additional restructuring costs of $0.2 million were incurred in the
fourth quarter of 2005. Total restructuring costs in 2005 were $6.4 million.
These costs include $3.4 million of inventory write-downs charged to cost of
goods sold; $2.2 million for the impairment of long-lived assets (primarily
machinery and equipment), $0.2 million of one-time employee termination benefits
and other costs of $0.2 million which were charged to operating expenses. In
addition, an impairment charge to goodwill of $0.4 million was recorded. This
goodwill was associated with an acquisition made to benefit our Central and
South American operations. Since these operations were closed during 2005, the
goodwill was impaired and written off.
In 2004, following negotiations with Tarrant Apparel Group, a former
customer, we determined that a significant portion of the obligations due from
this customer were uncollectible. Accordingly, included in general and
administrative expenses for 2004 are charges of $4.3 million related primarily
to the write-down of this receivable and leaving a remaining balance receivable
from this customer of $4.5 million. An affiliate
19
of the customer repaid the $4.5 million receivable balance over the period from
May through December 2005. In addition to this $4.3 million write-down in FY
2004, we also recorded an accounts receivable reserve of $5.0 million (or 9.1%
of net sales) in the fourth quarter of 2004 based on management's estimate of
the collectibility of accounts receivable primarily related to two other
customers.
Our bad debt expense as of December 31, 2005 includes reserves of $3.6
million recorded in the second quarter of 2005 based on management's estimate at
the time of the collectibility of accounts receivable from one customer. The
fourth quarter reserves include charges of $0.6 million representing the present
value discount of a subsequent note received in 2006 in exchange for that same
customer's accounts receivable.
In connection with our 2005 restructuring plan, we recorded an
inventory write-down of $3.4 million in the third quarter of 2005. During the
fourth quarter of 2004, we recorded inventory write-downs totaling $2.7 million
based on management's estimate of the net realizable value of certain
inventories.
In 2004, we incurred net operating losses and increased our valuation
allowance for deferred tax assets to reduce our net deferred tax asset from $2.8
million to $1.0 million. The decrease in the net deferred tax asset resulted in
a charge of $1.8 million against the provision for income taxes in the fourth
quarter of 2004. In 2005, we further reduced the net carrying value of the
deferred tax asset to zero, resulting in an addition to the provision for income
taxes of $1.0 million for the year ended December 31, 2005.
During the fourth quarter of 2003, we implemented a plan to restructure
certain business operations. In accordance with the restructuring plan, we
incurred costs related to the reduction of our Mexico operations, including the
relocation of our Florida operations to North Carolina and the downsizing of our
corporate operations by eliminating certain corporate expenses related to
operations, sales and marketing and general and administrative expenses. Total
restructuring charges for the year ended 2003 were $7.7 million. During the
first quarter of 2004, we incurred and recorded residual restructuring charges
of $0.4 million.
We have experienced substantial recurring losses from operations on
declining revenues and have an accumulated deficit of $50.4 million as of
December 31, 2005. These matters, among others, raise substantial doubt about
our ability to continue as a going concern. Our continuation as a going concern
is dependent on our ability to generate sufficient cash flow to meet our
obligations on a timely basis, to obtain additional financing as may be
required, and ultimately to attain profitable operations. In response to these
matters, during 2005 we adopted a restructuring plan designed to better align
our organizational and cost structures with our future growth opportunities. In
connection with this restructuring, management's operating plan for 2006
includes increased sales, higher margins on certain products, reduced expenses
as a percentage of revenues and improved cash flows sufficient to cover our
operating needs. There can be no assurance that we will be successful in these
matters. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
20
RESULTS OF OPERATIONS
SALES
For the years ended December 31, 2005, 2004, and 2003, total sales by
geographic region based on customer delivery locations were as follows (amounts
in thousands):
2005 CHANGE 2004 CHANGE 2003
------- ------- ------- ------- -------
United States ............ $ 8,903 85 % $ 4,823 (45)% $ 8,837
Asia ..................... 20,005 57 12,786 33 9,637
Mexico ................... 8,526 (60) 21,453 (19) 26,472
Dominican Republic ....... 5,915 (39) 9,678 (32) 14,219
Other .................... 3,982 (38) 6,369 20 5,278
------- ------- ------- ------- -------
Total ................ $47,331 (14)% $55,109 (14)% $64,443
======= ======= ======= ======= =======
Sales are influenced by a number of factors, including demand, pricing
strategies, foreign exchange effects, new product launches and indications,
competitive products, product supply, and acquisitions. See Item 1 "Business"
for a discussion of our principal products.
The net decrease of sales in 2005 was primarily due to a decrease in
sales to our customers in Mexico of trim products and, to a lesser extent, Talon
zippers, resulting from an industry shift of apparel production from Latin
America to Asia. Sales in Asia of our trim products and Talon zippers increased
significantly during 2005. We are responding to these market changes with a 2005
restructuring plan that includes reducing our operations in Mexico and focusing
our efforts on the market in Asia. Sales of our Tekfit waistband decreased
because of lower demand from the single customer for this product. During 2005,
we continued our plan to decrease reliance on two significant customers in
Mexico. These two customers contributed approximately $7.7 million or 16.3% of
revenues for the year ended December 31, 2005. Because we cannot accurately
predict the impact of the 2005 restructuring plan, we cannot estimate the full
effect on our business.
The net decrease of sales in 2004 was primarily due to a decrease in
trim-related sales of approximately $19 million from our operations in Mexico.
During the fourth quarter of 2003, we implemented a plan to restructure certain
business operations, including the reduction of our reliance on two of our
larger customers which contributed approximately $25.9 million or 40% of our net
sales for the year ended December 31, 2003. These customers contributed
approximately $7 million or 12% of net sales for the year ended December 31,
2004. We replaced in excess of 50% of the lost revenue from our operations in
Mexico during 2004 with sales to new customers from our TRIMNET programs related
to major U.S. retailers in our Hong Kong and Mexico facilities and an increase
in zipper sales under our TALON brand name in Asia. Fiscal 2004 was a
transitional year as we experienced the effects of diversifying our customer
base.
21
COST OF SALES AND SELECTED OPERATING EXPENSES
The following table summarizes cost of sales and selected operating
expenses for the years ended December 31, 2005, 2004, and 2003 (amounts in
thousands):
2005 CHANGE 2004 CHANGE 2003
------- ------- ------- ------- -------
Sales ............................ $47,331 (14)% $55,109 (14)% $64,443
------- ------- ------- ------- -------
Cost of sales .................... 47,070 5% 44,814 (15)% 52,821
% of sales ................... 99% 81% 82%
------- ------- ------- ------- -------
Selling expenses ................. 2,929 1% 2,899 (22)% 3,706
% of sales ................... 6% 5% 6%
------- ------- ------- ------- -------
General and administrative expense 22,267 4% 21,509 95% 11,028
% of sales ................... 47% 39% 18%
------- ------- ------- ------- -------
Restructuring charges ............ 2,474 496% 415 (85)% 2,769
% of sales ................... 5% 1% 4%
------- ------- ------- ------- -------
COST OF SALES
Cost of sales, increased 5% for the year ended December 31, 2005,
primarily due to a $3.4 million write-down of inventory in connection with the
2005 restructuring plan, and an increase in our inventory obsolescence reserve
of $2.1 million, including $0.5 million in the fourth quarter of 2005. Cost of
sales also increased as a percentage of sales due to unabsorbed overhead costs
incurred in our North Carolina manufacturing facility and charges of
approximately $0.2 million associated with unrealized charge-backs recorded in
the second quarter of 2005 and $0.6 million in credits issued to customers
during the first quarter for defective products received from a major supplier.
Cost of sales for the year ended December 31, 2004, decreased 15% due
to a 14% decline in sales for the year and a reduction in restructuring charges
included in cost of sales in the year ended December 31, 2003 of $4.9 million,
partially offset by inventory write-downs totaling $2.7 million (5% of net
sales) recorded in the fourth quarter of 2004 based on management's estimate of
the net realizable value of certain inventory, and lower sales volume. The
decrease in gross profit as a percentage of net sales for the year ended
December 31, 2004 was also due to a change in our product mix during the year.
SELLING EXPENSES
Selling expenses increased 1% for the year ended December 31, 2005
because we were unable to reduce expenses in direct proportion to the decrease
in sales.
In 2004, selling expenses decreased 22%, and represented 5% of sales
(1% decrease from 2003). The decrease was due in part to a contractual decrease
in the royalty rate related to our exclusive license and intellectual property
rights agreement with Pro-Fit. We incurred royalties related to this agreement
of approximately $411,000 in 2004 compared to $780,000 in 2003. Selling expenses
also decreased in 2004 due to the implementation of our restructuring plan in
the fourth quarter of 2003.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased approximately $758,000
(4%) in 2005 compared to 2004. This increase in general and administrative
expenses resulted from an net increase of $2.6 million in the reserve for
doubtful accounts recorded in 2005, higher legal expenses of approximately $3.5
million related primarily to the Pro-Fit litigation, and an impairment charge to
goodwill of $450,000 incurred in connection with the 2005 restructuring plan;
offset by reductions in employment levels and associated costs in connection
with the restructuring plan.
22
General and administrative expenses increased approximately $10.5
million (95%) to $21.5 million in 2004 compared to 2003. Included in general and
administrative expenses for the year ended December 31, 2004 are charges of $4.3
million related primarily to the write-down of receivables due from one
customer. We also recorded an accounts receivable reserve of $5.0 million (or 9%
of net sales) in the fourth quarter of 2004 based on management's estimate of
the collectibility of accounts receivable primarily related to two other
customers. The increase in general and administrative expenses was also due to
the hiring of additional employees related to the expansion of our operations in
Asia and our TALON franchising strategy. Additional administrative employees
were hired for our new TALON manufacturing facility in North Carolina that began
production in January 2005. In the first quarter of 2004, we incurred additional
restructuring charges of $0.4 million related to the final residual costs
associated with our restructuring plan implemented in the fourth quarter of
2003. This charge in 2004 was offset by a decrease in salaries, related benefits
and other costs as a result of the implementation of our 2003 restructuring
plan. General and administrative expenses increased to 39% (22% before customer
write-offs and other fourth quarter charges) of sales for 2004 compared to 2003.
RESTRUCTURING CHARGES
Restructuring costs in 2005 were the result of the 2005 restructuring
plan. Restructuring costs recorded in the third quarter of 2005 were $6.2
million. Additional costs of $0.2 million were incurred in the fourth quarter of
2005. Total restructuring costs of $6.4 million were recorded in the
Consolidated Statements of Operations for the year ended December 31, 2005 as
follows (in millions):
Cost of goods sold ................................ $ 3.4
Operating expenses:
General & administrative expenses .............. 0.5
Restructuring charges .......................... 2.5
------
Total restructuring costs ......................... $ 6.4
======
During the first quarter of 2004, we incurred restructuring charges of
$0.4 million for final residual costs associated with our 2003 restructuring
plan. Restructuring costs included in Operating expenses decreased $2.4 million
in 2004 compared to 2003 since the most of the 2003 restructuring plan costs
were incurred by December 31, 2003.
INTEREST EXPENSE
Interest expense increased approximately $264,000 (or 33%) to
$1,069,000 for 2005 from $805,000 for 2004. The increase in interest expense was
primarily due to higher debt levels associated with the $12.5 million 6% secured
convertible notes payable dated November 2004, the $765,000 6.5% mortgage note
payable to First National Bank dated June 2004, and the $880,000 6.5% equipment
note payable to First National Bank dated November 2004 which were outstanding
for the entire year in 2005 compared to a partial year in 2004; partially offset
by the repayment of a remaining $1.4 million due pursuant to a note payable and
a reduction in amounts due to factor in 2005.
Interest expense decreased approximately $391,000 (or 33%) to $805,000
for 2004 from $1,196,000 for 2003. Borrowings under our UPS Capital credit
facility decreased in 2004 as a result of the proceeds received from our private
placement transactions in May and December 2003 in which we raised approximately
$29 million from the sale of common and preferred stock. In November 2004, we
raised $12.5 million from the sale of 6% secured convertible notes payable.
Borrowings under our UPS credit facility were at prime plus 2% and 4%.
23
INCOME TAXES
The provision for income taxes decreased to approximately $1.2 million
for the year ended December 31, 2005 due to the elimination of our $1.0 million
net deferred tax asset in 2005. Based on the Company's net operating losses,
there is not sufficient evidence to determine that it is more likely than not
that the Company will be able to utilize its net operating loss carry forwards
to offset future taxable income.
The provision for income taxes was $2.3 million for the year ended
December 31, 2004 compared to a benefit for income taxes of $2.3 million for the
year ended December 31, 2003. The income tax provision as a percentage of loss
before income taxes increased to 15% for 2004, from an income tax benefit of 33%
for 2003, primarily due to the increase in the net deferred tax asset valuation
allowance related to net operating loss carry-forwards to $8.9 million at
December 31, 2004 from $1.1 million at December 31, 2003, which reduced the
carrying value of our net deferred tax asset to $1.0 million from $2.8 million.
The decrease in the net deferred tax asset resulted in a charge of $1.8 million
against the provision for income taxes in 2004.
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes selected financial data (amounts in
thousands):
DECEMBER 31, DECEMBER 31,
2005 2004
------- -------
Cash and cash equivalents .............. $ 2,277 $ 5,461
Total assets ........................... 30,321 56,448
Current debt ........................... 14,851 11,175
Non-current debt ....................... 14,558 15,078
Stockholders' equity ................... 912 30,195
CASH AND CASH EQUIVALENTS
Our cash is held with financial institutions. Substantially all of the
balances at December 31, 2005 and 2004 are in excess of federally insured
limits. As of December 31, 2005 we had restricted cash balances of $50,000
related to cash collateral for a letter of credit with Wells Fargo Bank. No cash
balances were restricted at December 31, 2004.
FINANCING ARRANGEMENTS
On November 10, 2004, we refinanced our working capital credit facility
with UPS Capital Global Trade Finance Corporation with a portion of the proceeds
received from a private placement of $12.5 million of Secured Convertible
Promissory Notes ("the Notes"). The Notes are convertible into common stock at a
price of $3.65 per share, bear interest at 6% payable quarterly, are due
November 9, 2007 and are secured by the TALON trademarks. The Notes are
convertible at the option of the holder at any time after closing. We may repay
the Notes at any time after one year from the closing date with a 15% prepayment
penalty. At maturity, we may repay the Notes in cash or require conversion if
certain conditions are met. In connection with the issuance of the Notes, we
issued to the Note holders warrants to purchase up to 171,235 shares of common
stock. The warrants have a term of five years, an exercise price of $3.65 per
share and vest 30 days after closing. We have registered with the SEC the resale
by the holders of the shares issuable upon conversion of the Notes and exercise
of the warrants
We financed building, land and equipment purchases through note payable
obligations expiring through June 2011. These obligations bear interest at rates
of 6.5% and 6.6% per annum. Pursuant to these obligations, we are required to
make monthly payments of principal and interest.
24
Pursuant to the terms of a factoring agreement for the purchase of
eligible receivables from our Hong Kong subsidiary, the factor purchases our
eligible accounts receivable and assumes the credit risk with respect to those
accounts for which the factor has given its prior approval. If the factor does
not assume the credit risk for a receivable, the collection risk associated with
the receivable remains with us. We pay a fixed commission rate and may borrow up
to 80% of eligible accounts receivable. Interest is charged at 1.5% over the
Hong Kong Dollar prime rate. As of December 31, 2005, no amounts were factored.
As of December 31, 2004, the amount factored with recourse and included in trade
accounts receivable was approximately $1,559,000. Outstanding advances as of
December 31, 2004 amounted to $615,000 (none as of December 31, 2005) and are
included on our consolidated balance sheet as due to factor.
In 2005, we entered into a letter of credit facility with Wells Fargo
Bank. This facility provides for letters of credit up to a maximum of $50,000,
expires in June 2006, and is secured by cash on hand managed by Wells Fargo
Bank. At December 31, 2005, outstanding letters of credit under the Wells Fargo
facility were $50,000. There were no outstanding letters of credit at December
31, 2004.
The outstanding balance of our demand notes payable to related
parties at December 31, 2005 and 2004 was $665,000. Included is a $500,000
convertible secured promissory note payable with interest at 11% payable
quarterly. The note is due on demand and is convertible into common stock at the
election of the holder at a rate of $4.50 per share. The remaining demand notes
totaling $165,000 bear interest at 0%-10%, have no scheduled monthly payments,
and are due within fifteen days from demand.
