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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2009.
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 has submitted
electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T (ss.232.405 of this chapter) during the preceding 12 months (or such shorter
period that the registrant was required to submit and post such files).
Yes [ ] 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 13, 2009 the issuer had 20,291,433 shares of Common Stock,
$.001 par value, issued and outstanding.
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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, 2009 (Unaudited)
and December 31, 2008 .............................................3
Consolidated Statements of Operations for the Three Months
and the Six Months Ended June 30, 2009 and 2008 (Unaudited)........4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2009 and 2008 (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...........33
Item 4T. Controls and Procedures..............................................33
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,
2009 2008
------------ ------------
(Unaudited)
Assets
Current Assets:
Cash and cash equivalents ............................................... $ 2,215,007 $ 2,399,717
Accounts receivable, net ................................................ 5,409,918 3,856,613
Inventories, net ........................................................ 1,935,198 1,669,149
Prepaid expenses and other current assets ............................... 651,744 473,955
------------ ------------
Total current assets ....................................................... 10,211,867 8,399,434
Property and equipment, net ................................................ 2,144,479 2,084,244
Fixed assets held for sale ................................................. 407,009 407,655
Due from related parties ................................................... 200,000 200,000
Intangible assets, net ..................................................... 4,110,751 4,110,751
Other assets ............................................................... 288,761 400,494
------------ ------------
Total assets ............................................................... $ 17,362,867 $ 15,602,578
============ ============
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable ......................................................... $ 8,930,217 $ 7,674,768
Accrued legal costs ...................................................... 540,679 383,075
Other accrued expenses ................................................... 2,465,014 2,292,681
Revolver note payable .................................................... 4,990,483 --
Term note payable, net of discounts ...................................... 9,112,891 --
Demand notes payable to related parties .................................. 225,810 222,264
Current portion of capital lease obligations ............................. 95,014 182,444
Current portion of notes payable ......................................... 46,427 144,064
------------ ------------
Total current liabilities .................................................. 26,406,535 10,899,296
Capital lease obligations, net of current portion .......................... 8,704 1,910
Revolver note payable, net of current portion .............................. -- 4,638,988
Term notes payable, net of discounts and current portion ................... -- 8,067,428
Other long term liabilities ................................................ 718,925 756,888
------------ ------------
Total liabilities .......................................................... 27,134,164 24,364,510
------------ ------------
Commitments and contingencies (Note 13)
Stockholders' Deficit:
Preferred stock Series A, $0.001 par value; 250,000 shares authorized; no
shares issued or outstanding ............................................ -- --
Common stock, $0.001 par value, 100,000,000 shares authorized; 20,291,433
shares issued and outstanding at June 30, 2009 and December 31, 2008 .. 20,291 20,291
Additional paid-in capital ............................................... 54,859,305 54,769,072
Accumulated deficit ...................................................... (64,754,705) (63,651,032)
Accumulated other comprehensive income ................................... 103,812 99,737
------------ ------------
Total stockholders' deficit ................................................ (9,771,297) (8,761,932)
------------ ------------
Total liabilities and stockholders' deficit ................................ $ 17,362,867 $ 15,602,578
============ ============
See accompanying notes to consolidated financial statements
3
TALON INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Six Months
Ended June 30, Ended June 30,
--------------------------- ----------------------------
2009 2008 2009 2008
------------ ------------ ------------ ------------
Net sales ........................................... $ 12,583,765 $ 17,020,629 $ 19,099,519 $ 27,006,118
Cost of goods sold .................................. 9,022,318 12,119,725 13,553,905 19,347,249
------------ ------------ ------------ ------------
Gross profit ..................................... 3,561,447 4,900,904 5,545,614 7,658,869
Selling expenses .................................... 531,365 767,865 1,046,909 1,487,828
General and administrative expenses ................. 2,198,037 3,082,164 4,201,830 6,430,400
------------ ------------ ------------ ------------
Total operating expenses ......................... 2,729,402 3,850,029 5,248,739 7,918,228
Income (loss) from operations ....................... 832,045 1,050,875 296,875 (259,359)
Interest expense, net ............................... 661,087 643,130 1,298,038 1,192,644
------------ ------------ ------------ ------------
Income (loss) before provision for (benefit from)
income taxes ..................................... 170,958 407,745 (1,001,163) (1,452,003)
Provision for (benefit from) income taxes ........... 96,103 (190,412) 102,510 (211,416)
------------ ------------ ------------ ------------
Net Income (loss) ................................ $ 74,855 $ 598,157 $ (1,103,673) $ (1,240,587)
============ ============ ============ ============
Basic income (loss) per share ....................... $ 0.01 $ 0.03 $ (0.05) $ (0.06)
============ ============ ============ ============
Diluted income (loss) per share ..................... $ 0.01 $ 0.03 $ (0.05) $ (0.06)
============ ============ ============ ============
Weighted average number of common shares outstanding:
Basic ............................................ 20,291,433 20,291,433 20,291,433 20,291,433
============ ============ ============ ============
Diluted .......................................... 20,291,433 20,291,433 20,291,433 20,291,433
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
4
TALON INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
----------------------------
2009 2008
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................... $ (1,103,673) $ (1,240,587)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization ............................ 363,881 546,844
Loss on disposal of property and equipment ............... 5,462 --
Amortization of deferred financing cost and debt discounts 699,340 556,755
Bad debt expense (recovery) .............................. 77,373 (5,326)
Decrease in inventory valuation reserves ................. -- (340,312)
Stock based compensation ................................. 90,233 284,433
Changes in operating assets and liabilities:
Accounts receivables, including related party ............ (1,632,941) (3,591,529)
Inventories .............................................. (266,046) 154,092
Prepaid expenses and other current assets ................ (178,697) 370,532
Other assets ............................................. 68,423 (50,012)
Accrued legal costs ...................................... 157,604 (261,181)
Accounts payable and other accrued expenses .............. 1,662,000 4,767,304
------------ ------------
Net cash provided by (used in) operating activities ...... (57,041) 1,191,013
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment ....................... (419,082) (132,754)
Proceeds from sale of equipment ............................. 1,822 12,045
------------ ------------
Net cash used in investing activities .................... (417,260) (120,709)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Revolver note borrowings .................................... 351,495 700,000
Repayment of revolver note borrowings ....................... -- (500,000)
Term note borrowings, net of issuance costs ................. 125,000 --
Payments on term note ....................................... -- (125,000)
Payment of notes payable .................................... (97,637) (147,110)
Payment of capital leases ................................... (91,130) (180,157)
------------ ------------
Net cash provided by (used in) financing activities ...... 287,728 (252,267)
------------ ------------
Net effect of foreign currency exchange translation on cash ... 1,863 4,509
------------ ------------
Net increase (reduction) in cash and cash equivalents ......... (184,710) 822,546
Cash and cash equivalents at beginning of period .............. 2,399,717 2,918,858
------------ ------------
Cash and cash equivalents at end of period .................... $ 2,215,007 $ 3,741,404
============ ============
See accompanying notes to consolidated financial statements
5
TALON INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Supplemental disclosures of cash flow information:
Six Months Ended June 30,
----------------------------
2009 2008
------------ ------------
Cash received (paid) during the period for:
Interest paid ....................................... $ (599,705) $ (671,906)
Interest received ................................... $ 1,007 $ 9,096
Income tax paid ..................................... $ (30,059) $ (10,553)
Non-cash financing activities:
Note payable issued in modification of loan agreement -- $ 1,000,000
Debt waiver / modification fee ...................... $ 225,210 $ 145,000
Effect of foreign currency translation on net assets $ 4,075 $ 113,027
Capital lease obligation ............................ $ 10,494 $ --
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 for interim financial information and in accordance with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. The accompanying unaudited 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, 2008. The balance sheet as of December 31, 2008 has been
derived from the audited financial statements as of that date but omits certain
information and footnotes required for complete financial statements.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal
course of business. The Company has experienced substantial recurring losses
from operations on declining revenues and has an accumulated deficit of $64.8
million as of June 30, 2009. These matters, among others, raise substantial
doubt about the Company's ability to continue as a going concern. The Company's
continuation as a going concern is dependent on its ability to generate
sufficient cash flow to meet its obligations on a timely basis, to obtain
additional financing as may be required, and ultimately to attain profitable
operations. See Note 3 "Significant Risks and Uncertainties".
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 for the year ended
December 31, 2008, 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.
