As filed with the Securities and Exchange Commission on March 10, 2004
Registration No. 333-_____
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United States
Securities and Exchange Commission
Washington, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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INNOVO GROUP INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 2390 11-2928178
(State or Other Jurisdiction of (Primary standard industrial (I.R.S. Employer
Incorporation or Organization) classification code number) Identification Number)
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5804 East Slauson Avenue
Commerce, California 90040
(323) 725-5516
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
Samuel J. Furrow, Jr.
Chief Executive Officer
Innovo Group Inc.
5804 East Slauson Avenue
Commerce, California 90040
(323) 725-5516
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
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With a copy to:
Paul A. Belvin, Esq.
Akin Gump Strauss Hauer & Feld LLP
1333 New Hampshire Avenue, N.W.
Washington, D.C. 20036
Telephone: (202) 887-4000
Approximate date of commencement of proposed sale to the public: As soon
as practicable on or after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box. |X|
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. |_| ______________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_| ________________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_| ________________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. |_|
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CALCULATION OF REGISTRATION FEE
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Amount to Proposed Maximum Proposed Maximum Aggregate Amount of
Title of Each Class of be Offering Price Per Offering Price(1) Registration Fee
Securities to be Registered Registered Unit(1)
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Common Stock, $0.10 par value 298,590 $2.66 $792,756.45 $100.44
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(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) of the Securities Act of 1933, as amended.
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant shall
file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, as amended, or until the registration statement
shall become effective on such date as the Securities and Exchange Commission,
acting pursuant to said Section 8(a), may determine.
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SUBJECT TO COMPLETION, DATED MARCH 10, 2004
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THE
SELLING STOCKHOLDERS MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN
OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT
PERMITTED.
PROSPECTUS
INNOVO GROUP INC.
COMMON STOCK
298,590 SHARES OF COMMON STOCK OFFERED BY SELLING STOCKHOLDERS
The shares of common stock offered by this prospectus are being sold by
the stockholders listed beginning on page 83 of this prospectus. We will not
receive any of the proceeds from the sale of Common Stock by the Selling
Stockholders.
Our Common Stock is traded on the Nasdaq SmallCap Market under the symbol
"INNO."
The selling stockholders may sell the shares of common stock described in
this prospectus in a number of different ways and at varying prices. See "Plan
of Distribution" beginning on page 87 for more information about how a selling
stockholder may sell its shares of common stock. We will not be paying any
underwriting discounts or commissions in this offering.
On March 8, 2004, the last reported sale price of the Common Stock on the
Nasdaq SmallCap Market was $2.73 per share. See "Price Range of Common Stock."
You should obtain a current market price quotation before you buy any of the
offered shares.
You should read this prospectus carefully before you invest in our Common
Stock offered hereby.
The securities offered by this prospectus involve a high degree of risk.
You should carefully consider the factors described under the heading "Risk
Factors" beginning on page 6 of this prospectus.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is March 10, 2004.
TABLE OF CONTENTS
Page
Prospectus summary........................................................1
Risk factors..............................................................6
Forward-looking statements................................................16
Use of proceeds...........................................................17
Dividend policy...........................................................17
Selected consolidated financial data......................................18
Management's discussion and analysis of financial condition and
results of operations...................................................20
Business..................................................................52
Management................................................................73
Principal and selling stockholders........................................83
Plan of Distribution......................................................87
Related party transactions................................................89
Description of capital stock..............................................91
Legal matters.............................................................92
Experts...................................................................92
Where you can find more information.......................................92
Index to consolidated financial statements ...............................F-1
In connection with this offering, no person is authorized to give any
information or to make any representations not contained or incorporated by
reference in this prospectus. If information is given or representations are
made, you may not rely on that information or representations as having been
authorized by us. This prospectus is neither an offer to sell nor a solicitation
of an offer to buy any securities other than those registered by this
prospectus, nor is it an offer to sell or a solicitation of an offer to buy
securities where an offer or solicitation would be unlawful. You may not imply
from the delivery of this prospectus, nor from any sale made under this
prospectus, that our affairs are unchanged since the date of this prospectus or
that the information contained in this prospectus is correct as of any time
after the date of this prospectus. The information in this prospectus speaks
only as of the date of this prospectus unless the information specifically
indicates that another date applies.
We are not making any representation to any purchaser of the common stock
regarding the legality of an investment in the common stock by such purchaser
under any legal investment or similar laws or regulations. You should not
consider any information in this prospectus to be legal, business or tax advice.
You should consult your own attorney, business advisor and tax advisor for
legal, business and tax advice regarding an investment in the common stock.
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In this prospectus, when we to refer to Innovo Group Inc. and its
subsidiaries, we use the terms "Innovo Group," "we," "our" and "us" when we do
not need to distinguish among these entities or their predecessors or when any
distinction is clear from the context.
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PROSPECTUS SUMMARY
You should read this summary together with the entire prospectus,
including the more detailed information in our consolidated financial statements
and related notes appearing elsewhere in this prospectus.
Our Business
Our principal business activity involves the design, development and
worldwide marketing of high quality consumer products for the apparel and
accessory markets. We do not manufacture any apparel or accessory products but
outsource the manufacturing to third parties. We sell our products to a large
number of different retail, distributors and private label customers around the
world. Retail customers and distributors purchase finished goods directly from
us. Retail customers then sell the product through their retail stores and
distributors sell our products to retailers in the international marketplace.
Private label customers outsource the production and sourcing of their private
label products to us and then sell through their own distribution channels.
Private label customers are generally retail chains who desire to sell apparel
and accessory products under their own brand name. We work with our private
label customers to create their own brand image by custom designing products. In
creating a unique brand, our private label customers may provide samples to us
or may select styles already available in our showrooms. We believe we have
established a reputation among these private label buyers for the ability to
arrange for the manufacture of apparel and accessory products on a reliable,
expeditious and cost-effective basis. Our branded label products, which include
accessories and apparel, are designed, developed and marketed by us internally
pursuant to the license agreement under which we have licensed the brand and/or
mark. We then outsource the manufacturing and distribution of the branded
products. We sell our branded products to the retail customers or distributors.
We are then obligated to pay a certain percentage of royalties on our net sales
of the branded products to the licensor. We believe that we have established a
reputation for our ability to produce a quality branded product in the
marketplace.
We operate our consumer products business through three wholly-owned
operating subsidiaries, Innovo, Inc., or Innovo, Joe's Jeans, Inc., or Joe's,
and Innovo Azteca Apparel, Inc., or IAA. Our products are currently manufactured
by independent contractors located in Los Angeles, California, Mexico and Asia,
including, Hong Kong, China, Korea, Vietnam and India. The products are then
distributed out of our warehouse facilities located in Los Angeles or directly
from the factory to the customer. For the fiscal year ended November 29, 2003,
or fiscal 2003, approximately 22% of our apparel and accessory products were
manufactured outside of North America. The rest of our accessory and apparel
products for fiscal 2003 were manufactured in the United States (approximately
21%) and Mexico (approximately 57%). All of our products manufactured in Mexico
are manufactured by Azteca Productions International, Inc., or Azteca, and/or
its affiliates, as discussed below. Azteca is controlled by two of our
significant stockholders, Hubert Guez and Paul Guez.
Our operations are comprised of two reportable segments: apparel and
accessory, with the operations of our Joe's and IAA subsidiaries representing
the apparel segment and our Innovo subsidiary conducting business in the
accessory segment. Segment revenues are generated from the sale of consumer
products by Joe's, IAA and Innovo. Our corporate activities are represented by
the operations of Innovo Group Inc., our parent company, or IGI, and our real
estate operations are conducted through our wholly-owned subsidiaries, Leasall
Management, Inc., or Leasall, and Innovo Realty, Inc., or IRI. Our real estate
operations do not currently require a substantial allocation of our resources
and are not a significant part of our management's daily operational functions.
Thus, our real estate operations are not currently defined as a distinct
operating segment, but are classified as "other" along with our other corporate
activities.
Strategic relationship with two of our significant stockholders, Hubert
Guez and Paul Guez, and affiliated companies
Beginning in the summer of 2000, we entered into a series of transactions
with two of our significant stockholders, Hubert Guez and Paul Guez, and their
affiliated companies, such as Azteca and/or Commerce Investment Group LLC, or
Commerce. The Guez brothers and their affiliated companies have in the aggregate
more than 50 years of experience in the apparel industry with a specialty in
denim apparel and related products. As discussed in greater detail below, our
strategic relationship with the Guez brothers and their affiliated companies has
had many tangible benefits for us.
Our relationship with the Guez brothers began in the summer of 2000 when
the Guez brothers through their affiliated company, Commerce, which the Guez
brothers control, invested in our company. Pursuant to a stock and warrant
purchase agreement, Commerce acquired 2,863,637 shares of our common stock and
3,300,000 common stock purchase warrants. An investor rights agreement also
provides Commerce with a contractual right to nominate three individuals to our
board of directors. Commerce has not exercised this right at this time. Based on
a Schedule 13D/A filed with the Securities
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and Exchange Commission on March 9, 2004 by Commerce, the Guez brothers and
their affiliates, they beneficially own in the aggregate approximately 26.47% of
our common stock.
As part of Commerce's equity investment in our company, we entered into
several other arrangements with Commerce in order to reduce our manufacturing
and distribution costs and to increase the effectiveness and capacity of our
distribution network. Pursuant to a supply agreement and a distribution
agreement with Commerce, we agreed to purchase all of our accessory products,
which at the time primarily consisted of denim tote bags and aprons, from
Commerce and to have Commerce distribute these products out of its Los Angeles
distribution facility. Commerce manufactures our accessory products out of its
facilities located in Mexico. These agreements were renewed in August 2002 for
an additional two-year term and are automatically renewed for additional
two-year terms unless terminated by either party with 90 days notice. See "Note
1 - Business Description - Restructuring of Operations" in the Notes to
Consolidated Financial Statements for a further discussion of the equity
investment by and the terms of the supply and distribution agreements with
Commerce.
Our strategic relationship with Commerce allowed us to close our domestic
manufacturing and distribution facilities and to move forward with diversifying
our product mix and offerings to include apparel products in addition to
accessory products. In an effort to enter the apparel market quickly and
efficiently we, through IAA, acquired Azteca's knit apparel division in August
2001 in exchange for 700,000 shares of our common stock and promissory notes in
the amount of $3.6 million. See "Note 3 - Acquisitions - Azteca Production
International, Inc. Knit Division" in the Notes to Consolidated Financial
Statements for a further discussion of this acquisition.
In February 2001, we continued to expand our apparel business by acquiring
a ten-year license for the "Joe's" and "Joe's Jean's" brands from JD Design, LLC
and forming our Joe's subsidiary. See "Business - License Agreements and
Intellectual Property" for a further discussion of this license agreement. This
license agreement enables Joe's to create, design and market high-end denim
apparel products. Our strategic relationship with the Guez brothers allowed us
to quickly and efficiently capitalize on this license and enter into the denim
apparel market by outsourcing the manufacture and distribution of the denim
apparel products created pursuant to the license to Commerce and its affiliates.
During fiscal 2001 and 2002, the combined accessory and denim apparel
products purchased from and other services provided by Commerce and/or its
affiliates were approximately $5.7 million and $16.0 million, respectively, or
90% and 80%, respectively, of our manufacturing and distribution costs for such
periods. During fiscal 2003, our dependence on Commerce and its affiliates
decreased for these services but still constituted 68% of our manufacturing and
distribution costs for fiscal 2003, or approximately $47.9 million of accessory,
craft and denim apparel products from and other services provided by Commerce
and/or its affiliates. Although we now use additional suppliers to meet our
needs, we intend to continue to take advantage of Commerce's expertise with
denim products so long as we believe it is in our best interest.