CASH FLOWS
The following table summarizes our cash flow activity for the years ended
December 31, 2005, 2004, and 2003 (amounts in thousands):
2005 2004 2003
-------- -------- --------
Net cash provided by (used in) operating activities $ 923 $(11,382) $ (2,086)
Net cash used in investing activities ............. (1,538) (3,616) (2,516)
Net cash provided by (used in) financing activities (2,842) 6,016 18,759
OPERATING ACTIVITIES
Cash provided by operating activities is one of our primary recurring
sources of funds. The increase in cash provided by operating activities during
the year ended December 31, 2005 resulted from, among other changes, a $10.6
million decrease in accounts receivable, including the collection of a $4.5
million receivable from one customer; a $3 million increase in accounts payable;
a $2.8 million decrease in inventories; a $2.1 million increase in accrued legal
costs; substantially offset by a net loss of $29.5 million. See Consolidated
Statements of Cash Flows.
At December 31, 2005, accounts receivable from Azteca Productions
International ("Azteca"), a significant customer, was approximately $10,968,000
less a reserve of $7,528,000, totaling $3,440,000, net. In February 2006, the
Company accepted a note agreement from Azteca which provides for total payments
including principal and interest of $4.0 million in exchange for the net
outstanding accounts receivable balance. The balance of the note receivable at
December 31, 2005 of $3,440,000 reflects a $560,000 charge to discount the note,
using a 10.5% discount rate, to its net present value. The Azteca accounts
receivable, net at December 31, 2005 has been reclassified on the accompanying
consolidated balance sheets to note receivable to reflect this subsequent
settlement. The $3,440,000 note is receivable in monthly installments over
thirty-one months beginning March 1, 2006. The payments are $50,000 per month
for the first 5 months, then range from $133,000 - $267,000 per month until paid
in full.
25
The decrease in cash provided by operations for 2004 resulted primarily
from a net loss of $17.6 million together with a net increase of $7.6 million in
accounts receivable due primarily to slower customer collections of receivables
during the year. This decrease was partially offset a $4 million net increase in
the allowance for doubtful accounts and a $7.8 million decrease in inventories.
See Consolidated Statements of Cash Flows.
INVESTING ACTIVITIES
Net cash used in investing activities for the year ended December 31,
2005 consisted of capital expenditures of $1.5 million for purchases of
equipment.
Net cash used in investing activities for the year ended December 31,
2004 consisted of capital expenditures of $3.6 million for computer equipment,
the purchase of additional TALON zipper equipment and building, land and
leasehold improvements related to our new TALON manufacturing facility in North
Carolina. The building and land purchase of the TALON manufacturing facility was
reported as a non-cash financing transaction.
FINANCING ACTIVITIES
Net cash used in financing activities for the year ended December 31,
2005 primarily reflects the repayment of borrowings under our bank line of
credit facility, repayment of notes payable and capital leases, partially offset
by funds raised from the exercise of stock options and warrants.
Net cash provided by financing activities for the year ended December
31, 2004 primarily reflects funds raised from secured convertible promissory
notes of $12.5 million, the exercise of stock options and warrants, proceeds
from notes payable and a capital lease obligation, offset by the repayment of
borrowings under our credit facility and notes payable.
We currently satisfy our working capital requirements primarily through
cash flows generated from operations, sales of equity securities and borrowings
from institutional investors and individual accredited investors.
As we continue to respond to the current industry trend of large retail
brands to outsource apparel manufacturing to offshore locations, our foreign
customers, though backed by U.S. brands and retailers, are increasing. This
makes receivables based financing with traditional U.S. banks more difficult.
Our current borrowings may not provide the level of financing we may need to
expand into additional foreign markets. As a result, we are continuing to
evaluate non-traditional financing of our foreign assets.
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.
We believe that our existing cash and cash equivalents and anticipated
cash flows from our operating activities and available financing will be
sufficient to fund our minimum working capital and capital expenditure needs for
at least the next twelve months. This conclusion is based on the assumption that
we will be successful in restructuring our operations in accordance with the
restructuring plan adopted in 2005, and that we will collect our note and
accounts receivable in accordance to existing terms. If we are unable to
successfully fully implement our restructuring initiative or collect the note
receivable, or 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 our failure to implement our restructuring initiative in accordance with our
plan, there may be substantial doubt about our ability to continue as a going
concern. Our auditors have included in their report on our financial statements
for the year ended December 31, 2005
26
an explanatory paragraph expressing substantial doubt about our ability to
continue as a going concern if we fail to successfully implement our
restructuring initiative.
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
financing will be available on acceptable terms or at all. If we are unable to
secure additional financing, we may not be able to execute our plans for
expansion, including expansion into foreign markets to promote our Talon brand
tradename, and we may need to implement additional cost savings initiatives.
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at December 31,
2005 and the effects such obligations are expected to have on liquidity and cash
flow in future periods:
Payments Due by Period
------------------------------------------------------------------
Less than 1-3 4-5 After
Contractual Obligations Total 1 Year Years Years 5 Years
------------------------- ----------- ----------- ----------- ----------- ----------
Demand notes payable
to related parties (1) $ 1,113,000 $ 1,113,000 $ -- $ -- $ --
Capital lease obligations $ 1,679,000 $ 707,000 $ 790,000 $ 182,000 $ --
Operating leases ........ $ 1,959,000 $ 602,000 $ 776,000 $ 581,000 $ --
Notes payable ........... $ 1,785,000 $ 276,000 $ 552,000 $ 328,000 $ --
Convertible notes payable $13,895,000 $ 750,000 $13,145,000 $ -- $ --
-----------
(1) The majority of notes payable to related parties are due on demand with
the remainder due and payable on the fifteenth day following the date
of delivery of written demand for payment, and include accrued interest
payable through December 31, 2005.
At December 31, 2005 and 2004, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
RELATED PARTY TRANSACTIONS
For a description of transactions to which we were or will be a party,
and in which any director, executive officer, shareholder of more than 5% of our
common stock or any member of their immediate family had or will have a direct
or indirect material interest, see Note 17 of the Notes to the consolidated
financial statements included in Item 8 of this Report.
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
27
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 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 or market value.
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 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 The Company records 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.
The Company believes that its estimate of deferred tax assets
and determination to record a valuation allowance against such
assets are critical accounting estimates because they are
subject to, among other things, an estimate of future taxable
income, which is susceptible to change and dependent upon
events that may or may not occur, and because the impact of
recording a valuation allowance may be material to the assets
reported on the balance sheet and results of operations. See
Notes to consolidated financial statements, Note 13, "Income
Taxes".
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
28
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. As part of the 2005 Restructuring Plan, certain
long-lived assets, primarily machinery and equipment, were
impaired and their values adjusted accordingly.
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, our 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, the
Company records 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.
The Company records 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. The
Company records 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 the Company 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 closure activities. The Company
reviews the status of restructuring activities on a quarterly
basis and, if appropriate, records changes based on updated
estimates. See Note 12, "Restructuring Costs".
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 November 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4."
SFAS No. 151 amends the guidance in Accounting Research Bulletin ("ARB") No. 43,
Chapter 4, "Inventory Pricing" and requires that items such as idle facility
expense, freight, handling costs and wasted material (spoilage) be recognized as
current-period charges regardless of whether they meet the criterion of "so
abnormal" under Paragraph 5 of ARB No. 43, Chapter 4. In addition, SFAS No. 151
requires that allocation of fixed production overheads to the costs of
29
conversion be based on the normal capacity of the production facilities. The
provisions of SFAS No. 151 are effective for inventory costs incurred during our
fiscal year beginning January 1, 2006. We believe that the adoption of SFAS No.
151 will not have a material impact on the Company's results of operations or
financial condition.
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment." This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123R addresses all forms of share
based payment ("SBP") awards including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
Under SFAS 123R, SBP awards result in a cost that will be measured at fair value
on the awards' grant date, based on the estimated number of awards that are
expected to vest. This statement is effective as of the beginning of the first
annual reporting period that begins after June 15, 2005. The Company has not
fully evaluated the effects of the adoption of this pronouncement.
In December 2004, the FASB issued Statement Accounting Standard
("SFAS") No. 153 "Exchanges of Nonmonetary Assets". This Statement amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods beginning after December
16, 2004. The provisions of this Statement should be applied prospectively. The
adoption of this pronouncement did not have material effect on the Company's
financial statements.
In March 2005, the SEC's Office of the Chief Accountant and its
Division of Corporation Finance released Financial Accounting Bulletin No. 107,
"Share-Based Payment" (SAB 107). SAB 107 provides interpretive guidance related
to the interaction between Statement of Financial Accounting Standard No. 123R
"Shared Based Payment" (SFAS 123R) and certain SEC rules and regulations. SAB
107 provides the staff's views regarding the valuation of shared-based payment
arrangements for public companies and stresses the importance of including
appropriate disclosures within SEC filings, particularly during the transition
to SFAS 123R.
In March 2005, the FASB issued FIN 47, "Accounting for Conditional
Asset Retirement Obligations," which is an interpretation of SFAS No. 143 ("SFAS
143"), "Accounting for Asset Retirement Obligations." FIN 47 clarifies
terminology within SFAS 143 and requires an entity to recognize a liability for
the fair value of a conditional asset retirement obligation when incurred if the
liability's fair value can be reasonably estimated. FIN 47 is effective for
fiscal years ending after December 15, 2005. The adoption of FIN 47 did not have
a material impact on our consolidated financial statements.
In May 2005, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 154, "Accounting Changes and Error Corrections", an
amendment to Accounting Principles Bulletin (APB) Opinion No. 20, "Accounting
Changes", and SFAS No. 3, "Reporting Accounting Changes in Interim Financial
Statements". Though SFAS No. 154 carries forward the guidance in APB No.20 and
SFAS No.3 with respect to accounting for changes in estimates, changes in
reporting entity, and the correction of errors, SFAS No. 154 establishes new
standards on accounting for changes in accounting principles, whereby all such
changes must be accounted for by retrospective application to the financial
statements of prior periods unless it is impracticable to do so. SFAS No. 154 is
effective for accounting changes and error corrections made in fiscal years
beginning after December 15, 2005, with early adoption permitted for changes and
corrections made in years beginning after May 2005. The Company will implement
SFAS No. 154 in its year beginning January 1, 2006. We are currently evaluating
the impact of this new standard, but believe that it will not have a material
impact upon the Company's financial position, results of operations or cash
flows.
30
In February 2006, the FASB issued Statement of Financial Accounting
Standards No. 155, "Accounting for Certain Hybrid Financial Instruments" ("SFAS
155"), which amends SFAS No. 133, "Accounting for Derivatives Instruments and
Hedging Activities" ("SFAS 133") and SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 140").
SFAS 155 amends SFAS 133 to narrow the scope exception for interest-only and
principal-only strips on debt instruments to include only such strips
representing rights to receive a specified portion of the contractual interest
or principle cash flows. SFAS 155 also amends SFAS 140 to allow qualifying
special-purpose entities to hold a passive derivative financial instrument
pertaining to beneficial interests that itself is a derivative instruments. We
are currently evaluating the impact this new Standard, but believes that it will
not have a material impact on the Company's financial position, results of
operations or cash flows.
31
ITEM 7A. 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 British Pounds. During 2004, we
purchased forward exchange contracts for British Pounds to hedge the payments of
product purchases. We intend to purchase additional contracts to hedge the
British Pound exposure for future product purchases. There were no hedging
contracts outstanding as of December 31, 2005. 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 bank accounts and we do not believe we
have significant market risk exposure with regard to our investments.
We are also exposed to the impact of interest rate changes on our
outstanding borrowings. At December 31, 2005, none of our indebtedness was
subject to interest rate fluctuations. Future fluctuations may increase our
interest expense and decrease our cash flows from time to time. For example,
based on average bank borrowings of $10 million during a three-month period, if
the interest rate indices on which our bank borrowing rates are based were to
increase 100 basis points in the three-month period, interest incurred would
increase and cash flows would decrease by $25,000.
32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
PAGE
----
Report of Independent Registered Public Accounting Firm.................. 34
Report of Independent Registered Public Accounting Firm.................. 35
Consolidated Balance Sheets.............................................. 36
Consolidated Statements of Operations.................................... 37
Consolidated Statements of Stockholders' Equity and Convertible
Redeemable Preferred Stock............................................ 38
Consolidated Statements of Cash Flows.................................... 39
Notes to Consolidated Financial Statements............................... 40
33
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Tag It Pacific Inc.
Woodland Hills, California
We have audited the consolidated balance sheet of Tag It Pacific Inc. and
subsidiaries (collectively, the "Company") as of December 31, 2005, and the
related consolidated statement of operations, stockholders' equity and cash
flows for the year then ended. Our audit also included the financial statement
schedule of Tag It Pacific Inc., listed in Item 15(a). These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provided a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tag It Pacific Inc.
and subsidiaries as of December 31, 2005, and the results of their operations
and their cash flows for the year then ended, in conformity with U.S. generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements, taken as a whole, present fairly in all material respects
the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
financial statements, during the year ended December 31, 2005, the Company
incurred a net loss of $29,537,709. In addition, the Company had an accumulated
deficit of $50,434,042 at December 31, 2005. These factors, among others, as
discussed in Note 2 to the financial statements, raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 2. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/S/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
April 7, 2006
34
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Tag-It Pacific, Inc.
Los Angeles, California
We have audited the accompanying consolidated balance sheets of Tag-It
Pacific, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of operations, stockholders' equity and convertible
redeemable preferred stock and cash flows for each of the two years in the
period ended December 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Tag-It
Pacific, Inc. and subsidiaries at December 31, 2004 and 2003, and the results of
their operations and their cash flows for each of the two years in the period
ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
/s/ BDO Seidman, LLP
Los Angeles, California
March 31, 2005
35
TAG-IT PACIFIC, INC.
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
2005 2004
------------ ------------
Assets
Current assets:
Cash and cash equivalents ....................... $ 2,277,397 $ 5,460,662
Accounts receivable, net ........................ 5,652,990 22,390,044
Note receivable ................................. 662,369 --
Inventories, net ................................ 5,573,099 9,305,819
Prepaid expenses and other current assets ....... 618,577 2,326,245
Deferred income taxes ........................... -- 1,000,000
------------ ------------
Total current assets ............................... 14,784,432 40,482,770
Property and equipment, net ........................ 6,438,096 9,380,026
Fixed assets held for sale ......................... 826,904 --
Note receivable, less current portion .............. 2,777,631 --
Due from related parties ........................... 730,489 556,550
Goodwill, net ...................................... -- 450,000
Other intangible assets, net ....................... 4,255,125 4,370,625
Other assets ....................................... 508,117 1,207,885
------------ ------------
Total assets ....................................... $ 30,320,794 $ 56,447,856
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ................................. $ 6,719,226 $ 3,732,921
Accrued legal costs .............................. 2,520,111 406,914
Other accrued expenses ........................... 4,168,552 3,321,081
Due to factor .................................... -- 614,506
Demand notes payable to related parties .......... 664,971 664,971
Current portion of capital lease obligations ..... 590,884 859,799
Current portion of notes payable ................. 186,837 174,975
Note payable ..................................... -- 1,400,000
------------ ------------
Total current liabilities .......................... 14,850,581 11,175,167
Capital lease obligations, less current portion .... 856,495 1,220,969
Notes payable, less current portion ................ 1,261,018 1,447,855
Secured convertible promissory notes ............... 12,440,623 12,408,623
------------ ------------
Total liabilities .................................. 29,408,717 26,252,614
------------ ------------
Commitments and contingencies (Note 14)
Stockholders' equity:
Preferred stock Series A, $0.001 par value;
250,000 shares authorized; eliminated at
December 31, 2005; none issued or
outstanding at December 31, 2004 .............. -- --
Common stock, $0.001 par value, 30,000,000
shares authorized; 18,241,045 shares
issued and outstanding at December 31,
2005; 18,171,301 at December 31, 2004 ......... 18,241 18,173
Additional paid-in capital ....................... 51,327,878 51,073,402
Accumulated deficit .............................. (50,434,042) (20,896,333)
------------ ------------
Total stockholders' equity ......................... 912,077 30,195,242
------------ ------------
Total liabilities and stockholders' equity ......... $ 30,320,794 $ 56,447,856
============ ============
See accompanying notes
36
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
--------------------------------------------
2005 2004 2003
------------ ------------ ------------
Net sales to unrelated parties ............ $ 46,756,831 $ 54,351,108 $ 38,560,045
Net sales to related parties .............. 574,345 758,373 25,882,770
------------ ------------ ------------
Total net sales ........................... 47,331,176 55,109,481 64,442,815
Cost of goods sold ........................ 47,070,381 44,813,736 52,820,980
------------ ------------ ------------
Gross profit .............................. 260,795 10,295,745 11,621,835
Selling expenses .......................... 2,928,659 2,899,329 3,706,143
General and administrative expenses ....... 22,267,070 21,508,607 11,028,291
Restructuring charges ..................... 2,474,281 414,675 2,768,829
------------ ------------ ------------
Total operating expenses .................. 27,670,010 24,822,611 17,503,263
Loss from operations ...................... (27,409,215) (14,526,866) (5,881,428)
Interest expense, net ..................... 1,069,015 804,888 1,196,110
------------ ------------ ------------
Loss before income taxes .................. (28,478,230) (15,331,754) (7,077,538)
Provision (benefit) for income taxes ...... 1,059,479 2,277,214 (2,332,880)
------------ ------------ ------------
Net loss .................................. $(29,537,709) $(17,608,968) $ (4,744,658)
============ ============ ============
Less: Preferred stock dividends ........... -- (30,505) (194,052)
------------ ------------ ------------
Net loss available to common shareholders . $(29,537,709) $(17,639,473) $ (4,938,710)
============ ============ ============
Basic loss per share ...................... $ (1.62) $ (1.02) $ (0.46)
============ ============ ============
Diluted loss per share .................... $ (1.62) $ (1.02) $ (0.46)
============ ============ ============
Basic weighted average shares outstanding . 18,225,851 17,316,202 10,650,684
============ ============ ============
Diluted weighted average shares outstanding 18,225,851 17,316,202 10,650,684
============ ============ ============
See accompanying notes.