ALLOWANCE FOR ACCOUNTS AND NOTES RECEIVABLE DOUBTFUL ACCOUNTS
The Company is required to make judgments as to the collectability of
accounts and notes receivable based on established aging policy, historical
experience and future expectations. The allowances for doubtful accounts
represent allowances for customer trade accounts and notes receivable that are
estimated to be partially or entirely uncollectible. These allowances are used
to reduce gross trade receivables or note receivable to their net realizable
value. The Company records these allowances based on estimates related to the
following factors: (i) customer specific allowances; (ii) amounts based upon an
aging schedule; and (iii) an estimated amount, based on our historical
experience, for issues not yet identified. Bad debt expense for the three and
six months ended June 30, 2009 is $72,703 and $77,373 respectively. Bad debt
recoveries for the three and six months ended June 30, 2008 are $4,021 and
$5,326, respectively.
FAIR VALUE MEASUREMENTS
The Company has adopted SFAS No. 157 which defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements.
7
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
SFAS 157 does not require any new fair value measurements, but provides guidance
on how to measure fair value by providing a fair value hierarchy used to
classify the source of the information. As of June 30, 2009, the Company held
certain assets and liabilities that are required to be measured at fair value on
a recurring basis. The fair value of these assets and liabilities was determined
using observable criteria and at June 30, 2009 was equal to their stated values,
except the Related Party Note Receivable of $200,000 and the Assets Held for
Sale of $407,000, both of which used unobservable criteria to determine their
value. There were no material adjustments to the fair value of these assets for
the three or six months ended June 30, 2009.
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.
The exclusive license and intellectual property rights are fully amortized.
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 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, 2009 were $2,051 and $29,195, respectively,
compared to $10,581 and $52,696 for the three and six months ended June 30,
2008, 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, 2009 totaled $661,800 and $1,299,000,
respectively. For the three and six months ended June 30, 2008, interest expense
was $658,000 and $1,225,600, respectively. Interest income consists of earnings
from outstanding amounts due to the Company under notes and other interest
bearing receivables. The Company recorded interest income of $700 and $1,000
respectively, for the three and six months ended June 30, 2009, as compared to
$15,500 and $32,900 for the same periods in 2008.
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 $103,812 and $99,737
at June 30, 2009 and December 31, 2008, respectively.
8
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
COMPREHENSIVE INCOME (LOSS)
Comprehensive income consists of net income (loss) and unrealized gains
and losses on marketable securities and foreign currency translation
adjustments. Comprehensive income (loss) and its components for the three and
six months ended June 30, 2009 and 2008 is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- --------------------------
2009 2008 2009 2008
----------- ----------- ----------- -----------
Net income (loss) ................ $ 74,855 $ 598,157 $(1,103,673) $(1,240,587)
Other comprehensive income (loss):
Available for sale securities .... -- 160,000 -- (500,000)
Foreign currency translation ..... 7,160 101,607 4,075 113,027
----------- ----------- ----------- -----------
Total comprehensive income (loss) $ 82,015 $ 859,764 $(1,099,598) $(1,627,560)
=========== =========== =========== ===========
The available-for-sale securities adjustment represented unrealized
losses due to temporary market declines related to our marketable securities
that were received in exchange for the Azteca note receivable. These marketable
securities were permanently impaired in the amount of $1,040,000 during the
third quarter of 2008 as discussed in Note 6 to the consolidated financial
statements. 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.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period financial
statements to conform to the current year presentation.
NOTE 3. SIGNIFICANT RISKS AND UNCERTAINTIES
The Company's consolidated financial statements have been prepared on a
going concern basis of accounting which contemplates the continuity of
operations and the realization of assets, liabilities and commitments in the
normal course of business. During the first six months of fiscal year 2009 and
fiscal year 2008, the Company experienced losses from operations and has an
accumulated deficit as of June 30, 2009 of $64,754,705. As of December 31, 2008,
the Company failed to meet the minimum EBITDA requirements in the Revolving
Credit and Term Loan Agreement with CVC California, LLC ("CVC") and was required
to pay a fee to waive these requirements at December 31, 2008. Additionally, the
Company did not meet the minimum EBITDA covenants at March 31, 2009, and it has
also paid a waiver fee to the lender for this period. The company was not in
default of the covenants at June 30, 2009; however it is uncertain whether the
Company will be in compliance with the financial covenants in future quarters.
Our consolidated financial statements do not reflect any adjustments
relating to the recoverability and classification of recorded asset amounts or
classification of liabilities that would be required if a default occurred and
the Company was unable to obtain a waiver or modify the covenants. Should the
Company fail to be in compliance with these covenants for three successive
quarters and was unable to obtain a waiver or amend these covenants, the Company
may be unable to continue as a going concern.
The Company's performance is subject to worldwide economic conditions
and their impact on levels of consumer spending that affect not only the
ultimate consumer, but also retailers, which constitute many of its largest
customers. Consumer spending recently has deteriorated significantly and may
remain depressed, or be subject to further deterioration for the foreseeable
9
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
future. The worldwide apparel industry is heavily influenced by general economic
cycles. Purchases of fashion apparel and accessories tend to decline in periods
of recession or uncertainty regarding future economic prospects, as disposable
income declines. Many factors affect the level of consumer spending in the
apparel industries, including, among others: prevailing economic conditions,
levels of employment, salaries and wage rates, energy costs, interest rates, the
availability of consumer credit, taxation and consumer confidence in future
economic conditions. During periods of recession or economic uncertainty, the
Company may not be able to maintain or increase the sales to existing customers,
make sales to new customers or maintain our earnings from operations as a
percentage of net sales. As a result, the operating results may be adversely and
materially affected by sustained or further downward trends in the United States
or global economy. The Company's ability to continue as a going concern is
dependent on its ability to generate sufficient cash flow to meet its
obligations on a timely basis, to obtain additional financing as may be required
and ultimately to attain profitable operations.
In response to these conditions, the Company has taken steps to
significantly reduce its operating costs, eliminate employees in response to
lower volumes, curtail capital and discretionary spending to better align the
Company's organizational and cost structures with future Company and industry
expectations and uncertainties and insure the Company will have sufficient cash
flow to cover its operating needs. The Company has also implemented programs to
increase sales incentives, to secure preferred supplier status with customers
and to accelerate cash collections from customers. There can be no assurance;
however, that the Company will be successful in these matters or that these
steps will be sufficient to ensure the Company can continue as a going concern.
NOTE 4. NEW ACCOUNTING PRONOUNCEMENTS
In April 2009, the FASB issued FSP FAS 157-4, "DETERMINING FAIR VALUE
WHEN VOLUME AND LEVEL OF ACTIVITY FOR THE ASSET OR LIABILITY HAVE SIGNIFICANTLY
DECREASED AND IDENTIFYING TRANSACTIONS THAT ARE NOT ORDERLY" (FSP 157-4). FSP
157-4 provides guidance on how to determine the fair value of assets and
liabilities when the volume and level of activity for the asset/liability has
significantly decreased. FSP 157-4 also provides guidance on identifying
circumstances that indicate a transaction is not orderly. In addition, FSP 157-4
requires disclosure in interim and annual periods of the inputs and valuation
techniques used to measure fair value and a discussion of changes in valuation
techniques. FSP 157-4 was effective beginning in the second quarter of fiscal
year 2009. The adoption of FSP 157-4 did not have a material impact on the
consolidated financial statements.
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2,
"RECOGNITION AND PRESENTATION OF OTHER-THAN-TEMPORARY Impairment" (FSP
115-2/124-2). FSP 115-2/124-2 amends the requirements for the recognition and
measurement of other-than-temporary impairments for debt securities by modifying
the pre-existing "intent and ability" indicator. Under FSP 115-2/124-2, an
other-than-temporary impairment is triggered when there is an intent to sell the
security, it is more likely than not that the security will be required to be
sold before recovery, or the security is not expected to recover the entire
amortized cost basis of the security. Additionally, FSP 115-2/124-2 changes the
presentation of an other-than-temporary impairment in the income statement for
those impairments involving credit losses. The credit loss component will be
recognized in earnings and the remainder of the impairment will be recorded in
other comprehensive income. FSP 115-2/124-2 was effective beginning in the
second quarter of fiscal year 2009. The implementation of FSP 115-2/124-2 did
not have a material impact on the consolidated financial statements.
In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "INTERIM
DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS" (FSP 107-1/APB 28-1). FSP
107-1/APB 28-1 requires interim disclosures regarding the fair values of
financial instruments that are within the scope of FAS 107, "DISCLOSURES ABOUT
THE FAIR VALUE OF FINANCIAL INSTRUMENTS." Additionally, FSP 107-1/APB 28-1
requires disclosure of the methods and significant assumptions used to estimate
the fair value of financial instruments on an interim basis as well as changes
10
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
of the methods and significant assumptions from prior periods. FSP 107-1/APB
28-1 does not change the accounting treatment for these financial instruments
and did not have a material impact on the consolidated financial statements.
