FILED PURSUANT TO RULE 424(B)(3)
REGISTRATION NO. 333-145344
PROSPECTUS SUPPLEMENT NO. 2 DATED SEPTEMBER 25, 2008
(TO PROSPECTUS DATED MAY 1, 2008)
TALON INTERNATIONAL, INC.
This is a prospectus supplement to our prospectus dated May 1, 2008
relating to the resale from time to time by selling shareholders of up to
1,750,000 shares of our common stock. On August 19, 2008, we filed with the
Securities and Exchange Commission a Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2008. The text of the Quarterly Report on Form
10-Q is attached to and made a part of this prospectus supplement. The exhibits
to the Quarterly Report on Form 10-Q are not included with this prospectus
supplement and are not incorporated by reference herein.
This prospectus supplement should be read in conjunction with the
prospectus and any prior prospectus supplements, and this prospectus supplement
is qualified by reference to the prospectus and any prior prospectus
supplements, except to the extent that the information provided by this
prospectus supplement supersedes the information contained in the prospectus or
any prior prospectus supplements.
THE SECURITIES OFFERED BY THE PROSPECTUS INVOLVE A HIGH DEGREE OF RISK.
YOU SHOULD CAREFULLY CONSIDER THE "RISK FACTORS" BEGINNING ON PAGE 4 OF THE
PROSPECTUS IN DETERMINING WHETHER TO PURCHASE THE COMMON STOCK.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THE
PROSPECTUS, AS SUPPLEMENTED, OR THIS PROSPECTUS SUPPLEMENT NO. 2 IS TRUTHFUL OR
COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS SUPPLEMENT NO. 2 IS SEPTEMBER 25, 2008
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2008.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
Commission file number 1-13669
TALON INTERNATIONAL, INC.
(Exact Name of Issuer as Specified in its Charter)
DELAWARE 95-4654481
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
21900 BURBANK BOULEVARD, SUITE 270
WOODLAND HILLS, CALIFORNIA 91367
(Address of Principal Executive Offices)
(818) 444-4100
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for past 90 days.
Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of "large accelerated filer," "accelerated filer" and
"smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [_]
Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]
AT AUGUST 19, 2008 THE ISSUER HAD 20,291,433 SHARES OF COMMON STOCK,
$.001 PAR VALUE, ISSUED AND OUTSTANDING.
TALON INTERNATIONAL, INC.
INDEX TO FORM 10-Q
PART I FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements..................................................3
Consolidated Balance Sheets as of June 30, 2008 (unaudited)
and December 31, 2007 ..............................................3
Consolidated Statements of Operations for the Three Months
and the Six Months Ended June 30, 2008 and 2007 (unaudited).........4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2008 and 2007 (unaudited).................5
Notes to the Consolidated Financial Statements........................7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................23
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........32
Item 4. Controls and Procedures..............................................32
PART II OTHER INFORMATION
Item 1. Legal Proceedings....................................................34
Item 1A. Risk Factors ........................................................35
Item 6. Exhibits ............................................................35
2
TALON INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2008 2007
(Unaudited)
------------- -------------
Assets
Current Assets:
Cash and cash equivalents .................. $ 3,741,404 $ 2,918,858
Marketable securities available for sale ... 540,000 1,040,000
Accounts receivable, net ................... 7,077,382 3,504,351
Inventories, net ........................... 2,673,647 2,487,427
Prepaid expenses and other current assets .. 790,749 945,566
------------- -------------
Total current assets .......................... 14,823,182 10,896,202
Property and equipment, net ................... 4,809,710 5,210,446
Fixed assets held for sale .................... 687,955 700,000
Due from related parties ...................... 649,278 625,454
Other intangible assets, net .................. 4,110,751 4,110,751
Other assets .................................. 190,795 140,782
------------- -------------
Total assets .................................. $ 25,271,671 $ 21,683,635
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ............................ $ 11,297,188 $ 6,603,929
Accrued legal costs ......................... 237,665 498,846
Other accrued expenses ...................... 2,841,258 2,646,662
Demand notes payable to related parties ..... 85,176 85,176
Current portion of capital lease obligations 282,796 323,317
Current portion of notes payable ............ 263,869 299,108
------------- -------------
Total current liabilities ..................... 15,007,952 10,457,038
Capital lease obligations, less current portion 50,069 189,705
Notes payable, less current portion ........... 736,613 848,484
Revolver note payable ......................... 4,160,710 3,807,806
Term notes payable, net of discounts of
$2,933,300 and $2,485,700 ................... 7,441,705 7,014,301
Other long term liabilities ................... 83,651 83,651
------------- -------------
Total liabilities ............................. 27,480,700 22,400,985
------------- -------------
Commitments and contingencies (Note 11)
Stockholders' Equity (Deficit):
Preferred stock Series A, $0.001 par value;
250,000 shares authorized; no
shares issued or outstanding .............. -- --
Common stock, $0.001 par value, 100,000,000
shares authorized; 20,291,433 shares
issued and outstanding at June 30, 2008
and December 31, 2007 ..................... 20,291 20,291
Additional paid-in capital .................. 54,646,042 54,510,161
Accumulated deficit ......................... (56,532,833) (55,292,246)
Accumulated other comprehensive income (loss) (342,529) 44,444
------------- -------------
Total stockholders' equity (deficit) .......... (2,209,029) (717,350)
------------- -------------
Total liabilities and stockholders' equity .... $ 25,271,671 $ 21,683,635
============= =============
See accompanying notes to consolidated financial statements
3
TALON INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ----------------------------
2008 2007 2008 2007
------------ ------------ ------------ ------------
Net sales ......................... $ 17,020,629 $ 13,566,981 $ 27,006,118 $ 22,657,099
Cost of goods sold ................ 12,119,725 9,484,488 19,347,249 15,827,411
------------ ------------ ------------ ------------
Gross profit ................... 4,900,904 4,082,493 7,658,869 6,829,688
Selling expenses .................. 767,865 841,326 1,487,828 1,547,561
General and administrative expenses 3,082,164 2,406,192 6,430,400 5,017,780
------------ ------------ ------------ ------------
Total operating expenses ....... 3,850,029 3,247,518 7,918,228 6,565,341
Income (loss) from operations ..... 1,050,875 834,975 (259,359) 264,347
Interest expense, net ............. 643,130 265,858 1,192,644 490,574
------------ ------------ ------------ ------------
Income (loss) before provision for
(benefit from) income taxes ..... 407,745 569,117 (1,452,003) (226,227)
Provision for (benefit from) income
taxes ........................... (190,412) 78,624 (211,416) 78,624
------------ ------------ ------------ ------------
Net Income (loss) .............. $ 598,157 $ 490,493 $ (1,240,587) $ (304,851)
============ ============ ============ ============
Basic income (loss) per share ..... $ 0.03 $ 0.03 $ (0.06) $ (0.02)
============ ============ ============ ============
Diluted income (loss) per share ... $ 0.03 $ 0.02 $ (0.06) $ (0.02)
============ ============ ============ ============
Weighted average number of common
shares outstanding:
Basic .......................... 20,291,433 18,590,884 20,291,433 18,562,151
============ ============ ============ ============
Diluted ........................ 20,291,433 20,058,682 20,291,433 18,562,151
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
TALON INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
----------------------------
2008 2007
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................................ $ (1,240,587) $ (304,851)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization .................................... 546,844 592,011
Amortization of deferred financing cost and debt discounts ....... 556,755 163,593
Increase (decrease) in allowance for doubtful accounts ........... (5,000) 61,500
Decrease in inventory valuation reserves ......................... (340,312) (165,280)
Stock based compensation ......................................... 284,433 125,000
Changes in operating assets and liabilities:
Receivables, including related party ............................. (3,591,855) (1,485,273)
Notes receivable ............ .................................... -- 671,808
Inventories ...................................................... 154,092 661,428
Recoverable legal costs .......................................... -- (1,073,640)
Prepaid expenses and other current assets ........................ 370,532 (241,137)
Other assets ..................................................... (50,012) 35,207
Accounts payable and accrued expenses ............................ 4,767,304 2,638,060
Accrued legal .................................................... (261,181) 769,467
Notes payable .................................................... -- (791,314)
------------ ------------
Net cash provided by operating activities ..................... 1,191,013 1,656,579
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment ............................ (132,754) (514,812)
Proceeds from disposition of equipment ........................... 12,045 --
------------ ------------
Net cash used by investing activities ......................... (120,709) (514,812)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and warrants ............. -- 42,746
Proceeds from issuance of stock and warrants, net of issuance costs -- 2,313,711
Revolver note borrowings ......................................... 700,000 1,307,806
Repayment of revolver note borrowings ............................ (500,000) --
Term note borrowings, net of issuance costs ...................... -- 6,842,789
Payments on term note ............................................ (125,000) --
Payment of demand notes payable to related party ................. -- (1,004,306)
Payment of notes payable ......................................... (147,110) (96,047)
Payment of capital leases ........................................ (180,157) (160,875)
------------ ------------
Net cash provided by (used in) financing activities ........... (252,267) 9,245,824
------------ ------------
Net increase in cash and cash equivalents ............................. 818,037 10,387,591
Net effect of foreign currency exchange translation on cash ........... 4,509 --
Cash at beginning of period ........................................... 2,918,858 2,934,673
------------ ------------
Cash and cash equivalents at end of period ............................ $ 3,741,404 $ 13,322,264
============ ============
5
Supplemental disclosures of cash flow information:
Cash received (paid) during the period for:
Interest paid ................................................. $ (671,906) $ (513,414)
Interest received ............................................. $ 9,096 $ 153,651
Income tax paid ............................................... $ 10,553 $ 95,056
Non-cash financing activities:
Note payable issued in modification of loan ................... $ 1,000,000 $ --
Debt modification fee ......................................... $ 145,000 $ --
Deferred financing cost ....................................... $ -- $ 203,434
Effect of foreign currency translation on net assets .......... $ 113,027 $ --
Capital lease obligation ...................................... $ -- $ 35,809
See accompanying notes to consolidated financial statements.