37
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
CONVERTIBLE REDEEMABLE PREFERRED STOCK
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Preferred Stock Preferred Stock
Common Stock Series A Series D
---------------------------- ---------------------------- ----------------------------
Shares Amount Shares Amount Shares Amount
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, JANUARY 1, 2003 ... 9,319,909 $ 9,321 -- $ -- -- $ --
Preferred stock issued in
private placement
transaction ........... -- -- -- -- 572,818 22,918,693
Common stock canceled in
settlement agreement .. (5,208) (5) -- -- -- --
Common stock issued upon
exercise of options ... 126,500 127 -- -- -- --
Common stock issued in
private placement
transaction ........... 2,025,000 2,025 -- -- -- --
Common stock issued for
services .............. 42,000 42 -- -- -- --
Tax benefit from exercise
of stock options ...... -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Net loss ................ -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 . 11,508,201 11,510 -- -- 572,818 22,918,693
Conversion of preferred
stock Series C and
accrued dividends ..... 700,144 700 -- -- -- --
Conversion of preferred
stock Series D ........ 5,728,180 5,728 -- -- (572,818) (22,918,693)
Warrants issued in
private placement
transaction ........... -- -- -- -- -- --
Common stock issued upon
exercise of options and
warrants .............. 214,276 214 -- -- -- --
Common stock and warrants
issued for services ... 20,500 21 -- -- -- --
Tax benefit from exercise
of stock options ...... -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Net loss ................ -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2004 . 18,171,301 18,173 -- -- -- --
Common stock issued upon
exercise of options and
warrants .............. 69,744 68 -- -- -- --
Net loss ................ -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2005 . 18,241,045 $ 18,241 -- $ -- -- $ --
============ ============ ============ ============ ============ ============
Convertible Redeemable
Preferred Stock
Additional Retained Series C
Paid-In Earnings ----------------------------
Capital (Deficit) Total Shares Amount
------------ ------------ ------------ ------------ ------------
BALANCE, JANUARY 1, 2003 ... $ 16,776,012 $ 1,681,850 $ 18,467,183 759,494 $ 2,895,001
Preferred stock issued in
private placement
transaction ........... 165,000 -- 23,083,693 -- --
Common stock canceled in
settlement agreement .. (31,712) -- (31,717) -- --
Common stock issued upon
exercise of options ... 317,823 -- 317,950 -- --
Common stock issued in
private placement
transaction ........... 6,333,475 -- 6,335,500 -- --
Common stock issued for
services .............. 166,698 -- 166,740 -- --
Tax benefit from exercise
of stock options ...... 163,060 -- 163,060 -- --
Preferred stock dividends -- (194,052) (194,052) -- --
Net loss ................ -- (4,744,658) (4,744,658) -- --
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 . 23,890,356 (3,256,860) 43,563,699 759,494 2,895,001
Conversion of preferred
stock Series C and
accrued dividends ..... 3,353,008 -- 3,353,708 (759,494) (2,895,001)
Conversion of preferred
stock Series D ........ 22,912,965 -- -- -- --
Warrants issued in
private placement
transaction ........... 189,815 -- 189,815 -- --
Common stock issued upon
exercise of options and
warrants .............. 557,514 -- 557,728 -- --
Common stock and warrants
issued for services ... 85,710 -- 85,731 -- --
Tax benefit from exercise
of stock options ...... 84,034 -- 84,034 -- --
Preferred stock dividends -- (30,505) (30,505) -- --
Net loss ................ -- (17,608,968) (17,608,968) -- --
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2004 . 51,073,402 (20,896,333) 30,195,242 -- --
Common stock issued upon
exercise of options and
warrants .............. 254,476 -- 254,544 -- --
Net loss ................ -- (29,537,709) (29,537,709) -- --
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2005 . $ 51,327,878 $(50,434,042) $ 912,077 -- $ --
============ ============ ============ ============ ============
See accompanying notes.
38
TAG-IT PACIFIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2005 2004 2003
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income ............................................ $(29,537,709) $(17,608,968) $ (4,744,658)
Adjustments to reconcile net (loss) income to net cash used in
operating activities:
Depreciation and amortization .............................. 1,931,990 1,547,223 1,280,380
Decrease (increase) in deferred income taxes ............... 1,000,000 1,800,000 (2,709,072)
Common stock and warrants issued for services .............. -- 85,731 135,023
Increase in allowance for doubtful accounts ................ 2,630,759 4,042,428 1,642,086
Increase in inventory valuation reserve .................... 940,973 -- --
Asset impairment due to restructuring ...................... 2,154,427 -- --
Impairment of goodwill ..................................... 450,000 -- --
Changes in operating assets and liabilities:
Accounts receivable ........................................ 10,666,295 (7,640,984) (392,522)
Inventories ................................................ 2,791,747 7,791,060 6,008,388
Prepaid expenses and other current assets .................. 1,880,443 13,121 (1,524,823)
Other assets ............................................... 314,998 147,046 (24,976)
Accounts payable ........................................... 2,986,302 (2,647,692) (2,266,993)
Accrued legal costs ........................................ 2,113,197 245,796 (21,673)
Other accrued expenses ..................................... 671,348 831,346 1,149,720
Deferred income ............................................ -- -- (1,027,984)
Income taxes payable ....................................... (71,589) 12,032 411,420
------------ ------------ ------------
Net cash provided by (used in) operating activities ............. 923,181 (11,381,861) (2,085,684)
------------ ------------ ------------
Cash flows from investing activities:
Decrease in loans to related parties ......................... -- -- 167,801
Acquisition of property and equipment ........................ (1,538,121) (3,615,899) (2,683,857
------------ ------------ ------------
Net cash used in investing activities ........................... (1,538,121) (3,615,899) (2,516,056)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from secured convertible promissory notes ........... -- 11,663,685 --
Proceeds from preferred stock issuance ....................... -- -- 23,083,693
Proceeds from common stock issuance .......................... -- -- 6,335,500
Proceeds from exercise of stock options and warrants ......... 254,544 557,728 317,950
(Repayment) of line of credit and due to factor, net ......... (614,506) (6,481,007) (8,838,743)
Proceeds from capital lease obligation ....................... -- 950,000 --
Payment of capital lease obligations ......................... (906,765) (332,583) (439,355)
Proceeds from notes payable .................................. -- 880,000 --
Repayment of notes payable ................................... (1,574,975) (1,222,170) (1,700,000)
------------ ------------ ------------
Net cash (used in) provided by financing activities ............. (2,841,702) 6,015,653 18,759,045
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents ............ (3,183,265) (8,982,107) 14,157,305
Cash and cash equivalents, beginning of year .................... 5,460,662 14,442,769 285,464
------------ ------------ ------------
Cash and cash equivalents, end of year .......................... $ 2,277,397 $ 5,460,662 $ 14,442,769
============ ============ ============
Supplemental disclosures of cash flow information:
Cash paid (received) during the year for:
Interest paid .............................................. $ 1,135,460 $ 693,045 $ 1,149,357
Interest received .......................................... $ (33,931) $ (32,340) $ (179)
Income taxes paid .......................................... $ (64,064) $ 495,345 $ 177,455
Income taxes received ...................................... $ (64,064) $ 495,345 $ 177,455
Non-cash financing activity:
Capital lease obligation ................................... $ 273,376 $ 249,418 $ 1,474,053
Preferred Series D stock converted to common stock ......... $ -- $ 22,918,693 $ --
Preferred Series C stock converted to common stock ......... $ -- $ 2,895,001 $ --
Accrued dividends converted to common stock ................ $ -- $ 458,707 $ --
Mortgage note payable ...................................... $ -- $ 765,000 $ --
Warrants issued to placement agent ......................... $ -- $ 93,815 $ --
Accounts receivable, net converted to notes receivable ..... $ 3,440,000 $ 470,799 $ --
See accompanying notes.
39
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Tag-It Pacific, Inc. (the "Company") is an apparel company that
specializes in the distribution of trim items to manufacturers of fashion
apparel, specialty retailers and mass merchandisers. The Company acts as a full
service outsourced trim management department for manufacturers, a specified
supplier of trim items to owners of specific brands, brand licensees and
retailers, a manufacturer and distributor of zippers under the TALON brand name
and a distributor of stretch waistbands that utilize licensed patented
technology under the TEKFIT brand name.
ORGANIZATION AND BASIS OF PRESENTATION
Tag-It Pacific, Inc. (the "Company") is the parent holding company of
Tag-It, Inc., a California corporation, Tag-It Pacific (HK) Ltd., a BVI
corporation, Tag-It de Mexico, S.A. de C.V., A.G.S. Stationery, Inc., a
California corporation (collectively, the "Subsidiaries"), all of which were
consolidated under a parent limited liability company on October 17, 1997 and
became wholly-owned subsidiaries of the Company immediately prior to the
effective date of the Company's initial public offering in January 1998.
Immediately prior to the initial public offering, the outstanding membership
units of Tag-It Pacific LLC were converted to 2,470,001 shares of Common Stock
of the Company. In January 2000, the Company formed Tag-It Pacific Limited, a
Hong Kong corporation, and in April 2000, the Company formed Talon
International, Inc., a Delaware corporation. All newly formed corporations are
100% wholly-owned Subsidiaries of Tag-It Pacific, Inc. Logistica en Avios, S.A.
de C.V. is an affiliated entity over which the Company exercises control, and as
such, is accounted for in the same manner as a wholly-owned subsidiary.
All significant intercompany accounts and transactions have been
eliminated in consolidation. Assets and liabilities of foreign subsidiaries are
translated at rates of exchange in effect at the close of the period. Revenues
and expenses are translated at the weighted average of exchange rates in effect
during the year. The resulting translation gains and losses are deferred and are
shown as a separate component of stockholders' equity, if material, and
transaction gains and losses, if any, are recorded in the consolidated statement
of income in the period incurred. During 2005, 2004 and 2003, foreign currency
translation and transaction gains and losses were not material. The Company does
not engage in hedging activities with respect to exchange rate risk.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the year.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with an
initial maturity of three months or less to be cash equivalents. The Company had
approximately $2.2 million and $5.4 million at financial institutions in excess
of federally insured limits at December 31, 2005 and 2004.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We are required to make judgments as to the collectibility of accounts
receivable based on established aging policy, historical experience and future
expectations. The allowances for doubtful accounts
40
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
represent allowances 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.
INVENTORIES
Inventories are stated at the lower of cost or market value and are
categorized as raw materials, work-in -progress or finished goods. 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 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.
Inventories consist of the following:
Year Ended December 31,
--------------------------------
2005 2004
----------- -----------
Raw materials ........................ $ -- $ 127,270
Work-in-process ...................... -- 11,439
Finished goods ....................... 12,879,099 15,532,110
----------- -----------
12,879,099 15,670,819
Less reserves ........................ 7,306,000 6,365,000
----------- -----------
Total inventories .................... $ 5,573,099 $ 9,305,819
=========== ===========
PROPERTY AND EQUIPMENT AND FIXED ASSETS HELD FOR SALE
Property and equipment are recorded at historical cost. Maintenance and
repairs are expensed as incurred. Upon retirement or other disposition of
property and equipment, the related cost and accumulated depreciation or
amortization are removed from the accounts and any gains or losses are included
in results of operations. During the year ended December 31, 2005 the Company
wrote-off fully depreciated equipment, films, dies and art designs no longer in
service, and changed its estimates of the expected useful lives of the dies and
molds to 3 months or 1 year, depending upon the nature of the tool.
41
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Depreciation of property and equipment is computed using the
straight-line method based on estimated useful lives as follows:
Furniture and fixtures 5 years
Machinery and equipment 5 to 10 years
Computer equipment 5 years
Leasehold improvements Term of the
lease or the estimated life
of the related improvements,
whichever is shorter.
Dies, and molds 3 months to 1 year
Building 39 years
Idle equipment 5 to 10 years
Property and equipment consist of the following:
Year Ended December 31,
---------------------------
2005 2004
----------- -----------
Furniture and fixtures ......................... $ 551,623 $ 670,988
Machinery and equipment ........................ 3,319,786 7,981,012
Computer equipment ............................. 3,325,997 3,337,986
Leasehold improvements ......................... 139,803 292,273
Dies, and molds ................................ 106,273 2,163,627
Land ........................................... -- 81,000
Building ....................................... -- 748,859
Idle equipment ................................. 2,806,475 --
----------- -----------
10,249,958 15,275,745
Accumulated depreciation and amortization ...... 3,811,862 5,895,719
----------- -----------
Net property and equipment ..................... $ 6,438,096 $ 9,380,026
=========== ===========
Depreciation expense for the years ended December 31, 2005, 2004 and
2003 was $1,499,000, $1,277,000, and $950,000, respectively.
During the year ended December 31, 2005, the Company wrote-off fixed
assets with a net book value of $2,036,000 in connection with their 2005
restructuring plan.
Fixed assets held for sale consists of the North Carolina manufacturing
facility. Management has the authority and has committed to sell the asset; the
asset is listed for sale with a commercial real estate agent who is actively
marketing the property; the sale of the asset is probable and the sale is
expected to be completed within one year. See Note 12, "2005 Restructuring
Plan".
GOODWILL AND OTHER INTANGIBLE ASSETS
Intangible assets consist of goodwill, tradename, and exclusive license
and intellectual property rights. Goodwill represents the excess of costs over
fair value of assets of businesses acquired. Goodwill and intangible assets
acquired in a purchase business combination and determined to have an indefinite
useful life
42
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
are not amortized, but instead 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, to their
estimated residual values, and reviewed for impairment in accordance with FASB
Statement No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.
At December 31, 2005, the Company evaluated its goodwill and tradename
assets and determined that an impairment adjustment in the amount of $450,000
related to goodwill was necessary to reduce the carrying value of goodwill to
zero. There were no changes in the net carrying amount of goodwill at December
31, 2004. There were no changes to the net carrying amounts of tradename for the
years ended December 31, 2005 and 2004. Amortization expense related to
exclusive license and intellectual property rights $115,500 for each of the
years ended December 31, 2005, 2004 and 2003.
Goodwill and other intangible assets as of December 31, 2005 and 2004
are as follows:
Year Ended December 31,
----------------------------
2005 2004
----------- -----------
Goodwill ..................................... $ 500,000 $ 500,000
Accumulated amortization ................... (50,000) (50,000)
Impairment write-off ....................... (450,000) --
----------- -----------
Goodwill, net .............................. $ -- $ 450,000
=========== ===========
Other Intangible Assets:
Tradename .................................. $ 4,110,750 $ 4,110,750
Accumulated amortization ................... -- --
----------- -----------
Tradename, net ......................... 4,110,750 4,110,750
Exclusive license and intellectual
property rights ........................ 577,500 577,500
Accumulated amortization ................... (433,125) (317,625)
----------- -----------
Exclusive license and intellectual
property rights, net ............... 144,375 259,875
----------- -----------
Other intangible assets, net ............... $ 4,255,125 $ 4,370,625
=========== ===========
The following table shows the estimated amortization expense for
these assets for each of the succeeding years:
YEARS ENDING DECEMBER 31, Amount
--------
2006 ................................... $115,500
2007 ................................... 28,875
--------
Total .................................. $144,375
========
IMPAIRMENT OF LONG-LIVED ASSETS
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
43
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
value. Changes in market conditions and management strategy have historically
caused us to reassess the carrying amount of our long-lived assets. During the
year ended December 31, 2005, the Company recorded asset impairment charges in
connection with its 2005 restructuring plan (See Note 12).
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and tax benefit carry-forwards. Deferred tax liabilities and assets at the
end of each period are determined using enacted tax rates. The Company records
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.
The provisions of SFAS No. 109, "Accounting for Income Taxes," require
the establishment of a valuation allowance when, based on currently available
information and other factors, it is more likely than not that all or a portion
of a deferred tax asset will not be realized. SFAS No. 109 provides that an
important factor in determining whether a deferred tax asset will be realized is
whether there has been sufficient income in recent years and whether sufficient
income is expected in future years in order to utilize the deferred tax asset.
