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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the quarterly period ended September 30, 1998.
OR
[ ] 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 Small Business Issuer as Specified in its Charter)
DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S.Employer
Incorporation or Organization) Identification No.)
3820 SOUTH HILL STREET
LOS ANGELES, CALIFORNIA 90037
(Address of Principal Executive Offices)
(213) 234-9606
(Issuer's Telephone Number)
Indicate by check whether the issuer: (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act 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 the past 90
days.
Yes X No
----- -----
State the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Common Stock, par value $0.001
per share, 6,460,011 shares issued and outstanding as of October 30, 1998.
Transitional Small Business Disclosure Format (check one):
Yes No X
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TAG-IT PACIFIC, INC.
INDEX TO FORM 10-QSB
<TABLE>
<CAPTION>
PAGE
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<C> <S> <C>
PART I FINANCIAL INFORMATION
Item 1. Condensed Financial Statements:
Condensed Consolidated Balance Sheets (unaudited) as of September 30, 1998
and December 31, 1997.................................................... 3
Condensed Consolidated Statements of Operations (unaudited) for the
Three Months and Nine Months Ended September 30, 1998 and 1997.......... 4
Condensed Consolidated Statements of Cash Flows (unaudited) for the
Nine Months Ended September 30, 1998 and 1997............................ 5
Notes to Condensed Consolidated Financial Statements...................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 9
PART II OTHER INFORMATION
Item 2 Changes in Securities and Use of Proceeds................................. 20
Item 5 Other Information......................................................... 21
Item 6 Exhibits and Reports on Form 8-K........................................... 21
</TABLE>
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TAG-IT PACIFIC, INC.
Condensed Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Assets
Current Assets:
Cash............................................................................. $ 262,657 $ 44,109
Due from factor, net............................................................. 151,378 -
Accounts receivable, trade....................................................... 4,244,969 3,017,391
Due from related parties......................................................... 163,624 138,418
Inventories...................................................................... 2,734,851 2,331,131
Prepaid expenses and other current assets........................................ 270,065 273,468
----------- -----------
Total current assets........................................................... 7,827,544 5,804,517
Property and Equipment (net of accumulate depreciation and amortization)............ 1,260,097 974,309
Other assets......................................................................... 45,103 392,238
----------- -----------
Total Assets......................................................................... $ 9,132,744 $ 7,171,064
=========== ===========
Liabilities and Stockholders' Equity (Deficiency)
Current Liabilities:
Bank overdraft.................................................................... $ - $ 306,565
Due to factor, net................................................................ - 1,404,133
Accounts payable.................................................................. 2,061,688 3,977,568
Accrued expenses.................................................................. 675,125 628,086
Line of Credit.................................................................... 1,689,000 -
Current portion of long-term debt................................................. 66,849 463,708
Current portion notes payable to related parties.................................. 930,026 277,003
----------- -----------
Total current liabilities....................................................... 5,422,688 7,057,063
Long-term debt, less current portion................................................. - 55,315
Notes payable to related parties, less current portion............................... - 1,249,698
----------- -----------
Total Liabilities.................................................................... 5,422,688 8,362,076
----------- -----------
Commitments and Contingencies (Note 4)
Stockholders' Equity (Deficiency):
Preferred stock................................................................... - -
Common stock...................................................................... 4,070 2,470
Additional paid-in capital........................................................ 5,583,266 957,530
Accumulated deficit............................................................... (1,877,280) (2,151,012)
----------- -----------
Total Stockholders' Equity (Deficiency)......................................... 3,710,056 (1,191,012)
----------- -----------
Total Liabilities and Stockholders' Equity (Deficiency).............................. $ 9,132,744 $ 7,171,064
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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TAG-IT PACIFIC, INC.
Condensed Consolidated Statements of Operations
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales.................................... $5,045,971 $6,301,498 $12,916,206 $14,893,746
Cost of goods sold........................... 3,283,871 4,067,854 8,270,344 9,409,092
---------- ---------- ----------- -----------
Gross profit............................. 1,762,100 2,233,644 4,645,862 5,484,654
Selling expenses............................. 484,809 558,960 1,155,586 1,344,626
General and administrative expenses.......... 883,386 1,107,973 2,884,039 3,024,793
Write-off of printing division............... 0 0 0 116,000
---------- ---------- ----------- -----------
Total operating expenses................. 1,368,195 1,666,933 4,042,625 4,485,419
Income (loss) from operations................ 393,905 566,711 603,237 999,235
Interest expense............................. 56,094 267,330 180,383 663,702
---------- ---------- ----------- -----------
Income (loss) before income taxes............ 337,811 299,381 422,854 335,533
Provision for Income Taxes................... 101,612 104,712 149,122 188,712
---------- ---------- ----------- -----------
Net Income (Loss)........................ $ 236,199 $ 194,669 $ 273,732 $ 146,821
========== ========== ========== ==========
Basic earnings per share..................... $ 0.06 $ 0.09 $ 0.07 $ 0.07
========== ========== ========== ==========
Diluted earnings per share................... $ 0.06 $ 0.09 $ 0.07 $ 0.07
========== ========== ========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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TAG-IT PACIFIC, INC.
Condensed Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Increase (decrease) in cash
Cash flows from operating activities:
Net income (loss)................................................................... $ 273,732 $ 146,821
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation..................................................................... 297,315 220,391
Changes in operating assets and liabilities:
Accounts receivable............................................................. (1,378,956) (578,277)
Inventories..................................................................... (403,720) (642,551)
Other assets.................................................................... 347,135 18,490
Prepaid expenses and other current assets....................................... 3,403 342,616
Accounts payable................................................................ (1,915,880) 469,584
Accrued expenses................................................................ 47,039 454,539
----------- -----------
Net cash provided (used in) operating activities.................................... (2,729,932) 431,614
Cash Flows From Investing Activities:
Loans to related parties............................................................. (25,206) (126,645)
Acquisition of property and equipment................................................ (583,103) (491,762)
----------- -----------
Net cash used in investing activities................................................ (608,309) (618,407)
Cash Flows from Financing Activities:
Bank overdraft....................................................................... (306,565) (83,725)
Net advances from factor............................................................. (1,404,133) (39,643)
Proceed from IPO, net................................................................ 4,627,336 -
Proceed from bank line of credit..................................................... 1,689,000 -
Proceeds (repayment) from long-term debt............................................. (452,174) 97,304
Proceeds (repayment) from notes payable to related parties, net...................... (596,675) 322,800
----------- -----------
Net cash provided (used in) financing activities....................................... 3,556,789 296,737
----------- -----------
Net increase in cash................................................................... 218,548 109,943
Cash at beginning of period............................................................ 44,109 5,057
----------- -----------
Cash at end of period.................................................................. $ 262,657 $ 115,000
=========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest.......................................................................... $ 180,383 $ 663,702
Income taxes...................................................................... $ 53,154 $ 9,715
Non-cash financing activity:
Note payable converted to equity.................................................. $ 0 $ 0
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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TAG-IT PACIFIC, INC.