In April 2009, the FASB issued FSP SFAS No. 141R-1, ACCOUNTING FOR
ASSETS ACQUIRED AND LIABILITIES ASSUMED IN A BUSINESS COMBINATION THAT ARISE
FROM CONTINGENCIES. FSP SFAS 141R-1 amends the guidance in SFAS 141R relating to
the initial recognition and measurement, subsequent measurement and accounting
and disclosures of assets and liabilities arising from contingencies in a
business combination. FSP SFAS 141R is effective for fiscal years beginning
after December 15, 2008. The Company has adopted FSP SFAS 141R as of the
beginning of fiscal 2009 and it did not have a material impact on the
consolidated financial statements. The Company will apply the requirements of
FSP FAS 141R-1 prospectively to any future acquisitions.
In May 2009, the FASB issued SFAS No. 165, SUBSEQUENT EVENTS ("SFAS
No. 165"). SFAS No. 165 provides general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. SFAS No. 165 was
adopted by the Company in the second quarter of 2009 and did not have a material
impact on the consolidated financial statements. The subsequent events have been
evaluated through August 14, 2009, which is the date the financial statements
were issued.
In June 2009, the FASB issued SFAS No. 166, ACCOUNTING FOR TRANSFERS OF
FINANCIAL ASSETS--an amendment of FASB Statement No. 140 (SFAS No. 166"). SFAS
No. 166 seeks to improve the relevance, representational faithfulness, and
comparability of the information that a reporting entity provides in its
financial statements about a transfer of financial assets; the effects of a
transfer on its financial position, financial performance, and cash flows and a
transferor's continuing involvement, if any, in transferred financial assets.
SFAS No. 166 is applicable for annual periods beginning after November 15, 2009.
The implementation of SFAS No. 165 and 166 is not expected to have a
material impact on the consolidated financial statements.
11
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
NOTE 5. INCOME (LOSS) PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted income (loss) per share computations:
Income
THREE MONTHS ENDED JUNE 30, 2009: (loss) Shares Per Share
-------------------------------- ----------- ----------- -----------
Basic Income per share:
Available to common stockholders .... $ 74,855 20,291,433 $ 0.01
Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
----------- ----------- -----------
Income available to common stockholders $ 74,855 20,291,433 $ 0.01
=========== =========== ===========
THREE MONTHS ENDED JUNE 30, 2008:
--------------------------------
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
=========== =========== ===========
SIX MONTHS ENDED JUNE 30, 2009:
------------------------------
Basic Loss per share:
Available to common stockholders .... $(1,103,673) 20,291,433 $ (0.05)
Effect of Dilutive Securities:
Options ............................... -- -- --
Warrants .............................. -- -- --
----------- ----------- -----------
Loss available to common stockholders . $(1,103,673) 20,291,433 $ (0.05)
=========== =========== ===========
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)
=========== =========== ===========
Warrants to purchase 318,495 shares of common stock exercisable at
$3.65 per share and options to purchase 5,398,100 shares of common stock
exercisable between $0.11 and $5.23 per share, were outstanding for the three
and six months ended June 30, 2009, but were not included in the computation of
diluted income (loss) per share because exercise or conversion would have an
antidilutive effect on the income (loss) per share.
12
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
Warrants to purchase 891,313 shares of common stock exercisable between
$3.65 and $4.74 and options to purchase 7,057,235 shares of common stock
exercisable between $0.20 and $5.23, were outstanding for the three and six
months ended June 30, 2008, but were not included in the computation of diluted
income (loss) per share because the effect of exercise or conversion would have
an antidilutive effect on income (loss) per share.
NOTE 6. MARKETABLE SECURITIES
The Company entered into an agreement with Azteca Production
International, Inc. ("Azteca"), a former distributor of Talon products,
effective December 31, 2007, in settlement of an existing note receivable
obligation. The agreement called for Azteca to deliver 2,000,000 shares of
unrestricted common stock in a separate public corporation with a value of
$1,040,000 in exchange for cancellation of the note. On January 30, 2008, the
unrestricted shares were delivered by Azteca. In the third quarter of 2008 the
Company determined that this asset had been permanently impaired and recognized
a valuation reserve for the full value of the investment of $1,040,000 at
September 30, 2008. An unrealized gain of $160,000 and unrealized loss of
$500,000 were previously recognized in other comprehensive income for the three
and six months ended June 30, 2008, respectively.
NOTE 7. ACCOUNTS AND NOTE RECEIVABLE
Accounts receivable are included on the accompanying consolidated
balance sheets net of an allowance for doubtful accounts. The total allowance
for doubtful accounts at June 30, 2009 and December 31, 2008 was $189,800 and
$217,300, respectively.
Due from related parties at June 30, 2009 and December 31, 2008
includes $699,680 and 674,010, respectively, of unsecured notes, advances and
accrued interest receivable from Colin Dyne, a director and stockholder of the
Company. The Company has a valuation reserve against this note of $499,680 and
$474,010 at June 30, 2009 and December 31, 2008, respectively.
In determining the fair value of the Note Receivable, the Company has
analyzed the expected recovery of the note amount and collection period through
anticipated payments from commissions earned on business opportunities presented
to the Company. The Company generally pays a commission of approximately 6% of
sales for these business opportunities realized.
NOTE 8. 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. The Company uses 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.
13
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
Inventories consist of the following:
June 30, December 31,
2009 2008
------------ ------------
Finished goods ............... $ 3,099,487 $ 2,880,319
Less reserves ................ (1,164,289) (1,211,170)
------------ ------------
Total inventories ............ $ 1,935,198 $ 1,669,149
============ ============
NOTE 9. FIXED ASSETS HELD FOR SALE
The Company has machinery and equipment formerly used for the
production of zipper chain and the assembly of finished zippers. This equipment
was originally associated with the production and assembly facilities in North
Carolina and in Mexico and was temporarily rendered idle with the closing of
those operations in 2005. The Company relocated this equipment to Asia in 2008
to more effectively redeploy or sell the equipment. The Company has analyzed the
cash flow of the potential sales value of the equipment and determined that it
is likely that a sale of this equipment will not recover its carrying value. As
a result, at December 31, 2008 the Company recorded an impairment charge of
$2,026,000 for the difference from the estimated sales value of the equipment
and the previous carrying value. The adjusted carrying value of the equipment at
June 30, 2009 is $349,009.
The Company also determined that certain components of its Tekfit
equipment, which is used in the manufacture of the Tekfit proprietary stretch
waistband, will not be redeployed as a consequence of lower demand for this
product and the affect of the current economic crisis on the apparel industry.
As a result at December 31, 2008 the Company recorded an impairment charge of
$403,500 for the equipment which will not be utilized in foreseeable operations.
The adjusted carrying value of the equipment at June 30, 2009 is $58,000.
NOTE 10. DEBT FACILITY
On June 27, 2007, the Company entered into a Revolving Credit and Term
Loan Agreement with Bluefin Capital, LLC that provides for a $5.0 million
revolving credit loan and a $9.5 million term loan for a three year period
ending June 30, 2010. Bluefin Capital subsequently assigned its rights and
obligations under the credit facility agreements to an affiliate, CVC
California, LLC ("CVC"). The revolving credit portion of the facility permitted
borrowings based upon a formula including 75% of the Company's eligible
receivables and 55% of eligible inventory, and provided for monthly interest
payments at the prime rate (5.25% at June 30, 2009) plus 2.0%. The term loan
bears interest at 8.5% annually with quarterly interest payments and repayment
in full at maturity. Borrowings under both credit facilities are secured by all
of the assets of the Company.
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 warrants to purchase 2,100,000 shares of common stock. The
warrants were exercisable over a five-year period and initially 700,000 warrants
were exercisable at $0.95 per share; 700,000 warrants were exercisable at $1.05
per share; and 700,000 warrants were exercisable at $1.14 per share. The
warrants did not require cash settlements. The relative fair value of the equity
($2,374,169, which includes a reduction for financing costs) issued with this
debt facility was allocated to paid-in-capital and reflected as a debt discount
to the face value of the term note.
This discount is being amortized over the term of the note and
recognized as additional interest cost as amortized. Costs associated with the
debt facility included debt fees, commitment fees, registration fees and legal
and professional fees of $486,000. The costs allocable to the debt instruments
are reflected as a reduction to the face value of the note on the balance sheet.
14
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
On November 19, 2007, the Company entered into an amendment of its
agreement 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 warrants for the purchase of 2,100,000 shares of common stock
was amended to an exercise price of $0.75 per share. The new relative fair value
of the equity issued with this debt of $2,430,000, including the modifications
in this amendment and a reduction for financing costs, is being amortized over
the term of the note.