6
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. PRESENTATION OF INTERIM INFORMATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and in accordance
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America for
complete financial statements. The accompanying unaudited consolidated financial
statements reflect all adjustments that, in the opinion of the management of
Talon International, Inc. and its consolidated subsidiaries (collectively, the
"Company"), are considered necessary for a fair presentation of the financial
position, results of operations, and cash flows for the periods presented. The
results of operations for such periods are not necessarily indicative of the
results expected for the full fiscal year or for any future period. The
accompanying financial statements should be read in conjunction with the audited
consolidated financial statements of the Company included in the Company's Form
10-K for the year ended December 31, 2007. The balance sheet as of December 31,
2007 has been derived from the audited financial statements as of that date but
omits certain information and footnotes required for complete financial
statements.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A complete description of the Company's Significant Accounting Policies
is included in the Company's Annual Report on Form 10-K (and amendments thereto)
for the year ended December 31, 2007, and should be read in conjunction with
these unaudited consolidated financial statements. The Significant Accounting
Policies noted below are only those policies that have changed materially or
have supplemental information included for the periods presented here.
INVENTORIES
Inventories are stated at the lower of cost, determined using the
first-in, first-out basis, or market value and are all substantially finished
goods. The costs of inventory include the purchase price, inbound freight and
duties, conversion costs and certain allocated production overhead. Inventory is
evaluated on a continual basis and reserve adjustments are made based on
management's estimate of future sales value, if any, of specific inventory
items. Inventory reserves are recorded for damaged, obsolete, excess and
slow-moving inventory. We use estimates to record these reserves. Slow-moving
inventory is reviewed by category and may be 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.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We are required to make judgments as to the collectability of accounts
receivable based on established aging policy, historical experience and future
expectations. The allowance for doubtful accounts represents amounts for
customer trade accounts receivable that are estimated to be partially or
entirely uncollectible. These allowances are used to reduce gross trade
receivables to their net realizable value. We record these allowances based on
estimates related to the following factors: (i) customer specific allowances;
(ii) amounts based upon an aging schedule; and (iii) an estimated amount, based
on our historical experience, for issues not yet identified. Bad debt recoveries
for the three and six months ended June 30, 2008 are $4,021 and $5,326,
respectively. For the three and six months ended June 30, 2007 bad debt expense
was $52,500 and $42,100 (net of bad debt recoveries of $1,500 and $19,500,
respectively).
7
INTANGIBLE ASSETS
Intangible assets consist of our trade name and exclusive license and
intellectual property rights. Intangible assets acquired in a purchase business
combination and determined to have an indefinite useful life are not amortized,
but instead are tested for impairment at least annually in accordance with the
provisions of Financial Accounting Standards Board ("FASB") Statement No. 142,
GOODWILL AND OTHER INTANGIBLE ASSETS. Intangible assets with estimable useful
lives are amortized over their respective estimated useful lives, which average
5 years, and reviewed for impairment in accordance with the provisions of FASB
Statement No. 144, ACCOUNTING FOR IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS.
Amortization expense for these assets for the three and six months ended June
30, 2008 was $0, compared to $0 and $30,600 for the three and six months ended
June 30, 2007, respectively. The Company determined that no impairment existed
at June 30, 2008.
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, or upon notice
from the customer to destroy or dispose of the goods. Sales, provisions for
estimated sales returns, and the cost of products sold are recorded at the time
title transfers to customers. Actual product returns are charged against
estimated sales return allowances.
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. Historically the
volume of sales rebates and discounts have been immaterial based on gross
revenues and accordingly there is no allowance for sales rebates and discounts
on the balance sheet.
CLASSIFICATION OF EXPENSES
COSTS OF GOODS SOLD - Cost of goods sold primarily includes expenses
related to inventory purchases, customs, duty, freight, overhead expenses and
reserves for obsolete inventory. Overhead expenses primarily consist of
warehouse and operations salaries, and other warehouse expense.
SELLING EXPENSES - Selling expenses primarily include royalty expense,
sales salaries and commissions, travel and entertainment, marketing and other
sales related costs. Marketing and advertising efforts are expensed as incurred
and for the three and six months ended June 30, 2008 were $10,581 and $52,696,
respectively, compared to $51,895 and $230,306 for the three and six months
ended June 30, 2007, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES - General and administrative
expenses primarily include administrative salaries, employee benefits,
professional service fees, facility expenses, information technology costs,
investor relations, travel and entertainment, depreciation and amortization, bad
debts and other general corporate expenses.
INTEREST EXPENSE, NET - Interest expense reflects the cost of borrowing
and amortization of deferred financing costs and discounts. Interest expense for
the three and six months ended June 30, 2008 totaled $658,600 and $1,225,600,
respectively. For the three and six months ended June 30, 2007, interest expense
8
was $360,200 and $677,000, respectively. Interest income consists of earnings
from outstanding amounts due to the Company under notes and other interest
bearing receivables and from earnings on cash balances. The Company recorded
interest income of $15,500 and $32,900 respectively, for the three and six
months ended June 30, 2008, as compared to $94,400 and $186,400 for the same
periods in 2007.
Cash paid for interest charges for the six months ended June 30, 2008
and 2007 amounted to $671,900 and $513,400, respectively. Cash interest payments
received during the six months ended June 30, 2008 and 2007 totaled $9,100 and
$153,600, respectively.
SHIPPING AND HANDLING COSTS
In accordance with Emerging Issues Task Force (EITF) 00-01, ACCOUNTING
FOR SHIPPING AND HANDLING FEES AND COSTS, the Company records shipping and
handling costs billed to customers as a component of revenue, and shipping and
handling costs incurred by the Company for outbound freight are recorded as a
component of cost of goods sold. Total shipping and handling costs included as a
component of revenue for the three and six months ended June 30, 2008 were
$56,700 and $107,700, respectively ($58,200 and $119,100 for the three and six
months ended June 30, 2007, respectively). Total shipping and handling costs
incurred as a component of cost of goods sold for the three and six months ended
June 30, 2008 were $486,110 and $770,641, respectively ($286,100 and $465,200
for the three months ended June 30, 2007, respectively).
FOREIGN CURRENCY TRANSLATION
The Company has operations and holds assets in various foreign
countries. The local currency is the functional currency for our subsidiaries in
China and India. Assets and liabilities are translated at end-of-period exchange
rates while revenues and expenses are translated at the average exchange rates
in effect during the period. Equity is translated at historical rates and the
resulting cumulative translation adjustments are included as a component of
accumulated other comprehensive income (loss) until the translation adjustments
are realized. Included in other accumulated comprehensive income were a
cumulative foreign currency translation adjustment gain of $113,027 at June 30,
2008 and a gain of $44,000 at December 31, 2007.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of net income (loss) and foreign
currency translation adjustments. Comprehensive income (loss) and its components
for the three and six months ended June 30, 2008 and 2007 is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- --------------------------
2008 2007 2008 2007
----------- ----------- ----------- -----------
Net income (loss) ............... $ 598,157 $ 490,493 $(1,240,587) $ (304,851)
Other comprehensive income (loss):
Available for sale securities ... 160,000 -- (500,000) --
Foreign currency translation .... 101,607 -- 113,027 --
----------- ----------- ----------- -----------
Total comprehensive income (loss) $ 859,764 $ 490,493 $(1,627,560) $ (304,851)
=========== =========== =========== ===========
The available-for-sale securities adjustment represents unrealized
gains and losses due to temporary changes in the market prices related to our
marketable securities that were received in exchange for the Azteca note
receivable discussed in Notes 4 and 5. These marketable securities are
classified as available-for-sale securities. The foreign currency translation
adjustment represents the net currency translation adjustment gains and losses
related to our China and India subsidiaries, which have not been reflected in
net income (loss) for the periods presented. The foreign current translation
adjustment for the three months ended June 30, 2007 was insignificant as we
commenced our foreign operations during the first quarter of 2007.
9
RECLASSIFICATIONS
Certain reclassifications have been made to prior period financial
statements to conform to the current year presentation.
NOTE 3. INCOME (LOSS) PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted income (loss) per share computations:
THREE MONTHS ENDED JUNE 30, 2008: INCOME (LOSS) SHARES PER SHARE
--------------------------------------- ------------- ------------- -------------
Basic Income per share:
Available to common stockholders ...... $ 598,157 20,291,433 $ 0.03
Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
------------- ------------- -------------
Income available to common stockholders $ 598,157 20,291,433 $ 0.03
============= ============= =============
THREE MONTHS ENDED JUNE 30, 2007:
---------------------------------------
Basic Income per share:
Available to common stockholders ...... $ 490,493 18,590,884 $ 0.03
Effect of Dilutive Securities:
Options ............................... -- 1,463,278 (0.01)
Warrants .............................. -- 4,520 --
------------- ------------- -------------
Income available to common stockholders $ 490,493 20,058,682 $ 0.02
============= ============= =============
SIX MONTHS ENDED JUNE 30, 2008:
---------------------------------------
Basic Loss per share:
Available to common stockholders ...... $ (1,240,587) 20,291,433 $ (0.06)
Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
------------- ------------- -------------
Loss available to common stockholders . $ (1,240,587) 20,291,433 $ (0.06)
============= ============= =============
SIX MONTHS ENDED JUNE 30, 2007:
---------------------------------------
Basic Loss per share:
Available to common stockholders ...... $ (304,851) 18,562,151 $ (0.02)
Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
------------- ------------- -------------
Loss available to common stockholders . $ (304,851) 18,562,151 $ (0.02)
============= ============= =============
10
Warrants to purchase 891,313 shares of common stock exercisable at
between $3.65 and $4.74, and options to purchase 7,057,235 shares of common
stock exercisable at between $0.20 and $5.23, were outstanding for the three and
six months ended June 30, 2008. In connection with the Share-Based Payment
calculation (see Note 9), 2,239,998 shares were included in the computation of
diluted income per share for the three month period ended June 30, 2008. These
shares were not included in the computation of diluted loss per share for the
six months ended June 30, 2008 because exercise or conversion would have an
antidilutive effect on the income or loss per share.