Notes to the Condensed Consolidated Financial Statements
(unaudited)
1. PRESENTATION OF INTERIM INFORMATION
In the opinion of the management of Tag-It Pacific, Inc. and
Subsidiaries (collectively, the "Company"), the accompanying unaudited
condensed consolidated financial statements include all normal adjustments
considered necessary to present fairly the financial position as of September
30, 1998, and the results of operation and cash flows for the nine months
ended September 30, 1998 and 1997. Interim results are not necessarily
indicative of results for a full year.
The condensed consolidated financial statements and notes are presented
as permitted by Form 10-QSB, and do not contain certain information included
in the Company's audited consolidated financial statements and notes for the
year ended August 31, 1997.
2. NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 129, "Disclosure of Information about
Capital Structure" ("Statement 129"), which is effective for financial
statements ending after December 15, 1997. Statement 129 reinstates various
securities disclosure requirements previously in effect under Accounting
Principles Board Opinion No. 15, which had been superseded by Statement 128.
The Company does not expect adoption of Statement 129 to have a material
effect, if any, on its consolidated financial position or results of
operation.
During June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("Statement 130"), which is effective for financial statements with
fiscal years beginning after December 15, 1997. Statement 130 establishes
standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. The
Company has not determined the effect on its consolidated financial position
or results of operations, if any, from the adoption of this statement.
During June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131, "Disclosure about
Segments of an Enterprise and Related Information" ("Statement 131"), which
is effective for financial statements with fiscal years beginning after
December 15, 1997. The new standard requires that public business
enterprises report certain information about operating segments in complete
sets of financial statements of the enterprise and in condensed financial
statements of interim periods issued to stockholders. It also requires that
public business enterprises report certain information about their products
and services, the geographic areas in which they operate and their major
customers. The Company does not expect adoption of Statement 131 to have a
material effect, if any, on its consolidated results of operation.
3. EARNINGS PER SHARE
The Company has adopted Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("Statement 128"), which is effective for financial statements issued for the
periods after December 15, 1997, including interim periods. Statement 128
requires the restatement of all prior period earnings per share ("EPS") data
presented.
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The following is a reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations:
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998:
- ----------------------------------------------
BASIC EARNINGS PER SHARE:
Income available to common stockholders...................... $236,199 4,070,011 $0.06
EFFECT OF DILUTIVE SECURITIES:
Options...................................................... -
Warrants..................................................... 7,828
Shares Issued................................................ -
-------- --------- -----
Income available to common stockholders...................... $236,199 4,097,839 $0.06
======== ========= =====
</TABLE>
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998:
- ---------------------------------------------
BASIC EARNINGS PER SHARE:
Income available to common stockholders...................... $273,732 3,881,440 $0.07
EFFECT OF DILUTIVE SECURITIES:
Options...................................................... -
Warrants..................................................... 41,607
Shares Issued................................................ -
-------- --------- -----
Income available to common stockholders...................... $273,732 3,923,046 $0.07
======== ========= =====
</TABLE>
For the three months and nine months ended September 30, 1997 basic and
diluted earning per share are the same amount based on weighted average
shares of 2,085,609.
Warrants to purchase 80,000, 110,000 and 35,555 shares of common stock
at $6.00, $4.80 and $3.60, respectively, were outstanding for the nine
months ended September 30, 1998 but were not included in the computations of
diluted earnings per share because the effect of exercise would have an
antidilutive effect on earnings per share. Stock options to purchase 260,000
shares of common stock at $3.20 were outstanding for the nine months ended
September 30, 1998 but were not included in the computations of diluted
earnings per share because the effect of exercise would have an antidilutive
effect on earnings per share.
On January 23, 1998 the Company completed its initial public offering
(the "IPO") and issued 1,600,000 shares of common stock at price of $4.00 per
share. In conjunction with the IPO the Company issued options to directors
to purchase 65,000 shares of common stock at $3.20, warrants to legal counsel
to purchase 35,555 shares of common stock at $3.60, warrants to underwriters
to purchase 110,000 shares of common stock at $4.80, and warrants in
connection with bridge financing to purchase 80,000 shares of common stock at
$6.00.
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4. CONTINGENCIES
The Company is subject to certain legal proceedings and claims arising
in connection with its business. In the opinion of management, there are
currently no claims that will have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Tag-It Pacific, Inc. (the "Company") is a single-source provider of
complete brand identity programs to manufacturers of fashion apparel and
accessories as well as specialty retailers and mass merchandisers. Such
programs communicate a certain lifestyle, image or identity and enable the
Company's customers to promote and differentiate their product line or brand.
The Company also designs and produces high-quality paper, metal and injection
molded boxes, woven and leather labels, paper-hanging and bar-coded tags,
metal jean buttons, and custom shopping bags. In addition, the Company
designs and produces specialty private label products as well as related
accessories and backpacks.
The Company is the parent holding company of Tag-It, Inc., a California
corporation, Tag-It Printing & Packaging Ltd., a BVI corporation, Tagit de
Mexico, SA de CV, A.G.S. Stationery, Inc., a California corporation ("AGS
Stationery") and Pacific Trim & Belt, Inc., a California corporation
(collectively, the "Subsidiaries"), all of which were consolidated under a
parent limited liability company on October 17, 1997 (the "Consolidation")
and became wholly-owned subsidiaries of the Company immediately prior to the
effective date of the Company's initial public offering in January 1998 (the
"Offering").
The following discussion and analysis, which should be read in
connection with the Company's Financial Statements and accompanying
footnotes, contain forward-looking statements that involve risks and
uncertainties. Important factors that could cause actual results to differ
materially from the Company's expectations are set forth in "Factors That May
Affect Future Results" below as well as those discussed elsewhere in this
Form 10-QSB. All subsequent written or oral forward-looking statements
attributable to the Company or persons acting on its behalf are expressly
qualified in their entirety by the "Factors That May Affect Future Results."
Those forward-looking statements relate to, among other things, the Company's
working capital requirements and need for additional financing.
RESULTS OF OPERATIONS
Net Sales. Net sales decreased approximately $1,255,000 to $5.0 million
(or 19.9%) for the three months ended September 30, 1998 from $6.3 million
for the three months ended September 30, 1997. The decrease in net sales was
primarily a result of a $1.0 million decrease in net sales of specialty
licensed products. This decrease resulted from the Company's decision to
discontinue its specialty licensed product line in early 1998. The remaining
decrease in net sales resulted from a general decrease in the Company's other
product lines.