The Company believes that its 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.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), establishes a fair value method of
accounting for stock-based compensation plans and for transactions in which a
company acquires goods or services from non-employees in exchange for equity
instruments. SFAS 123 also gives the option to account for employee stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock issued to Employees," or SFAS 123. The Company has
chosen to account for stock-based compensation for employees utilizing the
intrinsic value method prescribed in APB 25 and not the fair value method
established by SFAS 123. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the fair market price of the Company's stock
at the measurement date over the amount an employee must pay to acquire stock.
All stock options issued to employees had an exercise price not less than the
fair market value of the Company's Common Stock on the date of grant, and in
accounting for such options utilizing the intrinsic value method there is no
related compensation expense recorded in the Company's financial statements for
the years ended December 31, 2005, 2004 and 2003.
Under SFAS 123, the Company presents in a footnote the effect of
measuring the cost of stock-based employee compensation at the grant date based
on the fair value of the award and recognizes this cost over the service period.
The value of the stock-based award is determined using a pricing model whereby
compensation cost is the fair value of the option as determined by the model at
grant date or other measurement date.
All stock options issued to employees had an exercise price not less
than the fair market value of the Company's Common Stock on the date of grant,
and in accounting for such options utilizing the intrinsic value method there is
no related compensation expense recorded in the Company's financial statements
for
44
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the years ended December 31, 2005, 2004 and 2003. If compensation cost for
stock-based compensation had been determined based on the fair market value of
the stock options on their dates of grant in accordance with SFAS 123, the
Company's net loss and loss per share for the years ended December 31, 2005,
2004 and 2003 would have amounted to the pro forma amounts presented below:
2005 2004 2003
-------------- -------------- --------------
Net loss, as reported ......................... $ (29,537,709) $ (17,608,968) $ (4,744,658)
Add: Stock-based employee compensation expense
included in reported net income, net of
related tax effects ...................... -- -- --
Deduct: Total stock-based employee
compensation expense determined under fair
value method for all awards, net of
related tax effects ...................... (221,167) (55,228) (139,796)
-------------- -------------- --------------
Pro forma net loss ............................ $ (29,758,876) $ (17,664,196) $ (4,884,454)
============== ============== ==============
Loss per share:
Basic - as reported ...................... $ (1.62) $ (1.02) $ (0.46)
Basic - pro forma ........................ $ (1.63) $ (1.02) $ (0.48)
Diluted - as reported .................... $ (1.62) $ (1.02) $ (0.46)
Diluted - pro forma ...................... $ (1.63) $ (1.02) $ (0.48)
The fair value of option grants is estimated on the date of grant
utilizing the Black-Scholes option-pricing model with the following weighted
average assumptions for options granted during 2005; expected life of option of
1.2 years, expected volatility of 64%, risk free interest rate of 2% and a 0%
dividend yield. The weighted average fair value at the grant date for such
options was $0.76 per option for the year ended December 31, 2005. There were no
options granted during the year ended December 31, 2004. The Company used the
following weighted average assumptions for options granted during 2003; expected
life of option of 1.5 years, expected volatility of 19%, risk free interest rate
of 3% and a 0% dividend yield. The weighted average fair value at the grant date
for such options was $0.37 per option for the year ended December 31, 2003.
COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Standard No. 130,
"Reporting Comprehensive Income" ("SFAS 130"), issued by the FASB and effective
for financial statements with fiscal years beginning after December 15, 1997.
SFAS 130 establishes standards for reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements. There
were no material other comprehensive income items for the years ended December
31, 2005, 2004 and 2003.
REVENUE RECOGNITION
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, our upon
notice from the customer to destroy or dispose of the goods. Sales, provisions
for estimated sales returns, and the cost of products sold
45
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
are recorded at the time title transfers to customers. Actual product returns
are charged against estimated sales return allowances.
Sales rebates and discounts are common practice in the industries in
which the Company operates. Volume, promotional, price, cash and other discounts
and customer incentives are accounted for as a reduction to gross sales. Rebates
and discounts are recorded based upon estimates at the time products are sold.
These estimates are based upon historical experience for similar programs and
products. The Company reviews such rebates and discounts on an ongoing basis and
accruals for rebates and discounts are adjusted, if necessary, as additional
information becomes available.
RECLASSIFICATION
Certain reclassifications have been made to the prior year financial
statements to conform to 2005 presentation. Inventory write-downs and other cost
of sales charges of $4.9 million included in Restructuring charges in FY 2003
have been reclassified to Cost of goods sold to conform with FY 2005
classifications.
CLASSIFICATION OF EXPENSES
COST OF SALES - Cost of good 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 expenses.
SELLING EXPENSE - Selling expenses primarily include royalty expense,
sales salaries and commissions, travel and entertainment, marketing and other
sales-related costs.
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, restructuring costs and other general corporate expenses.
SHIPPING AND HANDLING COSTS
In accordance with Emerging Issues Task Force (EITF) 00-10, 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 costs incurred by the Company for inbound and outbound freight are
recorded as a component of cost of sales. Total shipping and handling costs
included as component of revenue for the years ended December 31, 2005, 2004 and
2003 amounted to $98,000, $194,000 and $428,000. Total shipping and handling
costs included as a component of cost of sales for each of these years amounted
to $2,744,000, $1,002,000 and $827,000.
RESTRUCTURING CHARGES
The Company records 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 as they are incurred and on the accrual basis for
one-time benefit arrangements. The Company records 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 the Company 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 closure activities.
The Company reviews the status of restructuring activities
46
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
on a quarterly basis and, if appropriate, records changes based on updated
estimates. See Note 12, "Restructuring Costs".
LITIGATION
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.
FAIR VALUE OF FINANCIAL INFORMATION
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value. ACCOUNTS RECEIVABLE: Due to the short-term nature of the
receivables, the fair value approximates the carrying value. DUE TO FACTOR, DUE
FROM RELATED PARTIES AND NOTES PAYABLE TO RELATED PARTIES: Due to the short-term
nature and current market borrowing rates of the loans and notes, the fair value
approximates the carrying value. NOTES PAYABLE: Fair value approximates carrying
value based upon current market borrowing rates for loans with similar terms and
maturities.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4."
SFAS No. 151 amends the guidance in Accounting Research Bulletin ("ARB") No. 43,
Chapter 4, "Inventory Pricing" and requires that items such as idle facility
expense, freight, handling costs and wasted material (spoilage) be recognized as
current-period charges regardless of whether they meet the criterion of "so
abnormal" under Paragraph 5 of ARB No. 43, Chapter 4. In addition, SFAS No. 151
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. The
provisions of SFAS No. 151 are effective for inventory costs incurred during our
fiscal year beginning January 1, 2006. The Company believes that the adoption of
SFAS No. 151 will not have a material impact on the Company's results of
operations or financial condition.
In December 2004, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 123R "Share Based Payment." This statement is a revision
of SFAS Statement No. 123, "Accounting for Stock-Based Compensation" and
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123R addresses all forms of share
based payment ("SBP") awards including shares issued under employee stock
purchase plans, stock options, restricted stock and stock appreciation rights.
Under SFAS 123R, SBP awards result in a cost that will be measured at fair value
on the awards' grant date, based on the estimated number of awards that are
expected to vest. This statement is effective as of the beginning of the first
annual reporting period that begins after June 15, 2005. The Company has not
fully evaluated the effects of the adoption of this pronouncement.
In December 2004, the FASB issued Statement Accounting Standard
("SFAS") No. 153 "Exchanges of Nonmonetary Assets". This Statement amends
Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary exchange
has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
Statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges occurring in fiscal periods
47
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
beginning after December 16, 2004. The provisions of this Statement should be
applied prospectively. The adoption of this pronouncement did not have material
effect on the Company's financial statements.
In March, 2005, the Securities and Exchange Commission's ("SEC") Office
of the Chief Accountant and its Division of Corporation Finance released
Financial Accounting Bulletin No. 107, "Share-Based Payment" (SAB 107). SAB 107
provides interpretive guidance related to the interaction between Statement of
Financial Accounting Standard No. 123R "Shared Based Payment" (SFAS 123R) and
certain SEC rules and regulations. SAB 107 provides the staff's views regarding
the valuation of shared-based payment arrangements for public companies and
stresses the importance of including appropriate disclosures within SEC filings,
particularly during the transition to SFAS 123R.
In March 2005, the FASB issued FIN 47, "Accounting for Conditional
Asset Retirement Obligations," which is an interpretation of SFAS No. 143 ("SFAS
143"), "Accounting for Asset Retirement Obligations." FIN 47 clarifies
terminology within SFAS 143 and requires an entity to recognize a liability for
the fair value of a conditional asset retirement obligation when incurred if the
liability's fair value can be reasonably estimated. FIN 47 is effective for
fiscal years ending after December 15, 2005. The adoption of FIN 47 did not have
a material impact on our consolidated financial statements.
In May 2005, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 154, "Accounting Changes and Error Corrections", an
amendment to Accounting Principles Bulletin (APB) Opinion No. 20, "Accounting
Changes", and SFAS No. 3, "Reporting Accounting Changes in Interim Financial
Statements". Though SFAS No. 154 carries forward the guidance in APB No.20 and
SFAS No.3 with respect to accounting for changes in estimates, changes in
reporting entity, and the correction of errors, SFAS No. 154 establishes new
standards on accounting for changes in accounting principles, whereby all such
changes must be accounted for by retrospective application to the financial
statements of prior periods unless it is impracticable to do so. SFAS No. 154 is
effective for accounting changes and error corrections made in fiscal years
beginning after December 15, 2005, with early adoption permitted for changes and
corrections made in years beginning after May 2005. The Company will implement
SFAS No. 154 in its year beginning January 1, 2006. We are currently evaluating
the impact of this new standard, but believe that it will not have a material
impact upon the Company's financial position, results of operations or cash
flows.
In February 2006, the FASB issued Statement of Financial Accounting
Standards No. 155, "Accounting for Certain Hybrid Financial Instruments" ("SFAS
155"), which amends SFAS No. 133, "Accounting for Derivatives Instruments and
Hedging Activities" ("SFAS 133") and SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 140").
SFAS 155 amends SFAS 133 to narrow the scope exception for interest-only and
principal-only strips on debt instruments to include only such strips
representing rights to receive a specified portion of the contractual interest
or principle cash flows. SFAS 155 also amends SFAS 140 to allow qualifying
special-purpose entities to hold a passive derivative financial instrument
pertaining to beneficial interests that itself is a derivative instruments. We
are currently evaluating the impact this new Standard, but believes that it will
not have a material impact on the Company's financial position, results of
operations or cash flows.
NOTE 2--LIQUIDITY AND MANAGEMENT'S PLANS
During fiscal years 2003, 2004 and 2005 the Company experienced
recurring losses from operations on declining revenues and has an accumulated
deficit as of December 31, 2005 of $50,434,000. The Company's operating cash
position has declined from $14.4 million at December 31, 2003 to $2.3 million at
December 31, 2005. These matters, among others, raise substantial doubt about
the Company's ability to continue as a going concern. The Company's continuation
as a going concern is dependent on its ability to generate sufficient cash flow
to meet its obligations on a timely basis, to obtain additional financing as may
be required, and ultimately to attain profitable operations.
48
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In response to these matters, during 2005 the Company adopted a
restructuring plan designed to better align the Company's organizational and
cost structures with its future growth opportunities. In connection with this
restructuring, management's operating plan for 2006 includes increased sales,
higher margins on certain products, reduced expenses as a percentage of revenues
and improved cash flows sufficient to cover the Company's operating needs. There
can be no assurance that the Company will be successful in these matters. The
inability of the Company to achieve one or all of the above results will have a
material impact on the Company's financial position and results of operations.
The financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
The Company's consolidated financial statements have been presented on
the basis that it is a going concern, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. If
the Company is not able to achieve its operating objectives or is unable to
obtain additional financing as may be required, the Company may be otherwise
unable to achieve its goals or continue its operations.
NOTE 3--ACCOUNTS AND NOTE RECEIVABLE
At December 31, 2005, accounts receivable from Azteca Productions
International ("Azteca"), a significant customer, was approximately $10,968,000
less a reserve of $7,528,000, totaling $3,440,000, net. In February 2006, the
Company accepted a note agreement from Azteca which provides for total payments
including principal and interest of $4.0 million in exchange for the net
outstanding accounts receivable balance. The balance of the note receivable at
December 31, 2005 of $3,440,000 reflects a $560,000 charge to discount the note,
using a 10.5% discount rate, to its net present value. The Azteca accounts
receivable, net at December 31, 2005 has been reclassified on the accompanying
consolidated balance sheets to note receivable to reflect this subsequent
settlement. The $3,440,000 note is receivable in monthly installments over
thirty-one months beginning March 1, 2006. The payments are $50,000 per month
for the first 5 months, then range from $133,000-$267,000 per month until paid
in full. The following summarizes the future minimum payments of the note
receivable:
YEARS ENDING DECEMBER 31, Amount
------------------------ -----------
2006 .................................................... $ 917,000
2007 .................................................... 1,600,000
2008 .................................................... 1,483,000
-----------
Total payments .......................................... 4,000,000
Less amount representing interest ....................... (560,000)
-----------
Balance at December 31, 2005 ............................ 3,440,000
Less current portion .................................... 662,000
-----------
Long-term portion ....................................... $ 2,778,000
===========
Accounts receivable are included on the accompanying consolidated
balance sheet net of an allowance for doubtful accounts and subsequent returns.
After reclassification of the net Azteca receivable to note receivable at
December 31, 2005, the total allowance for doubtful accounts and subsequent
returns was $1,188,758 and $6,085,999 at December 31, 2005 and 2004,
respectively.
In 2004, following negotiations with Tarrant Apparel Group, a former
customer, we determined that a significant portion of the obligations due from
this customer were uncollectible. Accordingly, included in general and
administrative expenses for 2004 are charges of $4.3 million related primarily
to the write-down of this receivable and leaving a remaining balance receivable
from this customer of $4.5 million. An affiliate
49
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of the customer repaid the $4.5 million receivable balance over the period from
May through December 2005.
NOTE 4--FACTORING AGREEMENT AND LINE OF CREDIT
FACTORING AGREEMENT
The Company entered into a factoring agreement with East Asia Heller
for the purchase of eligible receivables from its Hong Kong subsidiary, Tag-It
Pacific (HK) Limited. The Company's factor purchases eligible accounts
receivable and assumes the credit risk with respect to those accounts for which
they have given their prior approval. If the factor does not assume the credit
risk for a receivable, the collection risk associated with the receivable
remains with the Company. The Company pays a fixed commission rate and may
borrow up to 80% of its eligible accounts receivable. Interest is charged at
1.5% over the Hong Kong Dollar prime rate 7.75% and 6.5% at December 31, 2005
and 2004). As of December 31, 2004, the amount factored with recourse and
included in trade accounts receivable was approximately $1,559,000 and none at
December 31, 2005. Outstanding advances as of December 31, 2004 were
approximately $615,000 (none at December 31, 2005) and are included in Due to
factor on the accompanying balance sheet.
The Company measures the value of its retained interest in receivables
factored without recourse based on the fair value of the factored receivable at
the time the sale is initiated. Fair value is determined based on management's
estimate of the expected amount to be collected from the factored receivable.
Adjustments to the fair value of the Company's retained interest in the factored
receivable are made when management becomes aware of factors that could result
in a reduction of the amount paid by the customer. Adjustments are charged to
operations in the period in which the facts that give rise to the adjustments
become known. The Company has not recorded any adjustments to reduce the
carrying amount of its retained interest in factored receivables for the years
ended December 31, 2005 and 2004.
LINE OF CREDIT
On May 30, 2001, the Company entered into a loan and security agreement
with UPS Capital Global Trade Finance Corporation ("Line of Credit"), providing
for a working capital credit facility with a maximum available amount of $13
million. The loan had a three year term, an interest rate at prime plus 2%, and
was secured by all assets of the Company. On November 10, 2004, the Company
refinanced and canceled its Line of Credit with a portion of the proceeds
received from a private placement of $12.5 million of Secured Convertible
Promissory Notes (Note 8). No amounts were outstanding at December 31, 2004.