On July 17, 2003, we, through IAA, entered into an asset purchase
agreement, or Blue Concept APA, with Azteca and the Guez brothers. Pursuant to
the Blue Concept APA, we acquired Azteca's Blue Concept division, or the Blue
Concept Division, for a $21.8 million seven-year convertible promissory note,
subject to adjustment, or the Blue Concept Note. See "Management's Discussion
and Analysis of Financial Conditions and Results of Operations - Recent
Acquisitions and Licenses and - Long Term Debt" and "Note 9 - Long Term Debt -
Promissory Note to Azteca in connection with Blue Concept Division Acquisition"
in the Notes to Consolidated Financial Statements" for a further discussion of
certain terms of this acquisition and the Blue Concept Note. In accordance with
the APA and Nasdaq rules, on March 5, 2004, we conducted a special meeting of
our stockholders to approve the conversion of approximately $12.5 million of the
Blue Concept Note into a maximum of 4,166,667 shares of our common stock. The
conversion was approved by our stockholders and as a result, Azteca and the Guez
brothers were initially issued 3,125,000 shares of our common stock with the
possible issuance of up to 1,041,667 additional shares of common stock upon the
occurrence of certain contingencies described in the Blue Concept APA. In
addition, as part of the transaction, we entered into another supply agreement
with an Azteca affiliate to purchase products to be sold by our Blue Concept
Division. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations - Recent Acquisitions and Licenses" for a further
discussion of certain terms of this supply agreement.
We have continued to expand our denim product mix by entering into an
assignment with Blue Concept LLC, which is controlled by Paul Guez, for all the
rights, benefits and obligations of a license agreement between Blue Concept LLC
and B.J. Vines, Inc., the owner of the Betsey Johnson(R) brand, for exclusive
right to design, market and distribute women's jeans and coordinating denim
related apparel, such as t-shirts and tops under the Betsey Johnson(R) brand
name in the United States, its territories and possessions, and Canada. We did
not compensate Paul Guez for this assignment.
2
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On February 16, 2004, Joe's entered into a Master Distribution Agreement,
or MDA, with Beyond Blue, Inc., or Beyond Blue, whereby Joe's granted Beyond
Blue exclusive distribution rights for Joe's products outside the United States.
Beyond Blue, a Los Angeles-based company that specializes in international
consulting, distribution and licensing for apparel products, secured an
exclusive right to distribute Joe's products outside the United States, subject
to current license agreements such as the license with Itochu and Joe's Canadian
distributor remaining in place.
During fiscal 2003, we moved our headquarters and principal executive
offices from 5900 S. Eastern Avenue, Suite 120, Commerce, California 90040 to
5804 East Slauson Avenue, Commerce, California 90040. The 5804 East Slauson
Avenue space is utilized under a verbal agreement with Azteca, pursuant to which
we pay to Azteca a fee for allocated expenses associated with our use of office
and warehouse space and expenses incurred in connection with maintaining such
office and warehouse space. These allocated expenses include, but are not
limited to: rent, security, office supplies, machine leases and utilities. In
addition, we have verbal agreements with Azteca and/or its affiliates regarding
the supply and distribution of other apparel products we sell.
Other Third Party Manufacturers
As discussed above, historically, we have primarily used Commerce and its
affiliates for our manufacturing needs. In fiscal 2003, we significantly
diversified our apparel products to include a wider array of products,
including, but not limited to, denim products. These non-denim products, as well
as some denim products, are purchased from third party independent suppliers,
including Commerce and/or its affiliates. While we now use numerous suppliers to
meet our needs, we intend to continue to take advantage of Commerce's and its
affiliates' expertise with denim products when it is in our best interest to do
so.
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We are incorporated under the laws of the State of Delaware. Our corporate
headquarters are located at 5804 East Slauson Avenue, Commerce, California,
90040. Our telephone number is (323) 725-5516. We also have operational offices
and/or showrooms in Los Angeles, New York, Knoxville and Hong Kong and third
party showrooms in New York, Los Angeles, Tokyo and Paris. Although we maintain
a website at www.innovogroup.com, we do not intend that the information
available through our website be incorporated into this prospectus. For
additional information about us and our businesses, see "Where You Can Find More
Information."
3
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The Offering
Issuer........................................................... Innovo Group Inc.
Common stock offered by the selling stockholders................. 298,590
Common stock outstanding before and after the offering........... 28,917,850 (excludes 5,000 treasury shares issued
but not outstanding)
Use of Proceeds.................................................. We will not receive any proceeds from this
offering, except the proceeds from the exercise of
warrants offered hereby.
Registration Rights.............................................. We have agreed to use all reasonable efforts to
keep the shelf registration statement, of which
this prospectus forms a part, effective until the
earlier of:
o the first anniversary of the declaration
by the Securities and Exchange Commission that
the shelf registration statement is effective;
o the sale of all of the shares of common
stock covered by the shelf registration
statement; and
o the expiration of the holding period applicable
to the shares of common stock held by
non-affiliates of Innovo under Rule 144(k) of
the Securities Act, or any successor provision,
subject to certain exceptions.
Trading.......................................................... Our common stock is traded on the Nasdaq
SmallCap Market under the symbol "INNO."
Risk Factors..................................................... See "Risk Factors" and the other information in
this prospectus for a discussion of the factors
you should carefully consider before deciding to
invest in our common stock.
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The outstanding share information is based on our shares outstanding as of
March 5, 2004. This information excludes 2,353,332 shares of common stock
issuable upon the exercise of outstanding stock options at a weighted average
exercise price of $2.31 and an aggregate of 1,796,668 shares of common stock
available for future issuance under our employee and director stock option plan
as of March 5, 2004.
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Summary Consolidated Financial Information
The following table provides summary consolidated financial data for us
for the periods ended and as of the dates indicated. You should read the summary
consolidated financial data set forth below in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
with our consolidated financial statements and related notes appearing elsewhere
in this prospectus.
Years Ended
(in thousands, except per share data)
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11/29/03 11/30/02 12/01/01 11/30/00 11/30/99
-------- -------- -------- -------- --------
Net Sales $ 83,129 $ 29,609 $ 9,292 $ 5,767 $ 10,837
Cost of Goods Sold 70,153 20,072 6,335 5,195 6,252
-------- -------- -------------------- --------
Gross Profit 12,976 9,537 2,957 572 4,585
Selling, General & Administrative (2) 19,264 8,092 3,189 4,863 5,401
Depreciation & Amortization 1,227 256 167 250 287
-------- -------- -------------------- --------
Income (Loss) from Operations (7,515) 1,189 (399) (4,541) (1,103)
Interest Expense (1,216) (538) (211) (446) (517)
Other Income 526 235 84 30 280
Other Expense (68) (174) (3) (99) --
-------- -------- -------------------- --------
Income (Loss) before Income Taxes (8,273) 712 (529) (5,056) (1,340)
Income Taxes 44 140 89 -- --
-------- -------- -------------------- --------
Income (Loss) from Continuing Operations (8,317) 572 (618) (5,056) (1,340)
Discontinued Operations -- -- -- -- (1)
Extrordinary Items (1) -- -- -- (1,095) --
Net Income (Loss) $ (8,317) $ 572 $ (618) $ (6,151) $ (1,341)
Income (Loss) per Share from Continuing Operations
Basic $ (0.49) $ 0.04 $ (0.04) $ (0.62) $ (0.22)
Diluted $ (0.49) $ 0.04 $ (0.04) $ (0.62) $ (0.22)
Weighted Average Shares Outstanding
Basic 17,009 14,856 14,315 8,163 5,984
Diluted 17,009 16,109 14,315 8,163 5,984
Balance Sheet Data:
Total Assets $ 46,365 $ 15,143 $ 10,247 $ 7,416 $ 6,222
Long-Term Debt 22,344 3,387 4,225 1,340 2,054
Stockholders' Equity 16,482 5,068 4,519 3,758 1,730
(1) Represents the loss from the early extinguishments of debt in fiscal 2000.
(2) Amount includes a $145,000 impairment write down of long-term assets in
1999 as well as $293,000 related to the termination of a capital lease and
$100,000 for the settlement of a lawsuit in 1999, and a $600,000
impairment write down of long-term assets in fiscal 2000.
5
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RISK FACTORS
Before you invest in our common stock by purchasing shares from a selling
stockholder named in this prospectus, you should be aware that there are various
risks involved in investing in our common stock. We have described below all of
the risks which we deem material to your investment decision. You should
consider carefully these risk factors, together with all of the other
information included in this prospectus and in the periodic reports we have
filed with the Securities and Exchange Commission under the Securities Exchange
Act of 1934, before you decide to purchase any shares of our common stock.
Additional risks that we do not yet know of or that we currently think are
immaterial may also impair our business operations.
Certain Risk Factors
Risk Factors Relating to our Common Stock
The 298,590 shares of our common stock registered for resale by this prospectus
may adversely affect the market price of our common stock.
As of March 5, 2004, 28,917,850 shares of our common stock were issued and
outstanding, excluding 5,000 shares issued but held as treasury shares and not
considered to be outstanding. This prospectus registers for resale 298,590
shares, or 1.03% of our outstanding common stock (this amount includes 240,835
shares of common stock which may be issued upon exercise of warrants held by the
selling stockholders).
We are unable to predict the effect that sales into the market of 298,590
shares may have on the then prevailing market price of our common stock. On
March 8, 2004, the last reported sale price of our common stock on the Nasdaq
SmallCap Market was $2.73. During the four weeks prior to March 8, 2004, the
average daily volume of trading of our common stock was 184,305 shares. It is
likely that market sales of the 298,590 shares offered for resale pursuant to
this prospectus (or the potential for those sales even if they do not actually
occur) may have the effect of depressing the market price of our common stock.
As a result, the potential resale and possible fluctuations in trading volume of
such a substantial amount of our stock may affect the share price negatively
beyond our control.
We do not anticipate paying dividends on our common stock in the foreseeable
future.
We have not paid any dividends nor do we anticipate paying any dividends
on our common stock in the foreseeable future. We intend to retain earnings, if
any, to fund our operations and to develop and expand our business.
We have a substantial number of authorized common and preferred shares available
for future issuance that could cause dilution of our stockholder's interest and
adversely impact the rights of holders of our common stock.
We have a total of 40,000,000 shares of common stock and 5,000,000 shares
of "blank check" preferred stock authorized for issuance. As of March 5, 2004,
we had 11,006,150 shares of common stock and 4,806,000 shares of preferred stock
available for issuance. In fiscal 2003, we raised net proceeds of $17,540,000
through the sale in private placement transaction of 6,235,648 shares of our
common stock and 916,833 shares of common stock purchase warrants. On March 5,
2004, we held a special meeting of our stockholders to approve the conversion of
$12.5 million in principal amount of indebtedness from a convertible promissory
note issued in connection with the purchase of the Blue Concepts Division from
Azteca into a maximum of 4,166,667 shares of our common stock. The conversion
was approved by our stockholders and, as a result, Azteca and the Guez brothers
were initially issued 3,125,000 shares of our common stock with the possible
issuance of up to 1,041,667 additional shares of common stock upon the
occurrence of certain contingencies described in the Blue Concept APA. We expect
to continue to seek financing which could result in the issuance of additional
shares of our capital stock and/or rights to acquire additional shares of our
capital stock. Those additional issuances of capital stock would result in a
reduction of your percentage interest in us. Furthermore, the book value per
share of our common stock may be reduced. This reduction would occur if the
exercise price of the options or warrants or the conversion ratio of the
preferred stock was lower than the book value per share of our common stock at
the time of such exercise or conversion.