Net sales decreased approximately $1,978,000 to $12.9 million (or 13.3%)
for the nine months ended September 30, 1998 from $14.9 million for the nine
months ended September 30, 1997. The decrease in net sales was primarily the
result of a $1.3 million decrease in net sales of specialty licensed
stationery products, including $180,000 of returns shipped in 1997, as well
as general decreases in net sales of the other product lines. The sales
decrease in tags and specialty packaging was due, in part, to management's
efforts relating to the initial public offering (IPO), including the effect
of an approximate 5-week delay of the IPO from December 1997 to January 1998,
a period when substantial management focus on development of customer
programs was required. In January 1998, the Company also started focusing on
private label specialty stationery and de-emphasizing its specialty licensed
product line, which was discontinued in the third quarter of 1998.
Gross Profit. Gross profit decreased approximately $472,000 to $1.8
million (or 21.1%) for the three months ended September 30, 1998 from $2.2
million for the three months ended September 30, 1997. Gross margin as a
percentage of net sales decreased to approximately 34.9% as compared to 35.4%
for the three months ended September 30, 1997. The decrease in gross margin
was primarily attributable to the decrease in sales of higher margin
specialty licensed stationery products in 1998, offset by labor and other
cost savings associated with
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normalized production at the Company's Mexico facility and lower overhead
resulting from termination of printing operations in February 1997. Also, in
connection with liquidating the discontinued specialty licensed product line
inventory during the fourth quarter, the Company may have to sell the
remaining inventory at reduced prices which could further decrease the
Company's gross margin as a percentage of net sales.
Gross profit decreased approximately $839,000 to $4.6 million (or 15.3%)
for the nine months ended September 30, 1998 from $5.5 million for the nine
months ended September 30, 1997. Gross margin as a percentage of net sales
decreased to approximately 36.0% as compared to 36.8% for the nine months
ended September 30, 1997. The decrease in gross margin was primarily
attributable to the decrease in net sales of higher margin specialty licensed
stationery products and secondarily to lower overhead absorption, primarily
as a result from lower net sales in 1998. The foregoing factors were offset
by labor and other cost savings associated with normalized production at the
Company's Mexico facility, and lower overhead resulting from termination of
printing operations in February 1997. As mentioned above, the Company expects
that discontinuing its specialty licensed stationery product line and the
resulting sale of the remaining inventory, possibly at reduced prices, may
result in a decreased gross margin as a percentage of net sales for the
fourth quarter of 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased approximately $299,000 to $1.4 million for
the three months ended September 30, 1998 from $1.7 million for the three
months ended September 30, 1997. As a percentage of net sales, these
expenses increased to 27.1% in the three months ended September 30, 1998
compared to 26.5% for the three months ended September 30, 1997 due to the
combination of lower net sales and the increased expenses of hiring
additional salesmen, and expanding its advertising and promotion efforts,
offset by decreased expenses in specialty licensed stationery products.
Selling, general and administrative expenses decreased approximately
$327,000 to $4.0 million for the nine months ended September 30, 1998 from
$4.4 million for the nine months ended September 30, 1997. As a percentage
of net sales, these expenses increased to 31.3% in the nine months ended
September 30, 1998 compared to 29.3% for the nine months ended September 30,
1997 due to the combination of lower net sales and the increased expenses of
hiring additional salesmen, and expanding its advertising and promotion
efforts, offset by decreased expenses in specialty licensed stationery
products. A one-time incentive bonus of approximately $38,000 was paid to two
salesmen in the quarter ended March 31, 1998 which the Company does not
anticipate providing in the future.
Printing Division Expense. In the three months ended March 31, 1997,
the Company incurred approximately $116,000 of incremental printing costs
associated with its captive printing division which was closed in February
1997.
Interest Expense. Interest expense decreased approximately $211,000 (or
79.0%) to $56,000 for the three months ending September 30, 1998 from
$267,000 for the three months ended September 30, 1997. This decrease is
attributable to decreased factoring expenses associated with decreased
borrowings under the factoring arrangements due to proceeds received from the
initial public offering in January.
Interest expense decreased approximately $483,000 (or 72.8%) to $180,000
for the nine months ended September 30, 1998 from $664,000 for the nine
months September 30, 1997. During the nine months ended September 30, 1998,
the Company substantially reduced its use of factors, a trend which the
Company intends to continue. The Company intends to rely upon its $2 million
line of credit which was established in April 1998.
Provision for Income Taxes. The provision for income taxes decreased
approximately $3,000 to $102,000 for the three months ended September 30,
1998 as compared to $105,000 for the three months ended September 30, 1997.
The provision for income taxes decreased approximately $40,000 to $149,000
for the nine months ended September 30, 1998 as compared to $189,000 for the
nine months ended September 30, 1997. Provision for income taxes has been
made for each Subsidiary through October 17, 1997, the date of the
consummation of the Consolidation. Notwithstanding the Consolidation,
operating losses from AGS Stationery were not available to
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offset taxable income of the Company's other Subsidiaries and in future
periods may only be used to offset future AGS Stationery profits. Management
has established a valuation allowance on the deferred tax asset because it is
more likely than not that the deferred tax asset will not be realized.
Net Income (Loss). Net income was $236,000 for the three months ended
September 30, 1998 as compared to $195,000 for the three months ended
September 30, 1997, due to the factors set forth above. Net income of
$274,000 for the nine months ended September 30, 1998 as compared to $147,000
for the nine months ended September 30, 1997, due to the factors set forth
above.
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 1997 the Company satisfied its working capital
requirements primarily through cash flows generated from operations,
borrowings under factoring agreements with Heller Financial, Inc. ("Heller
Financial") and Safcor, Inc. ("Safcor") and related party borrowings.
Generally, the Company's borrowing requirements have been somewhat seasonal,
with peak working capital need occurring at the end of the year. The Company
has substantially reduced its use of factoring arrangements with Heller and
Safcor as of September 30, 1998.
Pursuant to the terms of its factoring agreements, the Company's factors
purchase the Company's eligible accounts receivable and assume the credit
risk only with respect to those accounts for which the factors have given
prior approval. As of September 30, 1998, the amount factored without
recourse was $150,000 and the amount due from the factor recorded as a
current asset was $151,000. Where the Company's factors do not assume the
credit risk for a receivable, the collection risk associated with the
receivable remains with the Company and if the factor, in its discretion,
determines to advance against the receivable, the customer's payment
obligation is recorded as a Company receivable and the advance from the
factor is recorded as a current liability.
The Company's initial public offering resulted in net proceeds to the
Company of approximately $4,627,000. As of September 30, 1998, $4,350,000
had been applied and the remaining $276,000 was available for working capital
and other purposes. The Company used a portion of the net proceeds from its
public offering to satisfy the majority of its obligations existing under the
Heller Financial and Safcor factoring arrangements. The Company also used a
portion of the proceeds to repay the senior subordinated secured notes held
by Cruttenden Roth Bridge Fund, LLC and Beta Research Corporation in the
principal amounts of $323,125 and $226,875, respectively.