On April 3, 2008, the Company executed a further amendment to its
existing loan agreement. The amendment included a redefining of the EBITDA
covenants, and the cancellation of the common stock warrants previously issued
to the lender in exchange for the issuance by the Company of an additional note
payable to CVC 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
incurred a one-time modification fee of $145,000 to secure the amendment of the
agreement. The new relative fair value of the equity issued with this debt of
$2,542,000, including the modifications in this amendment and a reduction for
financing costs, is being amortized over the term of the note.
In connection with this amendment the Company evaluated the debt
amendment under EITF 96-19 "Debtor's Accounting for a Modification or Exchange
or Debt Instruments". 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 is being amortized using
the interest-method over the life of the modified notes and is to be reflected
as interest expense.
Under the terms of the credit agreement, as amended, 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 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. The Company failed to satisfy the minimum EBITDA requirement for
quarter ended December 31, 2008 as well as the quarter ended March 31, 2009, and
in connection with such failures, on March 31, 2009 the Company entered into an
amendment to the existing revolving credit and term loan agreement with CVC.
The amendment provided for the following: issuance of an additional
term note to CVC in the principal amount of $225,210 in lieu of paying a cash
waiver fee in connection with our failures to satisfy the EBITDA requirements
for the quarters ended December 31, 2008 and March 31, 2009; deferral of the
term note quarterly interest payment of $215,000 due April 1, 2009; a temporary
increase to the borrowing base formulas and calculations under the revolving
credit facility; the re-lending by CVC of $125,000 under the term loan portion
of credit facility; a consent to allow the Company to sell equipment that has
been designated as held for sale more fully described in Note 9 to the
consolidated financial statements; and the granting to CVC of the right to
designate a non-voting observer to attend all meetings of our Board of
Directors.
15
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
As of June 30, 2009, the Company had outstanding borrowings of
$10,725,210 under the term notes (discounted carrying value of $9,112,891), and
$4,990,483 under the revolving credit note.
Interest expense related to the Revolving Credit and Term Loan
Agreement for the three and six months ended June 30, 2009 was $652,400 and
$1,275,880, respectively, which includes $357,240 and $699,340 in amortization
of discounts and deferred financing costs for the same periods.
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 same periods.
NOTE 11. 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 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 14, 2008, at the Company's annual meeting of stockholders, a
new 2008 Stock Plan was approved by the stockholders. The 2008 Stock Plan
authorizes up to 2,500,000 shares of common stock for issuance pursuant to
awards granted to individuals under the plan. On July 31, 2007, at the Company's
annual meeting of stockholders, the 2007 Stock Plan was approved which replaced
the 1997 Stock Plan. The 2007 Stock Plan authorizes up to 2,600,000 shares of
common stock for issuance pursuant to awards granted to individuals under the
plan. Options granted to certain employees in 2008 include certain acceleration
features based on Company performance as determined by the Board of Directors
each year. Consistent with SFAS 123(R), the stock based compensation expense for
the employee options are recognized on a time-phased vesting schedule through
the vesting date of December 31, 2010. In calculating the outcome of meeting
performance conditions for 2009 and 2008, the Company did not meet performance
criteria and accordingly, there was no accelerated vesting for these options.
Options granted for the three and six months ended June 30, 2009 totaled
480,000. For the three and six months ended June 30, 2008, 2,600,000 options
were granted.
As of June 30, 2009, the Company had approximately $318,885 of
unamortized stock-based compensation expense related to options issued to
employees and directors, which will be recognized over the weighted average
period of 1.7 years. As of June 30, 2008, unamortized stock-based compensation
expense related to options issued to employees and directors was $558,000, which
is being recognized over the weighted average period of approximately 6 years.
16
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
The following table summarizes the activity in the Company's share
based plans during the six months ended June 30, 2009.
Weighted
Average
Number of Exercise
Shares Price
---------- ----------
EMPLOYEES AND DIRECTORS
Options and warrants outstanding - January 1, 2009 .. 7,100,536 $ 0.98
Granted ........................................ -- --
Exercised ...................................... -- --
Cancelled ...................................... (2,164,937) $ 0.62
---------- ----------
Options and warrants outstanding - March 31, 2009 ... 4,935,599 $ 1.14
Granted ........................................ 480,000 $ 0.11
Exercised ...................................... -- --
Cancelled ...................................... (17,499) $ 0.65
---------- ----------
Options and warrants outstanding - June 30, 2009 .... 5,398,100 $ 1.20
========== ==========
NON-EMPLOYEES
Options and warrants outstanding - January 1, 2009 .. 318,495 $ 3.65
Granted ........................................ -- --
Exercised ...................................... -- --
Cancelled ...................................... -- --
---------- ----------
Options and warrants outstanding - March 31, 2009 ... 318,495 $ 3.65
Granted ........................................ -- --
Exercised ...................................... -- --
Cancelled ...................................... -- --
---------- ----------
Options and warrants outstanding - June 30, 2009 .... 318,495 3.65
========== ==========
NOTE 12. INCOME TAXES
The Company accrues interest and penalties related to unrecognized tax
benefits in interest and penalties expense. For the three and six months ended
June 30, 2009 and 2008, the Company accrued interest and penalties for
unrecognized tax benefits of approximately $4,000 and $8,000, respectively. At
June 30, 2009 and December 31, 2008, the Company had approximately $69,700 and
$61,800, respectively, accrued in interest and penalties associated with the
unrecognized tax liabilities.
Deferred tax assets were $150,952 and $218,000 at June 30, 2009 and
December 31, 2008, respectively, related to the Company's foreign operations and
were included in other assets. Due to prior operating losses incurred, no
benefit for domestic income taxes has been recorded since there is not
sufficient evidence to determine that the Company will be able to utilize our
net operating loss carryforwards to offset future taxable income. Other tax
liabilities were $3,005 and $1,450 as of June 30, 2009 and December 31, 2008,
respectively, and were included in other accrued liabilities.
NOTE 13. COMMITMENTS AND CONTINGENCIES
On October 12, 2005, a shareholder class action complaint was filed in
the United States District Court for the Central District of California
("District Court") against the Company, Colin Dyne, Mark Dyne, Ronda Ferguson
and August F. Deluca (collectively, the "Individual Defendants" and, together
with the Company, "Defendants"). The action is styled Huberman v. Tag-It
Pacific, Inc., et al., Case No. CV05-7352 R(Ex). On January 23, 2006, the
17
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
District Court heard competing motions for appointment of lead plaintiff. The
District Court appointed Seth Huberman as the lead plaintiff ("Plaintiff"). On
March 13, 2006, Plaintiff filed an amended complaint. Plaintiff's amended
complaint alleged that defendants made false and misleading statements about the
Company's financial situation and the Company's relationship with certain of the
Company's 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. The amended complaint purports to state claims under
Section 10(b)/Rule 10b-5 and Section 20(a) of the Securities Exchange Act of
1934. On August 21, 2006, Defendants filed their answer to the amended
complaint, denying the material allegations of wrongdoing. On February 20, 2007,
the District Court denied class certification. On April 2, 2007, the District
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 with the United States Court of
Appeals for the Ninth Circuit ("Ninth Circuit"), and his opening appellate brief
was filed on October 15, 2007. Defendants' brief was filed on November 28, 2007.
The Ninth Circuit held oral arguments on October 23, 2008. On January 16, 2009,
the Ninth Circuit issued an unpublished memorandum, instructing the District
Court to certify a class, reversing the District Court's grant of summary
judgment, and remanding for further proceedings consistent with its decision.
The District Court thereafter certified a class and adopted a schedule for the
case. On July 31, 2009, the parties entered into a stipulation of settlement
intended to settle the matter and result in its dismissal with prejudice. The
total settlement proceeds of $5.75 million are to be paid in full by the
Company's insurers without any contribution from the Company or individual
defendants. The Court has set a hearing for preliminary approval of the
settlement on August 17, 2009. If preliminary approval is given, notice will be
provided to class members and the Court will set a final fairness hearing on the
settlement. If the settlement is finally approved, the case will be dismissed
with prejudice per the terms of the settlement. If the settlement is not
approved, the Company will continue to vigorously defend this lawsuit; however,
in this case, the outcome of this lawsuit 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 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. 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 the second quarter of 2008, Pro-Fit and certain related companies
were placed into administration in the United Kingdom and filed petitions under
Chapter 15 of Title 11 of the United States Code. As a consequence of the
chapter 15 filings, all litigation by us against Pro-Fit has been stayed. 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 its 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 the Company's 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.