Warrants to purchase 3,193,813 shares of common stock exercisable at
between $0.95 and $5.06 per share, options to purchase 4,746,735 shares of
common stock exercisable at between $0.37 and $5.23 per share, and convertible
debt of $12,500,000 convertible at $3.65 per share, were outstanding for the
three and six months ended June 30, 2007. In connection with the Share-Based
Payment calculation (see Note 9), 4,880,135 shares were included in the
computation of diluted income per share for the three month period ended June
30, 2007. These shares were not included in the computation of diluted loss per
share for the six months ended June 30, 2007 because exercise or conversion
would have an antidilutive effect on the loss per share.
NOTE 4. MARKETABLE SECURITIES
The Company finalized an arrangement between the Company and Azteca
Production International, Inc. ("Azteca"), a former distributor of Talon
products, on December 31, 2007. The agreement called for Azteca to cause to be
delivered 2,000,000 shares of unrestricted common stock of a separate public
corporation with a value of $1,040,000, in exchange for cancellation of the
Azteca Note Receivable discussed in Note 5. On January 30, 2008, the Company
received the unrestricted common stock of this public corporation and the
Company could begin trading these shares, selling no more than 10,000 shares per
week in the open market, and without restriction in private transactions. The
portfolio of marketable securities is stated at the lower of cost or market at
the balance sheet date and consists of common stocks. No realized or unrealized
gains or losses were recognized during the year ended December 31, 2007.
Unrealized gains of $160,000 and unrealized losses of $500,000 were recognized
in other comprehensive income for the three months and six months ended June 30,
2008, respectively. The value of the common stock on August 19, 2008 had
decreased $180,000 to $360,000, as compared to the value on June 30, 2008.
The Company has examined the circumstances of the decline in the value
of the securities and considered its objectives and ability to hold the shares
pending a recovery in the market value, as well as the possibility of a recovery
in value. The Company believes that a recovery in the market value of the
securities is possible and that there is not sufficient evidence to warrant an
adjustment for an other than temporary impairment in the securities.
NOTE 5. ACCOUNTS AND NOTE RECEIVABLE
Accounts receivable are included on the accompanying consolidated
balance sheet net of an allowance for doubtful accounts. The total allowance for
doubtful accounts at June 30, 2008 and December 31, 2007 was $91,000
and$140,420, respectively.
At June 30, 2007 a note receivable from Azteca Productions
International, Inc, was outstanding in the amount of $2,127,653. The note was
receivable in monthly installments over thirty-one months beginning March 1,
2006. The payments were $50,000 per month for the first 5 months, and then
ranged from $133,000-$267,000 per month until paid in full, but no later than
July 1, 2008.
Azteca failed to make the scheduled note payments due on July 1, 2007,
and all subsequent periods thereafter, triggering a default and exhausting all
cure periods under the note, resulting in the entire note balance becoming
immediately due and payable. On September 10, 2007 after meeting with and
conducting extensive discussions with Azteca, they failed to provide to the
Company certain security interests as required under the note to make the
scheduled note payments and Azteca further expressed its belief that it would be
unable to make any note payments in the foreseeable future. As a result, in
September 2007, the Company reflected a charge of $2,127,653 to fully reserve
the outstanding balance from Azteca. In
11
December 2007 an agreement was reached whereby Azteca delivered shares of common
stock of a separate public company in lieu of the note receivable. In December
2007, the Company reversed part of the impairment recorded in September 2007 and
reflected income of $1,040,000 as the reversal of previously recorded bad debts.
See Note 4 for the status and valuation of the shares received in this exchange.
NOTE 6. INVENTORIES
Inventories are stated at the lower of cost, determined using the
first-in, first-out ("FIFO") basis, or market value and are all categorized as
finished goods. The costs of inventory include the purchase price, inbound
freight and duties, conversion costs and certain allocated production overhead
costs. Inventory valuation reserves are recorded for damaged, obsolete, excess
and slow-moving inventory. We use estimates to record these reserves.
Slow-moving inventory is reviewed by category and may be partially or fully
reserved for depending on the type of product and the length of time the product
has been included in inventory. Reserve adjustments are made for the difference
between the cost of the inventory and the estimated market value, if lower, and
charged to operations in the period in which the facts that give rise to these
adjustments become known. Market value of inventory is estimated based on the
impact of market trends, an evaluation of economic conditions and the value of
current orders relating to the future sales of this type of inventory.
Inventories consist of the following:
June 30, December 31,
2008 2007
------------ ------------
Finished goods ................. $ 3,352,300 $ 3,506,400
Less reserves .................. 678,700 1,019,000
------------ ------------
Total inventories .............. $ 2,673,600 $ 2,487,400
============ ============
NOTE 7. FIXED ASSETS HELD FOR SALE
Fixed assets held for sale consist of the North Carolina land and
manufacturing facility that was closed in connection with the Company's 2005
restructuring plan. The carrying value of these assets at June 30, 2008 was
$688,000 and at December 31, 2007 was $700,000. The assets are financed with a
mortgage note payable with $677,422 outstanding at June 30, 2008 and $690,000 at
December 31, 2007. As described in Note 15, Subsequent Events, on July 2, 2008
the Company entered into an agreement to sell the real property for $725,000.
Management has the authority and is committed to sell the asset.
NOTE 8. DEBT FACILITY
On June 27, 2007 the Company entered into a Revolving Credit and Term
Loan Agreement with Bluefin Capital, LLC ("Bluefin") that provides for a $5.0
million revolving credit loan and a $9.5 million term loan for a three year
period ending June 30, 2010. The revolving credit portion of the facility, as
amended permits borrowings based upon a formula including 85% the Company's
eligible receivables and 55% of eligible inventory, and provides for monthly
interest payments at the prime rate (5.0% at June 30, 2008) plus 2.0%. The term
loan bears interest at 8.5% annually with quarterly interest payments and
repayment in full at maturity. Borrowings under both credit facilities are
secured by all of the assets of the Company.
12
In connection with the Revolving Credit and Term Loan Agreement, the
Company issued 1,500,000 shares of common stock to the lender for $0.001 per
share, and issued 2,100,000 warrants for the purchase of common stock. The
warrants were exercisable over a five-year period and initially 700,000 warrants
were exercisable at $0.95 per share; 700,000 warrants were exercisable at $1.05
per share; and 700,000 warrants were exercisable at $1.14 per share. The
warrants did not require cash settlements. The relative fair value of the equity
($2,374,169, which includes a reduction for financing costs) issued with this
debt facility was allocated to paid-in-capital and reflected as a debt discount
to the face value of the term note. This discount is being amortized over the
term of the note and recognized as additional interest cost as amortized. Costs
associated with the debt facility included debt fees, commitment fees,
registration fees, and legal and professional fees of $486,000. The costs
allocable to the debt instruments are reflected in other assets as deferred
financing costs and are being amortized over the term of the notes.
Under the terms of the credit agreement the Company is required to meet
certain coverage ratios, among other restrictions including a restriction from
declaring or paying a dividend prior to repayment of all the obligations. The
initial financial covenants, as amended, require that the Company maintain at
the end of each fiscal quarter "EBITDA" (as defined in the Agreement) in excess
of the principal and interest payments for the same period of not less than
$1.00, and in excess of ratios set out in the agreement for each quarter. In the
event that the Company fails to satisfy the minimum EBITDA requirement for a
quarter, a waiver fee of 1% of the debt commitment may be paid and the
requirement delayed to the next quarter. If two consecutive quarters fail to
meet the minimum EBITDA the waiver fee increases to 2%. If three consecutive
quarters fail to meet the minimum EBITDA, or the Company does not pay the waiver
fee, the credit agreement would be in default and the lender may demand
immediate repayment of the full amount of the notes outstanding.
On November 19, 2007 the Company entered into an amendment of its
agreement with Bluefin to modify the original financial covenants and to extend
until June 30, 2008 the application of the original EBITDA covenant in exchange
for additional common stock of the Company and a price adjustment to the lenders
outstanding warrants issued in connection with the loan agreement. In connection
with this amendment the Company issued an additional 250,000 shares of common
stock to the lender for $0.001 per share, and the exercise price for all of the
previously issued 2,100,000 warrants for the purchase of common stock was
amended to an exercise price of $0.75 per share. The new relative fair value of
the equity issued with this debt, including the modifications in this amendment,
which is being amortized over the term of the note is $2,569,800, which includes
a reduction for financing costs.
On April 3, 2008 the Company executed an amendment to its existing loan
agreement with Bluefin. The amendment included a redefining of the EBITDA
covenants, and the surrender of the common stock warrants previously issued to
Bluefin in exchange for the issuance by the Company of an additional note
payable to Bluefin for $1.0 million. The note bears interest at 8.5% and both
the note and accrued interest are payable at maturity on June 30, 2010. In
addition, the Company's borrowing base was modified in this amendment by
increasing the allowable portion of inventory held by third party vendors to
$1.0 million with no more than $500,000 held at any one vendor and increasing
the percentage of accounts receivable to be included in the borrowing base to
85%. The Company paid a one-time modification fee of $145,000 to secure the
amendment of the agreement.
In connection with this amendment the Company evaluated the debt
amendment under EITF 96-19. It was determined that the debt modification did not
constitute a material change as defined by EITF 96-19 and did not qualify for
treatment as a troubled debt restructuring. Accordingly, the Company recorded a
reduction to equity and an increase to notes payable for the fair value of the
warrants of $260,205 and the difference ($739,795) between the fair value of the
warrants at the time of repurchase and the face value of the note has been
recorded as an additional deferred cost and is reflected as a reduction to the
face value of the note on the balance sheet. This cost will be accreted using
the interest-method over the life of the modified notes and will be reflected as
interest expense.
13
As of June 30, 2008, the Company had outstanding borrowings of
$10,375,000 under the term notes (discounted carrying value of $7,441,700), and
$4,161,000 under the revolving credit note.
At the initial closing of the agreement on June 27, 2007, the proceeds
of the term loan in the amount of $9.5 million were deposited into a restricted
cash escrow account and $3.0 million of the borrowings available under the
revolving credit note were reserved and held for payment of the Company's $12.5
million convertible promissory notes maturing in November 2007. During July 2007
waivers were obtained from all holders of the convertible promissory notes
allowing for early payment of their notes without penalty, and as of July 31,
2007 all of the note holders had been paid in full. At closing the Company also
borrowed $1,004,306 under the revolving credit note and used the proceeds to pay
the related party note payable and accrued interest due to Mark Dyne, Chairman
of the Board of the Company. Additionally initial borrowings under the revolving
credit note were used to pay the loan and legal fees due at closing.