6
The addition of a substantial number of shares of our common stock into
the market or by the registration of any of our other securities under the
Securities Act may significantly and negatively affect the prevailing market
price for our common stock. The future sales of shares of our common stock
issuable upon the exercise of outstanding warrants and options may have a
depressive effect on the market price of our common stock, as such warrants and
options would be more likely to be exercised at a time when the price of our
common stock is greater than the exercise price.
Our board of directors has the power to establish the dividend rates,
preferential payments on any liquidation, voting rights, redemption and
conversion terms and privileges for any series of our preferred stock. The sale
or issuance of any shares of our preferred stock having rights superior to those
of our common stock may result in a decrease in the value or market price of our
common stock. The issuance of preferred stock could have the effect of delaying,
deferring or preventing a change of ownership without further vote or action by
our stockholders and may adversely affect the voting and other rights of the
holders of our common stock.
We are controlled by our management and other related parties.
As of March 5, 2004, our executive officers and directors beneficially
owned approximately 22.14% of our common stock on a fully-diluted basis.
Furthermore, in connection with investments made by (1) Commerce and other
investors affiliated with Hubert Guez and Paul Guez, or collectively, the
Commerce Group, and (2) Mr. Joseph Mizrachi in fiscal 2000, each of the Commerce
Group and Mr. Mizrachi have the right to designate three individuals and one
individual, respectively, for election to our board of directors. If any or all
of the Commerce Group or Mizrachi designated directors are elected, then our
board has the obligation to appoint at least one Commerce and/or Mizrachi
designated director to each of its committees. Based on the Schedule 13D/A filed
by Messrs. Simon Mizrachi and Joseph Mizrachi on October 30, 2003, the Mizrachis
beneficially owned approximately 1.2% of our shares. As of February 21, 2003,
the Mizrachis ceased to be the beneficial owners of more than 5% of our
securities. As discussed above in "Business - Strategic relationship with two of
our significant stockholders, Hubert Guez and Paul Guez, and affiliated
companies," at the special meeting of our stockholders held on March 5, 2004,
our stockholders approved the conversion of the Blue Concept Note into a maximum
of 4,166,667 shares of our common stock, As a result, Azteca and the Guez
brothers were initially issued 3,125,000 shares of our common stock with the
possible issuance of up to 1,041,667 additional shares of common stock upon the
occurrence of certain contingencies described in the Blue Concept APA. Based
upon the initial conversion of the Blue Concept Note into 3,125,000 shares of
our common stock and on a Schedule 13D/A filed by Messrs. Hubert Guez and Paul
Guez on March 9, 2004, the Guez brothers beneficially own approximately 26.47%
of our common stock in the aggregate.
Because of their stock ownership and/or relationships with us, the
Mizrachis and the Guez brothers have been and will continue to be in a position
to greatly influence the election of our board of directors and thus control our
affairs. Additionally, our bylaws limit the ability of stockholders to call a
meeting of the stockholders. These bylaw provisions could have the effect of
discouraging a takeover of us, and therefore may adversely affect the market
price and liquidity of our securities. We are also subject to a Delaware statute
regulating business combinations that may hinder or delay a change in control.
The anti-takeover provisions of the Delaware statute may adversely affect the
market price and liquidity of our securities.
Our common stock price is extremely volatile and may decrease rapidly.
The trading price and volume of our common stock has historically been subject
to wide fluctuation in response to variations in actual or anticipated operating
results, announcements of new product lines or by us or our competitors, and
general conditions in the apparel and accessory industry. In the 52 week period
prior to March 5, 2004, the closing price of our common stock has ranged from
$2.07 to $7.80. In addition, stock markets generally have experienced extreme
price and volume trading volatility in recent years. This volatility has had a
substantial effect on the market prices of securities of many companies for
reasons frequently unrelated to the operating performance of the specific
companies. These broad market fluctuations may significantly and negatively
affect the market price of our common stock.
7
If we cannot meet the Nasdaq SmallCap Market maintenance requirements and Nasdaq
rules, Nasdaq may delist our common stock, which could negatively affect the
price of the common stock and your ability to sell the common stock.
In the future, we may not be able to meet the listing maintenance
requirements of the Nasdaq SmallCap Market and Nasdaq rules, which require,
among other things, minimum net tangible assets of $2 million, a minimum bid
price for our common stock of $1.00, and stockholder approval prior to the
issuance of securities in connection with a transaction involving the sale or
issuance of common stock equal to 20 percent or more of a company's outstanding
common stock before the issuance for less than the greater of book or market
value of the stock. If we are unable to satisfy the Nasdaq criteria for
maintaining listing, our common stock would be subject to delisting. Trading, if
any, of our common stock would thereafter be conducted in the over-the-counter
market, in the so-called "pink sheets" or on the National Association of
Securities Dealers, Inc., or NASD, "electronic bulletin board." As a consequence
of any such delisting, a stockholder would likely find it more difficult to
dispose of, or to obtain accurate quotations as to the prices of our common
stock.
If Nasdaq delists our common stock, you would need to comply with the penny
stock regulations which could make it more difficult to sell your common stock.
In the event that our securities are not listed on the Nasdaq SmallCap
Market, trading of our common stock would be conducted in the "pink sheets" or
through the NASD's Electronic Bulletin Board and covered by Rule 15g-9 under the
Securities Exchange Act of 1934. Under that rule, broker/dealers who recommend
these securities to persons other than established customers and accredited
investors must make a special written suitability determination for the
subscriber and receive the subscriber's written agreement to a transaction prior
to sale. Securities are exempt from this rule if their market price is at least
$5.00 per share.
Securities and Exchange Commission regulations generally define a penny
stock as any equity security that has a market price of less than $5.00 per
share, with certain exceptions. Unless an exception is available, the
regulations require the delivery, prior to any transaction involving a penny
stock, of a disclosure schedule explaining the penny stock market and the risks
associated with it. If our common stock were considered a penny stock, the
ability of broker/dealers to sell our common stock and the ability of our
stockholders to sell their securities in the secondary market would be limited.
As a result, the market liquidity for our common stock would be severely and
adversely affected. We cannot assure you that trading in our securities will not
be subject to these or other regulations in the future which would negatively
affect the market for such securities.
Risk Factors Relating to our Operations
Due to our negative cash flows we could be required to cut back or stop
operations if we are unable to raise or obtain needed funding.
Our ability to continue operations will depend on our positive cash flow,
if any, from future operations and on our ability to raise additional funds
through equity or debt financing. During fiscal 2003, we raised net proceeds of
approximately $17,540,000 in the aggregate through the sale of shares of
6,235,648 our common stock and 916,833 shares of common stock purchase warrants
in five private placement transactions and had an outstanding loan balance of
$8,786,000 with CIT with whom we have entered into financing agreements. These
sources of financing are used to fund our continuing operations and for working
capital. As of November 29, 2003, we had $8,536,000 of factored receivables with
CIT and $2,149,000 of unused letter of credit outstanding in the aggregate.
Although we had a $332,000 liability with CIT as of November 29, 2003 due to the
amount of factored receivables, our financial position may change such that
there may be the need for us to continue to raise needed funds through a mix of
equity and debt financing to fund our operations and working capital. Equity
financing will usually result in existing stockholders becoming "diluted" or
owning a smaller percentage of the total shares outstanding as of the date of
such dilution. A high degree of dilution can make it difficult for the price of
our common stock to rise rapidly, among other things. Dilution also lessens a
stockholder's voting power.
8
We do not know if we will be able to continue to raise additional funding or if
such funding will be available on favorable terms. We could be required to cut
back or stop operations if we are unable to raise or obtain needed funding.
Our cash requirements to run our business have been and will continue to
be significant.
Since 1997, our negative operating cash flow and losses from continuing
operations have been as follows:
(Negative) positive Cash
Flow
from Operating (Losses) income
Activities of from
Continuing Operations Continuing Operations
--------------------- ---------------------
Fiscal Year Ended:
November 29, 2003 ($9,857,000) ($8,317,000)
November 30, 2002 $1,504,000 $572,000
December 1, 2001 ($632,000) ($618,000)
November 30, 2000 ($4,598,000) ($5,056,000)
November 30, 1999 ($2,124,000) ($1,340,000)
November 30, 1998 ($1,238,000) ($2,267,000)
November 30, 1997 ($1,339,000) ($1,729,000)
Since November 30, 1997, we have experienced negative cash flow from our
operating activities except for the year ending November 30, 2002. As of
November 29, 2003, we had an accumulated deficit of approximately $41,824,000.
Although we have undertaken numerous measures to increase sales and
operate more efficiently, we may experience further losses and negative cash
flows. We can give you no assurance that we will in fact operate profitably in
the future.
We must expand sales of our existing products and successfully introduce new
products that respond to constantly changing fashion trends and consumer demands
to increase revenues and attain profitability.
Our success will depend on our ability to expand sales of our current
products to new and existing customers, as well as the development or
acquisition of new product designs and the acquisition of new licenses that
appeal to a broad range of consumers. We have little control over the demand for
our existing products, and we cannot assure you that the new products we
introduce will be successfully received by consumers. For example, in the past
year, we have acquired licenses to design and market apparel and accessory
products for the recording artists and entertainers known as "Bow Wow" and
"Eve", respectively. Each artist's apparel is sold under the Shago(R) and
Fetish(TM) brand. We have spent considerable resources to develop and market
each of these brands. We believe, but there can be no assurance, that there will
continue to be demand for products such as apparel and accessories associated
with "Bow Wow" or "Eve." See "Business - License Agreements" for further
discussion of our license agreements for Shago(R) and Fetish(TM).
Any failure on our part to anticipate, identify and respond effectively to
changing consumer demands and fashion trends could adversely affect the
acceptance of our products and leave us with a substantial amount of unsold
inventory or missed opportunities. If that occurs, we may be forced to rely on
markdowns or promotional sales to dispose of excess, slow-moving inventory,
which may negatively affect our ability to achieve profitability. At the same
time, our focus on tight management of inventory may result, from time to time,
in our not having an adequate supply of products to meet consumer demand and may
cause us to lose sales.
9
A substantial portion of our net sales and gross profit is derived from a small
number of large customers.
Our 10 largest customers accounted for approximately 52% and 67% of our
gross sales during fiscal 2002 and fiscal 2003, respectively. We do not enter
into any type of long-term agreements with any of our customers. Instead, we
enter into a number of individual purchase order commitments with our customers.
A decision by the controlling owner of a group of stores or store or any other
significant customer, whether motivated by competitive conditions, financial
difficulties or otherwise, to decrease the amount of merchandise purchased from
us, or to change their manner of doing business with us, could have a material
adverse effect on our financial condition and results of operations.
We are dependent on certain contractual relationships to generate revenues.
Our sales are dependent to a significant degree upon the contractual
relationships we can establish with licensors to exploit, on generally a
non-exclusive basis, proprietary rights in well-known logos, marks and
characters. Although we believe we will continue to meet all of our material
obligations under such license agreements, there can be no assurance that such
license rights will continue or will be available for renewal on favorable
terms. Failure to obtain new licenses or extensions on current licenses or to
sell such products, for any reason, could have a significant negative impact on
our business. As of November 30, 2002 and November 29, 2003, $61,938,000 (or
75%) and $16,092,000 (or 54%), respectively, of our gross revenues were
generated from licensed apparel and accessory products.