18
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
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 No. 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 14. 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, 2009
---------------------------------------------------------
Talon Trim Tekfit Consolidated
------------ ------------ ------------ ------------
Net sales .............. $ 7,696,659 $ 4,863,876 $ 23,230 $ 12,583,765
Cost of goods sold ..... 5,939,552 3,072,342 10,424 9,022,318
------------ ------------ ------------ ------------
Gross profit ........... 1,757,107 1,791,534 12,806 3,561,447
------------ ------------ ------------
Operating expenses ..... 2,729,402
------------
Income from operations . $ 832,045
============
19
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
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 ..... 3,850,029
------------
Income from operations . $ 1,050,875
============
Six Months Ended June 30, 2009
---------------------------------------------------------
Talon Trim Tekfit Consolidated
------------ ------------ ------------ ------------
Net sales .............. $ 11,028,352 $ 8,034,062 $ 37,105 $ 19,099,519
Cost of goods sold ..... 8,462,280 5,073,727 17,898 13,553,905
------------ ------------ ------------ ------------
Gross profit ........... 2,566,072 2,960,335 19,207 5,545,614
------------ ------------ ------------
Operating expenses ..... 5,248,739
------------
Income from operations . $ 296,875
============
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 ..... 7,918,228
------------
Loss from operations ... (259,359)
============
20
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
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:
SALES Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
Country / Region 2009 2008 2009 2008
----------- ----------- ----------- -----------
United States ...... $ 919,777 $ 1,187,600 $ 1,569,610 $ 1,845,100
Hong Kong .......... 3,064,825 4,408,300 5,482,757 8,063,600
China .............. 4,458,898 6,009,500 5,622,462 7,925,100
India .............. 486,631 788,900 826,436 1,498,000
Bangladesh ......... 596,128 593,200 1,140,413 1,326,800
Other .............. 3,057,506 4,033,100 4,459,841 6,347,500
----------- ----------- ----------- -----------
Total .............. $12,583,765 $17,020,600 $19,099,519 $27,006,100
=========== =========== =========== ===========
June 30, December 31,
2009 2008
------------ ------------
LONG-LIVED ASSETS:
United States ............................. $ 4,770,642 $ 4,955,725
Hong Kong ................................. 1,257,996 989,761
China ..................................... 221,731 243,905
Other ..................................... 4,861 5,604
------------ ------------
Total ....................................... $ 6,255,230 $ 6,194,995
============ ============
21
TALON INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(UNAUDITED)
NOTE 15. RELATED PARTY TRANSACTIONS
Colin Dyne, a director and stockholder of the Company is also a
director, officer and significant stockholder in People's Liberation, Inc., the
parent company of Versatile Entertainment, Inc. and William Rast Sourcing.
During the three and six months ended June 30, 2009 the Company had no sales to
Versatile Entertainment. During the three and six months ended June 30, 2008 the
Company had sales of $177,770 and $289,250, respectively, to Versatile
Entertainment. Accounts receivable of $40 and $18,000 were outstanding from
Versatile Entertainment at June 30, 2009 and December 31, 2008, respectively.
During the three and six months ended June 30, 2009 the Company had
sales of $77,500 and $123,690, respectively, to William Rast Sourcing. During
the three and six months ended June 30, 2008 the Company had sales of $60,200
and $91,900, respectively, to William Rast Sourcing. Accounts receivable of
$67,744 and $51,000 were outstanding from William Rast Sourcing at June 30, 2009
and December 31, 2008, respectively.
Due from related parties at June 30, 2009 and December 31, 2008
includes unsecured notes, advances and accrued interest receivable, net of
valuation reserves of $200,000 from Colin Dyne. The notes and advances bear
interest at 7.5% and are due on demand.
Demand notes payable to related parties includes notes and advances to
parties related to or affiliated with Mark Dyne, the Chairman of the Board of
Directors of the Company and significant stockholder. The balance of demand
notes payable and interest expense to related parties at June 30, 2009 and
December 31, 2008 was $225,800 and 222,000, respectively.
Freedom Apparel, an entity owned by the spouse and a relative of Larry
Dyne, an executive officer of the Company, has purchased products from the
Company. For the three and six months ended June 30, 2009 there were no sales to
this entity. For the three and six months ended June 30, 2008 sales to this
entity were $0 and $100, respectively. At June 30, 2009 and December 31, 2008,
accounts receivable included $34,900 and $35,000, respectively, due from this
entity.
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, 2009, respectively. Consulting fees paid for the three and six months
ended June 30, 2008 were $37,500 and $75,000, respectively. This consulting
arrangement terminates on March 31, 2010. For the three and six months ended
June 30, 2008 consulting fees of $75,000 and $150,000 were paid to Colin Dyne,
whose consulting agreement terminated November 30, 2008.
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 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(R) and
TEKFIT(R). We operate the business globally under three product groups.
We plan to continue to expand our distribution of TALON zippers through
a network of Talon distribution and manufacturing 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. Our efforts to promote this product offering have been
limited by a licensing dispute. As described more fully in this report under
Contingencies and Guarantees (see Note 13 to consolidated financial statements),
we are presently in litigation with Pro-Fit Holdings Limited regarding our
exclusively licensed rights to sell or sublicense stretch waistbands
manufactured under Pro-Fit's patented technology. Our growth prospects, results
of operations and financial condition have been materially adversely affected
due to our dispute with Pro-Fit not being resolved in a manner favorable to us.
23
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,
-------------------- ---------------------
2009 2008 2009 2008
-------- -------- -------- --------
Net sales ................................ 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ....................... 71.7 71.2 71.0 71.6
-------- -------- -------- --------
Gross profit ............................. 28.3 28.8 29.0 28.4
Selling expenses ......................... 4.2 4.5 5.5 5.5
General and administrative expenses ...... 17.5 18.1 22.0 23.9
Interest expense, net and income taxes ... 6.0 2.7 7.3 3.6
-------- -------- -------- --------
Net income (loss) ........................ 0.6% 3.5 (5.8)% (4.6)%
======== ======== ======== ========
SALES
For the three and six months ended June 30, 2009 and 2008, 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 2009 2008 2009 2008
-------- -------- -------- --------
United States .................. 7.3% 7.0% 8.2% 6.8%
Hong Kong ...................... 24.4% 25.9% 28.7% 29.9%
China .......................... 35.4% 35.3% 29.4% 29.4%
India .......................... 3.9% 4.6% 4.3% 5.5%
Bangladesh ..................... 4.7% 3.5% 6.0% 4.9%
Other .......................... 24.3% 23.7% 23.4% 23.5%
-------- -------- -------- --------
100.0% 100.0% 100.0% 100.0%
======== ======== ======== ========
Sales for the three months ended June 30, 2009 were $12.6 million, a
decrease of $4.4 million or 26.1%, from the same period in 2008. The net
decrease reflects the impact of the global recession on the apparel industry and
the corresponding lower demand for our Talon zipper and trims products. The
apparel industry and our customers are expected to be adversely impacted by this
recession for most of 2009, and early 2010, depending upon the global economic
trends.
Sales for the six months ended June 30, 2009 were $19.1 million, a
decrease of $7.9 million or 29.3%, from the same period in 2008. The net
decrease in sales is due to the impact of the global recession on the apparel
industry and the related lower demand for Talon products. The decline in sales
in the second quarter of 2009 as compared to the second quarter of 2008 (26.1%)
was less than the decline in sales in the first quarter of 2009 as compared to
the first quarter of 2008 (34.7%), which suggests a modest sales improvement in
the apparel industry.
During the three months ended June 30, 2009 it was discovered that
certain Chinese factories had counterfeited Talon zippers in conjunction with
former employees of the Company, and sold these products to existing and
potential customers. The extent of this counterfeiting is currently under
investigation and efforts are in process to eliminate and prosecute all
offenders. The full extent of the counterfeiting, its effect on our current
24
business operations and the costs to investigate and eliminate this activity are
ongoing and are, as of yet, undeterminable, however based upon evidence
available we believe the impact is not significant to our current overall
operations. We will aggressively combat these efforts worldwide to protect the
Talon brand.
GROSS PROFIT
Gross profit for the three months ended June 30, 2009 was $3.6 million,
as compared to $4.9 million for the same period in 2008. Gross profit for the
six months ended June 30, 2009 was $5.5 million, as compared to $7.7 million for
the same period in 2008. The reduction in gross profit for the three and six
months ended June 30, 2009 as compared to the same periods in 2008 was
principally attributable to lower overall sales volumes, partially offset by a
higher direct margin resulting from a change in the mix of product sales,
decreased freight and duty costs and decreased contract services.