Effective May 1, 1998, the Company entered into a line of credit
agreement with Sanwa Bank for $2 million to be used for working capital
purposes. The line of credit expires on May 31, 1999. The line of credit
interest rate is equal to the bank's reference rate and includes certain
financial covenants relating to net worth, debt to net worth, current ratio,
and profitability. As of September 30, 1998, the Company had an outstanding
balance of $1,689,000 on the bank line of credit.
As of September 30, 1998, the Company had outstanding related party debt
of $930,000 (the "Related Party Indebtedness") at a weighted average rate of
7.8% and non-related party debt of $67,000. All Related Party Indebtedness
is due and payable on the fifteenth day following the date of delivery of
written demand for payment which may be delivered at any time after December
31, 1998.
Net cash (used in) provided by operating activities was approximately
($2,730,000) and $432,000 for the nine months ended September 30, 1998 and
1997, respectively. Cash provided in the nine months ended September 30, 1997
resulted primarily from increased accounts payable, prepaid expenses, and
accrued expenses partially offset by decreases in accounts receivable and
inventory. Cash used in operations in the nine months ended September 30,
1998 resulted primarily from decreased accounts payable, increased accounts
receivables, inventory and expenses related to the Offering.
11
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Net cash used in investing activities was $608,000 and $618,000 for the
nine months ended September 30, 1998 and 1997, respectively. Those activities
related primarily to capital expenditures for production equipment, leasing
of equipment and expenditures for office and assembly equipment in connection
with the Mexico facility.
Net cash provided by financing activities was approximately $3,557,000
and $297,000 for the nine months ending September 30, 1998 and 1997,
respectively. Net cash provided by financing activities for the nine months
ended September 30, 1998 reflects proceeds from the IPO and bank line of
credit; offset by reductions in advances from factors, related parties and
non-related parties. Net cash provided for the nine months ending September
30, 1997 resulted from net advances from related parties and factors.
In October 1998 the Company received proceeds of $2,688,750 from the
sale of 2,390,000 shares to KG Investments, LLC, a strategic investor, which
will be used to fund a portion of its business growth plans and operations.
The Company believes that it may need to obtain additional financing in order
to provide adequate liquidity to funds its business growth plans and
operations during the next 12 months. The Company is continually evaluating
various financing strategies to be utilized in expanding its business and to
fund future growth or acquisitions. The extent of the Company's future
capital requirements will depend, however, on many factors, including but not
limited to, results of operations, the size and timing of future
acquisitions, if any, and the availability of additional financing. No
assurance can be given that such additional financing will be available or
that, if available, it can be obtained on terms favorable to the Company and
its stockholders. The Company's inability to obtain adequate funds would
adversely affect the Company's operations and ability to implements its
strategy. In addition, any equity financing could result in dilution to the
Company's stockholders. See "Factors That May Affect Future Results Future
Capital Needs; Uncertainty of Additional Funding".
NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 129, "Disclosure of Information about
Capital Structure" ("Statement 129"), which is effective for financial
statements ending after December 15, 1997. Statement 129 reinstates various
securities disclosure requirements previously in effect under Accounting
Principles Board Opinion No. 15, which had been superseded by Statement 128.
The Company does not expect adoption of Statement 129 to have a material
effect, if any, on its consolidated financial position or results of
operation.
During June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("Statement 130"), which is effective for financial statements with
fiscal years beginning after December 15, 1997. Statement 130 establishes
standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. The
Company has not determined the effect on its consolidated financial position
or results of operations, if any, from the adoption of this statement.
During June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131, "Disclosure about
Segments of an Enterprise and Related Information" ("Statement 131"), which
is effective for financial statements with fiscal years beginning after
December 15, 1997. The new standard requires that public business
enterprises report certain information about operating segments in complete
sets of financial statements of the enterprise and in condensed financial
statements of interim periods issued to stockholders. It also requires that
public business enterprises report certain information about their products
and services, the geographic areas in which they operate and their major
customers. The Company does not expect adoption of Statement 131 to have a
material effect, if any, on its consolidated results of operation.
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YEAR 2000 UPDATE
General. The Company's Year 2000 Project (the "Project") has been divided
into three major areas and is proceeding on schedule. The Project is
addressing the date-logic issues in hardware, software, and embedded computer
chips being able to distinguish between the year 1900 and the year 2000. In
1997, the Company began its systems replacement program to improve access to
business information through common, integrated computing systems with the
use of programs primarily from Sage/State of The Art (MAS90). The new
systems, scheduled for completion by mid-1999, are expected to make
approximately 80% of the company's business computer systems Year 2000
compliant. Implementation of MAS90 programs are approximately 50% complete
with the current versions utilized by the Company certified as Year 2000
compliant. Remaining business software programs are expected to be made Year
2000 compliant through the Project or they will be retired. There are no
other information technology projects which have been delayed due to the
implementation of the Year 2000 Project.
Project. The Project is divided into three major phases: Infrastructure,
Applications Software, and Third-Party suppliers and customers. Each phase
includes identification and assessment of Year 2000 compliance items
determined to be material to the Company; repair and/or replacement of items
determined not to be Year 2000 compliant; testing of material items; and
implementation of contingency and business continuation planning.
The Infrastructure section consists of hardware and systems software other
than Applications Software. This section is on schedule, and the Company
estimates that approximately 50% of the activities related to this section
have been completed as of September 30, 1998. The testing phase is ongoing
as system software and hardware is upgraded or replaced. The Company has
engaged a network consultant to assist in the program management of the
Project. Contingency planning is expected to commence in the first quarter
of 1999.
The Applications Software section includes both the conversion of
applications software that is not Year 2000 compliant and, where available
from the supplier, the replacement of such software. The Company estimates
that the software conversion phase was approximately 60% completed as of
September 30, 1998. The remaining conversions and testing is scheduled for
completion by mid-1999, including integration of the Mexico and Hong Kong
information systems to the Company's principal office in Los Angeles. The
Company has engaged a software consultant to assist in the program management
of the Project. Current versions of MAS90 utilized by the Company are Year
2000 compliant. Contingency planning is expected to commence in the first
quarter of 1999.
The Third Party suppliers and customers section includes the process of
identifying, prioritizing, and communicating with critical suppliers and
customers about their plans and progress in addressing the Year 2000 problem.
Detailed evaluation, via questionnaires, will be commenced in the fourth
quarter of 1998. Contingency planning is expected to commence in the first
quarter of 1999 with follow-up reviews scheduled through the remainder of
1999.
Costs. The total cost associated with required modifications to become
Year 2000 compliant is not expected to be material to the Company's financial
position. The estimated cost of the Year 2000 Project is approximately
$250,000 with approximately $150,000 expensed through September 30, 1998,
representing replacement software and hardware upgrades.