We are primarily dependent upon revenues from a certain number of
licenses, namely our licenses to produce the Joe's Jeans(R), Bongo(R),
Fetish(TM) and Shago(R) accessory and apparel products. As of November 29, 2003,
we recorded $5,917,000 in sales of products under our Shago(R) and Fetish(TM)
licenses. Our first product line to ship under the Shago(R) license was
delivered to retailers during August 2003, making the fall product line our
first line under the Shago(R) license. Our first product line to ship under the
Fetish(TM) license was delivered to retailers during May 2003, making the summer
product line our first line under the Fetish(TM) license. During that same
period, we recorded $2,534,000 and $11,476,000 in sales of product under our
Bongo(R) license and Joe's Jeans(R) license, respectively. See "Business -
License Agreements and Intellectual Property" for further discussion of our
license agreements.
We are currently dependent on supply and distribution arrangements with Commerce
Investment Group, LLC, or Commerce, and its related entities to generate a
substantial portion of our revenues.
During fiscal 2000, we entered into supply and distribution arrangements
with Commerce and its affiliated entities, whom we will collectively refer to as
the Commerce Group. Under the terms of the distribution arrangements, Commerce
purchased our equity securities and we became obligated to manufacture and
distribute all of our craft products with the Commerce Group for a two-year
period. The distribution arrangements contained an automatic renewal for an
additional two-year term. In fiscal 2002, we renewed these arrangements for
another two years. In July 2003, we entered into another supply agreement with
an Azteca affiliate, AZT International SA de CV, a Mexico corporation, or AZT.
Pursuant to this agreement, we are obligated to purchase certain products,
particularly the products that are sold by us under our division known as Blue
Concept Division acquired on July 17, 2003 from AZT. In addition, we have verbal
agreements with Azteca and/or its affiliates regarding the supply and
distribution of our other apparel products, including certain denim products for
our Fetish(TM) and Shago(R) branded accessory and apparel lines. We utilize
warehouse space in Los Angeles from Azteca. The loss of our supply and
distribution arrangements with the Commerce Group could adversely affect our
current supply and distribution responsibilities, primarily because if we, due
to unforeseen circumstances that may occur in the future, are unable to utilize
the services for manufacturing, warehouse and distribution provided by the
Commerce Group, such inability may adversely affect our operations until we are
able to secure manufacturing, warehousing and distribution arrangements with
other suppliers that could provide the magnitude of services to us that the
Commerce Group currently provides.
Commerce is an entity controlled by Hubert Guez and Paul Guez, whom we
will refer to as the Guez Brothers, who are affiliates of us. On March 5, 2004,
after the conversion of the promissory note was approved at the special
stockholders meeting into a maximum of 4,166,667 shares, Azteca and the Guez
brothers were initially
10
issued 3,125,000 shares of our common stock with the possible issuance of up to
1,041,667 additional shares of common stock upon the occurrence of certain
contingencies described in the Blue Concept APA. Based on a Schedule 13D/A filed
by Commerce and the Guez brothers with the SEC on March 9, 2004 reflecting the
initial conversion of into 3,125,000 shares, the Guez brothers beneficially own
approximately 26.47% of our outstanding common stock in the aggregate. See
Business - Strategic relationship with two of our significant stockholders,
Hubert Guez and Paul Guez, and affiliated companies" for a further discussion of
our relationship with the Guez brothers.
We outsource a substantial amount of our products to be manufactured to
Commerce. In fiscal 2002, we purchased approximately $16 million in goods and
services from Commerce Group or approximately 80% of our manufacturing and
distribution costs. As of November 29, 2003, we purchased approximately $47.9
million in goods and services or 68% of our manufacturing and distribution costs
from Commerce Group.
Should we, due to unforeseen circumstances that may occur in the future,
be unable to utilize the services of Commerce Group for manufacturing, warehouse
and distribution provided by Commerce Group, such inability may adversely affect
our operations until we are able to secure manufacturing, warehousing and
distribution agreements with other suppliers that could provide the magnitude of
services that Commerce Group currently provides to us.
The seasonal nature of our business makes management more difficult, severely
reduces cash flow and liquidity during parts of the year and could force us to
curtail our operations.
Our business is seasonal. The majority of our marketing and sales
activities take place from late fall to early spring. Our greatest volume of
shipments and sales occur from late spring through the summer, which coincides
with our second and third fiscal quarters. Our cash flow is strongest in the
third and fourth fiscal quarters. Unfavorable economic conditions affecting
retailers during the fall and holiday seasons in any year could have a material
adverse effect on our results of operations for the year. We are likely to
experience periods of negative cash flow throughout each year and a drop-off in
business commencing each December, which could force us to curtail operations if
adequate liquidity is not available. We cannot assure you that the effects of
such seasonality will diminish in the future.
The loss of the services of key personnel could have a material adverse effect
on our business.
Our executive officers have substantial experience and expertise in our
business and have made significant contributions to our growth and success. The
unexpected loss of services of one or more of these individuals could also
adversely affect us. We are currently not protected by a key-man or similar life
insurance covering any of our executive officers, nor do we have written
employment agreements with our Chief Executive Officer, Chief Financial Officer,
Chief Operating Officer or President. If, for example, any one of these
executive officers should leave us, his or her services would likely have a
substantial impact on our ability to operate, on a daily basis because we would
be forced to find and hire similarly experienced personnel to fill one or more
of those positions, and daily operations may suffer temporarily as a result.
Furthermore, with respect to Joe's, while we maintain an employment
agreement with Joe Dahan, its president, should Mr. Dahan leave Joe's, his
experience, design capabilities, and name recognition in the apparel and
accessory industry could materially adversely affect the operations of Joe's,
because Joe's relies heavily on Mr. Dahan's capabilities to design, direct and
produce product for the Joe's brand.
Our business could be negatively impacted by the financial instability or
consolidation of our customers.
We sell our product primarily to retail, private label and distribution
companies around the world based on pre-qualified payment terms. Financial
difficulties of a customer could cause us to curtail business with that
customer. We may also assume more credit risk relating to that customer's
receivables. Our inability to collect on our trade accounts receivable from any
one of these customers could have a material adverse effect on our business or
financial condition. More specifically, we are dependent primarily on lines of
credit that we establish from time to time with customers, and should a
substantial number of customers become unable to pay their respective debts as
they become due, we may be unable to collect some or all of the monies owed by
those customers.
11
Our current practice is to extend credit terms to a majority of our
customers, which is based on such factors as past credit history with us,
reputation of creditworthiness within our industry, and timelines of payments
made to us. A small percentage of our customers are required to pay by either
credit card or C.O.D., which is also based on such factors as lack of credit
history, reputation (or lack thereof) within our industry and/or prior negative
payment history. For those customers to whom we extend credit, typical terms are
net 30 to 60 days. Based on industry practices applicable to our business,
financial awareness of the customers with whom we conduct business, and business
experience of our industry, our management exercises professional judgment in
determining which customers will be extended credit. As of November 29, 2003, we
had $3,388,000 in accounts receivable from our customers.
Furthermore, in recent years, the retail industry has experienced
consolidation and other ownership changes. Some of our customers have operated
under the protection of the federal bankruptcy laws. While to date these changes
in the retail industry have not had a material adverse effect on our business or
financial condition, our business could be materially affected by these changes
in the future.
Our business could suffer as a result of manufacturer's inability to produce our
goods on time and to our specifications.
We do not own or operate any manufacturing facilities and therefore depend
upon independent third parties for the manufacture of all of our products. Our
products are manufactured to our specifications by both domestic and
international manufacturers. During fiscal 2002, approximately 24% of our
products were manufactured in the United States and approximately 76% of our
products were manufactured in foreign countries compared to 13% and 87%,
respectively, as of November 29, 2003. The inability of a manufacturer to ship
orders of our products in a timely manner or to meet our quality standards could
cause us to miss the delivery date requirements of our customers for those
items, which could result in cancellation of orders, refusal to accept
deliveries or a reduction in purchase prices, any of which could have a material
adverse effect on our financial condition and results of operations. Because of
the seasonality of our business, and the apparel and fashion business in
particular, the dates on which customers need and require shipments of products
from us are critical, as styles and consumer tastes change so rapidly in the
apparel and fashion business, particularly from one season to the next. Further,
because quality is a leading factor when customers and retailers accept or
reject goods, any decline in quality by our third-party manufacturers could be
detrimental not only to a particular order, but also to our future relationship
with that particular customer.
Our business could suffer if we need to replace manufacturers.
We compete with other companies for the production capacity of our
manufacturers and import quota capacity. Some of these competitors have greater
financial and other resources than we have, and thus may have an advantage in
the competition for production and import quota capacity. If we experience a
significant increase in demand, or if an existing manufacturer of ours must be
replaced, we may have to expand our third-party manufacturing capacity. We
cannot assure you that this additional capacity will be available when required
on terms that are acceptable to us or similar to existing terms which we have
with our manufacturers, either from a production standpoint or a financial
standpoint. We enter into a number of purchase order commitments each season
specifying a time for delivery, method of payment, design and quality
specifications and other standard industry provisions, but do not have long-term
contracts with any manufacturer. None of the manufacturers we use produces our
products exclusively.
Should we be forced to replace one or more of our manufacturers,
particularly a manufacturer that we may rely upon for a substantial portion of
its production needs, such as Commerce, then we may experience an adverse
financial impact, or an adverse operational impact, such as being forced to pay
increased costs for such replacement manufacturing or delays upon distribution
and delivery of our products to our customers, which could cause us to lose
customers or lose revenues because of late shipments.
12
If an independent manufacturer or license partner of ours fails to use
acceptable labor practices, our business could suffer.
While we require our independent manufacturers to operate in compliance
with applicable laws and regulations, we have no control over the ultimate
actions of our independent manufacturers. While our internal and vendor
operating guidelines promote ethical business practices and our staff
periodically visits and monitors the operations of our independent
manufacturers, we do not control these manufacturers or their labor practices.
The violation of labor or other laws by one of our independent manufacturers, or
by one of our license partners, or the divergence of an independent
manufacturer's or license partner's labor practices from those generally
accepted as ethical in the United States, could interrupt or otherwise disrupt
the shipment of finished products to us or damage our reputation. Any of these,
in turn, could have a material adverse effect on our financial condition and
results of operations. In particular, the laws governing garment manufacturers
in the State of California impose joint liability upon us and our independent
manufacturers for the labor practices of those independent manufacturers. As a
result, should one of our independent manufacturers be found in violation of
state labor laws, we could suffer financial or other unforeseen consequences.
Our trademark and other intellectual property rights may not be adequately
protected outside the United States.
We believe that our trademarks, whether licensed or owned by us, and other
proprietary rights are important to our success and our competitive position. In
the course of our international expansion, we may, however, experience conflict
with various third parties who acquire or claim ownership rights in certain
trademarks. We cannot assure that the actions we have taken to establish and
protect these trademarks and other proprietary rights will be adequate to
prevent imitation of our products by others or to prevent others from seeking to
block sales of our products as a violation of the trademarks and proprietary
rights of others. Also, we cannot assure you that others will not assert rights
in, or ownership of, trademarks and other proprietary rights of ours or that we
will be able to successfully resolve these types of conflicts to our
satisfaction. In addition, the laws of certain foreign countries may not protect
proprietary rights to the same extent as do the laws of the United States.
We cannot assure the successful implementation of our growth strategy.
As part of our growth strategy, we seek to expand our geographic coverage,
strategically acquiring select licensees and enhancing our operations. We may
have difficulty hiring and retaining qualified key employees or otherwise
successfully managing the required expansion of our infrastructure in our
current United States market and other international markets we may enter.
Furthermore, we cannot assure you that we will be able to successfully integrate
the business of any licensee that we acquire into our own business or achieve
any expected cost savings or synergies from such integration.