A recap of the change in gross margin for the three and six months
ended June 30, 2009 as compared with the same periods in 2008 is as follows:
(Amounts in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
Amount %(1) Amount %(1)
-------- -------- -------- --------
Gross profit decrease as a result of:
Lower volumes ............................ $ (1,470) (30.0) $ (2,662) (34.8)
Product margin mix ....................... 180 3.7 376 4.9
Decreased freight and duty costs ......... 60 1.2 59 0.8
Decreased outside services ............... 4 0.1 99 1.3
Overhead and other ....................... (113) (2.3) 15 0.2
-------- -------- -------- --------
Gross profit decrease .................... $ (1,339) (27.3) $ (2,113) (27.6)
======== ======== ======== ========
----------
(1) Represents the percentage change in the 2009 period, as compared to the
same period in 2008.
SELLING EXPENSES
Selling expenses for the three months ended June 30, 2009 were $0.5
million, or 4.2% of sales, as compared to $0.8 million, or 4.5% of sales, for
the same period in 2008. Sales costs decreased in dollar terms and as a
percentage of sales primarily due to a decrease in employees and related
employee costs. In addition, other production and marketing costs also decreased
as we continue to closely monitor all spending levels.
Selling expenses for the six months ended June 30, 2009 were $1.0
million, or 5.5% of sales, as compared to $1.5 million, or 5.5% of sales, for
the same period in 2008. The lower selling costs reflect lower salaries and
benefits along with lower production development supplies and samples primarily
associated with reduced sales volumes.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expense for the three months ended June 30,
2009 were $2.2 million, or 17.5% of sales, as compared with $3.1 million, or
18.1% of sales, for the same period in 2008. The decrease reflects a reduction
in the size of our workforce to align with current sales levels, achieved by
reduced salaries and benefit costs of $0.3 million, reduced facilities,
maintenance and insurance costs of $0.1 million, lower professional, legal and
25
audit costs of $0.4 million, and lower depreciation of $0.2 million mainly due
to idle equipment, which we have classified as for sale and are no longer
depreciating.
For the six months ended June 30, 2009, general and administrative
expenses were $4.2 million or 22.0% of sales, as compared with $6.4 million or
23.8% of sales, for the same period in 2008. The general and administrative
expenses in 2008 included $0.7 million in compensation and related costs mainly
associated with the severance of the former chief executive officer and chief
operating officer. 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 2009. The reduction in the general and administrative expenses, in
addition to the severance charges, reflects lower salaries and benefit costs of
$0.3 million principally associated with reduced staffing in Asia and the US due
to a reduction in sales volume, reduced facility, maintenance and insurance
costs of $0.2 million due to a reduction in our leased facilities, lower
professional and other outside services of $0.6 million primarily resulting from
the termination of a related party consulting contract, lower depreciation
charges of $0.2 million for idle equipment which we have classified as for sale
and are no longer depreciating, and lower stock-based compensation of $0.2
million.
INTEREST EXPENSE AND INTEREST INCOME
Interest expense for the three months ended June 30, 2009 increased by
approximately $3,000 to $662,000 as compared to the same period in 2008.
Interest expense for the six months ended June 30, 2009 increased by
approximately $73,000 to $1,299,000, as compared to the same period in 2008 due
to increased borrowings under our revolving credit and term loan facility and
the related amortization of deferred financing costs and debt discounts.
Interest income for the three months ended June 30, 2009 decreased by
approximately $15,000 to $1,000 due primarily to the reclassification of
interest on related party notes to the reserve against the note. Interest income
for the six months ended June 30, 2009 decreased by approximately $32,000 to
$1,000 due primarily to the application of valuation allowances against further
interest accruals on the related party notes.
A brief summary of interest expense and interest income is presented
below:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2009 2008 2009 2008
----------- ----------- ----------- -----------
Cash interest expense .................. $ 304,587 $ 351,026 $ 599,705 $ 671,906
Amortization of deferred financing costs
& debt discounts .................... 357,239 307,586 699,340 553,658
----------- ----------- ----------- -----------
Interest expense ....................... 661,826 658,612 1,299,045 1,225,564
Interest income ........................ (739) (15,482) (1,007) (32,920)
----------- ----------- ----------- -----------
Interest expense, net .................. $ 661,087 $ 643,130 $ 1,298,038 $ 1,192,644
=========== =========== =========== ===========
INCOME TAXES
Income tax provisions (benefit) for the three and six months ended June
30, 2009 reflected a tax provision of $96,103 and $102,510, respectively. In
addition, income tax provisions (benefit) for the three and six months ended
June 30, 2008 reflected a tax benefit of $190,412 and $211,416, respectively.
The net tax provision for the three months ended June 30, 2009 is associated
with domestic state income taxes, foreign withholding taxes from our domestic
royalty charges to our foreign operations offset by a tax benefit for
carry-forward losses in our foreign office. The net tax benefit in 2008 is
associated with foreign income taxes from taxable losses and earnings within our
Asian facilities.
26
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes selected financial data at (amounts in
thousands):
June 30, December 31,
2009 2008
------------ ------------
Cash and cash equivalents ...................... $ 2,215 $ 2,400
Total assets ................................... 17,363 15,603
Current liabilities ............................ 26,406 10,899
Long-term debt, net of current liabilities ..... 728 13,466
Stockholders' deficit .......................... (9,771) (8,762)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents decreased by $185,000 at June 30, 2009 as
compared to December 31, 2008, principally due to lower cash generated by
operating activities and higher cash provided by financing activities, net of
increases in capital expenditures.
Cash provided by operating activities is our primary recurring source
of funds, and for the six months ended June 30, 2009 reflected a net use of
$57,000. The cash used in operating activities during the six months resulted
principally from:
Net income before non-cash expenses ......................... $ 55,000
Inventory increase, net of reserves ......................... (266,000)
Receivable increases, net of reserves ....................... (1,556,000)
Increase in accounts payable and accrued expense ............ 1,820,000
Other reduction in operating capital ........................ (110,000)
-----------
Cash used in operating activities ........................... $ (57,000)
===========
Net cash used in operating activities reflects net income from
operations excluding non cash charges, seasonal inventory increases offset by
the increased liability for these purchases to our trade suppliers and seasonal
trade receivables increases.
Net cash used in investing activities for the six months ended June 30,
2009 was approximately $417,000 as compared to $121,000 for the six months ended
June 30, 2008. The expenditures in the first six months of 2009 were principally
associated with the development of our new ERP system that was implemented in
March 2009.
Net cash provided by financing activities for the six months ended June
30, 2009 was approximately $288,000 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, 2008 net cash of
$252,000 was used by financing activities and primarily reflects the repayment
of borrowings under capital leases and notes payable, net of borrowings under
our debt facility.
On June 27, 2007, we entered into a Revolving Credit and Term Loan
Agreement with Bluefin Capital, LLC that provides for a $5.0 million revolving
credit loan and a $9.5 million term loan for a three year period ending June 30,
2010. Bluefin Capital subsequently assigned its rights and obligations under the
credit facility agreements to an affiliate, CVC California, LLC ("CVC"). The
revolving credit portion of the facility, as amended, permits borrowings based
upon a formula including 85% of eligible receivables and 55% of eligible
inventory and provides for monthly interest payments at the prime rate (5.25% at
June 30, 2009) plus 2.0%. The term loan bears interest at 8.5% annually with
quarterly interest payments and repayment in full at maturity.
27
Borrowings under both credit facilities are secured by all of our
assets. There was $9,500 and $3,000 in available borrowings at June 30, 2009 and
December 31, 2008, 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 warrants to purchase 2,100,000 shares of common stock. The warrants were
exercisable over a five-year period and initially 700,000 warrants were
exercisable at $0.95 per share; 700,000 warrants were exercisable at $1.05 per
share; and 700,000 warrants were exercisable at $1.14 per share. The warrants
did not require cash settlements. The relative fair value of the equity
($2,374,169, which includes a reduction for financing costs) issued with this
debt facility was allocated to paid-in-capital and reflected as a debt discount
to the face value of the term note.
This discount is being amortized over the term of the note and
recognized as additional interest cost as amortized. Costs associated with the
debt facility included debt fees, commitment fees, registration fees and legal
and professional fees of $486,000. The costs allocable to the debt instruments
are reflected as a reduction to the face value of the note on the balance sheet.
On November 19, 2007, we entered into an amendment of our agreement
with the lender to modify the original financial covenants and to extend until
June 30, 2008 the application of the original EBITDA covenants in exchange for
additional common stock and a price adjustment to the lenders outstanding
warrants issued in connection with the loan agreement. In connection with this
amendment we issued an additional 250,000 shares of common stock to the lender
for $0.001 per share, and the exercise price for all of the previously issued
warrants for the purchase of 2,100,000 shares of common stock was amended to an
exercise price of $0.75 per share. The new relative fair value of the equity
issued with this debt of $2,430,000, including the modifications in this
amendment and a reduction for financing costs, is being amortized over the term
of the note.