50
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5--DEMAND NOTES PAYABLE TO RELATED PARTIES
Demand notes payable to related parties consist of the following:
Year Ended December 31,
----------------------------
2005 2004
---------- ----------
Two notes payable issued from 1995-1998 to
parties related to or affiliated with
directors of the Company with interest
rates ranging from 0% to 10% per annum,
due and payable on the fifteenth day
following delivery of written demand for
payment................................. $ 85,176 $ 85,176
Convertible secured note payable issued
in October 2000 to a director of the
Company bears interest at 11%, payable
quarterly, is due on demand and
convertible into common stock at the
election of the holder at a rate of
$4.50 per share, the market value of the
Company's common stock on the date of
approval by the Company's Board of
Directors. The note is secured by
substantially all of the Company's
assets.................................. 500,000 500,000
Unsecured notes payable to a director of
the Company accrue interest at 7% and
8.5% per annum, principal and interest
due on demand and fifteen days from
demand.................................. 79,795 79,795
---------- ----------
$ 664,971 $ 664,971
========== ==========
Interest expense related to the demand notes payable to related parties
for the years ended December 31, 2005, 2004 and 2003 amounted to $67,753,
$81,628 and $88,102. Included in accrued expenses at December 31, 2005 and 2004
was $447,986 and $380,233 of related accrued interest. There was no interest
paid on the demand notes during the years ended December 31, 2005 and 2004.
NOTE 6--CAPITAL LEASE OBLIGATIONS
The Company financed equipment purchases through various capital lease
obligations expiring through August 2010. These obligations bear interest at
various rates ranging from 6.3% to 15% per annum. Future minimum annual payments
under these capital lease obligations are as follows:
YEARS ENDING DECEMBER 31, Amount
------------------------ -----------
2006 .................................................... $ 707,057
2007 .................................................... 478,715
2008 .................................................... 310,855
2009 .................................................... 182,064
2010 .................................................... 430
-----------
Total payments .......................................... 1,679,121
Less amount representing interest ....................... (231,742)
-----------
Balance at December 31, 2005 ............................ 1,447,379
Less current portion .................................... 590,884
-----------
Long-term portion ....................................... $ 856,495
===========
At December 31, 2005, total property and under capital lease
obligations and related accumulated depreciation was $3,468,721 and $661,533,
respectively. At December 31, 2004, total equipment, included in
51
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
property and equipment under capital lease obligations and related accumulated
depreciation was $3,258,589 and $316,826, respectively.
NOTE 7--NOTES PAYABLE
Notes payable consist of the following:
Year Ended December 31,
----------------------------
2005 2004
---------- ----------
$765,000 note payable to First National
Bank dated June 3, 2004; interest at
6.5%; payable in eighty-four monthly
payments of principal and interest of
$5,746 beginning July 2004; twenty-year
amortization, all unpaid principal and
interest due June 3, 2011 (seven years);
secured by building in North Carolina... $ 734,787 $ 755,253
$880,000 note payable to First National
Bank dated November 22, 2004; interest
at 6.5%; payable in sixty monthly
payments of principal and interest of
$17,254 beginning December 2004; all
unpaid principal and interest due
November 22, 2009; secured by
manufacturing equipment................. 713,068 867,577
---------- ----------
Notes payable 1,447,855 1,622,830
Less current portion 186,837 174,975
---------- ----------
Notes payable, net of current portion $1,261,018 $1,447,855
========== ==========
Future minimum annual payments under these notes payable obligations
are as follows:
YEARS ENDING DECEMBER 31, Amount
------------------------ ----------
2006 .................................................. $ 186,837
2007 .................................................. 199,504
2008 .................................................. 213,030
2009 .................................................. 210,218
2010 .................................................. 28,301
2011 and thereafter ................................... 609,965
----------
Total ................................................. $1,447,855
==========
NOTE 8--SECURED CONVERTIBLE PROMISSORY NOTES
On November 10, 2004, the Company raised $12.5 million from the sale of
Secured Convertible Promissory Notes (the "Notes") to existing shareholders. The
Notes are convertible into common stock at a price of $3.65 per share, bear
interest at 6% payable quarterly, are due November 9, 2007 and are secured by
the TALON trademarks. The Notes are convertible at the option of the holder at
any time after closing. The Company may repay the Notes at any time after one
year from the closing date with a 15% prepayment penalty. At maturity, the
Company may repay the Notes in cash or require conversion if certain conditions
are met. In connection with the issuance of the Notes, the Company issued to the
Note holders, warrants to purchase up to 171,235 shares of common stock. The
warrants have a term of five years, an exercise price of $3.65 per share and
vested 30 days after closing. The fair value of the warrants was estimated at
52
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
approximately $96,000 utilizing the Black-Scholes option-pricing model and
recorded as a discount against the face value of the Notes. The discount is
amortized over the three-year term of the Notes on a straight-line basis. The
Company has registered with the SEC the resale by the holders of the shares
issuable upon conversion of the Notes and exercise of the warrants. In
connection with this financing, the Company paid the placement agent $704,000 in
cash, and issued the placement agent a warrant to purchase 215,754 common shares
at an exercise price of $3.65 per share. The warrant is exercisable beginning
May 10, 2005 through November 10, 2009. The fair value of the warrant was
estimated at $93,815 utilizing the Black-Scholes option-pricing model and
recorded as deferred financing costs which are amortized over the three- year
term of the Notes.
Future minimum annual principal payments under these secured
convertible promissory notes are as follows:
YEARS ENDING DECEMBER 31, Amount
------------------------ -----------
2006 .............................................. $ --
2007 .............................................. 12,500,000
-----------
Total ............................................. $12,500,000
===========
NOTE 9--STOCKHOLDERS' EQUITY AND CONVERTIBLE REDEEMABLE PREFERRED STOCK
PREFERRED STOCK
STOCKHOLDER'S RIGHTS PLAN
In October 1998, the Company adopted a stockholder's rights plan. Under
the rights plan the Company distributed one preferred share purchase right for
each outstanding share of Common Stock outstanding on November 6, 1998. Upon the
occurrence of certain triggering events related to an unsolicited takeover
attempt of the Company, each purchase right not owned by the party or parties
making the unsolicited takeover attempt will entitle its holder to purchase
shares of the Company's Series A Preferred Stock at a value below the then
market value of the Series A Preferred Stock. The rights of holders of the
Common Stock will be subject to, and may be adversely affected by, the rights of
holders of the share purchase rights, the Series A Preferred Stock and any other
preferred stock that may be issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could make it more difficult for a
third party to acquire a majority of the Company's outstanding voting stock.
SERIES D PREFERRED STOCK PRIVATE PLACEMENT TRANSACTION
On December 18, 2003, the Company sold an aggregate of 572,818 shares
of non-voting Series D Convertible Preferred Stock, at a price of $44.00 per
share, to institutional investors and individual accredited investors in a
private placement transaction. The Company received net proceeds of $23,083,693
after commissions and other offering expenses. The Series D Convertible
Preferred Stock was convertible after approval at a special meeting of
stockholders at a rate of 10 common shares for each share of Series D
Convertible Preferred Stock. Except as required by law, the Preferred Shares had
no voting rights. The Preferred Shares accrued dividends, commencing on June 1,
2004, at an annual rate of 5% of the initial stated value of $44.00 per share,
payable quarterly. In the event of a liquidation, dissolution or winding-up of
the Company, the Preferred Shares would have been entitled to receive, prior to
any distribution on the common stock, a distribution equal to the initial stated
value of the Preferred Shares plus all accrued and unpaid dividends.
53
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At a special meeting of stockholders held on February 11, 2004, the
stockholders of the Company approved the issuance of 5,728,180 shares of common
stock upon conversion of the Series D Preferred Stock. At the conclusion of the
meeting, all of the shares of the Series D Convertible Preferred Stock
automatically converted into common shares and the Series D Convertible
Preferred Stock was eliminated.
The Company has registered the common shares issued upon conversion of
the Series D Convertible Preferred Stock with the Securities and Exchange
Commission for resale by the investors. In conjunction with the private
placement transaction, the Company issued a warrant to purchase 572,818 common
shares to the placement agent. The warrant is exercisable beginning June 18,
2004 through December 18, 2008. The fair value of the warrant was estimated at
approximately $165,000 utilizing the Black-Scholes option-pricing model and was
recorded as a reduction of the proceeds from the placement of the Series D
Convertible Preferred Stock. The Company has determined that this transaction
did not result in a beneficial conversion feature.
SERIES C PREFERRED STOCK PURCHASE AGREEMENT AND CO-MARKETING AND SUPPLY
AGREEMENT
In accordance with the Series C Preferred Stock Purchase Agreement
entered into with Coats North America Consolidated, Inc. ("Coats") on September
20, 2001, the Company issued 759,494 shares of Series C Convertible Redeemable
Preferred Stock (the "Shares") to Coats North America Consolidated, Inc. in
exchange for an equity investment from Coats of $3,000,001 cash. The Shares were
convertible at the option of the holder after one year at the rate of the
closing price multiplied by 125% of the ten-day average closing price prior to
closing. The Shares were redeemable at the option of the holder after four
years. If the holders elected to redeem the Shares, the Company had the option
to redeem for cash at the stated value of $3,000,001 or in the form of the
Company's common stock at 85% of the market price of the Company's common stock
on the date of redemption. If the market price of the Company's common stock on
the date of redemption was less than $2.75 per share, the Company was required
to redeem for cash at the stated value of the Shares. The Company could elect to
redeem the Shares at any time for cash at the stated value. The Preferred Stock
Purchase Agreement provided for cumulative dividends at a rate of 6% of the
stated value per annum, payable in cash or the Company's common stock. The
dividends were payable at the earlier of the declaration of the Board,
conversion or redemption. Each Preferred Share had the right to vote for each of
the Company's common shares that the Shares could then be converted into on the
record date. Total legal and other costs associated with this transaction of
$105,000 were netted against the $3,000,001 proceeds received from Coats.
Dividends accrued but unpaid at December 31, 2003 amounted to $428,202.
In connection with the Series C Preferred Stock Purchase Agreement, the
Company also entered into a 10-year Co-Marketing and Supply Agreement with
Coats. The Co-Marketing and Supply Agreement provides for selected introductions
into Coats' customer base and the Company's trim packages will exclusively offer
thread manufactured by Coats.
On February 25, 2004, the holders of the Series C Preferred Stock
converted all 759,494 shares of Series C Preferred Stock, plus $458,707 of
accrued dividends, into 700,144 shares of common stock. The Series C Preferred
Stock was eliminated in March 2004.
SERIES B PREFERRED STOCK PURCHASE AGREEMENT, DISTRIBUTION AGREEMENT AND
TRADENAME PURCHASE AGREEMENT
On April 3, 2000, the Company entered into a ten-year exclusive license
and distribution agreement with Talon, Inc. and its parent company, Grupo
Industrial Cierres Ideal, S.A. de C.V. ("GICISA"). Under this agreement, Tag-It
Pacific, Inc. was the exclusive sales, marketing, distribution and e-commerce
arm for "Talon" products for all customers in the United States, Mexico-based
maquiladores, Canada and the Pacific Rim and had the exclusive license to market
trim products under the "Talon" brand name. In exchange for these exclusive
distribution rights, the Company issued 850,000 shares of Series B Convertible
Preferred stock to GICISA. After a period of 30 months, the shares were
convertible into the Company's common
54
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
stock once the average price per share of the Company's common stock reached or
exceeded $8.00 for a 30-day consecutive period. The preferred stock was
automatically convertible into shares of the Company's common stock based on a
rate of one minus the fraction of $2.50 over the average per share closing price
of the Company's common stock for the 30-day period preceding the conversion.
The Series B Convertible Preferred stock had a liquidation preference
of $.001 per share, and is entitled to receive non-cumulative dividends on an as
converted basis, if and when, such dividends were declared on the Company's
common stock and was redeemable by the Company under certain conditions as
outlined in the agreement.
The estimated fair value of the Series B Convertible Preferred stock on
April 3, 2000 was $1,400,000. The Company recorded the value of the license and
distribution rights as a long-term asset, which was being amortized over the
ten-year period of the agreement. The unamortized balance of the long-term asset
at December 21, 2001 was $1,166,667.
On September 30, 2000, the Company purchased inventory from GICISA in
exchange for an unsecured note payable in the amount of $2,830,024. The note
payable was non-interest bearing and was due April 1, 2002. The Company imputed
interest for the holding period of the note amounting to $272,000. The note was
subordinate to the obligations due under the credit facility with UPS Capital.
The note payable balance at December 21, 2001 was $2,767,182, net of imputed
interest of $62,842.
On December 21, 2001, the Company entered into an Asset Purchase
Agreement with Talon, Inc. and GICISA. Pursuant to the Asset Purchase Agreement,
the Company acquired from Talon, Inc. and GICISA: (1) certain inventory and
equipment, (2) all patent rights held by Talon, Inc. and (3) all of Talon's
rights to its trade names and trademarks bearing the TALON (R) name. In
addition, the Asset Purchase Agreement terminated the exclusive 10-year license
and distribution agreement, dated as of April 3, 2000 by and among the Company,
GICISA and Talon, Inc.
Under the Asset Purchase Agreement, the Company issued to Talon, Inc.
500,000 shares of common stock, par value $0.001 per share, a promissory note in
the amount of $4,900,000 and $100,000 in cash held in escrow. The Asset Purchase
Agreement required Talon, Inc. to place 50,000 shares of the Company's common
stock and $100,000 in escrow for a period of 12 months to satisfy any
indemnification claims the Company may have under the Asset Purchase Agreement.
The common stock was valued at the market value of the Company's stock on the
date of closing. The promissory note is unsecured, bears interest at prime plus
2%. In connection with the Asset Purchase Agreement, the Company also entered
into a mutual release with Talon, Inc. and GICISA pursuant to which Talon, Inc.
and GICISA released the Company from its obligations under the unsecured note
payable of $2,830,024 dated September 30, 2000 and other current liabilities
under the Exclusive License and Distribution Agreement. Further, 850,000 shares
of the Company's series B convertible preferred stock held by GICISA were
canceled at the closing of the Asset Purchase Agreement.
The balance of the unsecured promissory note was $1.4 million at
December 31, 2004. The unsecured promissory note and all outstanding obligations
due under the note payable were paid in full as of June 1, 2005.
The Series B Convertible Preferred Stock was eliminated in February
2004.
55
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMON STOCK
2003 PRIVATE PLACEMENT
On May 30, 2003, the Company raised approximately $6,037,500 in a
private placement transaction with five institutional investors. Pursuant to a
securities purchase agreement with these institutional investors, the Company
sold 1,725,000 shares of its common stock at a price per share of $3.50. After
commissions and expenses, the Company received net proceeds of approximately
$5.5 million. The Company has registered the shares issued in the private
placement with the Securities and Exchange Commission for resale by the
investors. In conjunction with the private placement transaction, the Company
issued warrants to purchase 172,500 shares of common stock to the placement
agent. The warrants are exercisable beginning August 30, 2003 through May 30,
2008 and have a per share exercise price of $5.06.
STOCK GRANT AGREEMENTS
Pursuant to Stock Grant Agreements between the Company and Herman Roup,
dated December 1, 2001, January 1, 2002 and July 17, 2002, the Company issued to
Mr. Roup an aggregate of 42,000 shares of common stock during the year ended
December 31, 2003 and 20,500 shares of common stock in 2004 for services
provided to the Company valued at $166,740 and $74,825 in 2003 and 2004,
respectively.
EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY RIGHTS AGREEMENT
On April 2, 2002, the Company entered into an Exclusive License and
Intellectual Property Rights Agreement (the "Agreement") with Pro-Fit Holdings
Limited ("Pro-Fit"). The Agreement gives the Company the exclusive rights to
sell or sublicense waistbands manufactured under patented technology developed
by Pro-Fit for garments manufactured anywhere in the world for the United States
market and all United States brands. In accordance with the Agreement, the
Company issued 150,000 shares of its common stock which were recorded at the
market value of the stock on the date of the Agreement. The shares contain
restrictions related to the transfer of the shares and registration rights. The
Agreement has an indefinite term that extends for the duration of the trade
secrets licensed under the Agreement. The Company has recorded an intangible
asset amounting to $577,500 and is amortizing this asset on a straight-line
basis over its estimated useful life of five years. The Company is currently in
litigation with this supplier (See Notes 1 and 14 ).
2002 PRIVATE PLACEMENTS
In a series of sales on December 28, 2001, January 7, 2002 and January
8, 2002, the Company entered into Stock and Warrant Purchase Agreements with
three private investors, including Mark Dyne, the chairman of the Company's
board of directors. Pursuant to the Stock and Warrant Purchase Agreements, the
Company issued an aggregate of 516,665 shares of common stock at a price per
share of $3.00 for aggregate proceeds of $1,549,995. The Stock and Warrant
Purchase Agreements also included a commitment by one of the two non-related
investors to purchase an additional 400,000 shares of common stock at a price
per share of $3.00 at a second closing (subject of certain conditions) on or
prior to March 1, 2003, as amended, for additional proceeds of $1,200,000.
Pursuant to the Stock and Warrant purchase agreements, 258,332 warrants to
purchase common stock were issued at the first closing of the transactions and
200,000 warrants are to be issued at the second closing. The warrants are
exercisable immediately after closing, one half of the warrants at an exercise
price of 110% and the second half at an exercise price of 120% of the market
value of the Company's common stock on the date of closing. The exercise price
for the warrants shall be adjusted upward by 25% of the amount, if any, that the
market price of our common stock on the exercise date exceeds the initial
exercise price (as adjusted) up to a maximum exercise price of $5.25. The
56
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
warrants have a term of four years. The shares contain restrictions related to
the sale or transfer of the shares, registration and voting rights.