Interest expense related to the Revolving Credit and Term Loan
Agreement for the three and six months ended June 30, 2008 was $622,270 and
$1,150,850, respectively, which includes $305,180 and $548,850 in amortization
of discounts and deferred financing costs for the three and six months ended
June 30, 2008, respectively.
NOTE 9. STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees and directors
in accordance with Statement of Financial Accounting Standards No. 123 revised,
SHARE-BASED PAYMENT, SFAS 123(R) which requires the measurement and recognition
of compensation expense for all share-based payment awards made to employees and
directors based on estimated fair values. Options issued to consultants are
accounted for in accordance with the provisions of Emerging Issues Task Force
(EITF) No. 96-18, "ACCOUNTING FOR EQUITY INSTRUMENTS THAT ARE ISSUED TO OTHERS
THAN EMPLOYEES FOR ACQUIRING, OR IN CONJUNCTION WITH SELLING, GOODS OR
SERVICES".
On July 31, 2007, at the Company's annual meeting of stockholders, the
2007 Stock Plan was approved. The 2007 Stock Plan authorized up to 2,600,000
shares of common stock for issuance pursuant to awards granted to individuals
under the plan. During the three month period ended June 30, 2008 there were
2,600,000 shares granted to executive employees and directors at a weighted
average exercise price of $0.23 per share. Options granted to certain employees
include certain acceleration features based on Company performance as determined
by the Board of Directors each year. The estimated fair value of options granted
during the three and six months ended June 30, 2008 was $452,400. Assumptions
used to value options granted to employees were an expected volatility of 91%,
expected term of 6.08 years, a risk-free interest rate of approximately 3.3%,
and an expected dividend yield of zero. Consistent with SFAS 123(R), the stock
based compensation expense for the employee options will be recognized on a
time-phased vesting schedule through the vesting date of December 31, 2010,
subject to acceleration based upon the performance criteria established for
2008. In evaluating the probable outcome of meeting performance conditions, the
Company estimates that approximately 100% of the first tranche, or approximately
1/3 of the grants, will be earned in 2008. Accordingly, the Company assumed
accelerated vesting for this tranche and will recognize its fair value as stock
based compensation during 2008. The Company will assess the probable outcome of
the performance criteria quarterly and adjust the expense accordingly.
On July 14, 2008, at the Company's annual meeting of stockholders, a
new 2008 Stock Plan was approved by the stockholders. The 2008 Stock Plan
authorized up to 2,500,000 shares of common stock for issuance pursuant to
awards granted to individuals under the plan. The Board of Directors granted
awards of 310,000 shares under this plan to employees contingent upon the
approval of the plan by the California Department of Corporations.
There were 46,600 options granted to employees during the three and six
months ended June 30, 2007 at a weighted average exercise price of $1.02 per
share. The estimated fair value of options granted during the three and six
months ended June 30, 2007 was $31,700. Common shares of 1,500,000 and warrants
14
to acquire 2,100,000 shares of common stock were issued during the three and six
months ended June 30, 2007 to a non-employee in connection with a debt financing
facility at a weighted average exercise price of $1.05 per share for the
warrants and $0.001 per share for the common shares issued. The estimated total
fair value of the warrants and shares of common stock granted during the three
and six months ended June 30, 2007 was $2,879,020. The relative fair value of
warrants and shares of common stock issued, less financing costs, is accounted
for as debt discount related to the $9.5 million term note entered into in June
2007. Assumptions used to value options granted to employees were expected
volatility of 69%, expected term of 6.1 years, risk-free interest rate of
approximately 5.0%, and an expected dividend yield of zero. Assumptions used to
value warrants granted to non-employees were expected volatility of 78%,
expected term of 5 years (contractual life), risk-free interest rate of 5.0%,
and expected dividend yield of zero. In January, 2007, a consultant exercised
options to acquire 75,000 shares of common stock. Cash received upon exercise
was $42,750 or $0.57 per share. At the time of exercise, the total intrinsic
value of the options exercised was approximately $72,000 (or $0.96 per share).
Because the option exercised was a non-qualified stock option, the Company
received a tax deduction for the intrinsic value amount.
As of June 30, 2008, the Company had approximately $558,000 of
unamortized stock-based compensation expense related to options issued to
employees and directors, which will be recognized over the weighted average
period of approximately 6 years. As of June 30, 2007, unamortized stock-based
compensation expense related to options issued to employees and directors was
$537,000, which was recognized over the weighted average period of 2.3 years.
This expected expense will change if any stock options are granted or cancelled
prior to the respective reporting periods or if there are any changes required
to be made for estimated forfeitures.
15
The following table summarizes the activity in the Company's share
based plans during the six months ended June 30, 2008.
Weighted
Average
Number of Exercise
Shares Price
---------- ----------
EMPLOYEES AND DIRECTORS
Options and warrants outstanding - January 1, 2008 .. 4,673,235 $ 1.46
Granted ........................................ -- --
Exercised ...................................... -- --
Cancelled ...................................... (211,000) $ .72
---------- ----------
Options and warrants outstanding - March 31, 2008 ... 4,462,235 $ 1.49
Granted ........................................ 2,600,000 $ 0.23
Exercised ...................................... -- --
Cancelled ...................................... (5,000) $ 1.27
---------- ----------
Options and warrants outstanding - June 30, 2008 .... 7,057,235 $ 1.03
========== ==========
NON-EMPLOYEES
Options and warrants outstanding - January 1, 2008 .. 3,163,813 $ 1.97
Granted ........................................ -- --
Exercised ...................................... -- --
Cancelled ...................................... -- --
---------- ----------
Options and warrants outstanding - March 31, 2008 ... 3,163,813 $ 2.00
Granted ........................................ -- --
Exercised ...................................... -- --
Redeemed ....................................... (2,100,000) 0.75
Cancelled ...................................... (172,500) $ 5.06
---------- ----------
Options and warrants outstanding - June 30, 2008 .... 891,313 $ 4.35
========== ==========
NOTE 10. INCOME TAXES
On January 1, 2007 the Company adopted the provisions of FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an
interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements and prescribes a recognition threshold and measurement
process for financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. FIN 48 also provides guidance on
the recognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition associated with income tax liabilities.
As a result of the implementation of FIN 48, the Company recognized an
increase in liabilities for unrecognized tax benefits of approximately $245,800,
which was accounted for as an increase in the January 1, 2007 accumulated
deficit.
The Company recognizes interest accrued related to unrecognized tax
benefits in interest expense and penalties in income tax expense. For the three
and six months ended June 30, 2008, the Company recognized accrued interest for
16
unrecognized tax benefits of approximately $3,900 and $7,800, respectively. For
the three and six months ended June 30, 2007 the Company recognized accrued
interest for unrecognized tax benefits of approximately $4,000. At June 30, 2008
and 2007 the Company had approximately $53,775 and $37,875, respectively,
accrued in interest and penalties associated with the unrecognized tax
liabilities.
NOTE 11. COMMITMENTS AND 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
the Company and certain of its current and former officers and directors in the
United States District Court for the Central District of California, alleging
claims under Section 10(b) and Section 20 of the Securities Exchange Act of
1934. A lead plaintiff was appointed, and his amended complaint alleged that
defendants made false and misleading statements about the Company's financial
situation and its relationship with certain of its large customers. The action
was brought on behalf of all purchasers of the Company's publicly-traded
securities during the period from November 13, 2003 to August 12, 2005. On
February 20, 2007, the Court denied class certification. On April 2, 2007 the
Court granted defendants' motion for summary judgment, and on or about April 5,
2007, the Court entered judgment in favor of all defendants. On or about April
30, 2007, plaintiff filed a notice of appeal, and his opening appellate brief
was filed on October 15, 2007. The Company's brief was filed on November 28,
2007. The Company believes that this matter will be resolved favorably on
appeal, or in a later trial or in settlement within the limits of its insurance
coverage. However, the outcomes of this action or an estimate of the potential
losses, if any, related to the lawsuit cannot be reasonably predicted, and an
adverse resolution of the lawsuit could potentially have a material adverse
effect on the Company's financial position and results of operations.
On April 16, 2004 the Company filed suit against Pro-Fit Holdings,
Limited in the U.S. District Court for the Central District of California -
Tag-It Pacific, Inc. v. Pro-Fit Holdings, Limited, CV 04-2694 LGB (RCx) --
asserting various contractual and tort claims relating to our exclusive license
and intellectual property agreement with Pro-Fit, seeking declaratory relief,
injunctive relief and damages. It is the Company's position that the agreement
with Pro-Fit gives the Company exclusive rights in certain geographic areas to
Pro-Fit's stretch and rigid waistband technology. On June 5, 2006 the Court
denied the Company's motion for partial summary judgment, but did not find that
the Company breached the agreement with Pro-Fit and a trial is required to
determine issues concerning the Company's activities in Columbia and whether
other actions by Pro-Fit constituted an unwillingness or inability to fill
orders. The Court also held that Pro-Fit was not "unwilling or unable" to
fulfill orders by refusing to fill orders with goods produced in the United
States. The Company also filed a second civil action against Pro-Fit and related
companies in the California Superior Court which was removed to the United
States District Court, Central District of California. In April 2008, Pro-Fit
and certain related companies were placed into administration in the United
Kingdom. On May 21, 2008, the joint administrators for Pro-Fit and its related
companies filed petitions under Chapter 15 of Title 11 of the United States Code
for Pro-Fit and two related companies in the United States Bankruptcy Court for
the Central District of California seeking recognition of the United Kingdom
administration proceedings and related relief. As a consequence of the chapter
15 filings by the joint administrators, all litigation by the Company against
Pro-Fit has been stayed. The Company has derived a significant amount of revenue
from the sale of products incorporating the stretch waistband technology in the
past and the Company's business, results of operations and financial condition
could be materially adversely affected if the dispute with Pro-Fit is not
resolved in a manner favorable to the Company. Additionally, the Company has
incurred significant legal fees in this litigation, and unless the case is
settled or resolved, may continue to incur additional legal fees in order to
assert its rights and claims against Pro-Fit and any successor to those assets
of Pro-Fit that are subject to the Company's exclusive license and intellectual
property agreement with Pro-Fit and to defend against any counterclaims.