On April 3, 2008, we executed a further amendment to our existing loan
agreement. The amendment included a redefining of the EBITDA covenants, and the
cancellation of the common stock warrants previously issued to Bluefin Capital
in exchange for our issuance of an additional note payable to the lender for
$1.0 million. The note bears interest at 8.5% and both the note and accrued
interest are payable at maturity on June 30, 2010. In addition, our borrowing
base was modified in this amendment by increasing the allowable portion of
inventory held by third party vendors to $1.0 million with no more than $500,000
held at any one vendor and increasing the percentage of accounts receivable to
be included in the borrowing base to 85%. We incurred a one-time modification
fee of $145,000 to secure the amendment of the agreement. The new relative fair
value of the equity issued with this debt of $2,542,000, including the
modifications in this amendment and a reduction for financing costs, is being
amortized over the term of the note.
Under the terms of the credit agreement, as amended, we are required to
meet certain coverage ratios, among other restrictions including a restriction
from declaring or paying a dividend prior to repayment of all the obligations.
The financial covenants, as amended, require that we maintain at the end of each
fiscal quarter "EBITDA" (as defined in the agreement) in excess of the principal
and interest payments for the same period of not less than $1.00 and in excess
of ratios set out in the agreement for each quarter.
We failed to satisfy the minimum EBITDA requirement for quarter ended
December 31, 2008 as well as the quarter ended March 31, 2009, and in connection
with such failures, on March 31, 2009 we entered into an amendment to our
existing revolving credit and term loan agreement with CVC. The amendment
provided for the following: issuance of an additional term note to CVC in the
principal amount of $225,210 in lieu of paying a cash waiver fee in connection
with our failures to satisfy the EBITDA requirements for the quarters ended
December 31, 2008 and March 31, 2009; deferral of the term note quarterly
interest payment of $215,000 due April 1, 2009; a temporary increase to the
borrowing base formulas and calculations under the revolving credit facility;
the re-lending by CVC of $125,000 under the term loan portion of credit
facility; a consent to allow us to sell equipment that has been designated as
held for sale more fully described in Note 9 to the consolidated financial
statements; and the granting to CVC of the right to designate a non-voting
observer to attend all meetings of our Board of Directors.
28
We financed building, land and equipment purchases through notes
payable and capital lease obligations expiring through June 2011. The building
and land mortgage were fully paid when the property was sold in October 2008.
The remaining equipment obligations bear interest at rates of 6.6% and 12.1% per
annum, and under these obligations, we are required to make monthly payments of
principal and interest.
The outstanding balance including accrued interest of our demand notes
payable to related parties at June 30, 2009 and December 31, 2008 was $226,000
and $222,000, respectively. The demand notes of $85,000 bear interest at 10%
have no scheduled monthly payments and are due within fifteen days following
demand.
We believe that our existing cash and cash equivalents and our
anticipated cash flows from our operating activities will be sufficient to fund
our minimum working capital and capital expenditure needs for 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 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 with our apparel
manufacturing in offshore locations, our customers (some of which are backed by
U.S. brands and retailers) are substantially all foreign based entities. Our
revolving credit facility provides limited financing secured by our accounts
receivable, and our current borrowing capability may not provide the level of
financing we need to continue in or to expand into additional foreign markets.
We are continuing to evaluate non-traditional financing of our foreign assets
and equity transactions to provide capital needed to fund our expansion and
on-going operations. If we experience greater than anticipated reductions in
sales, we may need to raise additional capital, or further reduce the scope of
our business in order to fully satisfy our future short-term operating
requirements. The extent of our future long-term capital requirements will
depend on many factors, including our results of operations, future demand for
our products, the size and timing of future acquisitions, our borrowing base
availability limitations related to eligible accounts receivable and inventories
and our expansion into foreign markets. Our need for additional long-term
financing includes the integration and expansion of our operations to exploit
our rights under our Talon trade name, the expansion of our operations in the
Asian, Central and South American markets. If our cash from operations is less
than anticipated or our working capital requirements and capital expenditures
are greater than we expect, we may need to raise additional debt or equity
financing in order to provide for our operations.
We do not believe that our cash flows from operating activities will be
sufficient to satisfy the CVC debt facility due at June 30, 2010. Accordingly we
anticipate that an extension or modification of the CVC debt will be required
prior to the due date or it will be necessary for us to raise additional debt or
equity financing in order to satisfy the CVC debt. If we cannot obtain an
extension or modification of the CVC debt, or raise additional equity or debt to
satisfy this requirement we will default on our credit agreement.
There can be no assurance that additional debt or equity financing
will be available on acceptable terms or at all. If we are unable to secure
additional financing, we may not be able to execute our operating plans, expand
into foreign markets to promote our Talon brand trade name, or meet our debt
obligations any of which could have a material adverse effect on our financial
condition and results of operations and affect our ability to operate as a going
concern. See Note 3 to the consolidated financial statements.
29
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The following summarizes our contractual obligations at June 30, 2009
and the effects such obligations are expected to have on liquidity and cash flow
in future periods:
Payments Due by Period
-------------------------------------------------------------------
Less than 1-3 4-5 After
Contractual Obligations Total 1 Year Years Years 5 Years
------------------------- ----------- ----------- ----------- ----------- -----------
Demand notes payable to
related parties (1) .. $ 225,800 $ 225,800 $ -- $ -- $ --
Capital lease obligations 112,100 98,100 12,300 1,700 --
Operating leases ........ 907,000 517,700 389,300 -- --
Revolver and term note .. 16,889,300 16,889,300 -- -- --
Other notes payable ..... 46,700 46,700 -- -- --
----------- ----------- ----------- ----------- -----------
Total Obligations .. $18,180,900 $17,777,600 $ 401,600 $ 1,700 $ --
=========== =========== =========== =========== ===========
----------
(1) The majority of notes payable to related parties is due on demand with
the remainder due and payable on the fifteenth day following the date
of delivery of written demand for payment and includes accrued interest
payable through June 30, 2009.
At June 30, 2009 and 2008, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.
RELATED PARTY TRANSACTIONS
See Note 15 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 and note receivable balances are evaluated on a
continual basis and allowances are provided for potentially
uncollectible accounts based on management's estimate of the
collectability of customer accounts. If the financial
condition of a customer were to deteriorate, resulting in an
impairment of its ability to make payments, an additional
allowance may be required. Allowance adjustments are charged
to operations in the period in which the facts that give rise
to the adjustments become known.
30
The net bad debt expenses, recoveries and allowances for the
three and six months ended June 30, 2009 and 2008 are as
follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2009 2008 2009 2008
-------- -------- -------- --------
Bad debt expenses for accounts
receivable ..................... $ 72,703 $(25,945) $ 77,373 $ (2,250)
Recoveries ....................... -- 21,924 -- (3,076)
Allowance for doubtful accounts. . 89,783 91,000 189,783 91,000
Allowance for doubtful accounts,
related party .................. 499,680 -- 499,680 --
o Inventories are stated at the lower of cost, determined using
the first-in, first-out ("FIFO") basis, or market value and
are all substantially finished goods. The costs of inventory
include the purchase price, inbound freight and duties,
conversion costs and certain allocated production overhead
costs. Inventory is evaluated on a continual basis and reserve
adjustments are made based on management's estimate of future
sales value, if any, of specific inventory items. Inventory
reserves are recorded for damaged, obsolete, excess, impaired
and slow-moving inventory. We use estimates to record these
reserves. Slow-moving inventory is reviewed by category and
may be partially or fully reserved for depending on the type
of product and the length of time the product has been
included in inventory.
Reserve adjustments are made for the difference between the
cost of the inventory and the estimated market value, if
lower, and charged to operations in the period in which the
facts that give rise to these adjustments become known. Market
value of inventory is estimated based on the impact of market
trends, an evaluation of economic conditions and the value of
current orders relating to the future sales of this type of
inventory. No inventory reserve provisions were recorded for
the three and six months ended June 30, 2009 and 2008.
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. See
Note 12 to the consolidated financial statements.
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o We record impairment charges when the carrying amounts of
long-lived assets are determined not to be recoverable.
Impairment is measured by assessing the usefulness of an asset
or by comparing the carrying value of an asset to its fair
value. Fair value is typically determined using quoted market
prices, if available, or an estimate of undiscounted future
cash flows expected to result from the use of the asset and
its eventual disposition.