Risks. The failure to correct a material Year 2000 problem could have a
material adverse effect on the Company's results of operations and its
ability to implement its business strategy. Due to the general uncertainty
inherent in the Year 2000 problem, resulting in part from the uncertainty of
the Year 2000 readiness of third-party suppliers and customers, the Company
is unable to determine at this time whether the consequences of Year 2000
failures will have a material impact on the company's results of operations
and financial condition. The Year 2000 Project is expected to significantly
reduce the Company's level of uncertainty and possibility of significant
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interruptions of normal operations relating to the Year 2000 problem and, in
particular, about the Year 2000 compliance and readiness of its material
suppliers and customers.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The following is a discussion of certain factors that may affect the
Company's financial condition and results of operations.
Management of Business Changes; Potential Growth; Potential
Acquisitions. The Subsidiaries have been operated under family management
since inception and have recently significantly expanded their operations.
Such expansion has placed, and any future expansion, internally or through
acquisitions, will place, significant demands on the Company's management,
operational, administrative, financial and accounting resources. Successful
management of the Company's operations will require the Company to continue
to implement and improve its financial and management information and
reporting systems and procedures on a timely basis. The Company's ability to
manage its future growth, if any, will also require it to hire and train new
employees, including management and operating personnel, and motivate and
manage its new employees and integrate them into its overall operations and
culture. The Company recently has made additions to its management team and
is in the process of improving its financial and management information and
reporting systems to adapt to its new role as a public company, a process
which is expected to continue. The Company's failure to manage
implementation of its growth strategies and to implement and improve its
financial and management information and reporting systems would have a
material adverse effect on the Company's results of operations and its
ability to implement its growth strategy.
In the future, the Company may acquire complementary companies, products
or technologies, although no specific acquisitions currently are pending or
under negotiation. Acquisitions involve numerous risks, including adverse
short-term effects on the combined business' reported operating results,
impairments of goodwill and other intangible assets, the diversion of
management's attention, the dependence on retention, hiring and training of
key personnel, the amortization of intangible assets and risks associated
with unanticipated problems or legal liabilities.
Potential Fluctuations in Quarterly Operating Results; Seasonality. The
Company may in the future experience significant quarterly fluctuations in
sales, operating income and cash flows as a result of certain factors,
including the volume and timing of customer orders received during the
quarter, the timing and magnitude of customers' marketing campaigns, the loss
of a major customer, the availability and pricing of materials for the
Company's products, increased selling, general and administrative expenses
incurred in connection with acquisitions or the introduction of new products,
the costs and timing of any future acquisitions, the timing and magnitude of
capital expenditures, and changes in the Company's product mix or in the
relative contribution to sales of the various Subsidiaries. Due to the
foregoing factors, it is possible that in some quarters the Company's
operating results may be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would
likely be materially and adversely affected.
In addition, most of the Company's customers are in the apparel
industry, which historically has been subject to substantial cyclical
variations. The Company's business has experienced and is expected to
continue to experience significant seasonality, in part due to customer
buying patterns. A recession in the general economy or uncertainties
regarding future economic prospects that affect consumer spending habits
could have a material adverse effect on the Company's financial condition and
results of operations.
Requirement for Integrated Information System. The Consolidation and
resulting centralized management of the Subsidiaries, implementation of the
Company's growth strategies and the general strains of the Company's new role
as a public company will place significant demands on the Company's financial
and management
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information and reporting systems and require that the Company significantly
expand and improve its financial and operating controls. Additionally, the
Company must update its computer systems to become Year 2000 compliant and
effectively integrate the information systems of Hong Kong and Mexico to the
Company's principal offices in Los Angeles. There are no assurances that the
Company will be successful in implementing and improving its financial and
management information reporting systems and staff, and the Company's failure
to do so could have a material adverse effect on the Company's results of
operations and its ability to implement its business strategy.
Dependence on Key Customers; Absence of Long-Term Contracts with
Customers. The Company's two largest customers, Guess? and Swank (a licensee
of Yves Saint Laurent, Kenneth Cole, Geoffrey Beene and Pierre Cardin),
accounted for approximately 9.6% and 11.4%, respectively, of the Company's
net sales (on a consolidated basis) for the nine months ended September 30,
1998, and approximately 14.4% and 12.2%, respectively, of the Company's net
sales (on a consolidated basis) for the year ended December 31, 1997. There
can be no assurance that the Company will be able to maintain the current
level of sales derived from these or any other customer in the future.
The Company generally does not enter into long-term sales contracts with
its customers requiring them to make purchases from the Company. The
Company's sales are generally evidenced by a purchase order and similar
documentation limited to a specific sale. As a result, a customer from whom
the Company generates substantial revenue in one period may not be a
substantial source of revenue in a subsequent period. In addition, the
Company's customers generally have the right to terminate their relationships
with the Company without penalty and on little or no notice. In the absence
of such long-term contracts, there can be no assurance that these customers
will continue to engage the Company to design and produce products, and thus
there can be no assurance that the Company will be able to maintain a
consistent level of sales.
The termination of the Company's business relationship with any of its
significant customers or a material reduction in sales to a significant
customer could have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Key Personnel. The Company's success has and will
continue to depend to a significant extent upon certain key management and
design and sales personnel, many of whom would be difficult to replace,
particularly Colin Dyne, its Chief Executive Officer and Harold Dyne, its
President, neither of whom is bound by an employment agreement or the subject
of key man insurance. The Company intends to enter into employment
agreements with Colin Dyne or Harold Dyne and also intends to obtain $1
million key man life insurance on Colin Dyne. The loss of the services of one
or more of these key executives and other key employees could have a material
adverse effect on the Company, including the Company's ability to establish
and maintain client relationships. The Company's future success will depend
in large part upon its ability to identify, attract, assimilate, retain and
motivate personnel with a variety of design, sales, operating and managerial
skills. There can be no assurance that the Company will be able to retain
and motivate its managerial, design, sales and operating personnel or attract
additional qualified members to management, design or sales staff.
Future Capital Needs; Uncertainty of Additional Funding. The Company
anticipates that it may need to obtain additional capital to fund its
business growth plans and operations during the next 12 months. To the extent
that existing resources and future earnings are insufficient to fund the
Company's activities, the Company will need to raise additional funds through
debt or equity financings. No assurance can be given that such additional
financing will be available or that, if available, it can be obtained on
terms favorable to the Company and its stockholders. Even if the Company is
able to obtain alternative financing on acceptable terms, any decrease or
material limitation on the amount of capital available to the Company under
such arrangements will limit the ability of the Company to expand its sales
levels and, therefore, would have a material adverse effect on the Company's
financial position, operating results and cash flows. In addition, any
significant increases in interest rates will increase the cost of financing
to the Company and would have a material adverse effect on the Company's
financial position, operating results and cash flows. In addition, any
equity financing could result in
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dilution to the Company's stockholders. The Company's inability to obtain
adequate funds would adversely affect the Company's operations and ability to
implement its strategy.