In March 2002 and February 2003, one of the non-related investors
purchased an additional 100,000 and 300,000 shares, respectively, of common
stock at a price per share of $3.00 pursuant to the second closing provisions of
the related agreement for total proceeds of $1,200,000. Pursuant to the second
closing provisions of the Stock and Warrant Purchase Agreement, 50,000 and
150,000 warrants were issued to the investor in March 2002 and February 2003,
respectively. There are no remaining commitments due under the stock and warrant
purchase agreements.
NOTE 10--STOCK OPTION INCENTIVE PLAN AND WARRANTS
STOCK OPTION INCENTIVE PLAN
On October 1, 1997, the Company adopted the 1997 Stock Incentive Plan
("the 1997 Plan"), which authorized the granting of a variety of stock-based
incentive awards. The 1997 Plan is administered by the Board of Directors, or a
committee appointed by the Board of Directors, which determines the recipients
and terms of the awards granted.
In 2002, the Company's Board of Directors amended its 1997 Stock
Incentive Plan to provide for a total of 2,277,500 shares of common stock to be
reserved for issuance under the Plan.
In 2003, the Company's Board of Directors further amended its 1997
Stock Incentive Plan to provide for a total of 2,577,500 shares of common stock
to be reserved for issuance under the Plan. During the year ended December 31,
2003, the Company granted 510,000 options to purchase common stock at exercise
prices of $3.50 and $3.70 per share, the closing price of the Company's common
stock on the date of the grants.
In 2004, the Company's Board of Directors amended its 1997 Stock
Incentive Plan to provide for a total of 3,077,500 shares of common stock to be
reserved for issuance under the Plan. There were no options granted during the
year ended December 31, 2004.
During the year ended December 31, 2005, the Company granted 425,000
options to purchase common stock at exercise prices of $5.00, $5.23, $3.14 and
$0.41 per share, the closing price of the Company's common stock on the date of
the grants.
The following table summarizes the activity in the 1997 Plan:
Weighted
Average
Number of Exercise
Shares Price
---------- ----------
Options outstanding - January 1, 2003 ....... 1,733,500 $ 3.48
Granted ................................ 510,000 3.59
Exercised .............................. (126,500) 2.51
Canceled ............................... (139,000) 3.84
---------- ----------
Options outstanding - December 31, 2003 ..... 1,978,000 3.55
Granted ................................ -- --
Exercised .............................. (115,375) 3.36
Canceled ............................... (120,625) 4.00
---------- ----------
Options outstanding - December 31, 2004 ..... 1,742,000 3.53
Granted ................................ 425,000 3.22
Exercised .............................. (1,250) 3.63
Canceled ............................... (332,750) 3.50
---------- ----------
Options outstanding - December 31, 2005 ..... 1,833,000 $ 3.46
========== ==========
57
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Additional information relating to stock options and warrants
outstanding and exercisable at December 31, 2005, summarized by exercise price
is as follows:
Exercisable
Outstanding Weighted Average Weighted Average
---------------------------------- --------------------------
Life Exercise Exercise
Exercise Price Per Share Shares (years) Price Shares Price
--------------------------- ---------- --------- ---------- ---------- -------------
$ 1.30 215,000 2.5 $ 1.30 215,000 $ 1.30
$ 4.31 273,000 4.0 $ 4.31 273,000 $ 4.31
$ 4.63 81,000 4.0 $ 4.63 81,000 $ 4.63
$ 3.78 126,000 5.5 $ 3.78 126,000 $ 3.78
$ 4.25 72,000 4.5 $ 4.25 72,000 $ 4.25
$ 3.75 90,000 5.0 $ 3.75 90,000 $ 3.75
$ 3.63 150,000 7.0 $ 3.63 150,000 $ 3.63
$ 3.64 110,000 6.0 $ 3.64 110,000 $ 3.64
$ 3.50 260,000 7.3 $ 3.50 260,000 $ 3.50
$ 3.70 131,000 7.3 $ 3.70 121,000 $ 3.70
$ 5.00 35,000 9.1 $ 5.00 13,125 $ 5.00
$ 5.23 100,000 9.2 $ 5.23 100,000 $ 5.23
$ 3.14 100,000 9.4 $ 3.14 86,875 $ 3.14
$ 0.41 90,000 9.9 $ 0.41 90,000 $ 0.41
---------- ----------
Total options 1,833,000 1,788,000
$ 3.65 (warrants) 318,495 3.9 $ 3.65 318,495 $ 3.65
$ 4.29 (warrants) 30,000 1.5 $ 4.29 30,000 $ 4.29
$ 3.50 (warrants) (1) 150,000 1.1 $ 3.50 150,000 $ 3.50
$ 4.34 (warrants) (1) 66,667 0.3 $ 4.34 66,667 $ 4.34
$ 4.73 (warrants) (1) 66,667 0.3 $ 4.73 66,667 $ 4.73
$ 4.74 (warrants) 572,818 3.0 $ 4.74 572,818 $ 4.74
$ 5.06 (warrants) 172,500 2.5 $ 5.06 172,500 $ 5.06
---------- ----------
Total warrants 1,377,147 1,377,147
---------- ----------
Total 3,210,147 5.07 $ 3.85 3,165,147 $ 3.84
========== ==========
(1) The exercise price of these warrants includes an upward adjustment of
25% of the amount, if any, that the market price of the Company's
common stock on the exercise date exceeds the stated exercise price, up
to a maximum of $5.25.
58
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--LOSS PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted loss per share computations:
December 31, 2005 December 31, 2004
---------------------------------------- -----------------------------------------
Loss Shares Per Share Loss Shares Per Share
Years ended: (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
--------------------- ------------ ------------ ------------ ------------ ------------ ------------
Basic loss per share:
Loss available)
to common
stockholders .... $(29,537,709) 18,225,851 $ (1.62) $(17,639,473) 17,316,202 $ (1.02)
Effect of dilutive
securities:
Options ......... -- -- -- -- -- --
Warrants ........ -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Loss available to
common stockholders . $(29,537,709) 18,225,851 $ (1.62) $(17,639,473) 17,316,202 $ (1.02)
============ ============ ============ ============ ============ ============
December 31, 2003
-----------------------------------------
Loss Shares Per Share
Years ended: (Numerator) (Denominator) Amount
--------------------- ------------ ------------ ------------
Basic loss per share:
Loss available)
to common
stockholders .... $ (4,938,710) 10,650,684 $ (0.46)
Effect of dilutive
securities:
Options ......... -- -- --
Warrants ........ -- -- --
------------ ------------ ------------
Loss available to
common stockholders . $ (4,938,710) 10,650,684 $ (0.46)
============ ============ ============
Warrants to purchase 1,377,147 shares of common stock at between $3.50
and $5.06, options to purchase 1,833,000 shares of common stock at between $0.41
and $5.23, 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 for the year ended December 31, 2005, but were not included in the
computation of diluted loss per share because the effect of exercise or
conversion would have an antidilutive effect on loss per share.
Warrants to purchase 1,578,973 shares of common stock at between $3.50
and $5.06, options to purchase 1,742,000 shares of common stock at between $1.30
and $4.63, 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 for the year ended December 31, 2004, but were not included in the
computation of diluted loss per share because the effect of exercise or
conversion would have an antidilutive effect on loss per share.
Warrants to purchase 1,277,885 shares of common stock at between $0.71
and $5.06, options to purchase 1,978,000 shares of common stock at between $1.30
and $4.63, 759,494 shares of preferred Series C stock convertible at $4.94 per
share, and convertible debt of $500,000 convertible at $4.50 per share were
outstanding for the year ended December 31, 2003, but were not included in the
computation of diluted loss per share because the effect of exercise or
conversion would have an antidilutive effect on loss per share. For the year
ended December 31, 2003, 572,818 shares of preferred Series D stock, convertible
into 5,728,180 shares of common stock after shareholder approval on February 11,
2004, were not included in the computation of diluted earnings per share because
the conversion contingency related to the preferred shares was not met.
During the year ended December 31, 2005, 1,250 options and 68,494
warrants were exchanged for $254,544 in cash.
NOTE 12--RESTRUCTURING COSTS
2005 RESTRUCTURING PLAN
In an effort to better align the Company's organizational and cost
structures with its future growth opportunities, in August 2005 the Company's
Board of Directors adopted a restructuring plan for the Company that was
substantially completed by December 2005. The plan includes restructuring the
Company's global operations by eliminating redundancies in its Hong Kong
operation, closing its Mexican facilities, converting its Guatemala facility
from a manufacturing site to a distributor, and closing its North
59
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Carolina manufacturing facility. The Company also intends to focus its sales
efforts on higher margin products, which may result in lower net sales over the
next twelve months. As a result, the Company will operate with fewer employees
and reduced associated operating and manufacturing expenses. The Company has
recorded charges in connection with its restructuring plan in accordance with
SFAS No. 146 (As Amended), "Accounting for Costs Associated with Exit or
Disposal Activities." In addition, the Company's restructuring plan has resulted
in the carrying value of certain long-lived assets, primarily equipment, being
impaired. Accordingly, the Company has recorded a charge to recognize the
impairment of these assets in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets. The Company will continue to
monitor its progress during this restructuring period and adjust its business
strategies and plans to achieve its planned operating efficiencies and costs
reductions.
The North Carolina manufacturing facility is a long-lived asset that is
classified as "held for sale" because it meets the criteria listed in Paragraph
30 of SFAS 144. Management has committed to sell the asset, and is listing the
property for sale with a commercial real estate agent. The Company believes the
sale of the asset is probable and the sale is expected to be completed within
one year. The major components of manufacturing equipment used in this plant to
manufacture zippers are not classified as held for sale since the Company
intends to re-deploy this equipment in the manufacture of Talon zippers through
investment or sale of this equipment to its distributors of Talon zippers. This
equipment is separately identified as idle equipment as a component of "Property
and equipment" which are included in the accompanying consolidated balance
sheets (See Note 1).
Restructuring costs recorded in 2005 were $6,371,000. Restructuring
costs include $3,447,000 of inventory write-downs, restructuring charges of
$2,474,000 consisting of $2,036,000 for the impairment of long-lived assets,
primarily machinery and equipment, $170,000 of one-time employee termination
benefits and other costs of $268,000. In addition, an impairment charge to
goodwill in the amount of $450,000 was recorded. This goodwill was associated
with an acquisition made to benefit the Central and South American operations.
Since these operations are being exited, management concluded that this goodwill
was impaired and should be written off. These restructuring costs were recorded
in the Consolidated Statements of Operations for the year ended December 31,
2005 in the following line items and amounts:
Cost of goods sold ............................ $3,447,000
Operating expenses:
General & administrative expenses .......... 450,000
Restructuring charges ...................... 2,474,000
----------
Total restructuring costs ..................... $6,371,000
==========
2003 RESTRUCTURING PLAN
During the fourth quarter of 2003, the Company implemented a plan to
restructure certain business operations. In accordance with the restructuring
plan, the Company incurred costs related to the reduction of its Mexico
operations, including the relocation of its Florida operations to North Carolina
and the downsizing of its corporate operations by eliminating certain corporate
expenses related to operations, sales and marketing and general and
administrative expenses. The reduction of operations in Mexico was in response
to the following:
60
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
o An anticipated reduction in sales volume from the Company's
larger Mexico customers;
o The Company's efforts to decrease its reliance on its larger
Mexico customers;
o The difficulty in obtaining financing in Mexico due to the
location of assets outside the U.S. and customer concentration
and other limits imposed by financial institutions.
Total restructuring charges for the year ended 2003 amounted to $7.7
million. Restructuring charges include approximately $4.3 million of inventory
write-downs, $1.6 million of additional reserves for doubtful accounts
receivable, $1.0 million of costs incurred related to the reduction of
operations in Mexico, including the relocation of inventory and facilities, $0.5
million of benefits paid to terminated employees and $0.3 million of other
costs. All restructuring costs were incurred and paid for in the fourth quarter
of 2003, and the Company did not anticipate any further charges as a result of
this restructuring plan. Therefore, no liabilities related to restructuring
charges were included in the balance sheet at December 31, 2003. During the
first quarter of 2004, however, the Company incurred residual restructuring
charges of $0.4 million.
Restructuring charges included in the Company's Consolidated Statement
of Operations for the year ended December 31, 2003 are as follows:
Amount
----------
Cost of goods sold .......................... $4,931,218
Operating expenses:
Restructuring charges .................. 2,768,829
----------
Total restructuring charges ................. $7,700,047
==========
NOTE 13--INCOME TAXES
The components of the provision (benefit) for income taxes included in
the consolidated statements of operations are as follows:
Year Ended December 31,
----------------------------------------------
2005 2004 2003
----------- ----------- -----------
Current:
Federal .............. $ 55,479 $ 405,632 $ 360,000
State ................ 4,000 71,582 16,193
----------- ----------- -----------
59,479 477,214 376,193
Deferred:
Federal .............. 850,000 1,530,000 (2,302,711)
State ................ 150,000 270,000 (406,362)
----------- ----------- -----------
1,000,000 1,800,000 (2,709,073)
----------- ----------- -----------
$ 1,059,479 $ 2,277,214 $(2,332,880)
=========== =========== ===========
61
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the statutory Federal income tax rate with the
Company's effective income tax rate is as follows:
Year Ended December 31,
--------------------------
2005 2004 2003
------ ------ ------
Current:
Federal statutory rate ..................... (34.0)% (34.0)% (34.0)%
State taxes net of Federal benefit ......... (5.8) (6.0) (6.0)
Income earned from foreign subsidiaries .... 0.2 3.1 6.4
Net operating loss valuation allowance ..... 43.5 51.3 2.3
Other ...................................... (0.2) 0.5 (1.7)
------ ------ ------
3.7 % 14.9 % (33.0)%
====== ====== ======
(Loss) income before income taxes are as follows:
Year Ended December 31,
--------------------------------------------------
2005 2004 2003
------------ ------------ ------------
Domestic .............. $(28,724,518) $(17,574,926) $ (9,303,639)
Foreign ............... 246,288 2,243,172 2,226,101
------------ ------------ ------------
$(28,478,230) $(15,331,754) $ (7,077,538)
============ ============ ============
The primary components of temporary differences which give rise to the
Company's deferred tax assets and deferred tax liabilities are as follows:
Year Ended December 31,
-----------------------------
2005 2004
------------ ------------
Net deferred tax asset:
Net operating loss carryforwards ........ $ 20,820,849 $ 8,110,000
Dies, film and art library .............. (106,862) (103,894)
Depreciation and amortization ........... 49,356 83,078
Intangible assets ...................... (385,403) (494,193)
Bad debt reserve ....................... 403,494 2,198,402
Related party interest ................. 160,996 105,824
Inventory reserve ...................... 448,674 --
Other ................................... 56,343 783
------------ ------------
21,447,447 9,900,000
Less: Valuation Allowance .............. (21,447,447) (8,900,000)
------------ ------------
$ -- $ 1,000,000
============ ============
At December 31, 2005, Tag-It Pacific, Inc. had Federal and state NOL
carryforwards of approximately $53.3 million and $44.7 million, respectively.
The Federal NOL is available to offset future taxable income through 2024, and
the state NOL expires in 2014. Section 382 ("Section 382") of the Internal
Revenue Code of 1986, as amended (the "Code"), places a limitation on the
realizability of net operating losses in future periods if the ownership of the
Company has changed more than 50% within a three-year period. As of December 31,
2005, some of our net operating losses may be limited by the Section 382 rules.
The amount of such limitations, if any, has not yet been determined.
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
62
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
statement carrying amounts of existing assets and liabilities and their
respective tax bases and tax benefit carry-forwards. Deferred tax liabilities
and assets at the end of each period are determined using enacted tax rates. The
Company records deferred tax assets arising from temporary timing differences
between recorded net income and taxable net income when and if it believes 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.
The provisions of SFAS No. 109, "Accounting for Income Taxes," require
the establishment of a valuation allowance when, based on currently available
information and other factors, it is more likely than not that all or a portion
of a deferred tax asset will not be realized. SFAS No. 109 provides that an
important factor in determining whether a deferred tax asset will be realized is
whether there has been sufficient income in recent years and whether sufficient
income is expected in future years in order to utilize the deferred tax asset.
In 2003, the Company determined, based upon its operating loss, that it
was more likely than not that it would not be in a position to fully realize all
of its deferred tax assets in future years. Accordingly, in 2003, the Company
recorded a valuation allowance of $1.1 million, which reduced the carrying value
of its net deferred tax assets to $2.8 million. In 2004, the Company incurred
additional net operating losses and, as a result, increased its valuation
allowance to $8.9 million, which reduced the carrying value of its net deferred
tax asset to $1.0 million. In 2005, the Company incurred additional net
operating losses and, as a result, increased its valuation allowance to $21.4
million, which reduced the carrying value of its net deferred tax asset to $0.