The amount of impairment loss is calculated as the excess of
the carrying value over the fair value. Changes in market
conditions and management strategy have historically caused us
to reassess the carrying amount of our long-lived assets. See
Note 9 to the consolidated financial statements.
o Sales are recognized when persuasive evidence of an
arrangement exists, product title has passed, pricing is fixed
or determinable and collection is reasonably assured. Sales
resulting from customer buy-back agreements, or associated
inventory storage arrangements are recognized upon delivery of
the products to the customer, the customer's designated
manufacturer, or upon notice from the customer to destroy or
dispose of the goods. Sales, provisions for estimated sales
returns and the cost of products sold are recorded at the time
title transfers to customers. Actual product returns are
charged against estimated sales return allowances, which
returns have been insignificant.
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 April 2009, the FASB issued FSP FAS 157-4, "DETERMINING FAIR VALUE
WHEN VOLUME AND LEVEL OF ACTIVITY FOR THE ASSET OR LIABILITY HAVE SIGNIFICANTLY
DECREASED AND IDENTIFYING TRANSACTIONS THAT ARE NOT ORDERLY" (FSP 157-4). FSP
157-4 provides guidance on how to determine the fair value of assets and
liabilities when the volume and level of activity for the asset/liability has
significantly decreased. FSP 157-4 also provides guidance on identifying
circumstances that indicate a transaction is not orderly. In addition, FSP 157-4
requires disclosure in interim and annual periods of the inputs and valuation
techniques used to measure fair value and a discussion of changes in valuation
techniques. FSP 157-4 was effective beginning in the second quarter of fiscal
year 2009. The adoption of FSP 157-4 did not have a material impact on the
consolidated financial statements.
In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2,
"RECOGNITION AND PRESENTATION OF OTHER-THAN-TEMPORARY Impairment" (FSP
115-2/124-2). FSP 115-2/124-2 amends the requirements for the recognition and
measurement of other-than-temporary impairments for debt securities by modifying
the pre-existing "intent and ability" indicator. Under FSP 115-2/124-2, an
other-than-temporary impairment is triggered when there is an intent to sell the
security, it is more likely than not that the security will be required to be
sold before recovery, or the security is not expected to recover the entire
amortized cost basis of the security. Additionally, FSP 115-2/124-2 changes the
presentation of an other-than-temporary impairment in the income statement for
those impairments involving credit losses. The credit loss component will be
recognized in earnings and the remainder of the impairment will be recorded in
other comprehensive income. FSP 115-2/124-2 was effective beginning in the
second quarter of fiscal year 2009. The implementation of FSP 115-2/124-2 did
not have a material impact on the consolidated financial statements.
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In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "INTERIM
DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS" (FSP 107-1/APB 28-1). FSP
107-1/APB 28-1 requires interim disclosures regarding the fair values of
financial instruments that are within the scope of FAS 107, "DISCLOSURES ABOUT
THE FAIR VALUE OF FINANCIAL INSTRUMENTS." Additionally, FSP 107-1/APB 28-1
requires disclosure of the methods and significant assumptions used to estimate
the fair value of financial instruments on an interim basis as well as changes
of the methods and significant assumptions from prior periods. FSP 107-1/APB
28-1 does not change the accounting treatment for these financial instruments
and did not have a material impact on the consolidated financial statements.
In April 2009, the FASB issued FSP SFAS No. 141R-1, ACCOUNTING FOR
ASSETS ACQUIRED AND LIABILITIES ASSUMED IN A BUSINESS COMBINATION THAT ARISE
FROM CONTINGENCIES. FSP SFAS 141R-1 amends the guidance in SFAS 141R relating to
the initial recognition and measurement, subsequent measurement and accounting
and disclosures of assets and liabilities arising from contingencies in a
business combination. FSP SFAS 141R is effective for fiscal years beginning
after December 15, 2008. We adopted FSP SFAS 141R as of the beginning of fiscal
2009 and it did not have a material impact on the consolidated financial
statements. We will apply the requirements of FSP FAS 141R-1 prospectively to
any future acquisitions.
In May 2009, the FASB issued SFAS No. 165, SUBSEQUENT EVENTS ("SFAS No.
165"). SFAS No. 165 provides general standards of accounting for and disclosure
of events that occur after the balance sheet date but before financial
statements are issued or are available to be issued. SFAS No. 165 was adopted by
us in the second quarter of 2009 and did not have a material impact on the
consolidated financial statements.
In June 2009, the FASB issued SFAS No. 166, ACCOUNTING FOR TRANSFERS OF
FINANCIAL ASSETS--an amendment of FASB Statement No. 140 (SFAS No. 166"). SFAS
No. 166 seeks to improve the relevance, representational faithfulness, and
comparability of the information that a reporting entity provides in its
financial statements about a transfer of financial assets; the effects of a
transfer on its financial position, financial performance, and cash flows; and a
transferor's continuing involvement, if any, in transferred financial assets.
SFAS No. 166 is applicable for annual periods beginning after November 15, 2009.
The implementation of SFAS No. 165 and 166 is not expected to have a
material impact on the consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable
ITEM 4T. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under the
Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities Exchange Commission's rules and forms, including to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is accumulated and communicated to our management,
including our principal executive and principal financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange
Act.
As of the end of the period covered by this report, management, with
the participation of Lonnie D. Schnell, our principal executive officer and
principal financial officer and Jim Reeder our principal accounting 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 and Mr. Reeder 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.
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CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarter ended June 30, 2009, there were no changes in our
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On October 12, 2005, a shareholder class action complaint was filed in
the United States District Court for the Central District of California
("District Court") against us, Colin Dyne, Mark Dyne, Ronda Ferguson and August
F. Deluca (collectively, the "Individual Defendants" and, together with us, the
"Defendants"). The action is styled HUBERMAN V.TAG-IT PACIFIC, INC., ET AL.,
Case No. CV05-7352 R(Ex). On January 23, 2006, the District Court heard
competing motions for appointment of lead plaintiff. The District Court
appointed Seth Huberman as the lead plaintiff ("Plaintiff"). On March 13, 2006,
Plaintiff filed an amended complaint. Plaintiff's 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. The amended complaint purports to
state claims under Section 10(b)/Rule 10b-5 and Section 20(a) of the Securities
Exchange Act of 1934. On August 21, 2006, Defendants filed their answer to the
amended complaint, denying the material allegations of wrongdoing. On February
20, 2007, the District Court denied class certification. On April 2, 2007, the
District 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 with the United States
Court of Appeals for the Ninth Circuit ("Ninth Circuit"), and his opening
appellate brief was filed on October 15, 2007. Defendants' brief was filed on
November 28, 2007. The Ninth Circuit held oral arguments on October 23, 2008. On
January 16, 2009, the Ninth Circuit issued an unpublished memorandum,
instructing the District Court to certify a class, reversing the District
Court's grant of summary judgment, and remanding for further proceedings
consistent with its decision. The District Court thereafter certified a class
and adopted a schedule for the case. On July 31, 2009, the parties entered into
a stipulation of settlement intended to settle the matter and result in its
dismissal with prejudice. The total settlement proceeds of $5.75 million are to
be paid in full by our insurers without any contribution from us or individual
defendants. The Court has set a hearing for preliminary approval of the
settlement on August 17, 2009. If preliminary approval is given, notice will be
provided to class members and the Court will set a final fairness hearing on the
settlement. If the settlement is finally approved, the case will be dismissed
with prejudice per the terms of the settlement. If the settlement is not
approved, we will continue to vigorously defend this lawsuit; however, in this
case, the outcome of this lawsuit 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. We also filed a second civil action against Pro-Fit and
related companies in the California Superior Court which was removed to the
United States District Court, Central District of California. In the second
quarter of 2008, Pro-Fit and certain related companies were placed into
administration in the United Kingdom and filed petitions under Chapter 15 of
Title 11 of the United States Code. As a consequence of the chapter 15 filings,
all litigation by us against Pro-Fit has been stayed.
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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 our business. We believe that we
have meritorious defenses to these claims and that the claims are either covered
by insurance or, after taking into account the insurance in place, would not
have a material effect on our consolidated financial condition if adversely
determined against us.
ITEM 1A. RISK FACTORS
Risk factors are contained in Item 1A of our Annual Report on Form 10-K
for the fiscal year ended December 31, 2008. No material change to such risk
factors has occurred during the six months ended June 30, 2009.
ITEM 6. EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
31.1 Certificate of Chief Executive Officer and Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certificate of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
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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 14, 2009 /S/ LONNIE D. SCHNELL
---------------------------
Lonnie D. Schnell
Chief Executive Officer
and Chief Financial Officer
/S/ JAMES E. REEDER
---------------------------
James E. Reeder
Chief Accounting Officer
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