The Company currently has pending a number of other claims, suits and
complaints that arise in the ordinary course of our business. The Company
believes that it has meritorious defenses to these claims and that the claims
are either covered by insurance or, after taking into account the insurance in
place, would not have a material effect on the Company's consolidated financial
condition if adversely determined against the Company.
17
In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others - an 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 12. NEW ACCOUNTING PRONOUNCEMENTS
In March 2008, the FASB issued SFAS No. 161, DISCLOSURES ABOUT
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - AN AMENDMENT OF FASB STATEMENT
NO. 133 (SFAS 161). SFAS 161 changes the disclosure requirements for derivative
instruments and hedging activities. Entities are required to provide enhanced
disclosures about how and why an entity uses derivative instruments, how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and how derivative instruments
and related hedged items affect an entity's financial position, financial
performance, and cash flows. SFAS 161 is effective for fiscal years and interim
periods beginning after November 15, 2008. We do not believe SFAS 161 will have
any impact on our consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, THE HIERARCHY OF GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES (SFAS 162). SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy). SFAS 162 is effective 60 days following
the SEC's approval of the Public Company Accounting Oversight Board amendments
to Au Section 411. We do not believe SFAS 162 will have any impact on our
consolidated financial statements.
18
NOTE 13. SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
The Company manufactures and distributes a full range of zipper, trim
and waistband items to manufacturers of fashion apparel, specialty retailers and
mass merchandisers. Our organization is based on divisions representing the
major product lines, and our operating decisions use these divisions to assess
performance, allocate resources and make other operating decisions. Within these
product lines there is not enough difference between the types of products to
justify segmented reporting by product type or to account for these products
separately. The net revenues and operating margins for the three primary product
groups are as follows:
Three Months Ended June 30, 2008
------------------------------------------------------
Talon Trim Tekfit Consolidated
----------- ----------- ----------- -----------
Net sales ............. $11,445,062 $ 5,539,175 $ 36,392 $17,020,629
Cost of goods sold .... 8,503,617 3,578,655 37,453 12,119,725
----------- ----------- ----------- -----------
Gross profit (loss) ... 2,941,445 1,960,520 (1,061) 4,900,904
----------- ----------- -----------
Operating expenses (not
segregated by division) 3,850,029
-----------
Income from operations $ 1,050,875
===========
Three Months Ended June 30, 2007
-----------------------------------------------------
Talon Trim Tekfit Consolidated
----------- ----------- ----------- -----------
Net sales............... $ 8,368,160 $ 4,940,404 $ 258,417 $13,566,981
Cost of goods sold ..... 6,039,210 3,223,992 221,286 9,484,488
----------- ----------- ----------- -----------
Gross profit ........... 2,328,950 1,716,412 37,131 4,082,493
----------- ----------- -----------
Operating expenses (not
segregated by division) 3,247,518
-----------
Income from operations . $ 834,975
===========
Six Months Ended June 30, 2008
-----------------------------------------------------
Talon Trim Tekfit Consolidated
----------- ----------- ----------- -----------
Net sales ............. $17,056,938 $ 9,905,031 $ 44,149 $27,006,118
Cost of goods sold .... 13,121,221 6,179,212 46,816 19,347,249
----------- ----------- ----------- -----------
Gross profit (loss) ... 3,935,717 3,725,819 (2,667) 7,658,869
----------- ----------- -----------
Operating expenses (not
segregated by division) 7,918,228
-----------
Loss from operations .. $ (259,359)
===========
19
Six Months Ended June 30, 2007
-----------------------------------------------------
Talon Trim Tekfit Consolidated
----------- ----------- ----------- -----------
Net sales .............. $12,986,118 $ 9,032,859 $ 638,122 $22,657,099
Cost of goods sold ..... 9,509,055 5,858,137 460,219 15,827,411
----------- ----------- ----------- -----------
Gross profit ........... 3,477,063 3,174,722 177,903 6,829,688
----------- ----------- -----------
Operating expenses (not
segregated by division) 6,565,341
-----------
Income from operations . $ 264,347
===========
The Company distributes its products internationally and has reporting
requirements based on geographic regions. Revenues are attributed to countries
based upon customer delivery locations and the net book value of long-lived
assets (consisting of property and equipment, intangible assets and property
held for sale) is attributed to countries based on the location of the assets,
as follows:
Three Months Ended June 30, Six Months Ended June 30,
-------------------------- --------------------------
Country / Region 2008 2007 2008 2007
----------- ----------- ----------- -----------
United States ...... $ 1,187,600 $ 1,048,400 $ 1,845,100 $ 1,890,900
Hong Kong .......... 4,408,300 4,181,300 8,063,600 7,744,200
China .............. 6,009,500 5,151,700 7,925,100 6,771,300
India .............. 788,900 562,700 1,498,000 1,045,000
Bangladesh ......... 593,200 325,200 1,326,800 955,500
Other .............. 4,033,100 2,297,700 6,347,500 4,250,200
----------- ----------- ----------- -----------
$17,020,600 $13,567,000 $27,006,100 $22,657,100
=========== =========== =========== ===========
June 30, December 31,
2008 2007
----------- -----------
LONG-LIVED ASSETS:
United States ..................... $ 8,363,600 $ 8,778,400
Hong Kong ......................... 547,900 556,900
Dominican Republic ................ 503,700 558,200
China ............................. 178,700 109,800
Other ............................. 14,500 17,900
----------- -----------
Total .................................. $ 9,608,400 $10,021,200
=========== ===========
20
NOTE 14. RELATED PARTY TRANSACTIONS
Todd Kay, a director and significant shareholder of Tarrant Apparel
Group, is also a significant shareholder of the Company. Sales to Tarrant for
both the three and six months ended June 30, 2008 were $37,550. Sales to Tarrant
for the three months and six months ended June 30, 2007 were $139,900, and
$140,000, respectively. At June 30, 2008, accounts receivable included $37,550
outstanding from Tarrant Apparel Group while at December 31, 2007 there were no
amounts due from Tarrant.
Colin Dyne, a director and stockholder of the Company, is also an
executive officer, director and significant stockholder in People's Liberation,
Inc. During the three and six months ended June 30, 2008, we had sales of
$177,770 and $289,250, respectively, to subsidiaries of People's Liberation,
Inc. For the three and six months ended June 30, 2007, we had sales of $65,600
and $349,200, respectively, to subsidiaries of People's Liberation, Inc. At June
30, 2008, accounts receivable included $ 173,690 outstanding from People's
Liberation subsidiaries. At December 31, 2007, accounts receivables of $44,000
were outstanding from subsidiaries of People's Liberation, Inc.
Due from related parties at June 30, 2008 and December 31, 2007
includes $ 649,280 and $625,500, respectively, of unsecured notes, advances and
accrued interest receivable from Colin Dyne. The notes and advances bear
interest at 7.5% and are due on demand.
Demand notes payable to related parties includes notes and advances to
Mark Dyne, the Chairman of the Board of Directors of the Company or to parties
related to or affiliated with Mark Dyne. The balance of Demand notes payable to
related parties at June 30, 2008 and at December 31, 2007 was $85,200
respectively.
Jonathan Burstein, a former director of the Company, purchases products
from the Company through an entity operated by his spouse. For the three and six
months ended June 30, 2008, sales to this entity were $ 48,760 and $ 48,860,
respectively. Sales to this entity for the three and six months ended June 30,
2007 were $30,000 and $33,600, respectively. At June 30, 2008 and December 31,
2007, accounts receivable included $ 48,760 and $28,700, respectively, due from
this entity. On October 25, 2007, Mr. Burstein resigned as a director of the
Company.
Consulting fees of $73,800 and $147,200 were paid for services provided
by Mr. Burstein for the three and six months ended June 30, 2007. During the
fourth quarter of 2007 the Mr. Burstein's services to the Company terminated
with his resignation as a director of the Company. In December, 2007, we
recorded a onetime charge for the remainder of the consulting contract with Mr.
Burstein in recognition of the termination of his services. We continue to make
payments under this contract and payments of $72,700 and $145,400 were paid
under the terms of the contract for the three and six months ended June 30,
2008, respectively.
Consulting fees paid to Diversified Investments, a company owned by
Mark Dyne, amounted to $37,500 and $75,000 for the three and six months ended
June 30, 2008, respectively. Consulting fees paid for the three and six months
ended June 30, 2007 were $37,500 and $75,000, respectively.
Consulting fees of $75,000 and $150,000 were paid for services provided
by Colin Dyne for the three and six months ended June 30, 2008, respectively.
For the three and six months ended June 30, 2007 consulting fees of $75,000 and
$125,200 were paid to Colin Dyne.
21
NOTE 15. SUBSEQUENT EVENTS
DISPOSITION OF ASSETS HELD FOR SALE
As part of its 2005 restructuring plan, on July 2, 2008, the Company
entered into an agreement to sell its building including certain equipment,
furnishings and fixtures, located in North Carolina, for $725,000. The Company
intends to use the proceeds to retire the mortgage on this property of
approximately $650,000. The carrying value of the property is $688,000. The
transaction is expected to close in the fourth quarter of 2008. This transaction
will not have a significant impact on results in that quarter.
ADOPTION OF 2008 STOCK INCENTIVE PLAN
On July 14, 2008, at the Company's annual meeting of stockholders, the
stockholders approved the 2008 Stock Plan. Under the 2008 Stock Plan, the
Company may grant equity-based awards in the form of stock, stock options and
stock purchase awards to employees, directors and consultants of the Company and
its subsidiaries. The maximum number of shares available for grant under the
plan is 2,500,000 shares of common stock. The plan is administered by the Board
of Directors or committees of the Board.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This report and other documents we file with the Securities and
Exchange Commission contain forward looking statements that are based on current
expectations, estimates, forecasts and projections about us, our future
performance, our business or others on our behalf, our beliefs and our
management's assumptions. These statements are not guarantees of future
performance and involve certain risks, uncertainties, and assumptions that are
difficult to predict. We describe our respective risks, uncertainties, and
assumptions that could affect the outcome or results of operations below. We
have based our forward looking statements on our management's beliefs and
assumptions based on information available to our management at the time the
statements are made. We caution you that actual outcomes and results may differ
materially from what is expressed, implied, or forecast by our forward looking
statements. Reference is made in particular to forward looking statements
regarding projections or estimates concerning our business, including demand for
our products and services, mix of revenue streams, ability to control and/or
reduce operating expenses, anticipated gross margins and operating results, cost
savings, product development efforts, general outlook of our business and
industry, international businesses, competitive position, adequate liquidity to
fund our operations and meet our other cash requirements.