Our business is exposed to domestic and foreign currency fluctuations.
We generally purchase our products in U.S. dollars. However, we source
most of our products overseas and, as such, the cost of these products may be
affected by changes in the value of the relevant currencies. Changes in currency
exchange rates may also affect the relative prices at which we and our foreign
competitors sell products in the same market. We currently do not hedge our
exposure to changes in foreign currency exchange rates. We cannot assure you
that foreign currency fluctuations will not have a material adverse impact on
our financial condition and results of operations. For example, we are subject
to currency fluctuations in Japan and Hong Kong. In fiscal 2002, our earnings
were negatively impacted by $41,000 due to currency fluctuations in Japan and
Hong Kong. As of November 29, 2003, our earnings were positively impacted by
$154,000 due to currency fluctuations in Japan and Hong Kong.
Our ability to conduct business in international markets may be affected by
legal, regulatory, political and economic risks.
Our ability to capitalize on growth in new international markets and to
maintain the current level of operations in our existing international markets
is subject to risks associated with international operations. Some of these
risks include:
13
- the burdens of complying with a variety of foreign laws and
regulations,
- unexpected changes in regulatory requirements, and
- new tariffs or other barriers to some international markets.
We are also subject to general political and economic risks associated with
conducting international business, including:
- political instability,
- changes in diplomatic and trade relationships, and
- general economic fluctuations in specific countries or markets.
We cannot predict whether quotas, duties, taxes, or other similar
restrictions will be imposed by the United States, the European Union, Canada,
China, Japan, India, Korea or other countries upon the import or export of our
products in the future, or what effect any of these actions would have on our
business, financial condition or results of operations. Changes in regulatory or
geopolitical policies and other factors may adversely affect our business in the
future or may require us to modify our current business practices.
We face intense competition in the worldwide apparel and accessory industry.
We face a variety of competitive challenges from other domestic and
foreign fashion-oriented apparel and accessory producers, some of whom may be
significantly larger and more diversified and have greater financial and
marketing resources than we have. We do not currently hold a dominant
competitive position in any market. We compete with competitors such as
Kellwood, Jones Apparel Group, and VF Corp. primarily on the basis of:
- anticipating and responding to changing consumer demands in a timely
manner,
- maintaining favorable brand recognition,
- developing innovative, high-quality products in sizes, colors and
styles that appeal to consumers,
- appropriately pricing products,
- providing strong and effective marketing support,
- creating an acceptable value proposition for retail customers,
- ensuring product availability and optimizing supply chain
efficiencies with manufacturers and retailers, and
- obtaining sufficient retail floor space and effective presentation
of our products at retail.
A downturn in the economy may affect consumer purchases of discretionary
items, which could adversely affect our sales.
The fashion apparel and accessory industry in which we operate is
cyclical. Many factors affect the level of consumer spending in the apparel,
accessories and craft industries, including, among others:
- general business conditions,
- interest rates,
- the availability of consumer credit,
14
- taxation, and
- consumer confidence in future economic conditions.
Consumer purchases of discretionary items, including accessory and apparel
products, including our products, may decline during recessionary periods and
also may decline at other times when disposable income is lower. A downturn in
the economies in which we sell our products, whether in the United States or
abroad, may adversely affect our sales.
Impact of potential future acquisitions.
From time to time, we have pursued, and may continue to pursue,
acquisitions. Most recently, we acquired our Blue Concept Division from Azteca
Production International, Inc., which is owned by our affiliates, Mr. Hubert
Guez and Mr. Paul Guez. We initially issued a $21.8 million convertible note for
the acquisition, which increased our long-term debt by over 600%. On March 5,
2004, our stockholders approved the partial conversion of the note into a
maximum of 4,166,667 shares of our common stock. As a result of this partial
conversion, the note was reduced by $12.5 million to leave a balance of $9.3
million. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations - Long-Term Debt" for further discussion regarding our
long-term debt. Additional acquisitions may result in us becoming substantially
more leveraged on a consolidated basis and may adversely affect our ability to
respond to adverse changes in economic, business or market conditions.
15
FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements are not statements
of historical fact but rather reflect our current expectations, estimates and
predictions about future results and events. These statements may use words such
as "anticipate," "believe," "estimate," "expect," "intend," "predict," "project"
and similar expressions as they relate to us or our management. When we make
forward-looking statements, we are basing them on our management's beliefs and
assumptions, using information currently available to us. These forward-looking
statements are subject to risks, uncertainties and assumptions, including but
not limited to, risks, uncertainties and assumptions discussed in this
prospectus. Factors that can cause or contribute to these differences include
those described under the headings "Risk Factors" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations." These forward
looking statements include, but are not limited to, statements regarding the
following: growth opportunities and increasing market share, earnings estimates,
future financial performance and other matters. Although we believe that the
expectations contained in these forward-looking statements are reasonable, you
cannot be assured that these expectations will prove correct.
If one or more of these or other risks or uncertainties materialize, or if
our underlying assumptions prove to be incorrect, actual results may vary
materially from what we projected. Any forward-looking statements you read in
this prospectus reflect our current views with respect to future events and are
subject to these and other risks, uncertainties and assumptions relating to our
operations, results of operations, growth strategy and liquidity. All subsequent
written and oral forward-looking statements attributable to us or individuals
acting on our behalf are expressly qualified in their entirety by this
paragraph. You should carefully review and consider all information, including
the information included in the section entitled "Risk Factors" and the
financial statements and the notes to the financial statements and related
disclosures incorporated by reference in this prospectus before making an
investment decision. We are under no duty to update any of the forward-looking
statements after the date of this prospectus or to conform these statements to
actual results.
16
USE OF PROCEEDS
Each selling stockholder will receive all of the proceeds from the sale of
its common stock offered by this prospectus. We will not receive any of the
proceeds from the sale of the shares of common stock offered by the selling
stockholders. We will, however, receive the exercise price with respect to
warrants to purchase 240,835 shares of our common stock, when exercised by the
selling stockholders who hold them. If all the warrants are exercised, we
estimate our net proceeds would be $532,771. Any proceeds received will be used
for working capital, inventory purchases and other general corporate purposes.
DIVIDEND POLICY
We have never declared or paid a dividend on our common stock. We intend
to retain earnings to finance the growth and development of our business and do
not expect to declare or pay any cash dividends on our common stock in the
foreseeable future. The declaration of dividends is within the discretion of our
board of directors, which will review this dividend policy from time to time.
See "Risk Factors - We Do Not Anticipate Paying Any Dividends on the Common
Stock."
17
SELECTED CONSOLIDATED FINANCIAL DATA
In the table below, we provide you with summary historical financial data
for us, Innovo Group Inc. We have prepared this information using our
consolidated financial statements for the five years ended November 29, 2003.
The financial statements for the four fiscal years ended November 29, 2003 have
been audited by Ernst & Young LLP, our independent auditors. The financial
statements for the year ended November 30, 1999 have been audited by other
auditors.
When you read this summary historical financial data, it is important that
you read along with the section titled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our consolidated financial
statements and the related notes appearing elsewhere in this prospectus. The
historical results are not necessarily indicative of future results.
18
Years Ended
(in thousands, except per share data)
--------------------------------------------------------
11/29/03 11/30/02 12/01/01 11/30/00 11/30/99
-------- -------- -------- -------- --------
Net Sales $ 83,129 $ 29,609 $ 9,292 $ 5,767 $ 10,837
Cost of Goods Sold 70,153 20,072 6,335 5,195 6,252
-------- -------- -------------------- --------
Gross Profit 12,976 9,537 2,957 572 4,585
Selling, General & Administrative (2) 19,264 8,092 3,189 4,863 5,401
Depreciation & Amortization 1,227 256 167 250 287
-------- -------- -------------------- --------
Income (Loss) from Operations (7,515) 1,189 (399) (4,541) (1,103)
Interest Expense (1,216) (538) (211) (446) (517)
Other Income 526 235 84 30 280
Other Expense (68) (174) (3) (99) --
-------- -------- -------------------- --------
Income (Loss) before Income Taxes (8,273) 712 (529) (5,056) (1,340)
Income Taxes 44 140 89 -- --
-------- -------- -------------------- --------
Income (Loss) from Continuing Operations (8,317) 572 (618) (5,056) (1,340)
Discontinued Operations -- -- -- -- (1)
Extrordinary Items (1) -- -- -- (1,095) --
Net Income (Loss) $ (8,317) $ 572 $ (618) $ (6,151) $ (1,341)
Income (Loss) per Share from Continuing Operations
Basic $ (0.49) $ 0.04 $ (0.04) $ (0.62) $ (0.22)
Diluted $ (0.49) $ 0.04 $ (0.04) $ (0.62) $ (0.22)
Weighted Average Shares Outstanding
Basic 17,009 14,856 14,315 8,163 5,984
Diluted 17,009 16,109 14,315 8,163 5,984
Balance Sheet Data:
Total Assets $ 46,365 $ 15,143 $ 10,247 $ 7,416 $ 6,222
Long-Term Debt 22,344 3,387 4,225 1,340 2,054
Stockholders' Equity 16,482 5,068 4,519 3,758 1,730
(1) Represents the loss from the early extinguishments of debt in fiscal 2000.
(2) Amount includes a $145,000 impairment write down of long-term assets in
1999 as well as $293,000 related to the termination of a capital lease and
$100,000 for the settlement of a lawsuit in 1999, and a $600,000
impairment write down of long-term assets in fiscal 2000.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
You should read the following discussion and analysis of our financial
condition and results of operations in conjunction with our financial statements
and related notes included elsewhere in this prospectus. This discussion and
analysis contains forward-looking statements that involve risks, uncertainties
and assumptions. Our actual results may differ materially from those anticipated
in these forward-looking statements as a result of a number of factors,
including, but not limited to those set forth under "Risk Factors" and elsewhere
in this prospectus.
Introduction
This discussion and analysis summarizes the significant factors affecting
our results of operations and financial conditions during the fiscal years ended
November 29, 2003, November 30, 2002, and December 1, 2001. This discussion
should be read in conjunction with our Consolidated Financial Statements, Notes
to Consolidated Financial Statements and supplemental information in Item 16 of
this Registration Statement on Form S-1. The discussion and analysis contains
statements that may be considered forward-looking. These statements contain a
number of risks and uncertainties as discussed here, under the heading
"Forward-Looking Statements" of this Registration Statement on Form S-1 that
could cause actual results to differ materially.
Executive Overview
Our principal business activity involves the design, development and
worldwide marketing of high quality consumer products for the apparel and
accessory markets. We do not manufacture any apparel or accessory products. We
sell our products to many retail, distributors and private label customers
around the world. Retail customers and distributors purchase finished goods
directly from us. Retail customers then sell the products through their retail
stores and distributors sell our products to retailers in the international
market place. Private label customers outsource the production and sourcing of
their private label products to us and then sell through their own distribution
channels. Private label customers are generally retail chains who desire to sell
apparel and accessory products under their own brand name. We work with our
private label customers to create their own brand image by custom designing
products. In creating a unique brand, our private label customers may provide
samples to us or may select styles already available in our showrooms. We
believe we have established a reputation among these private label buyers for
the ability to arrange for the manufacture of apparel and accessory products on
a reliable, expeditious and cost-effective basis.
Reportable Segments
For the years ended November 29, 2003 and November 30, 2002, we operated
in two segments: apparel and accessories. The apparel segment is conducted by
our Joe's and IAA subsidiaries. The apparel segment represents the operations of
our two-wholly owned subsidiaries, Joe's and IAA, both of which are involved in
the design, development and marketing of apparel products. The accessory
segment, which represents our historical business, is conducted by our Innovo
subsidiary. The apparel and accessory operating segments have been classified
based upon the nature of their respective operations, customer base and the
nature of the products sold.