Control by Existing Stockholders. As of September 30, 1998, the
Company's officers and directors (and their affiliates), owned approximately
46.6% of the Company's outstanding shares; and the Dyne family (Harold Dyne,
Mark Dyne, Colin Dyne, Larry Dyne and Jonathan Burstein) owned approximately
46.2% of the Company's outstanding shares. As a result, these stockholders,
or the Dyne family acting as a group, effectively control the Company and its
operations, including the election of at least a majority of the Company's
Board of Directors and thus the policies of the Company. The voting power of
these stockholders could also serve to discourage potential acquirors from
seeking to acquire control of the Company through the purchase of the Common
Stock, which might have a depressive effect on the price of the Common Stock.
Dependence on Limited Assembly Facilities. Certain of the Company's
products are assembled or finished at the foreign assembly facilities of the
Company. Since the Company does not currently operate duplicate facilities
in different geographic areas, a disruption of the Company's manufacturing
operations resulting from various factors, including human error, foreign
trade disruptions, import restrictions, labor disruptions, embargos,
government intervention or a natural disaster such as fire, earthquake or
flood, could cause the Company to cease or limit its assembly or finishing
operations and consequently could have a material adverse effect on the
Company's business, financial condition and results of operations.
Limited Sources of Supply. The Company generally does not have long-
term agreements with its key sources of supply. Lead times for materials
ordered by the Company can vary significantly and depend on factors such as
the specific supplier, contract terms and demand for particular materials at
a given time. From time to time, the Company has experienced fluctuations in
materials prices and disruptions in supply. Shortages or disruptions in the
supply of materials, or the inability of the Company to procure such
materials from alternate sources at acceptable prices in a timely manner,
could lead to the loss of customers due to the failure to timely meet orders
which in turn could result in a material adverse effect on the Company's
business, financial condition and results of operations.
Fluctuating Paper Costs and Paper Shortages. The cost of paper is a
principal component of the price the Company charges for its paper products,
including its high quality paper boxes, custom shopping bags, hang tags,
packaging and stationery products. Historically, the Company has been able to
pass on to its customers any increase or decrease in the cost of paper, and
therefore maintain its gross margins on paper products during fluctuations in
the cost of paper. There can be no assurance, however, that the Company will
continue to be able to pass increases in paper costs to its customers. To
the extent that the Company's customers are unwilling to absorb increases in
paper costs, the Company's results of operations could be materially
adversely affected.
While capacity in the paper industry has remained relatively stable in
recent years, increases or decreases in demand for paper have led to
corresponding pricing changes and, in periods of high demand, to limitations
on the availability of certain grades of paper, including grades utilized by
the Company. Any disruption in the Company's paper sources could cause
shortages in needed materials which could have a material adverse effect on
the Company's results of operations. Although the Company actively manages
its paper supply and has established strong relationships with its paper
suppliers, the Company does not have any long-term agreements with its key
paper suppliers and there can be no assurance that the Company's sources of
paper supply will be adequate or, in the event that such sources are not
adequate, that alternative sources can be developed in a timely manner.
Competition. The industries in which the Company competes are highly
competitive and fragmented and include numerous local and regional companies
that provide some or all of the services offered by the Company. The Company
also competes with United States and international design companies,
distributors and manufacturers of tags, packaging products and trims. Some
of the Company's competitors, including Paxar, Inc., RVL, Inc, Copac
International Packaging, Inc., Universal Button, Inc., and Scovill Fasteners,
Inc., have greater
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name recognition, longer operating histories and, in many cases,
substantially greater financial and other resources than the Company.
In addition, new competitors, potentially with substantially greater
resources than the Company, may arise and may develop products which compete
with the Company's products. Moreover, there can be no assurance that new or
proprietary technology will not be introduced by an existing or new
competitor that may make some of the Company's products or services obsolete.
To the extent that the Company is unable to compete successfully against its
existing and future competitors, its business, operating results and
financial condition would be materially adversely affected. While the
Company believes that it competes effectively within the value-added design
and packaging industry, there are numerous factors that could reduce the
Company's ability to compete effectively.
Dependence Upon Guess? License. The Company, through AGS Stationery,
manufactures Guess? stationery products pursuant to an exclusive license with
Guess? entered into as of March 1, 1996. Net sales of Guess? stationery
products accounted for 2.6% and 11.0% of the Company's consolidated net sales
for the nine months ended September 30, 1998 and 1997, respectively.
Effective August 7, 1998 the Company and Guess? mutually agreed to terminate
the license. However, the Company is allowed to sell-off any remaining
inventory through December 1998. The termination results in no payoff or
penalties to either party and therefore, the Company does not expect any
material adverse effect on the Company's business, operating results, and
financial condition, other than the possibility that the Company will have to
sell off the remaining inventory at reduced prices, thus decreasing its gross
margin as a percentage of net sales.
Risk of Product Returns. The Company incurs expenses as a result of the
return of products by customers, particularly in connection with customers of
the Company's licensed stationery business. Such returns may result from
sale or return arrangements, defective goods, inadequate performance relative
to customer expectations, shipping errors and other causes which are outside
the Company's control. Generally, returned items have limited or no value
and the Company will be forced to bear the cost of such returns. Product
returns could result in loss of revenue or delay in market acceptance,
diversion of development resources, damage to the Company's reputation, and
increases service and warranty costs. Any significant increase in the rate
of product returns could have a material adverse effect on the Company's
financial position, operating results, and cash flows.
International Business. For the year ended December 31, 1997, and the
nine months ended September 30, 1998, approximately 40% of the Company's
products were purchased, assembled or finished outside the United States,
principally in Hong Kong and Mexico, and the Company intends to continue to
purchase, assemble or finish a similar or greater percentage of its products
outside of the United States in the future. The Company's international
business is subject to numerous risks, including the need to comply with a
wide variety of foreign and United States export and import laws, changes in
export or import controls, tariffs and other regulatory requirements, the
imposition of governmental controls, political and economic instability,
trade restrictions, the difficulty of administering business overseas and
general economic conditions. The inability of a contractor or supplier to
ship orders in a timely manner could cause the Company to miss the delivery
date requirements of its customers for those items, which could result in the
cancellation of orders, refusal to accept deliveries or a reduction in sales
price. Although the Company's international operations are denominated
principally in United States dollars, purchases from foreign vendors and
sales to foreign customers may also be affected by changes in demand
resulting from fluctuations in interest and currency exchange rates,
including the recent Asian currency fluctuations. There can be no assurance
that these factors will not have a material adverse effect on the Company's
business and results of operations. In addition, the Company cannot predict
the effects the above risks will have on its business arrangements with its
customers, contractors or suppliers. If any such risks were to render the
conduct of business in a particular country undesirable or impractical, or if
the Company's current contractors or suppliers were to cease doing business
with the Company for any reason, the Company's financial position, operating
results and cash flows could be adversely affected.