The Company intends to maintain a valuation allowance for its deferred tax
assets until sufficient evidence exists to support the reversal or reduction of
the allowance. At the end of each quarter, the Company will review supporting
evidence, including the performance against sales and income projections, to
determine if a release of the valuation allowance is warranted. If in future
periods it is determined that it is more likely than not that the Company will
be able to recognize all or a greater portion of its deferred tax assets, the
Company will at that time reverse or reduce the valuation allowance.
The Company believes that its 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 its balance sheet
and results of operations.
The Company has not provided withholding and U.S. federal income taxes
on undistributed earnings of its foreign subsidiaries because the Company
intends to reinvest those earnings indefinitely or any taxes on these earnings
will be offset by the approximate credits for foreign taxes paid. It is not
practical to determine the U.S. federal tax liability, if any, which would be
payable if such earnings were not invested indefinitely.
NOTE 14--COMMITMENTS AND CONTINGENCIES
EXCLUSIVE SUPPLY AGREEMENT
On July 12, 2002, the Company entered into an exclusive supply
agreement with Levi Strauss & Co. ("Levi"). In accordance with the supply
agreement, the Company is to supply Levi with stretch waistbands, various other
trim products, garment components, equipment, services and technological
know-how. The supply agreement has an exclusive term of two years and provides
for minimum purchases of stretch waistbands, various other trim products,
garment components and services from the Company of $10 million over the
two-year period. On July 16, 2004, the Company amended its exclusive supply
agreement with Levi to provide for an additional two-year term through November
2006. The supply agreement also appoints Talon as an approved zipper supplier to
Levi.
63
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DISTRIBUTION / FRANCHISE AGREEMENTS
In 2004 the Company has entered into six distribution agreements for
the sale of TALON zippers. The agreements provided for minimum purchases from
the Company of TALON zipper products to be received over the term of the
agreements. In 2005 several of these distribution partners experienced delays in
their acquisition of necessary zipper equipment, and this in turn delayed the
distribution of Talon zippers within their respective territories. As a result
of these delays, and other performance deficiencies, all of the distribution
agreements were terminated.
OPERATING LEASES
The Company is a party to a number of non-cancelable operating lease
agreements involving buildings and equipment, which expire at various dates
through 2010. The Company accounts for its leases in accordance with SFAS No.
13, whereby step provisions, escalation clauses, tenant improvement allowances,
increases based on an existing index or rate, and other lease concessions are
accounted for in the minimum lease payments and are charged to the income
statement on a straight-line basis over the related lease term.
The future minimum lease commitments at December 31, 2005 are as
follows:
Years Ending December 31, Amount
------------------------ ----------
2006 ....................................... $ 602,649
2007 ....................................... 396,035
2008 ....................................... 379,762
2009 ....................................... 353,546
2010 ....................................... 227,497
----------
Total minimum payments .................. $1,959,489
==========
Total rental expense for the years ended December 31, 2005, 2004 and
2003 aggregated $750,536, $696,590 and $966,867, respectively.
PROFIT SHARING PLAN
In October 1999, the Company established a 401(k) profit-sharing plan
for the benefit of eligible employees. The Company may make annual contributions
to the plan as determined by the Board of Directors. Total contributions for the
year ended December 31, 2005 amounted to $16,807. There were no contributions
made during the years ended December 31, 2004 and 2003.
CONTINGENCIES
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, as amended,
and Rule 10b-5 promulgated thereunder. The action is brought on behalf of all
purchasers of our publicly-traded securities during the period from November 14,
2003 to August 12, 2005. On January 23, 2006 the court heard competing motions
for appointment of lead plaintiff/counsel and appointed Seth Huberman as lead
plaintiff. The lead plaintiff thereafter filed an amended complaint on March 13,
2006. The amended complaint alleges that defendants made false and misleading
statements about the company's financial situation and its relationship with
certain of its large customers during a purported class period between November
13, 2003 and August 12, 2005. It
64
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
purports to state claims under Section 10(b)/Rule 10b-5 and Section 20(a) of the
Securities Exchange Act of 1934. The Company intends to file a motion to dismiss
the amended complaint which motion is scheduled to be heard on June 19, 2006.
Pursuant to the Private Securities Litigation Reform act, discovery is stayed in
the case. Although we believe that we and the other defendants have meritorious
defenses to the class action complaint and intend to contest the lawsuit
vigorously, an adverse resolution of any of the lawsuit could have a material
adverse effect on our financial position and results of operations. At this
early stage of the litigation, we are not able to reasonably predict the outcome
of this action or estimate potential losses, if any, related to the lawsuit.
We have filed suit against Pro-Fit Holdings Limited in the U.S.
District Court for the Central District of California -- TAG-IT PACIFIC, INC. V.
PRO-FIT HOLDINGS LIMITED, CV 04-2694 LGB (RCx) - based on various contractual
and tort claims relating to our exclusive license and intellectual property
agreement, seeking declaratory relief, injunctive relief and damages. The
agreement with Pro-Fit gives us the exclusive rights in certain geographic areas
to Pro-Fit's stretch and rigid waistband technology. Pro-Fit filed an answer
denying the material allegations of the complaint and filed a counterclaim
alleging various contractual and tort claims seeking injunctive relief and
damages. We filed a reply denying the material allegations of Pro-Fit's
pleading. Pro-Fit has since purported to terminate the exclusive license and
intellectual property agreement based on the same alleged breaches of the
agreement that are the subject of the parties' existing litigation, as well as
on an additional basis unsupported by fact. In February 2005, we amended our
pleadings in the litigation to assert additional breaches by Pro-Fit of its
obligations us under the agreement and under certain additional letter
agreements, and for a declaratory judgment that Pro-Fit's patent No. 5,987,721
is invalid and not infringed by us. Thereafter, Pro-Fit filed an amended answer
and counterclaim denying the material allegations of the amended complaint and
alleging various contractual and tort claims seeking injunctive relief and
damages. Pro-Fit further asserted that we infringed its United States Patent
Nos. 5,987,721 and 6,566,285. We filed a reply denying the substantive
allegations of the reply. At our request, the Court bifurcated the contract
issues for trial to commence on January 10, 2006. The parties have filed summary
judgment motions which may dispose of some of the issues in this case prior to
trial. The remaining issues will be tried at a later date. We derive a
significant amount of revenue from the sale of products incorporating the
stretch waistband technology, our business, results of operations and financial
condition could be materially adversely affected if 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.
In December 2005 a lawsuit was filed against us in the United States
District Court, Central District of California -- TODO TEXTIL, S.A. V. TAG-IT
PACIFIC, INC., TALON INTERNATIONAL, INC., COLIN DYNE, JONATHAN MARKILES, ET AL.
, Case No. CV05-8498 MMM (RCx) in which the claimant alleges the Company
breached an operating contract with the plaintiff. This matter is in the initial
stages of litigation and the Company believes it is without merit and that there
will not be a material affect on the Company.
A subsidiary, Tag-It de Mexico, S.A. de C.V., was operating under the
Mexican government's Maquiladora Program, which entitled Tag-It de Mexico to
certain favorable treatment as respects taxes or duties regarding certain
imports. In July of 2005, the Mexican Federal Tax Authority asserted a claim
against the company alleging that certain taxes had not been paid on imported
products during the years 2000, 2001, 2002 and 2003. In October of 2005, Tag-It
filed a procedural opposition to the claim and, in December of 2005, 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 has failed to respond to the opposition filed, and the required
response period has lapsed. In addition, an controlled entity incorporated in
Mexico (Logistica en Avios, S.A. de C.V.) through which Tag-It currently
conducts its operations, 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. Tag-It believes that the
claim is defective on both procedural and documentary grounds and does not
believe there will be a material adverse affect on the Company.
65
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We currently have pending a number of other claims, suits and
complaints that arise in the ordinary course of our business. We believe that we
have meritorious defenses to these claims and that the claims are 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.
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
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 15--GEOGRAPHIC INFORMATION
The Company specializes in the distribution of a full range of 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.
66
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company distributes its products internationally and has reporting
requirements based on geographic regions. Long-lived assets are attributed to
countries based on the location of the assets and revenues are attributed to
countries based on customer delivery locations, as follows:
Year Ended December 31,
-------------------------------------------
2005 2004 2003
----------- ----------- -----------
Sales:
United States ............. $ 8,902,734 $ 4,822,935 $ 8,836,546
Asia ...................... 20,005,036 12,785,977 9,637,268
Mexico .................... 8,526,367 21,452,805 26,472,044
Dominican Republic ........ 5,914,792 9,678,078 14,219,236
Other ..................... 3,982,247 6,369,686 5,277,721
----------- ----------- -----------
$47,331,176 $55,109,481 $64,442,815
=========== =========== ===========
Long-lived Assets:
United States ............. $ 9,797,111 $12,911,377 $ 8,594,804
Asia ...................... 226,221 234,746 1,243,388
Mexico .................... 23,754 187,721 267,704
Dominican Republic ........ 776,279 866,807 975,092
----------- ----------- -----------
$10,823,364 $14,200,651 $11,080,988
=========== =========== ===========
NOTE 16--MAJOR CUSTOMERS AND VENDORS
No customer accounted for more than 10% of the Company's net sales on a
consolidated basis for the year ended December 31, 2005. Two major customers
accounted for approximately 22% of the Company's net sales on a consolidated
basis for the year ended December 31, 2004. Three major customers, two of which
were related parties, accounted for approximately 64% of the Company's net sales
on a consolidated basis for the year ended December 31, 2003. Included in trade
accounts receivable at December 31, 2004 is $8,133,000 due from these customers.
Terms are net 30 and 60 days.
Three major vendors accounted for approximately 39% of the Company's
purchases for the year ended December 31, 2005. Four major vendors accounted for
approximately 70% of the Company's purchases for the year ended December 31,
2004. Two major vendors, one a related party, accounted for approximately 43% of
the Company's purchases for the year ended December 31, 2003. Included in
accounts payable and accrued expenses at December 31, 2005 and 2004 is
$2,206,000 and $2,548,000 due to these vendors. Terms are sight and 60 days.
NOTE 17--RELATED PARTY TRANSACTIONS
In October 1998, the Company sold 2,390,000 shares of Common Stock at a
purchase price per share of $1.125 to KG Investment, LLC. KG Investment is owned
by Gerard Guez and Todd Kay, executive officers and significant shareholders of
Tarrant Apparel Group ("Tarrant"). KG Investment agreed that it would not seek
to dispose of its shares prior to October 16, 2000, except to certain affiliated
parties, without the Company's prior written consent. KG Investment also agreed
to certain additional restrictions on the transfer and voting of the shares it
purchased and has been granted piggyback registration rights.
Commencing in December 1998, the Company began to provide trim products
to Tarrant for its operations in Mexico. In connection therewith, the Company
purchased $2.25 million of Tarrant's existing inventory in December 1998 for
resale to Tarrant. The Company has terminated its supply relationship with
Tarrant. In December 2004, the Company wrote-off the remaining obligations due
from Tarrant (see Note 3).
67
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commencing in December 2000, the Company began to provide trim products
to Azteca Production International, Inc. for its operations in Mexico. In
connection therewith, the Company purchased $4.0 million of Azteca's existing
inventory in December 2000 for resale to Azteca. As a result of the sale of its
ownership in the Company's common stock, Azteca Production International is no
longer considered a related party customer for the year ended December 31, 2004.
Total sales to Tarrant for the year ended December 31, 2005 were
$574,000. Total sales to Tarrant and Azteca for the years ended December 31,
2004 and 2003 were $6,784,000 and $25,883,000, respectively. As of December 31,
2005, accounts receivable, related party included $0.5 million due from Tarrant.
As of December 31, 2004, accounts receivable included approximately $6,596,000
due from Azteca and its affiliates. As of December 31, 2004, accounts
receivable, related party included $4.5 million due from Tarrant's affiliate,
United Apparel Ventures.
Transportation fees paid to a company that has common ownership with
Azteca for the years ended December 31, 2005, 2004 and 2003 amounted to $29,600,
$200,000 and $210,000.
Included in Due from related parties at December 31, 2005 and 2004 is
$730,489 and $556,550 respectively, of unsecured notes, advances and accrued
interest receivable from a former officer and stockholder of the Company who is
related to or affiliated with a director of the Company. The notes and advances
bear interest at 0%, 8.5% and prime and, together with accrued interest, are due
on demand.
Demand notes payable to related parties include notes and advances to a
director of the Company or to parties related to or affiliated with a director
of the Company. The balance of Demand notes payable to related parties at
December 31, 2005 and 2004 was $664,971. See Note 5 for further discussion of
these notes, and related accrued interest and interest expense.
Transportation fees paid to or on behalf of a company that has common
ownership with Mark Dyne, Chairman of the Board of Directors, for the years
ended December 31, 2004 and 2003 amounted to $211,000 and $20,000.
Consulting fees paid to Diversified Investments, a company owned by a
member of the Board of Directors of the Company, amounted to $150,000, $150,000
and $137,000 for the years ended December 31, 2005, 2004 and 2003.
Consulting fees paid for services provided by two members of the Board
of Directors was $45,000, $98,000 and $41,000 for the years ended December 31,
2005, 2004 and 2003.
NOTE 18--SUBSEQUENT EVENTS
During the first quarter of 2006, the Company granted non-qualified
options to purchase shares of its common stock to the following executive
officers:
o As of January 16, 2006, the Company granted its Chief
Executive Officer an option to purchase 900,000 shares of
common stock at an exercise price of $0.37 per share, which
vests over a period of three years;
o As of January 26, 2006, the Company granted its newly
appointed Chief Financial Officer, an option to purchase
400,000 shares of common stock at an exercise price of $0.59
per share, which vests over a period of four years; and
68
TAG-IT PACIFIC, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
o As of March 1, 2006, the Company granted its newly appointed
Chief Operating Officer, an option to purchase 325,000 shares
of common stock at an exercise price of $0.53 per share, which
vests over a period of three years.
Each of the foregoing option grants were issued as an inducement to
employment pursuant to AMEX Company Guide Section 711(a), and were approved by
the Board of Directors, including a majority of the independent directors. The
issuances of these options were exempt from the registration and prospectus
delivery requirements of the Securities Act pursuant to Section 4(2) of the
Securities Act.
NOTE 19 - QUARTERLY RESULTS (UNAUDITED)
Quarterly results for the years ended December 31, 2005 and 2004 are
reflected below:
4TH 3RD 2ND 1ST
---------------------------------------------------------------------------------------------
2005
----
Revenue ......................... $ 9,163,355 $ 9,472,898 $ 15,639,646 $ 13,055,277
Operating loss (1,2) ............ $ (5,002,769) $(10,281,054) $(10,907,621) $ (1,217,771)
Net loss (2) .................... $ (5,127,754) $(10,284,874) $(12,476,638) $ (1,648,443)
Basic and diluted loss per share $ (0.28) $ (0.56) $ (0.68) $ (0.09)
2004
----
Revenue ......................... $ 13,021,287 $ 17,004,775 $ 14,923,121 $ 10,160,298
Operating (loss) income (1,2) ... $(14,761,124) $ 472,901 $ 398,563 $ (637,206)
Net (loss) income (2) ........... $(17,438,261) $ 211,004 $ 170,319 $ (552,030)
Basic and diluted (loss) earnings
per share .................... $ (0.96) $ 0.01 $ 0.01 $ (0.04)
---------------------------------------------------------------------------------------------
(1) The Company recorded restructuring charges of $6.2 million in the third
quarter of 2005; $ $414,675 during the first quarter of 2004; and, 7.7
million during the fourth quarter of 2003. (Note 12).
(2) The Company recorded net charges of $4.3 million from the write-off of
obligations, primarily accounts receivable and inventories, due from a
former major customer (Note 16), an additional allowance for bad debts
of $5.0 million, inventory write-downs of $2.7 million and a decrease
in net deferred tax asset resulting in a charge to the provision for
income taxes of $1.8 million during the fourth quarter of 2004. During
2005, the Company recorded further net increases of $3.7 million to
reserves for accounts receivable and inventories, and an additional
decrease in net deferred tax asset resulting in a charge to the
provision for income taxes of $1 million during 2005.
Quarterly and year-to-date computations of per share amounts are made
independently. Therefore, the sum of per share amounts for the quarters may not
agree with the per share amounts for the year.
69
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During the fourth quarter of fiscal year 2005, BDO Seidman, LLP
resigned and Singer Lewak Greenbaum & Goldstein, LLP was appointed as our
Independent Registered Public Accounting Firm.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
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, as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended, or the Exchange Act, as of December 31, 2005, to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under 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. Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that as of December 31, 2005, our disclosure controls and procedures
were not effective at the reasonable assurance level due to the material
weaknesses described below.