OVERVIEW
The following management's discussion and analysis is intended to
assist the reader in understanding our consolidated financial statements. This
management's discussion and analysis is provided as a supplement to, and should
be read in conjunction with, our consolidated financial statements and
accompanying notes.
Talon International, Inc. designs, sells and distributes apparel
zippers, specialty waistbands and various apparel trim products to manufacturers
of fashion apparel, specialty retailers and mass merchandisers. We sell and
market these products under various branded names including Talon and Tekfit. We
operate the business globally under three product groups.
We plan to continue to increase our global expansion of Talon zippers
through the establishment of a network of Talon locations, distribution
relationships, and joint ventures. The network of global manufacturing and
distribution locations are expected to improve our global footprint and allow us
to more effectively serve apparel brands and manufacturers globally.
Our Trim business focus is as an outsourced product development,
sourcing and sampling department for the most demanding brands and retailers. We
believe that trim design differentiation among brands and retailers has become a
critical marketing tool for our customers. By assisting our customers in the
development, design and sourcing of trim, we expect to achieve higher margins
for our trim products, create long-term relationships with our customers, grow
our sales to a particular customer by supplying trim for a larger proportion of
their brands, and better differentiate our trim sales and services from those of
our competitors.
Our Tekfit services provide manufacturers with the patented technology,
manufacturing know-how and materials required to produce garments incorporating
an expandable waistband. Prior to 2007 these products were produced by several
manufacturers for one single brand and we derived a significant amount of
revenue and earnings from the sale of products incorporating the stretch
waistband technology. In October 2006 our exclusive supply contract with this
brand expired and we initiated efforts to offer this product to other customers
in 2007 and 2008. Our sales and marketing efforts have produced limited results
in part due to a licensing dispute. As described more fully in this report under
Commitments and Contingencies (see Note 11 to the Unaudited Consolidated
Financial Statements), we are presently in litigation with Pro-Fit Holdings
Limited regarding our exclusively licensed rights to sell or sublicense stretch
23
waistbands manufactured under Pro-Fit's patented technology. Our success in
selling this product to other customers could be adversely affected if our
dispute with Pro-Fit is not resolved in a manner favorable to us.
RESULTS OF OPERATIONS
The following table sets forth selected statements of operations data
shown as a percentage of net sales for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2008 2007 2008 2007
-------- -------- -------- --------
Net sales .......................... 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ................. 71.2 70.4 71.6 70.3
-------- -------- -------- --------
Gross profit ....................... 28.8 29.6 28.4 29.7
Selling expenses ................... 4.5 6.2 5.7 6.8
General and administrative expenses 15.7 17.3 18.2 21.7
Interest & taxes ................... 3.8 2.5 4.4 2.5
-------- -------- -------- --------
Net income (loss) .................. 4.8% 3.6% 0.1% (1.3)%
======== ======== ======== ========
SALES
For the three and six months ended June 30, 2008 and 2007, sales by
geographic region based on the location of the customer as a percentage of sales
were as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
REGION 2008 2007 2008 2007
-------- -------- -------- --------
United States .................. 7.0% 7.7% 6.8% 8.3%
Hong Kong ...................... 25.9% 30.8% 29.9% 34.2%
China .......................... 35.3% 38.0% 29.4% 29.9%
India .......................... 4.6% 4.1% 5.5% 4.6%
Bangladesh ..................... 3.5% 2.4% 4.9% 4.2%
Other .......................... 23.7% 17.0% 23.5% 18.8%
-------- -------- -------- --------
100.0% 100.0% 100.0% 100.0%
======== ======== ======== ========
Sales for the three months ended June 30, 2008 were $17.0 million or
$3.5 million (25.4%) greater than sales for the same period in 2007. The
increased sales were principally attributable to higher sales of Talon zipper
products ($3.0 million), in particular to customers manufacturing garments for
one brand with whom we obtained nomination as their principal supplier in late
2007. Increased sales of Trim products ($0.6 million) resulting from new program
awards from existing and new customers also contributed to the increase, offset
by lower Tekfit product sales.
Sales for the six months ended June 30, 2008 were $27.0 million or $4.4
million (19.2%) greater than sales for the same period in 2007. The sales
increase reflects improved Talon zipper sales ($4.1 million or 23.8%) as a
result of new brand nominations and sales within Southeast Asia, together with
new and increased program sales in the Trim division ($0.8 million or 9.7%),
partially offset by a decline in sales of Tekfit products resulting from the
termination of an exclusive contract for this product.
24
GROSS PROFIT
Gross profit for the three months ended June 30, 2008 was $4.9 million,
as compared to $4.1 million for the same period in 2007. Gross profit for the
six months ended June 30, 2008 was $7.7 million, as compared to $6.8 million for
the same period in 2007. The increase in gross profit for the three and six
months ended June 30, 2008 as compared to the same periods in 2007 was
principally attributable to higher overall sales volumes, partially offset by
higher manufacturing costs, increased freight and delivery charges, and customer
accommodations for delayed deliveries.
A recap of the change in gross margin for the three and six months
ended June 30, 2008 as compared with the same periods in 2007 is as follows:
(Amounts in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
Amount %(1) Amount %(1)
-------- -------- -------- --------
Gross profit increase (decrease) as a result of:
Higher volumes ................................. $ 1,144 28.0 $ 1,465 21.4
Product margin mix ............................. (188) (4.6) (412) (6.0)
Increased freight and duty costs ............... (59) (1.5) (95) (1.4)
Increased manufacturing costs .................. (98) (2.4) (176) (2.6)
Increased (decreased) inventory costs .......... (5) (0.1) 32 0.5
Overhead and burden charges .................... 24 0.6 15 0.2
-------- -------- -------- --------
Gross profit increase (decrease) ............... $ 818 20.0 $ 829 12.1
======== ======== ======== ========
(1) Represents the percentage change in the 2008 period, as compared to the
same period in 2007.
SELLING EXPENSES
Selling expenses for the three months ended June 30, 2008 were
$768,000, or 4.5% of sales, as compared to $841,000, or 6.2% of sales, for the
same period in 2007. Selling costs for the quarter ended June 30, 2008 were
slightly less than the costs incurred in the same period in 2007 and declined as
a percentage of sales mainly due to the increase in sales volume. Selling costs
reflected an increase in salaries and benefits ($15,000); increased production
supplies and samples ($37,000); and increased facilities expense ($27,000)
primarily associated with expanded sales efforts and the higher sales volumes.
The cost increases were offset by cost reductions in marketing and advertising
($33,000); lower bad debt provisions ($47,000); lower travel and communication
costs ($59,000); and other selling cost reductions ($14,000).
Selling expense for the six months ended June 30, 2008 were $1,488,000,
or 5.5% of sales, as compared to $1,548,000, or 6.8% of sales, for the same
period in 2007. Selling costs reflected an increase in salaries and benefits
($94,000); increased production supplies and samples ($37,000); and increased
facilities expense ($40,000) primarily associated with expanded sales efforts
and the higher sales volumes. The cost increases were offset by cost reductions
in marketing and advertising ($128,000); lower bad debt provisions ($48,000);
lower travel and communication costs ($25,000); and other selling cost
reductions ($30,000).
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expense for the three months ended June 30,
2008 were $3,082,000, or 18.1% of sales, as compared with $2,406,000, or 17.7%
of sales, for the same period in 2007. The increase in
25
general and administrative expenses reflects higher salaries and benefit costs
($242,000) principally associated with increased staffing in Asia in support of
the higher sales; and higher sampling costs ($67,000) associated with new
programs and developments. Increased facilities and insurance costs ($75,000)
resulting from new offices and higher rates; higher professional, legal and
audit costs ($168,000) resulting from increased audits, SEC filings and
modifications to our debt facility; and higher depreciation and stock-based
compensation charges ($138,000); net of other cost reductions ($14,000) also
contributed to the increase in general and administrative costs for the period
as compared to the same period in 2007.
For the six months ended June 30, 2008, general and administrative
expenses were $6,430,000, or 23.8% of sales, as compared with $5,018,000, or
22.2% of sales, for the same period in 2007. The general and administrative
expenses in 2008 include $724,000 in one-time compensation and related costs
mainly associated with the severance of the former chief executive officer and
chief operating officer. General and administrative expenses for the six months
ended June 30, 2008, were 21.1% of sales before these charges as compared to the
same period in 2007. The increase in the general and administrative expenses, in
addition to the severance charges, reflects higher salaries and benefit costs
($295,000) principally associated with increased staffing in Asia in support of
the higher sales; higher sampling costs ($69,000) associated with new programs
and developments; increased facility and insurance costs ($133,000) due to new
offices and higher rates; higher depreciation charges ($108,000); and higher
stock based compensation charges ($92,000) associated with new option grants,
net of other cost reductions ($8,000).
INTEREST EXPENSE AND INTEREST INCOME
Interest expense for the three months ended June 30, 2008 increased by
approximately $334,000 to $643,130 as compared to the same period in 2007.
Interest expense for the six months ended June 30, 2008 increased by
approximately $702,070 to $1,192,644, as compared to the same period in 2007.
The increased interest expense is due partly to increased borrowings under the
Bluefin term notes and revolver debt facility which carry interest rates of 8.5%
and prime (5.0% at June 30, 2008) +2%, respectively as compared to a 6% interest
rate on the promissory notes outstanding in 2007 (See Note 8 to the unaudited
consolidated financial statements). The principal increase in interest costs is
attributable to the amortization of deferred financing costs and debt discounts
associated with the fair value of equity components issued in connection with
the debt facility.