Our real estate transactions and our other corporate activities are
categorized under "other" and are represented by the operations of Innovo Group
Inc., the parent company, and our two-wholly owned subsidiaries, Leasall and
IRI, which conduct our real estate operations. Our real estate operations do not
currently require a substantial allocation of our resources and are not a
significant part of management's daily operational functions.
20
Our Principal Sources of Revenue
Joe's
Since its introduction in 2001, Joe's has gained national and
international recognition, primarily in the women's denim market. However, since
this introduction and beginning in fiscal 2003, Joe's has expanded its offerings
to include women's sportswear and men's apparel items. While Joe's experienced
excess inventory in fiscal 2003, which we discuss in detail below, Joe's has
entered fiscal 2004 with a focus on solidifying its international reputation. To
this effect, Joe's has recently signed a Master Distribution Agreement with
Beyond Blue, Inc., or Beyond Blue, for exclusive distribution of Joe's products
in territories outside the United States. Beyond Blue is a reputable apparel
company that specializes in distribution and licensing of high-end fashion
products. We believe that this relationship will allow Joe's to gain greater
recognition in those international markets where Joe's products are currently
sold, as well as to expand into other international markets.
IAA
Under our IAA subsidiary, we design and market branded apparel products
under various license agreements. We currently license and market the Fetish(TM)
by Eve and Shago(R) by Bow Wow apparel lines, which are sold to better
departments stores, such as Macy's and the Federated Department Stores, Inc.'s
stores. These products are exploited through the high-end fashion and urban
markets, which have proven successful for other well known brands such as Sean
John(R), Rocawear(R) and Phat Farm(R). Eve and Bow Wow, both as world-renowned
recording artists and actors, provide marketing and exposure for their
respective brands through their talents and celebrity status. While we have yet
to generate sales during a full fiscal year for either line, we believe that the
creation of these brands in fiscal 2003 and the positive reception from retail
buyers and the consumer marketplace will allow us to derive greater sales as
brand awareness increases. Further, while we experienced production and delivery
inefficiencies in our IAA branded business during the fourth quarter of fiscal
2003, which we discuss in greater detail below, that hindered better sales, we
believe we have corrected these issues and will be able to improve the results
of our IAA branded business in fiscal 2004. We are currently seeking similar
opportunities to capitalize on our resources and experience in the branded
apparel market. During the first quarter of 2004, we entered into a license
agreement to produce denim and denim-related apparel for the Betsey Johnson(R)
brand. This license allows us to utilize our strengths in producing denim
apparel and provides another avenue to increase our sales in fiscal 2004.
The private label business represents our strongest source of sales, both
under IAA and in the aggregate, primarily because of our knowledge and
experience within the denim apparel business. Through private label
arrangements, we sell primarily denim products to AEO and Target. We anticipate
growth in private label sales in fiscal 2004, primarily because we will have
conducted a full fiscal year of sales to AEO in connection with the Blue Concept
Division acquisition.
Innovo
Our accessories business is conducted through our Innovo subsidiary. As we
continue to produce craft accessories to sell to large retailers such as
Wal-Mart and Michaels Stores, Inc., we have been able to contribute to the
branded apparel licenses we pursue through our IAA subsidiary.
While our overall operations expanded in depth, sophistication and
complexity and our net sales grew significantly during fiscal 2003 and our
fourth quarter, respectively, we generated significant losses for these periods.
Management is confident that certain activities conducted during fiscal 2003,
such as the launch of the Fetish(TM) brand and the Blue Concept Division
acquisition have created assets and a foundation which will benefit us on a
going-forward basis and further establish us as a quality apparel and accessory
marketer. We believe the reasons for the disappointing financial results during
the fourth quarter of fiscal 2003 have been identified and should be mitigated
in future periods.
21
Results of Operations
We completed our acquisition of the Blue Concept Division from Azteca on
July 17, 2003. The results of operations of the Blue Concept Division are
included in our operating results from the date of acquisition.
Accordingly, the financial position and results of operations
presented and discussed herein are not directly comparable between years. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of the
Blue Concept Division acquisition.
The following table sets forth certain statements of operations data for
the years indicated (in thousands):
Years Ended
(in thousands)
--------------------------------------------
11/29/03 11/30/02 $ Change % Change
-------- -------- -------- --------
Net Sales $ 83,129 $ 29,609 $ 53,520 181%
Cost of Goods Sold 70,153 20,072 50,081 250
-------- -------- -------- --------
Gross Profit 12,976 9,537 3,439 36
Selling, General & Administrative 19,264 8,092 11,172 138
Depreciation & Amortization 1,227 256 971 379
-------- -------- -------- --------
Income (Loss) from Operations (7,515) 1,189 (8,704) (732)
Interest Expense (1,216) (538) (678) 126
Other Income 526 235 291 124
Other Expense (68) (174) 106 (61)
-------- -------- -------- --------
Income (Loss) before Income Taxes (8,273) 712 (8,985) (A)
Income Taxes 44 140 (96) (69)
Net Income (Loss) $ (8,317) $ 572 $ (8,889) (A)
(A) Not Meaningful
Comparison of Fiscal Year Ended November 29, 2003 to Fiscal Year Ended November
30, 2002
Fiscal 2003 Overview
While our net sales grew by 181% during fiscal 2003, we incurred
$8,317,000 of losses during this period. Although we incurred significant losses
in fiscal 2003, we believe that many of the efforts during fiscal 2003 such as
the creation of the IAA branded business and our launch of such brands as
Fetish(TM) and the Blue Concept Division acquisition have established us as
designers, developers and worldwide marketers of high quality consumer products
for the apparel and accessory markets. As further discussed below, we have
identified the issues associated with our losses in fiscal 2003 and we are
taking steps to address these issues.
The primary reasons for our net loss in fiscal 2003 were the following:
o We experienced lower gross margins due to: (i) an increase in the
percentage of our overall sales coming from our lower margin private label
accessory and apparel, and craft products businesses; and (ii) increased
inventory markdowns related to excess inventory that we were unable to sell;
22
o Increased employee wages of $3,643,000 primarily attributable to: (i)
hiring needs for the launch of Fetish(TM) and Shago(R); (ii) hiring needs to
support the growth of the Joe's(R) and Joe's Jeans(R) brand; and (iii) the
hiring of 31 employees which we absorbed as a result of the Blue Concept
Division acquisition;
o Advertising, marketing, tradeshow and related costs of $1,732,000
incurred to market the Joe's(R) and Joe's Jeans(R) brand and to launch the
Fetish(TM) and Shago(R);
o Significant increases in legal, accounting, and other professional fees
which increased due to the increase in business activity during fiscal 2003, as
well as increased insurance expenses of $965,000; and
o Increase in interest expense of $678,000 and depreciation and
amortization costs of $971,000 primarily associated with the acquisition of the
Blue Concept Division.
In order to support our 181% growth in sales, our expenses increased
significantly during fiscal 2003. To support our expanded business platform, we
(i) hired an additional 110 employees in fiscal 2003; (ii) incurred increased
royalty and commission expense as a result of strong sales of our new branded
accessory and apparel lines; and (iii) incurred a substantial increase in
advertising expenditures to establish and market our Fetish(TM), Shago(R) and
Joe's(R) branded products. In an effort to align our personnel needs with our
operational needs, we have undertaken measures to reduce our payroll expenses
subsequent to November 29, 2003. Furthermore, we expect that advertising costs
associated with the launch, establishment and expansion of our branded products
will decrease in the aggregate in fiscal 2004.
Internal distribution problems and weakening demand for certain branded
apparel products from IAA's branded division primarily contributed to our net
loss in fiscal 2003. As a result of the overall success of the initial delivery
of Shago(R) products in the summer of 2003, we hired additional employees to
support the demand and increased the amount of Shago(R) apparel to be
manufactured. Unfortunately, during the second delivery of our Shago(R) apparel
in the fall of 2003, we started to receive indications that favorable consumer
response had weakened for these fall 2003 deliveries. As a result of weakening
demand, we did not sell all of our fall 2003 Shago(R) inventory. With further
indications of weakening demand, we immediately tried to reduce the original
Shago(R) fall 2003 deliveries and/or manufacturing orders in an attempt to limit
our exposure to unsold inventory. We were able to cancel some of the goods;
however, a majority of the Shago(R) products were in production or had already
been shipped, requiring us to accept the products into our inventory.
Although demand had weakened, we had received indications from our
retailers that we would still be able to sell our slower moving Shago(R)
products to the better retailers at a discount, or, in the alternative, sell
these products to discounters either at or above our cost.
While we experienced initial success with this strategy, we discovered
that we would not be able to move these goods at a price above our cost, which
would result in a write-down on this inventory. As a result, we believed that it
was in our best interest to sell these goods through alternative distribution
channels in an effort to turn this excess inventory into cash. Following the end
of fiscal 2003, those goods have been sold, but the year end financial results
reflect reserves taken at what management believes is the fair market value of
these goods at the end of fiscal 2003. Goods were moved out of our inventory,
but losses were taken as a result of selling these goods below cost.
In our efforts to sell the Fetish(TM) branded products, we experienced a
similar situation with respect to excess inventory. We initially launched our
Fetish(TM) products for the fall 2003 season, and our first delivery was an
overall success. We did, however, have excess inventory that was anticipated to
be moved to discount retailers. In an effort to support the reputation of the
Fetish(TM) brand in the consumer and retail marketplace, we did not immediately
move the product into alternative market. As a result, we did not begin to move
the excess Fetish(TM) fall inventory until the beginning of December 2003.
The second delivery for Fetish(TM) products, or the Holiday delivery, was
scheduled to be delivered between November 15, 2003 and December 15, 2003. A
portion of this delay was due to production problems and as a result, when
shipped, a portion of the goods was held in customs. This required us to
reconfigure a significant number of our orders to address customers' needs
because some of the purchased products were no longer available.
23
The production delays were primarily a function of the design department for
Fetish(TM) not completing the design of the Holiday line in a timely manner,
thereby reducing production time.
These problems resulted in excess inventory since a large portion of the
products could not be shipped prior to the end of the Holiday delivery season.
Rather than risk holding the goods and attempting to sell them slowly with no
assurance of successfully doing so, we chose to move these goods even though
often at a loss. Consequently, our financial results for the fourth quarter of
fiscal 2003 reflect the necessary inventory reserves as what we believe to be
the fair market value of the goods.
Another operational factor leading to our financial losses for fiscal 2003
was the unexpected and significant number of returns and charge-backs we
received on the Fetish(TM) products Holiday delivery. This problem was
attributable to Fetish(TM) products Holiday delivery delays and the
substitutions and delivery problems attributable to certain styles being held in
customs. While we did experience some returns and charge-backs on our Shago(R)
inventory, the amount was insignificant compared to the Fetish(TM) inventory
returns and charge-backs.
While IAA was responsible for a large portion of our losses during fiscal
2003 and our fourth quarter, our Innovo subsidiary also experienced inventory
reserve issues due to slow moving inventory for its Bongo(R) and Fetish(TM)
accessory products. This was due to weaker Bongo(R) sales during fiscal 2003 and
similar design, production and delivery delays and issues similar to those
discussed above for our Fetish(TM) products. Also, our Joe's subsidiary's
financial performance was negatively impacted by an inventory write-down for
slow moving inventory sold after our fiscal 2003 year end.