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Shared Responsibilities of Chairman. The Company's Chairman, Mark
Dyne, also serves as Chief Executive Officer and Chairman of Brilliant
Digital Entertainment, Inc. ("Brilliant"), as the joint managing director of
Sega Ozisoft Pty., Limited ("Sega Ozisoft"), a director of Monto Holdings
Pty. Ltd. ("Monto Holdings") and Nu-Metro Multimedia Pty. Ltd. ("Nu-Metro"),
and a co-owner and director of Packard Bell Australia Pty. Ltd. ("Packard
Bell NEC Australia"). Mr. Dyne is a shareholder of Sega Enterprises
(Australia) Pty. Ltd., which operates a $70 million interactive indoor theme
park in Darling Harbor in Sydney, Australia. Brilliant is a production and
development studio involved in the production of a new generation of digital
entertainment that is being distributed over the internet and on CD-ROM.
Sega Ozisoft is an Australia-distributor of software products for many
leading publishers. Monto Holdings is a private investment holding company,
Nu-Metro is a South African based distributor of multi-media software
products and Packard Bell NEC Australia is one of the leading manufacturers
and distributors of personal computers through the Australian mass merchant
channel. Mr. Dyne is not required to spend a certain amount of time at the
Company nor is he able to devote his full time and resources to the Company.
Holding Company Structure. The Company is a holding company with no
substantial operations and, consequently, is dependent on dividends and other
payments from the Subsidiaries for virtually all of its cash flow, including
cash flow for management salaries and overhead, to service debt, to make
equity investments and to finance its growth.
No Earthquake Insurance. The Company's principal executive offices are
located in Los Angeles, California -- an area which often experiences
earthquakes. The Company faces the risks that it may experience uninsured
property damage and/or sustain interruption of its business and operations.
The Company does not currently carry insurance against earthquake-related
risks.
Limited Proprietary Protection. The Company relies on trademark, trade
secret and copyright laws to protect its designs and other proprietary
property. The Company does not have United States or foreign patents or
patent applications currently pending. If litigation is necessary in the
future to enforce the Company's intellectual property rights, to protect the
Company's 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 and could have a material adverse effect on
the Company's business, operating results and financial condition.
Ultimately, the Company may be unable, for financial or other reasons, to
enforce its rights under intellectual property laws, and the laws of certain
countries in which the Company's products are or may be distributed may not
protect the Company's products and intellectual rights to the same extent as
the laws of the United States.
The Company believes that its products do not infringe any validly
existing proprietary rights of third parties. Although the Company has
received no communication from third parties alleging the infringement of
proprietary rights of such parties, there can be no assurance that third
parties will not assert infringement claims in the future and the Company
could be subject to such claims in the future. Any such third party claims,
whether or not meritorious, could result in costly litigation or require the
Company to enter into royalty or licensing agreements. There can be no
assurance that any such licenses would be available on acceptable terms, if
at all, or that the Company would prevail in any such litigation. If the
Company were found to have infringed upon the proprietary rights of third
parties, it could be required to pay damages, cease sales of the infringing
products and redesign or discontinue such products, any of which could have a
material adverse effect on the Company's business, operating results and
financial condition.
Shares Eligible for Future Sale. Future sales of Common Stock by
existing stockholders could adversely affect the prevailing market price of
the Common Stock and the Company's ability to raise capital in the equity
markets. The Company has 6,460,011 shares of Common Stock outstanding. Of
those shares, 1,680,000 shares are freely tradeable without restriction or
further registration under the Securities Act, unless purchased by
"affiliates" of the Company as that term is defined in Rule 144 under the
Securities Act ("Rule 144"). The remaining 4,780,011 shares of Common Stock
outstanding are "restricted securities," as that term is defined by Rule 144,
and are also subject to the holding period, volume and manner of sale
limitations of Rule 144. Under
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certain lock-up agreements, the officers, directors and other stockholders,
holding an aggregate of 2,277,894 shares of Common Stock, have agreed that
they will not, directly or indirectly, sell, assign or otherwise transfer any
shares of Common Stock owned by them until January 1999, without the prior
written consent of Cruttenden Roth Incorporated. Upon expiration of the lock-
up agreements, such 2,277,894 shares of Common Stock will become eligible for
sale, subject to compliance with the volume and manner of sale limitations of
Rule 144. The Company also registered the shares of Common Stock reserved for
issuance pursuant to the Company's 1997 Stock Incentive Plan (the "1997
Plan"). As of September 30, 1998, options to purchase 260,000 shares of
Common Stock and warrants to purchase 287,631 shares of Common Stock had been
granted, none of which had been exercised. The availability for sale, as well
as actual sales, of currently outstanding shares of Common Stock, and shares
of Common Stock issuable upon the exercise of options and warrants, may
depress the prevailing market price for the Common Stock and could adversely
affect the terms upon which the Company would be able to obtain additional
equity financing.
Environmental Regulations. Certain of the Subsidiaries use hazardous
materials in their manufacturing operations. As a result, the Company is
subject to federal, state and local regulations governing the storage, use
and disposal of such materials. The use and disposal of hazardous materials
involves the risk that the Company could be required to incur substantial
expenditures for preventive or remedial action, reduction of chemical
exposure, or waste treatment or disposal. The liability in the event of an
accident or the costs of such actions could exceed the Company's resources or
otherwise have a material adverse effect on the Company's business, financial
condition or results of operations.
Effect of Certain Charter Provisions; Stockholders' Rights Plan; Anti-
Takeover Effects of Certificate of Incorporation, Bylaws and Delaware Law.
The Company's Board of Directors has the authority to issue up to 3,000,000
shares of Preferred Stock and to determine the price, rights, preferences,
privileges and restrictions, including voting rights, of those shares without
any further vote or action by the stockholders. The Preferred Stock could be
issued with voting, liquidation, dividend and other rights superior to those
of the Common Stock. In October 1998, the Company adopted a stockholder's
rights plan (the "Rights Agreement") and, in connection therewith,
distributed one preferred share purchase right for each outstanding share of
the Company's Common Stock outstanding on November 6, 1998. Pursuant to the
Rights Agreement, upon the occurrence of certain triggering events related to
an unsolicited takeover attempt of the Company, each purchase right not owned
by certain hostile acquirers will entitle its holder to purchase shares of
the Company's Series A Preferred Stock at a value below the then current
market value of the preferred stock. The holders of the Series A Preferred
Stock will have voting rights equivalent to the holders of the Common Stock.
The rights of the holders of Common Stock will be subject to, and may be
adversely affected by, the rights of the holders of the shares purchase
rights and of any 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
have the effect of making it more difficult for a third party to acquire a
majority of the outstanding voting stock of the Company. Further, certain
provisions of the Company's Certificate of Incorporation and Bylaws and of
Delaware law could delay or make more difficult a merger, tender offer or
proxy contest involving the Company.