In light of the material weaknesses described below, we performed
additional analysis and other post-closing procedures to ensure our consolidated
financial statements were prepared in accordance with generally accepted
accounting principles. Accordingly, we believe that the consolidated financial
statements included in this report fairly present, in all material respects, our
financial condition, results of operations and cash flows for the periods
presented.
A material weakness is a control deficiency (within the meaning of the
Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or
combination of control deficiencies that result in more than a remote likelihood
that a material misstatement of the annual or interim financial statements will
not be prevented or detected. Management has identified the following
deficiencies that represented material weaknesses in internal control over
financial reporting which have caused management to conclude that, as of
December 31, 2005, our disclosure controls and procedures were not effective at
the reasonable assurance level:
In conjunction with preparing our Form 10-K for the period ended
December 31, 2005, management reviewed our revenue recognition practices as they
relate to the recognition of revenues on certain sale and inventory storage
transactions. As a result of this review, management concluded that our controls
over the identification and monitoring of assumptions and factors affecting the
recording of revenue were not in accordance with generally accepted accounting
principles and that our revenue for the quarters ended June 30, 2005 and
September 30, 2005 had been misstated. Based upon this conclusion, management
with concurrence of our Audit Committee, decided to restate our financial
statements as of and for those quarters to reflect the corrections in the
application of our revenue recognition policies.
We failed to maintain sufficient documentation supporting inventory
costs necessary to effectively analyze our inventory for lower-of-cost or market
reserves. This control deficiency did not result in a material misstatement of
our consolidated financial statements.
We failed to maintain sufficient documentation supporting our perpetual
inventory counts and our year end physical inventories were not effectively
controlled, requiring a recount of our inventory balances at
70
year end. This control deficiency did not result in a material misstatement of
our consolidated financial statements.
To address these material weaknesses, management performed additional
analyses and other procedures to ensure that the financial statements included
herein fairly present, in all material respects, our financial position, results
of operations and cash flows for the periods presented.
REMEDIATION OF MATERIAL WEAKNESSES
To remediate the material weaknesses in our disclosure controls and
procedures identified above, we have done the following subsequent to December
31, 2005, which correspond to the material weaknesses identified above:
We have revised our review procedures over the application of our
revenue recognition practices, particularly as they relate to inventory storage
transactions. We have instituted additional control and disclosure procedures to
effectively and timely identify such transactions including a review of all
major sale transactions by our disclosure committee.
We have implemented additional documentation control procedures over
the assumptions and factors affecting our inventory costs and reserves to ensure
that inventory balances are appropriately supported and reduced to their net
realizable values on a timely basis. These controls include the segregation and
review of selected inventory adjustment transactions and management analysis of
inventory cost and reserve changes during the reporting period.
We have modified our physical inventory process procedures and
instructions to ensure that the appropriate documentation regarding physical
inventories is maintained and controlled, and that the physical counting of
inventories is performed at regular intervals.
ITEM 9B. OTHER INFORMATION
None.
71
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item 10 will appear in the proxy statement
for the 2006 Annual Meeting of Stockholders, and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear in the proxy
statement for the 2006 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners
and management and related stockholder matters will appear in the proxy
statement for the 2006 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions
will appear in the proxy statement for the 2006 Annual Meeting of Stockholders,
and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal accountant fees and services will
appear in the proxy statement for the 2006 Annual Meeting of Stockholders, and
is incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) FINANCIAL STATEMENTS AND SCHEDULES .
72
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT ON SCHEDULE II
To the Board of Directors
Tag-It Pacific, Inc.
Los Angeles, California
The audits referred to in our report, dated March 31, 2005, included the related
financial statement schedule as of December 31, 2004, and for each of the two
years in the period ended December 31, 2004, included in the annual report on
Form 10-K of Tag-It Pacific, Inc. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement schedule based on our audits. In our
opinion, such financial statement schedule presents fairly, in all material
respects, the information set forth therein.
/s/ BDO Seidman, LLP
Los Angeles, California
March 31, 2005
73
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
----------- ----------- ----------- ----------- -----------
Balance at Balance at
Beginning End of
DESCRIPTION of year Additions Deductions Year
----------- ----------- ----------- ----------- -----------
2005
----
Allowance for doubtful accounts deducted
from accounts receivable in the balance
sheet .................................. $ 6,086,000 $ 2,631,000 $ 7,528,000 $ 1,189,000
Reserve for obsolescence deducted from
inventories on the balance sheet ....... 6,365,000 2,538,000 1,597,000 7,306,000
Valuation reserve deducted from Deferred
tax Assets ............................. 8,900,000 12,547,000 -- 21,447,000
----------- ----------- ----------- -----------
$21,351,000 $17,716,000 $ 9,125,000 $29,942,000
=========== =========== =========== ===========
2004
----
Allowance for doubtful accounts deducted
from accounts receivable in the balance
sheet .................................. $ 2,044,000 $ 5,500,000 $ 1,458,000 $ 6,086,000
Reserve for obsolescence deducted from
inventories on the balance sheet ....... 6,125,000 2,240,000 2,000,000 6,365,000
Valuation reserve deducted from Deferred
tax Assets ............................. 1,119,000 7,781,000 -- 8,900,000
----------- ----------- ----------- -----------
$ 9,288,000 $15,521,000 $ 3,458,000 $21,351,000
=========== =========== =========== ===========
2003
----
Allowance for doubtful accounts deducted
from accounts receivable in the balance
sheet .................................. $ 401,000 $ 1,822,000 $ 179,000 $ 2,044,000
Reserve for obsolescence deducted from
inventories on the balance sheet ....... 1,662,000 4,665,000 202,000 6,125,000
Valuation reserve deducted from Deferred
tax Assets ............................. -- 1,119,000 -- 1,119,000
----------- ----------- ----------- -----------
$ 2,063,000 $ 7,606,000 $ 381,000 $ 9,288,000
=========== =========== =========== ===========
(b) Exhibits:
See Exhibit Index attached to this Annual Report on Form 10-K.
74
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
TAG-IT PACIFIC, INC.
/s/ Lonnie D. Schnell
-----------------------------
By: Lonnie D. Schnell
Its: Chief Financial Officer
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints
Stephen Forte and Lonnie D. Schnell, and each of them, as his true and lawful
attorneys-in-fact and agents with full power of substitution and resubstitution,
for him and his name, place and stead, in any and all capacities, to sign any or
all amendments to this Annual Report on Form 10-K and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
foregoing, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or either of them, or their substitutes, may lawfully do or cause to be
done by virtue hereof.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Mark Dyne Chairman of the Board of Directors April 17, 2006
----------------------
Mark Dyne
/s/ Stephen Forte Chief Executive Officer (Principal April 17, 2006
---------------------- Executive Officer) and Director
Stephen Forte
/s/ Lonnie Schnell Chief Financial Officer (Principal April 17, 2006
---------------------- Accounting and Financial Officer)
Lonnie Schnell
/s/ Kevin Bermeister Director April 17, 2006
----------------------
Kevin Bermeister
/s/ Colin Dyne Director April 17, 2006
----------------------
Colin Dyne
/s/ Jonathan Burstein Director, Vice President of April 17, 2006
---------------------- Operations and Secretary
Jonathan Burstein
/s/ Brent Cohen Director April 17, 2006
----------------------
Brent Cohen
/s/ Susan White Director April 17, 2006
----------------------
Susan White
/s/ Raymond Musci Director April 17, 2006
----------------------
Raymond Musci
/s/ Joseph Miller Director April 17, 2006
----------------------
Joseph Miller
75
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
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.
3.2 Bylaws of Registrant. Incorporated by reference to Exhibit 3.2 to
Form SB-2 filed on October 21, 1997, and the amendments thereto.
3.3 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 as of November 4, 1998.
3.4 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.
4.1 Specimen Stock Certificate of Common Stock of Registrant.
Incorporated by reference to Exhibit 4.1to Form SB-2 filed on
October 21, 1997, and the amendments thereto.
4.2 Rights Agreement, dated as of November 4, 1998, between
Registrant and American Stock Transfer and Trust Company as
Rights Agent. Incorporated by reference to Exhibit 4.1 to Current
Report on Form 8-K filed as of November 4, 1998.
4.3 Form of Rights Certificate. Incorporated by reference to Exhibit
B to the Rights Agreement filed as Exhibit 4.1 to Current Report
on Form 8-K filed as of November 4, 1998.
10.1 Form of Indemnification Agreement. Incorporated by reference to
Exhibit 10.1to Form SB-2 filed on October 21, 1997, and the
amendments thereto.
10.2 Promissory Note, dated September 30, 1996, provided by Tag-It,
Inc. to Harold Dyne. Incorporated by reference to Exhibit 10.21
to Form SB-2 filed on October 21, 1997, and the amendments
thereto.
10.3 Promissory Note, dated June 30, 1991, provided by Tag-It, Inc. to
Harold Dyne. Incorporated by reference to Exhibit 10.23 to Form
SB-2 filed on October 21, 1997, and the amendments thereto.
10.4 Promissory Note, dated January 31, 1997, provided by Tag-It Inc.
to Mark Dyne. Incorporated by reference to Exhibit 10.24 to Form
SB-2 filed on October 21, 1997, and the amendments thereto.
10.5 Promissory Note, dated February 29, 1996, provided by A.G.S.
Stationary, Inc. to Monto Holdings Pty. Ltd. Incorporated by
reference to Exhibit 10.25 of Form SB-2 filed on October 21,
1997, and the amendments thereto.
10.6 Promissory Note, dated January 19, 1995, provided by Pacific Trim
& Belt, Inc. to Monto Holdings Pty. Ltd. Incorporated by
reference to Exhibit 10.26 to Form SB-2 filed on October 21,
1997, and the amendments thereto.
10.7 Registrant's 1997 Stock Incentive Plan, as amended. (2)
Incorporated by reference to Exhibit 10.1 to Form 10-Q filed on
August 16, 2004.
EX-1
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
10.8 Form of Non-statutory Stock Option Agreement. (2) Incorporated by
reference to Exhibit 10.30 to Form SB-2 filed on October 21,
1997, and the amendments thereto.
10.9 Promissory Note, dated August 31, 1997, provided by Harold Dyne
to Pacific Trim & Belt, Inc. Incorporated by reference to Exhibit
10.32 to Form SB-2 filed on October 21, 1997, and the amendments
thereto.
10.10 Promissory Note, dated October 15, 1997, provided by Harold Dyne
to Pacific Trim & Belt, Inc. Incorporated by reference to Exhibit
10.34 to Form SB-2 filed on October 21, 1997, and the amendments
thereto.
10.11 Promissory Note, dated October 15, 1997, provided by A.G.S.
Stationary Inc. to Monto Holdings Pty. Ltd. Incorporated by
reference to Exhibit 10.48 to Form SB-2 filed on October 21,
1997, and the amendments thereto.
10.12 Promissory Note, dated November 4, 1997, provided by Pacific Trim
& Belt, Inc. to Monto Holdings Pty. Ltd. Incorporated by
reference to Exhibit 10.49 to Form SB-2 filed on October 21,
1997, and the amendments thereto.
10.13 Guaranty, dated as of October 4, 2000, by A.G.S. Stationery, Inc.
in favor or Mark I. Dyne. Incorporated by reference to Exhibit
10.40 to Form 10-K filed on April 4, 2001.
10.14 Guaranty, dated as of October 4, 2000, by Tag-It, Inc. in favor
of Mark I. Dyne. Incorporated by reference to Exhibit 10.41 to
Form 10-K filed on April 4, 2001.
10.15 Guaranty, dated as of October 4, 2000, by Talon International,
Inc. in favor of Mark I. Dyne. Incorporated by reference to
Exhibit 10.42 to Form 10-K filed on April 4, 2001.
10.16 Security Agreement, dated as of October 4, 2000, between A.G.S.
Stationery, Inc. and Mark I. Dyne. Incorporated by reference to
Exhibit 10.44 to Form 10-K filed on April 4, 2001. Incorporated
by reference to Exhibit 10.44 to Form 10-K filed on April 4,
2001.
10.17 Security Agreement, dated as of October 4, 2000, between Tag-It,
Inc. and Mark I. Dyne. Incorporated by reference to Exhibit 10.45
to Form 10-K filed on April 4, 2001.
10.18 Security Agreement, dated as of October 4, 2000, between Talon
International Inc. and Mark I. Dyne. Incorporated by reference to
Exhibit 10.46 to Form 10-K filed on April 4, 2001.
10.19 Security Agreement, dated as of October 4, 2000, between Tag-It
Pacific, Inc. and Mark I. Dyne. Incorporated by reference to
Exhibit 10.47 to Form 10-K filed on April 4, 2001.
10.20 Convertible Secured Subordinated Promissory Note, dated October
4, 2000, provided by Mark I. Dyne to the Registrant. Incorporated
by reference to Exhibit 10.48 to Form 10-K filed on April 4,
2001.
10.21 Form of Warrant to Purchase Common Stock Agreements dated
December 28, 2001. Incorporated by reference to Exhibit 99.2 to
Form 8-K filed on January 23, 2002.
EX-2
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
10.22 Form of Stockholders Agreements dated December 28, 2001.
Incorporated by reference to Exhibit 99.3 to Form 8-K filed on
January 23, 2002.
10.23 Form of Investor Rights Agreements dated December 28, 2001.
Incorporated by reference to Exhibit 99.4 to Form 8-K filed on
January 23, 2002.
10.24 Exclusive Supply Agreement dated July 12, 2002, among Tag-It
Pacific, Inc. and Levi Strauss & Co. (1) Incorporated by
reference to Exhibit 10.68 to Form 10-Q filed on November 15,
2002.
10.24.1 Amendment to Exclusive Supply Agreement, dated July 12, 2002,
between Tag-It Pacific, Inc. and Levi Strauss & Co. (1)
Incorporated by reference to Exhibit 10.70 to Form 10-K filed on
March 28, 2003.
10.24.2 Amendment, dated June 29, 2004, to Exclusive Supply Agreement,
dated July 12, 2002, between Tag-It Pacific, Inc. and Levi
Strauss & Co.
10.25 Intellectual Property Rights Agreement, dated April 2, 2002,
between the Company and Pro-Fit Holdings, Ltd. (1) Incorporated
by reference to Exhibit 10.69 to Form 10-K/A filed on October 1,
2003.
10.26 Common Stock Purchase Warrant dated December 18, 2003 between the
Company and Sanders Morris Harris Inc. Incorporated by reference
to Exhibit 99.4 to Form 8-K filed on December 22, 2003.
10.27 Form of Subscription Agreement, dated as of November 9, 2004,
between the Company and the Purchaser identified therein.
Incorporated by reference to Exhibit 10.1 to Form S-3 filed on
December 9, 2004.
10.28 Form of Secured Convertible Promissory Note, dated as of November
9, 2004. Incorporated by reference to Exhibit 10.2 to Form S-3
filed on December 9, 2004.
10.29 Form of Common Stock Purchase Warrant, dated as of November 9,
2004. Incorporated by reference to Exhibit 10.3 to Form S-3 filed
on December 9, 2004.
10.30 Trademark Security Agreement, dated as of November 9, 2004, among
the Registrant and the Secured Parties identified on the
signature page thereto. Incorporated by reference to Exhibit 10.4
to Form S-3 filed on December 9, 2004.
10.31 Registration Rights Agreement, dated as of November 9, 2004,
among the Registrant, Sanders Morris Harris Inc. and the
Purchasers identified therein. Incorporated by reference to
Exhibit 10.5 to Form S-3 filed on December 9, 2004.
10.32 Placement Agent Agreement, dated as of November 9, 2004, between
the Registrant and Sanders Morris Harris Inc. Incorporated by
reference to Exhibit 10.6 to Form S-3 filed on December 9, 2004.
10.33 Common Stock Purchase Warrant dated as of November 9, 2004,
issued by the Registrant in favor of Sanders Morris Harris Inc.
Incorporated by reference to Exhibit 10.7 to Form S-3 filed on
December 9, 2004.
EX-3
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
14.1 Code of Ethics. Incorporated by reference to Exhibit 14.1 to Form
10-K filed on March 30, 2004.
21.1 Subsidiaries. Incorporated by reference to Exhibit 14.1 to Form
10-K filed on March 30, 2004.
23.1 Consent of Singer Lewak Greembaum & Goldstein LLP.
23.2 Consent of BDO Seidman, LLP.
24.1 Power of Attorney (included on signature page).
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.
(1) Certain portions of this agreement have been omitted and filed separately
with the Securities and Exchange Commission pursuant to a request for an
order granting confidential treatment pursuant to Rule 406 of the General
Rules and Regulations under the Securities Act of 1933, as amended.
(2) Indicates a management contract or compensatory plan.
EX-4