Our fiscal 2003 net loss was also attributable to certain other
adjustments, namely:
o the recording of a charge for the Hot Wheels(R) royalty guarantees
due to the fact we have generated no sales under this license
agreement and are in discussions with Mattel regarding the future of
this license agreement and a reserve against the potential royalty
obligations; and
o an increase in our bad debt reserve to address concerns of the
likelihood of collection of certain outstanding accounts.
We are making a focused effort to address these operational issues. In
February of 2004, we promoted Pierre Levy, who has over 20 years' of management
experience in the apparel industry, as our General Manager of Apparel Operations
to oversee all aspects of apparel related operations as we move into fiscal
2004. We believe his experience will minimize the design, production and
delivery issues that we experienced in fiscal 2003.
In connection with our discussion below of the results of our operations
in fiscal 2003 compared to fiscal 2002, we explain in greater detail the reasons
for the net loss incurred in fiscal 2003.
24
As discussed above, we classify our business in two reportable segments.
The following table sets forth certain statements of operations data by segment
for the periods indicated:
November 29, 2003 Accessories Apparel Other (A) Total
--------------------------------------------------
(in thousands)
Net Sales $ 14,026 $ 69,103 $ -- $ 83,129
Gross Profit 3,095 9,881 -- 12,976
Depreciation & Amortization 39 1,087 101 1,227
Interest Expense 214 946 56 1,216
November 30, 2002 Accessories Apparel Other (A) Total
--------------------------------------------------
(in thousands)
Net Sales $ 12,072 $ 17,537 $ -- $ 29,609
Gross Profit 3,393 6,144 -- 9,537
Depreciation & Amortization 21 183 52 256
Interest Expense 140 339 59 538
2003 to 2002 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
-------------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 1,954 16% $51,566 294% $ -- N/A $53,520 181%
Gross Profit (298) (9) 3,737 61 -- N/A 3,439 36
Depreciation & Amortization 18 86 904 494 49 94 971 379
Interest Expense 74 53 607 179 (3) (5) 678 126
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
Net Sales
Net sales increased to $83,129,000 in fiscal 2003 from $29,609,000 in
fiscal 2002, or a 181% increase. The primary reasons for the increase in our net
sales were: (i) increased sales to our private label customers in both the
apparel and accessories segments, a large portion of which is attributable to
sales generated as a result of the Blue Concept Division acquisition; (ii)
growth in Joe's and Joe's Jeans branded apparel products; (iii) growth in sales
of our craft products; and (iv) initial sales from our Fetish(TM) and Shago(R)
branded apparel and accessory products.
25
Accessory
Innovo
Sales for our accessory segment increased to $14,026,000 in fiscal 2003
from $12,072,000 in fiscal 2002, or a 16% increase. The increase is primarily a
result of higher sales of Innovo's private label and craft accessories products.
Net Sales
($ in thousands) % of Total Net Sales
-------------------- --------------------
2003 2002 % Chg. 2003 2002
-------------------- -------- --------------------
Craft $ 5,372 $ 4,417 22% 38% 37%
Private Label 4,856 3,317 46% 35% 27%
Bongo 2,534 3,125 -19% 18% 26%
Fetish 192 -- N/A 1% 0%
Other Branded 1,072 1,213 -12% 8% 10%
--------------------
Total Branded 3,798 4,338 -12% 27% 36%
--------------------
Total Net Sales $ 14,026 $ 12,072 16% 100% 100%
====================
Craft Accessories.
Innovo's net sales from its craft business increased to $5,372,000 in
fiscal 2003 from $4,417,000 in fiscal 2002, or a 22% increase. Craft accessories
sales accounted for 38% of Innovo's sales in fiscal 2003. Sales of craft
accessories increased due to increased sales to our existing customer base,
which was a function of our customers opening new stores. In fiscal 2004, we
expect sales to continue to increase as our customers continue to aggressively
expand their store bases and we take on new customers. However, we anticipate
that sales of craft products will decline as a percentage of Innovo's total net
sales because of anticipated growth from our private label and branded
accessories products.
Private Label Accessories.
Innovo's net sales from its private label business increased to $4,856,000
in fiscal 2003 from $3,317,000 in fiscal 2002, or a 46% increase. Private label
accessories sales accounted for 35% of Innovo's sales in fiscal 2003. This
increase was due to (1) sales to new private label customers, (2) increased
sales to existing customers, and (3) a full fiscal year of sales to a new retail
customer we acquired at the end of fiscal 2002. In fiscal 2004, we expect sales
to private label customers to increase as we continue to expand sales with
existing customers and increase our customer base.
Branded Accessories.
Innovo's net sales from its branded accessory business decreased to
$3,798,000 in fiscal 2003 from $4,338,000 in fiscal 2002, or a 12% decrease.
Branded accessories sales accounted for 27% of Innovo's sales in fiscal 2003.
Innovo's branded accessories carry the following brand names: Bongo(R),
Fetish(TM), Friendship(TM) and Clear Gear(TM). Sales of branded accessories
declined primarily as a result of a decline in the Bongo(R) line of bags, which
in 2003 represented the majority of branded accessory sales. The decline in
sales of Bongo(R) bags was a result of a decline in sales of junior branded bags
in the mid-tier retailers such as The May Department Stores Company, Sears,
Roebuck and Company, and J.C. Penney Company, Inc. While sales of Fetish(TM)
accessories offset a portion of the decline of net sales of Bongo(R) bags,
Fetish(TM) accessories did not start shipping until November 2003, the last
month of Innovo's fiscal 2003. In fiscal 2004, we anticipate sales of certain
branded accessories, such as Friendship(TM) and Clear Gear(TM), to decrease as
we continue to sell off existing inventory, and we anticipate that this decrease
will be offset by the growth in our Bongo(R) and Fetish(TM) accessories. In
fiscal 2004, we anticipate
26
branded accessories sales to increase as a result of: (i) increased sales of
Bongo(R) bags based on our initial projections for the back-to-school season;
and (ii) the generation of sales of Fetish(TM) bags for the full year of fiscal
2004 compared to just one month of sales in fiscal 2003.
Apparel
Joe's
Joe's net sales increased to $11,476,000 in fiscal 2003 from $9,179,000 in
fiscal 2002, or a 25% increase.
Net Sales
($ in thousands) % of Total Net Sales
-------------------- --------------------
2003 2002 % Chg. 2003 2002
-------------------- -------- --------------------
Domestic $ 6,075 $ 5,398 13% 53% 59%
Joe's Jeans Japan 3,018 1,902 59% 26% 21%
International Distributors 2,383 1,879 27% 21% 20%
--------------------
Total International Markets 5,319 3,781 41% 46% 41%
--------------------
Total Net Sales $ 11,476 $ 9,179 25% 100% 100%
====================
Domestic.
Joe's domestic net sales increased to $6,057,000 in fiscal 2003 from
$5,398,000 in fiscal 2002, or a 13% increase. This increase occurred despite the
presence of pricing pressures for our products in the domestic market. The
increase in sales is attributable to higher unit demand for Joe's products. The
number of units shipped in the domestic market increased to 146,000 units in
fiscal 2003 from 120,000 units in fiscal 2002, or a 22% increase. In fiscal
2004, we plan to take the following steps to further increase sales
domestically: (1) expand our collection of products to include not only pants in
materials other than denim, but also tops such as shirts and jackets; (2) expand
our denim pants line to include four fits that are tailored to different body
types; and (3) increase advertising spending to include billboard, in addition
to print ads.
Joe's Jeans Japan.
Joe's net sales in Japan increased to $3,018,000 in fiscal 2003 from
$1,902,000 in fiscal 2002, or a 59% increase. The majority of the increase is
attributable to sales by Joe's Jeans Japan of approximately $1,000,000 of
discounted inventory to Itochu. During the third fiscal quarter of 2003, Joe's
decided to terminate its direct sales operations in Japan in favor of entering
into a licensing and distribution agreement with Itochu for the licensing of
Joe's and the Joe's Jeans brands in Japan. See "Management's Discussion &
Analysis - Recent Acquisitions and Licenses" for a further discussion regarding
the Joe's Jeans licensing agreement. In fiscal 2004, Joe's Jeans Japan does not
anticipate having any sales. However, as discussed below, we believe that our
sales in Japan will grow as a result of our agreement with Itochu.
International Distributors.
Joe's net sales to international distributors increased to $2,383,000 in
fiscal 2003 from $1,879,000 in fiscal 2002, or a 27% increase. Currently, Joe's
products are sold internationally in Canada, Japan, Australia, France, England
and Korea. The increase in international sales is attributable to sales to
Itochu. In fiscal 2003, Joe's shipped $1,477,000 to Itochu. Excluding sales to
Itochu, sales to international distributors declined. Sales to France, which
represents our second largest international market behind Japan, declined to
$350,000 in fiscal 2003 from $937,000 in fiscal 2002, or a 63% decrease. In
fiscal 2004, we expect sales to international distributors to increase as a
result of adding Itochu as our international distributor in Japan and as a
result of partnering with Beyond Blue to
27
increase Joe's distribution in the international marketplace. Beyond Blue will
be responsible for the management of the existing relationships with Joe's
international distributors and will work to open new territories by obtaining
additional international sub-distributors and sales agents.
IAA
IAA's net sales increased to $57,627,000 in fiscal 2003 from $8,358,000 in
fiscal 2002, or a 589% increase. IAA segregates its operations between two
businesses: private label and branded apparel. IAA's increase in net sales is
attributable to an increase in sales from the private label business, most
notably due to sales of the Blue Concept division acquired from Azteca, Hubert
Guez and Paul Guez in July 2003. Also, as a result of the license agreements
entered into during fiscal 2002 and 2003, IAA generated approximately 11% of its
net sales from its branded business, which began shipping branded apparel in May
of fiscal 2003.
Net Sales
($ in thousands) % of Total Net Sales
-------------------- --------------------
2003 2002 % Chg. 2003 2002
-------------------- -------- --------------------
Branded $ 5,917 $ -- (A) 10% 0%
Private Label (Existing) 23,950 8,358 187% 42% 100%
Private Label (Blue Concept) 27,760 -- (A) 48% 0%
--------------------
Total Private Label 51,710 8,358 519% 90% 100%
--------------------
Total Net Sales $ 57,627 $ 8,358 589% 100% 100%
====================
(A) Not Meaningful
Private Label.
IAA's net sales from its private label business increased to $51,710,000
in fiscal 2003 from $8,358,000 in fiscal 2002, or a 519% increase. This increase
is attributable to an increase in sales to the private label division's existing
customer base and sales generated in connection with the Blue Concept Division
acquisition in July 2003. Approximately one-third (1/3) of the increase in the
private label division's sales is attributable to sales from the division's
existing customer base with the balance of the growth coming from the Blue
Concepts acquisition. In fiscal 2004, we expect sales from the private label
division to increase as a result of the benefit of a full year's contribution of
sales from the Blue Concept Division acquisition versus only four months in
fiscal 2003.
Branded.
IAA's net sales from its branded apparel business was $5,917,000 in fiscal
2003. IAA did not have branded apparel sales in fiscal 2002. Branded apparel
sales accounted for 11% of IAA's net sales in fiscal 2003. During fiscal 2003,
IAA's branded apparel carried the following brand names: Shago(R) by Bow Wow,
Fetish(TM) by Eve and Hot Wheels(R) by Mattel. IAA did not generate sales from
its Hot Wheels(R) branded apparel line. See "Business - License Agreements and
Intellectual Property" for further discussion regarding the Hot Wheels(R)
license. IAA commenced shipping its Shago(R) apparel and Fetish(TM) apparel
lines in May 2003 and in September 2003, respectively. The Shago(R) and
Fetish(TM) apparel products were shipped to retailers such as better department
stores and specialty stores in the United States. In fiscal 2004, we expect to
increase sales in our branded division through (1) sales of Fetish(TM) apparel
for the full fiscal year; (2) sales of Shago(R) branded apparel potentially
through alternative channels of distribution, including mid-tier department and
specialty stores, and (3) sales from new licensed apparel, such as the Betsey
Johnson(R) license. See "Business - Subsequent Events" for further discussion
regarding the Betsey Johnson(R) license.