Interest income for the three months ended June 30, 2008 decreased by
approximately $79,000 to $15,482 due primarily to the reduction of the Azteca
note receivable.
A brief summary of interest expense and interest income is presented
below:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
2008 2007 2008 2007
----------- ----------- ----------- -----------
Cash interest expense .................. $ 351,026 $ 272,731 $ 671,906 $ 513,414
Amortization of deferred financing costs
& debt discounts ..................... 307,586 87,550 553,658 163,593
----------- ----------- ----------- -----------
Interest expense ....................... 658,612 360,281 1,225,564 677,007
Interest income ........................ (15,482) (94,423) (32,920) (186,433)
----------- ----------- ----------- -----------
Interest expense, net .................. $ 643,130 $ 265,858 $ 1,192,644 $ 490,574
=========== =========== =========== ===========
26
INCOME TAXES
Income tax provisions for the three and six months ended June 30, 2008
reflected a tax benefit of $190,412 and $211,416, respectively. Income tax
expense for the three and six months ended June 30, 2007 was $78,624. The net
tax benefit in 2008 and expense in 2007 is associated with foreign income taxes
from taxable losses and earnings within our Asian facilities. Due to prior
operating losses incurred no benefit for domestic income taxes has been recorded
since there is not sufficient evidence to determine that we will be able to
utilize our net operating loss carryforwards to offset future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes selected financial data at (amounts in
thousands):
June 30, December 31,
2008 2007
----------- ------------
Cash and cash equivalents ...................... $ 3,741 $ 2,919
Total assets ................................... 25,272 21,684
Current liabilities ............................ 15,008 10,457
Long-term debt, less current liabilities ....... 12,473 11,944
Stockholders' equity (deficit) ................. (2,209) (717)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents increased by $822,000 at June 30, 2008 as
compared to December 31, 2007, principally due to cash generated by operating
activities and lower cash used in financing activities, net of increases in
capital expenditures.
Cash provided by operating activities is our primary recurring source
of funds, and was approximately $1,191,000 for the six months ended June 30,
2008. The cash provided by (used in) operating activities during the six months
resulted principally from:
Net income before non-cash expenses ......................... $ 147,500
Inventory increase, net of reserves ......................... (186,200)
Receivable increases, net of reserves ....................... (3,596,900)
Increase in accounts payable and accrued expense ............ 5,179,900
Other increases in operating capital ........................ (353,300)
-----------
$ 1,191,000
===========
The cash provided by operating activities reflects net income from
operations excluding non-cash charges of approximately $148,000, but the
increase in cash provided by operations principally results from changes in our
operating capital. Increases in receivables are the result of substantially
higher sales in the second quarter and the change in outstanding receivables at
June 30, 2008, the end of our peak sales season, as compared to our receivables
at December 31, 2007, seasonally one of our lower sales periods. Accounts
payable increases reflect similar seasonal fluctuations as well as the increase
in our business volume in 2008 as compared with 2007. Accounts payable also
reflects the benefits of longer negotiated terms with suppliers.
Net cash used in investing activities for the six months ended June 30,
2008 was $121,000 as compared to $515,000 for the six months ended June 30,
2007. These expenditures were principally associated with the development of a
new ERP system. In the first six months of 2007 net cash used for investing
activities represents capital expenditures principally associated with leasehold
improvements in new facilities, office equipment for new employees, improvements
in our technology systems and a marketing website acquisition.
27
Net cash used in financing activities for the six months ended June 30,
2008 was approximately $252,000 and primarily reflects the repayment of
borrowings under capital leases and notes payable, net of borrowings under our
revolver line of credit. For the six months ended June 30, 2007 net cash of
$9,246,000 was generated from financing activities and primarily reflects the
proceeds provided by the issuance of common stock and warrants of $10,507,000
(net of issuance costs) and borrowings under the debt facility for the repayment
of our borrowings under the convertible promissory notes, a related party note,
capital leases and notes payable, net of collections under our note receivable.
On June 27, 2007, we entered into a Revolving Credit and Term Loan
Agreement with Bluefin Capital, LLC ("Bluefin") that provides for a $5.0 million
revolving credit loan and a $9.5 million term loan for a three year period
ending June 30, 2010. The revolving credit portion of the facility, as amended,
permits borrowings based upon a formula including 85% of our eligible
receivables and 55% of eligible inventory, and provides for monthly interest
payments at the prime rate (5.0% at June 30, 2008) plus 2.0%. The term loan
bears interest at 8.5% annually with quarterly interest payments and repayment
in full at maturity. Borrowings under both credit facilities are secured by all
our assets. There was $839,300 and $879,000 in available borrowings at June 30,
2008 and December 31, 2007, respectively.
In connection with the revolving credit and term loan agreement, we
issued 1,500,000 shares of common stock to the lender for $0.001 per share, and
issued 2,100,000 warrants for the purchase of common stock. The warrants were
exercisable over a five-year period and initially 700,000 warrants were
exercisable at $0.95 per share; 700,000 warrants were exercisable at $1.05 per
share; and 700,000 warrants were exercisable at $1.14 per share. The relative
fair value of the equity issued with this debt facility was allocated to
paid-in-capital and reflected as a debt discount to the face value of the term
note. This discount is being amortized over the term of the note and recognized
as additional interest cost as amortized. Costs associated with the debt
facility included debt fees, commitment fees, registration fees, and legal and
professional fees of $486,000.
Under the terms of the credit agreement we are required to meet certain
coverage ratios, among other restrictions including a restriction from declaring
or paying a dividend prior to repayment of all the obligations. The financial
covenants, as amended, require that we to maintain at the end of each fiscal
quarter "EBITDA" (as defined in the Agreement) in excess of our principal and
interest payments for the same period of not less than $1.00, and in excess of
ratios set out in the agreement for each quarter. In the event that we fail to
satisfy the minimum EBITDA requirement for a quarter, a waiver fee of 1% of the
debt commitment may be paid and the requirement delayed to the next quarter. If
two consecutive quarters fail to meet the minimum EBITDA the waiver fee
increases to 2%. If three consecutive quarters fail to meet the minimum EBITDA
the credit agreement would be in default and the lender may demand immediate
payment of the full amount of the notes outstanding.
On November 19, 2007 we entered into an amendment with Bluefin to
modify the original financial covenants and to extend until June 30, 2008 the
application of the original EBITDA covenant in exchange for additional common
stock of the Company and a price adjustment to the lenders outstanding warrants
issued in connection with the loan agreement. In connection with this amendment
we issued an additional 250,000 shares of common stock to the lender for $0.001
per share. The exercise price for all of the previously issued 2,100,000
warrants for the purchase of common stock was amended to $0.75 per share.
On April 3, 2008 we executed an amendment to the existing loan
agreement with Bluefin. The amendment included a redefining of the EBITDA
covenants, the surrender of the common stock warrants previously issued to
Bluefin in exchange for the issuance by us, of an additional note payable to
Bluefin for $1.0 million. The note bears interest at 8.5% and both the note and
accrued interest are payable at maturity on June 30, 2010. In addition, our
borrowing base was modified in this amendment by increasing the allowable
portion of inventory held by third party vendors to $1.0 million with no more
than $500,000 held at any one vendor and increasing the percentage of accounts
receivable to be included in the borrowing base to 85%. We paid a one-time
modification fee of $145,000 to secure the amendment of the agreement. As of
June 30, 2008, we had outstanding borrowings of $10,375,000 under the term notes
(discounted carrying value of $7,441,700), and $4,161,000 under the revolving
credit note.
28
We believe that our existing cash and cash equivalents, and our
anticipated cash flows from our operating activities will be sufficient to fund
our minimum working capital and capital expenditure needs as well as provide for
our scheduled debt service requirements for at least the next twelve months.
This conclusion is based on the belief that our operating assets, strategic
plan, operating expectations and operating expense structure will provide for
sufficient profitability from operations before non-cash charges to fund our
operating capital requirements and to achieve our debt service requirements, and
that our existing cash and cash equivalents will be sufficient to fund our
expansion and capital requirements.
We have historically satisfied our working capital requirements
primarily through cash flows generated from operations and borrowings under our
credit facility. As we continue to expand globally in response to the industry
trend to outsource apparel manufacturing to offshore locations, our foreign
customers, some of which are backed by U.S. brands and retailers, are
increasing. Our revolving credit facility provides limited financing secured by
our accounts receivable, and our current borrowing capability may not provide
the level of financing we need to continue in or to expand into additional
foreign markets. We are continuing to evaluate non-traditional financing of our
foreign assets and equity transactions to provide capital needed to fund our
expansion and operations.
If we experience greater than anticipated reductions in sales, we may
need to raise additional capital, or further reduce the scope of our business in
order to fully satisfy our future short-term liquidity requirements. If we
cannot raise additional capital or reduce the scope of our business in response
to a substantial decline in sales, we may default on our credit agreement.
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
trade name, and we may need to implement additional cost savings initiatives.
29
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at June 30, 2008
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) $ 216,600 $ 216,600 $ -- $ -- $ --
Capital lease obligations $ 357,300 $ 306,000 $ 51,300 $ -- $ --
Operating leases ........ $ 961,000 $ 529,200 $ 431,800 $ -- $ --
Notes payable ........... $16,881,900 $ 1,173,100 $15,708,800 $ -- $ --
Convertible notes payable $ 1,140,300 $ 321,000 $ 819,300 $ -- $ --
----------- ----------- ----------- ----------- -----------
Total Obligations .. $19,557,100 $ 2,545,900 $17,011,200 $ -- $ --
=========== =========== =========== =========== ===========
(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 June 30, 2008.
At June 30, 2008 and 2007, 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
See Note 14 of accompanying notes to consolidated financial statements
for a discussion of related party transactions.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions for the reporting period and as of
the financial statement date. We base our estimates on historical experience and
on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. These estimates and assumptions affect the reported amounts of
assets and liabilities, the disclosure of contingent liabilities and the
reported amounts of revenue and expense. Actual results could differ from those
estimates.