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PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In January 1998, in connection with the purchase of $550,000 of Bridge
Notes, Cruttenden Roth Bridge Fund, LLC and Beta Research Corporation
received Bridge Warrants to purchase 47,000 shares and 33,000 shares,
respectively, of Common Stock. The Bridge Warrants will be exercisable for a
period of four years, commencing January 23, 1999, at an initial per share
exercise price of $6.00. The Bridge Warrants provide for demand and
piggyback registration rights. The issuance and sale of these securities was
made in reliance on Section 4(2) of the Securities Act as a transaction not
involving any public offering.
Also in January 1998, in connection with the Company's initial public
offering, the Company granted to Cruttenden Roth Incorporated and Josephtal &
Co. Inc. (the "Representatives") warrants to purchase up to 110,000 shares of
Common Stock (the "Representatives' Warrants"). The Representatives'
Warrants will be exercisable for a period of four years, commencing January
23, 1999, at an initial per share exercise price of $4.80. Neither the
Representatives' Warrants nor the shares of Common Stock issuable upon
exercise thereof may be transferred, assigned or hypothecated until one year
from the date of the Offering, except that they may be assigned, in whole or
in part, (i) to individuals who are either officers or partners of the
Representatives, or (ii) by will or the laws of descent and distribution or
(iii) to certain successor of the Representatives. Any profit realized by
the Representatives on the sale of securities issuable upon exercise of the
Representatives' Warrants may be deemed to be additional compensation. The
issuance and sale of these securities was made in reliance on Section 4(2) of
the Securities Act as a transaction not involving any public offering.
The Company's Registration Statement on Form SB-2 (File No. 333-38397)
relating to the offer and sale (the "Offering") of an aggregate of 1,680,000
shares (the "Shares") of Common Stock, par value $0.001 per share (the
"Common Stock"), of the Company was declared effective by the Securities and
Exchange Commission (the "Commission") on January 23, 1998. Of the 1,680,000
shares of Common Stock registered under the Registration Statement, 1,600,000
shares were sold by the Company and 80,000 shares were sold by a stockholder
of the Company (the "Selling Stockholder").
The Offering closed on January 28, 1998. All of the Shares registered
were sold in the Offering at an aggregate price of $4.00 per share, for
aggregate proceeds of $6,400,000 and $320,000 to the Company and the Selling
Stockholder, respectively. After deducting underwriting discounts and
commissions of $0.32 per share, the Selling Stockholder received net proceeds
of $294,400 and the Company received net proceeds equal to $5,888,000 less
expenses of $1,260,664 incurred in connection with the Offering (all of
which were paid or are payable by the Company). Of the $1,260,664, $134,400
represents non-accountable expenses payable to the underwriters. Cruttenden
Roth Incorporated and Josepthal & Co. Inc. were the co-managing underwriters.
The Offering resulted in net proceeds ("Net Proceeds") to the Company of
approximately $4,627,000. As of September 30, 1998, the Company had applied
an aggregate of approximately $4,350,000 of the Net Proceeds as follows: (i)
$2,463,000 to repay certain indebtedness (of which approximately $597,000
was paid to officers, directors, stockholders and/or other affiliates of the
Company), (ii) $500,000 to develop a national sales and marketing network,
including hiring additional sales personnel, (iii) $340,000 to acquire
computer & production equipment, (iv) $410,000 to purchase inventories, and
(v) $637,000 for working capital. As of September 30, 1998, the Company had
invested the remaining $276,000 of the Net Proceeds in short-term interest
bearing securities.
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As required by Rule 463 of the Securities Act, the Company will disclose
the application of the remaining Net Proceeds in the Company's periodic
report for the year ending December 31, 1998 and, to the extent necessary, in
subsequent periodic reports filed by the Company pursuant to Section 13(a) or
15(d) of the Exchange Act.
On October 16, 1998, the Company sold 2,390,000 shares of its Common
Stock to KG Investment, LLC for an aggregate purchase price of $2,688,750 (or
$1.125 per share). KG Investment, LLC has agreed that it will not seek to
dispose of its shares prior to October 16, 2000, except to certain affiliated
parties, without the prior written consent of the Company. KG Investment,
LLC has also agreed to certain additional restrictions on the transfer and
voting of the shares it purchased and has been granted piggyback registration
rights. The issuance and sale of these securities was made in reliance on
Rule 506 and Section 4(2) of the Securities Act as a transaction not
involving any public offering.
In October 1998, the Company adopted a stockholder's rights plan and, in
connection therewith, distributed one preferred share purchase right for each
outstanding share of the Company's Common Stock outstanding on November 6,
1998. Upon the occurrence of certain events, each purchase right not owned
by certain hostile acquirers will entitle its holder to purchase shares of
the Company's Series A Preferred Stock at a value below the then current
market value of the preferred stock. The holders of the Series A Preferred
Stock will have voting rights equivalent to the holders of the Common Stock.
The rights of the holders of Common Stock will be subject to, and may be
adversely affected by, the rights of the holders of the share purchase rights
and of any Preferred Stock that may be issued in the future.
ITEM 5. OTHER INFORMATION
Effective May 1, 1998, the Company entered into a $2 million line of
credit agreement with Sanwa Bank to be used for working capital purposes and
expires on May 31, 1999. The Line of Credit interest rate is equal to the
bank's reference rate and includes certain financial covenants relating to
net worth, debt to net worth, current ratio, and profitability.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 27.1 Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the period covered by this
transition report.
21
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 6, 1998 TAG-IT PACIFIC, INC.
By: /s/ Francis Shinsato
-------------------------------------
Francis Shinsato
Chief Financial Officer
(Principal Financial & Accounting
Officer)
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM UNAUDITED
FINANCIAL STATEMENTS OF TAG-IT PACIFIC, INC. AS OF AND FOR THE FOUR MONTHS ENDED
DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 262,657
<SECURITIES> 0
<RECEIVABLES> 4,560,312
<ALLOWANCES> 163,965
<INVENTORY> 2,734,851
<CURRENT-ASSETS> 7,827,544
<PP&E> 2,324,840
<DEPRECIATION> 1,064,743
<TOTAL-ASSETS> 9,132,744
<CURRENT-LIABILITIES> 5,422,688
<BONDS> 0
0
0
<COMMON> 4,070
<OTHER-SE> 3,705,986
<TOTAL-LIABILITY-AND-EQUITY> 9,132,744
<SALES> 12,916,206
<TOTAL-REVENUES> 12,916,206
<CGS> 8,270,344
<TOTAL-COSTS> 12,312,969
<OTHER-EXPENSES> 180,383
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 180,383
<INCOME-PRETAX> 422,854
<INCOME-TAX> 149,122
<INCOME-CONTINUING> 273,732
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 273,732
<EPS-PRIMARY> 0.07
<EPS-DILUTED> 0.07
</TABLE>