Critical accounting policies are those that are important to the
portrayal of our financial condition and results, and which require us to make
difficult, subjective and/or complex judgments. Critical accounting policies
cover accounting matters that are inherently uncertain because the future
resolution of such matters is unknown. We believe the following critical
accounting policies affect our more significant judgments and estimates used in
the preparation of our 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
collectability of customer accounts. If the financial
condition of a customer were to deteriorate, resulting in an
impairment of its ability to make payments, an additional
allowance may be required. Allowance adjustments are charged
to operations in the period in which the facts that give rise
to the adjustments become known. During the three months ended
30
June 30, 2008, bad debt recovery was $4,021 (with provisions
of $91,000), compared to net bad debt expense of $52,500 (with
provisions of $55,600) for the same period ended June 30,
2007. For the six months ended June 30, 2008, bad debt
recovery was $5,326 (with provisions of $91,000), compared to
net bad debt expense of $42,100 (with recoveries of $19,500
and provisions of $64,800) for the same period in 2007.
o Inventories are stated at the lower of cost, determined using
the first-in, first-out basis, or market value and are all
substantially finished goods. The costs of inventory include
the purchase price, inbound freight and duties, conversion
costs and certain allocated production overhead. Inventory is
evaluated on a continual basis and reserve adjustments are
made based on management's estimate of future sales value, if
any, of specific inventory items. Inventory reserves are
recorded for damaged, obsolete, excess and slow-moving
inventory. We use estimates to record these reserves.
Slow-moving inventory is reviewed by category and may be
partially or fully reserved for depending on the type of
product and the length of time the product has been included
in inventory. Reserve adjustments are made for the difference
between the cost of the inventory and the estimated market
value, if lower, and charged to operations in the period in
which the facts that give rise to these adjustments become
known. Market value of inventory is estimated based on the
impact of market trends, an evaluation of economic conditions
and the value of current orders relating to the future sales
of this type of inventory. Provisions for reserves for
inventory valuation for the three and six months ended June
30, 2008 were $677,336 and $678,655, respectively. For the
three and six months ended June 30, 2007, provisions for
reserve for inventory valuation were $120,700.
o We record deferred tax assets arising from temporary timing
differences between recorded net income and taxable net income
when and if we believe that future earnings will be sufficient
to realize the tax benefit. For those jurisdictions where the
expiration date of tax benefit carry-forwards or the projected
taxable earnings indicate that realization is not likely, a
valuation allowance is provided. If we determine that we may
not realize all of our deferred tax assets in the future, we
will make an adjustment to the carrying value of the deferred
tax asset, which would be reflected as an income tax expense.
Conversely, if we determine that we will realize a deferred
tax asset, which currently has a valuation allowance, we would
be required to reverse the valuation allowance, which would be
reflected as an income tax benefit. We believe that our
estimate of deferred tax assets and determination to record a
valuation allowance against such assets are critical
accounting estimates because they are subject to, among other
things, an estimate of future taxable income, which is
susceptible to change and dependent upon events that may or
may not occur, and because the impact of recording a valuation
allowance may be material to the assets reported on the
balance sheet and results of operations.
o We record impairment charges when the carrying amounts of
long-lived assets are determined not to be recoverable. In
accordance with SFAS 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETS, impairment is measured by
assessing the usefulness of an asset or by comparing the
carrying value of an asset to its fair value. Fair value is
typically determined using quoted market prices, if available,
or an estimate of undiscounted future cash flows expected to
result from the use of the asset and its eventual disposition.
The amount of impairment loss is calculated as the excess of
the carrying value over the fair value. Changes in market
conditions and management strategy have historically caused us
to reassess the carrying amount of our long-lived assets.
Long-lived assets were evaluated during the second quarter
2008 and it was determined that the fair value was in excess
of the carrying value and accordingly, no impairment
adjustments were made.
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o Sales are recognized when persuasive evidence of an
arrangement exists, product delivery has occurred, pricing is
fixed or determinable, and collection is reasonably assured.
Sales resulting from customer buy-back agreements, or
associated inventory storage arrangements are recognized upon
delivery of the products to the customer, the customer's
designated manufacturer, or upon notice from the customer to
destroy or dispose of the goods. Sales, provisions for
estimated sales returns, and the cost of products sold are
recorded at the time title transfers to customers. Actual
product returns are charged against estimated sales return
allowances.
o 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 March 2008, the FASB issued SFAS No. 161, DISCLOSURES ABOUT DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES - AN AMENDMENT OF FASB STATEMENT NO. 133
("SFAS 161"). SFAS 161 changes the disclosure requirements for derivative
instruments and hedging activities. Entities are required to provide enhanced
disclosures about how and why an entity uses derivative instruments, how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and how derivative instruments
and related hedged items affect an entity's financial position, financial
performance, and cash flows. SFAS 161 is effective for fiscal years and interim
periods beginning after November 15, 2008. We do not believe SFAS 161 will have
any impact on our consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, THE HIERARCHY OF GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES ("SFAS 162"). SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy). SFAS 162 is effective 60 days following
the SEC's approval of the Public Company Accounting Oversight Board amendments
to Au Section 411. We do not believe SFAS 162 will have any impact on our
consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under the
Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities Exchange Commission's rules and forms, including to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is accumulated and communicated to our management,
including our principal executive and principal financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange
Act.
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As of the end of the period covered by this report, management, with
the participation of Lonnie D. Schnell, our Chief Executive Officer and Chief
Financial Officer, carried out an evaluation of the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in Rule
13a-15(e) under the Exchange Act). Based upon that evaluation, Mr. Schnell
concluded that these disclosure controls and procedures were effective as of the
end of the period covered in this Quarterly Report on Form 10-Q.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarter ended June 30, 2008 there were no changes in our
internal controls over financial reporting that have materially affected or are
reasonably likely to materially affect our internal controls over financial
reporting.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On October 12, 2005, a shareholder class action complaint -- HUBERMAN
V.TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex) -- was filed against us
and certain of our current and former officers and directors in the United
States District Court for the Central District of California, alleging claims
under Section 10(b) and Section 20 of the Securities Exchange Act of 1934. A
lead plaintiff was appointed, and his amended complaint alleged that defendants
made false and misleading statements about our financial situation and our
relationship with certain of our large customers. The action was brought on
behalf of all purchasers of our publicly-traded securities during the period
from November 13, 2003 to August 12, 2005. On February 20, 2007, the Court
denied class certification. On April 2, 2007 the Court granted defendants'
motion for summary judgment, and on or about April 5, 2007, the Court entered
judgment in favor of all defendants. On or about April 30, 2007, plaintiff filed
a notice of appeal, and his opening appellate brief was filed on October 15,
2007. Our brief was filed on November 28, 2007. We believe that this matter will
be resolved favorably on appeal, or in a later trial or in settlement within the
limits of its insurance coverage. However, the outcomes of this action or an
estimate of the potential losses, if any, related to the lawsuit cannot be
reasonably predicted, and an adverse resolution of the lawsuit could potentially
have a material adverse effect on our financial position and results of
operations.
On April 16, 2004 we filed suit against Pro-Fit Holdings, Limited in
the U.S. District Court for the Central District of California - Tag-It Pacific,
Inc. v. Pro-Fit Holdings, Limited, CV 04-2694 LGB (RCx) -- asserting various
contractual and tort claims relating to our exclusive license and intellectual
property agreement with Pro-Fit, seeking declaratory relief, injunctive relief
and damages. It is our position that the agreement with Pro-Fit gives us
exclusive rights in certain geographic areas to Pro-Fit's stretch and rigid
waistband technology. On June 5, 2006 the Court denied our motion for partial
summary judgment, but did not find that we breached the agreement with Pro-Fit
and a trial is required to determine issues concerning the our activities in
Columbia and whether other actions by Pro-Fit constituted an unwillingness or
inability to fill orders. The Court also held that Pro-Fit was not "unwilling or
unable" to fulfill orders by refusing to fill orders with goods produced in the
United States. We also filed a second civil action against Pro-Fit and related
companies in the California Superior Court which was removed to the United
States District Court, Central District of California. In April 2008, Pro-Fit
and certain related companies were placed into administration in the United
Kingdom. On May 21, 2008, the joint administrators for Pro-Fit and its related
companies filed petitions under Chapter 15 of Title 11 of the United States Code
for Pro-Fit and two related companies in the United States Bankruptcy Court for
the Central District of California seeking recognition of the United Kingdom
administration proceedings and related relief. As a consequence of the chapter
15 filings by the joint administrators, all litigation by us against Pro-Fit has
been stayed. We have derived a significant amount of revenue from the sale of
products incorporating the stretch waistband technology in the past and our
business, results of operations and financial condition could be materially
adversely affected if the dispute with Pro-Fit is not resolved in a manner
favorable to us. Additionally, we have incurred significant legal fees in this
litigation, and unless the case is settled or resolved, may continue to incur
additional legal fees in order to assert its rights and claims against Pro-Fit
and any successor to those assets of Pro-Fit that are subject to our exclusive
license and intellectual property agreement with Pro-Fit and to defend against
any counterclaims.
We currently have pending a number of other claims, suits and
complaints that arise in the ordinary course of 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.
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ITEM 1A. RISK FACTORS
Risk factors are included in Item 1A of our Annual Report on Form 10-K for the
fiscal year ended December 31, 2007. No material changes to such risk factors
has occurred during the six months ended June 30, 2008.
ITEM 6. EXHIBITS
10.18+ Executive Employment Agreement, dated June 18, 2008, between
the Registrant and Lonnie Schnell. Incorporated by reference
to Exhibit 10.1 to Current Report on Form 8-K filed on June
24, 2008.
10.27+ Executive Employment Agreement, dated June 18, 2008, between
the Registrant and Larry Dyne. Incorporated by reference to
Exhibit 10.1 to Current Report on Form 8-K filed on June 24,
2008.
10.28+ Talon International, Inc. 2008 Stock Incentive Plan.
Incorporated by reference to Exhibit 4.10 to Registration
Statement on Form S-8 filed on July 18, 2008.
31.1 Certificate of Chief Executive Officer and 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.
------------------
+ Indicates a management contract or compensatory plan
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 19, 2008 TALON INTERNATIONAL, INC.
/S/ LONNIE D. SCHNELL
---------------------------------------
By: Lonnie D. Schnell
Its: Chief Executive Office
& Chief Financial Officer
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