28
Gross Margin
Our gross profit increased to $12,976,000 in fiscal 2003 from $9,537,000
in fiscal 2002, or a 36% increase. The increase was due to our increase in net
sales. Overall, gross margin, as a percentage of net sales, decreased to 16% in
fiscal 2003 from 32% in fiscal 2002. The decline was attributable to: (i) a
higher percentage of our total sales coming from our private label accessory and
apparel products as well as our craft products, and (ii) significant inventory
markdowns taken in the fourth quarter of fiscal 2003. Generally, private label
apparel, accessories and craft product lines have lower gross margins than our
branded product lines. Our private label accessory and apparel and craft
products represented approximately 75% of our total sales in fiscal 2003
compared to 54% of our total sales in fiscal 2002. Additionally, in fiscal 2003,
we recorded a fourth quarter charge of $3,875,000, or 5% of net sales, related
to of out-of-season and second quality inventory in the Joe's, Innovo, and IAA
divisions. In fiscal 2004, we believe that gross margins will be lower than our
historical averages due to a higher percentage of sales coming from sales to
private label customers. The increase in sales to private label customers is
primarily the result of the acquisition of the Blue Concept Division, which
sells private label apparel to retailers, particularly American Eagle
Outfitters, Inc.
Accessory
Innovo
Innovo's gross profit decreased to $3,095,000 in fiscal 2003 from
$3,393,000 in fiscal 2002, or a 9% decrease. Innovo's gross margin decreased to
22% in fiscal 2003 from 28% in fiscal 2002. The decrease in gross margin is a
result of a greater percentage of sales coming from lower margin products and a
charge related to out-of-season inventory. Our craft and private label accessory
products have traditionally experienced lower gross margins than our branded
accessory products. Our craft and private label accessory product represented
74% of net sales in fiscal 2003 compared to 64% of net sales in fiscal 2002. In
addition, we recorded a charge of $335,000 in the fourth quarter related to
out-of-season and slow moving Fetish(TM), Shago(R) and Bongo(R) accessories,
which reduced gross margins by 2%. Approximately 80% of the charge recorded to
mark down out-of-season and slow moving inventory was related to Bongo(R)
products. The decline in Bongo(R) sales relative to our expectations of growth
resulted in over-ordering of excess Bongo(R) inventory. Further, we anticipate
that branded products will grow faster than total sales for the accessories
business, which would result in a greater portion of net sales attributable to
branded accessories in fiscal 2004 than in fiscal 2003.
Apparel
Joe's
Joe's gross profit decreased to $4,087,000 in fiscal 2003 from $4,515,000
in fiscal 2002, or a 9% decrease. Joe's gross margins decreased to 36% in fiscal
2003 from 51% in fiscal 2002. Joe's gross margin decrease was primarily
attributable to the following factors: (i) Joe's Jeans Japan sold the majority
of its inventory, equaling approximately $1,000,000, to Itochu, which
approximated our book value. See "Business - License Agreements and Intellectual
Property" for further discussion of this sale of Joe's Jeans Japan's inventory;
(ii) we recorded a charge of $143,000 related to second-quality inventory in
Japan in the third quarter of fiscal 2003; (iii) we recorded a charge of
$287,000 related to out-of-season fabric; (iv) we recorded a charge of $247,000
related to second-quality goods and damaged goods in the U.S to mark down the
value of the goods carried on our books to market value; and (v) our cost of
goods sold increased as a result of no longer being able to purchase finished
goods from our domestic supplier, which resulted in the need to change our
inventory purchasing strategy during the second quarter of fiscal 2003 from
buying finished goods to buying raw materials and outsourcing the manufacturing
of our goods. Joe's cost to buy raw materials and outsource the manufacturing of
its own goods was significantly higher than its cost to buy finished goods. The
above referenced charges in the U.S. and in Japan reduced gross margins by 6%.
29
IAA
IAA's gross profit increased to $5,794,000 in fiscal 2003 from $1,629,000
in fiscal 2002, or a 256% increase. However, gross margin decreased to 10% from
19% in fiscal 2002. The decrease in gross margin is primarily attributable to
the following factors: (i) lower gross margins associated with sales of private
label apparel products, primarily sales to AEO as part of the Blue Concept
Division. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Recent Acquisitions and Licenses" for further discussion
of the Blue Concept Division acquisition; (ii) we recorded a charge of $33,000
related to slow moving inventory in our private label division; and (iii) we
recorded a charge of $3,134,000 to markdown out-of-season Shago(R) and
Fetish(TM) inventory carried on our books to its estimated market value. This
$3,134,000 charge was due to not only our over-estimation of the demand in the
marketplace for our initial deliveries of Shago(R) and Fetish(TM) branded
apparel products, but also our production delays that caused certain customers
to cancel their orders. In aggregate, the charges related to inventory lowered
gross margins by 5%.
Selling, General and Administrative Expense
Selling, general and administrative ("SG&A") expenses increased to
$19,264,000 in fiscal 2003 from $8,092,000 in fiscal 2002, or a 138% increase.
The SG&A increase is largely a result of the following factors: (i) an increase
in advertising expenditures to establish and market our Fetish(TM), Shago(R) and
Joe's(R) branded products through both advertising and tradeshows; (ii) the
hiring of 31 employees as a result of the Blue Concept Division acquisition;
(iii) the hiring of 60 employees to support or facilitate the establishment of
and increase sales for Fetish(TM), Shago(R) and Joe's(R) branded products; (iv)
the hiring of 19 employees to support our Far East outsourcing operations and 4
employees to increase our management personnel; (v) increased royalty and
commission expense associated with our existing and new branded accessory and
apparel lines; (vi) increased outside legal, accounting and other professional
fees as a result of continued growth of the business in fiscal 2003; and (vii)
increased insurance costs primarily as a result of increase in our general
liability and D & O insurance.
As discussed in greater detail below, we incurred the following SG&A
expenses in fiscal 2003: (i) $1,732,000 of expense in fiscal 2003 from $491,000
of expense in fiscal 2002, or a 253% increase, to establish and market our
branded products through advertising and tradeshows; (ii) $6,475,000 of expense
in fiscal 2003 from $2,832,000 of expense in fiscal 2002, or a 129% increase,
for hiring additional employees and wage increases; (iii) $2,032,000 of expense
in fiscal 2003 from $1,568,000 of expense in fiscal 2002, or a 30% increase, for
royalties and commissions associated with our existing and new branded accessory
and apparel lines; (iv) $1,577,000 of expense in fiscal 2003 from $611,000 of
expense in fiscal 2002, or a 158% increase, for increased legal, accounting and
other professional fees; and (vi) $240,000 of expense in fiscal 2003 from
$134,000 in fiscal 2002, or a 79% increase, for increased D & O and general
liability insurance.
Accessory
Innovo
Innovo's SG&A expenses increased to $3,345,000 in fiscal 2003 from
$2,854,000 in fiscal 2002, or a 17% increase. This SG&A expense increase is
primarily attributable to wage increases. Innovo's employee wages increased to
$1,284,000 in fiscal 2003 from $842,000 in fiscal 2002, or a 52% increase. Wage
increases are a result of the following factors: (i) hiring of two additional
salespersons to replace outsourced sales personnel working on a commission only
basis, which accounted for $152,000 of the wage expense increase; (ii) wage
increases for existing employees, which accounted for $50,000 of the wage
expense increase; (iii) hiring of new employees in functions including
purchasing, data entry, merchandising, designing and accounting, which accounted
for $200,000 of the wage expense increase; and (4) the hiring of additional
employees added to the Hong Kong sourcing office, which accounted for $40,000 of
the wage expense. Further, as a result of shifting to using in-house sales
personnel instead of outsourcing sales to sales representatives that work for
commissions, wage increases were partially offset by lower commission expenses.
Commission expense declined to $130,000 in fiscal 2003 from $292,000 in fiscal
2002, or a 26% decrease.
30
Due to the expansion of the branded accessories product line, three other
SG&A expense categories increased, namely: (i) product sample expenses; (ii)
contract labor; and (iii) rent. First, expenses to make samples of future
products increased to $137,000 in fiscal 2003 from $54,000 in fiscal 2002, or a
154% increase. Sample expense increased due to additional development of branded
accessories such as Fetish(TM) accessories. Second, in addition to using our own
design and development personnel for branded accessories, we also used contract
labor. As a result, contract labor expense increased to $46,000 in fiscal 2003
from $12,000 in fiscal 2002, or a 283% increase. Finally, rental expense
increased to $191,000 in fiscal 2003 from $120,000 in fiscal 2002, or a 59%
increase. The increase in rent is primarily attributable to an increase in rent
to expand the New York showroom to include support for the branded accessories
lines.
Apparel
Joe's
Joe's SG&A expenses increased to $5,426,000 in fiscal 2003 from $3,245,000
in fiscal 2002, or a 67% increase. This increase is primarily attributable to
the following factors: (i) a wage and benefits expense increase in connection
with the hiring of additional employees in order to expand Joe's product lines
from denim pants to a full sportswear collection of pants and tops bearing the
Joe's(R) brand for Spring 2004; (ii) severance payments paid in connection with
the termination of operations in Japan pursuant to the agreement with Itochu.
See "Business - License Agreements and Intellectual Property" for further
discussion of the Itochu agreement; (iii) increases in legal and accounting fees
due to the termination of operations in Japan in connection with the Itochu
agreement; (iv) increased expenditures on marketing and advertising the Joe's(R)
and Joe's Jeans(R) brand; (v) increased apparel sample costs; and (vi) increased
royalty and factoring expenses due to increased sales of Joe's products.
More specifically, Joe's employee wages and related benefits expenses
increased to $1,794,000 in fiscal 2003 from $1,140,000 in fiscal 2002, or a 57%
increase, as a result of hiring 11 new employees to support the growth in Joe's
business. Severance payments totaling $274,000 were paid in the second and third
quarters of 2003 to certain employees as part of a separation payment in
connection with the termination of operations in Japan, compared to no severance
payments being made in fiscal 2002. Joe's legal and accounting expenses
increased to $434,000 in fiscal 2003 from $82,000 in fiscal 2002, or a 429%
increase, and were attributable to the termination of operations in connection
with the Itochu agreement. Joe's expenses associated with marketing and
advertising, including trade show expenditures, increased to $706,000 in fiscal
2003 from $426,000 in fiscal 2002, or a 66% increase. Sample costs were $291,000
in fiscal 2003, compared to no sample costs in fiscal 2002. This expense is due
to changes in inventory strategy in the second quarter of fiscal 2003 whereby
Joe's began purchasing raw materials and outsourcing the manufacturing of its
goods as opposed to purchasing finished goods. As a result of this change in
inventory strategy, Joe's began buying its own samples. By contrast, in fiscal
2002 our supplier of finished goods bore the cost of producing samples. Finally,
as a result of higher net sales, Joe's royalty expense increased to $339,000 in
fiscal 2003 from $277,000 in fiscal 2002, or a 22% increase. and Joe's factoring
expense under its factoring arrangement with CIT Commercial Services increased
to $72,000 in fiscal 2003 from $41,000 in fiscal 2002, or a 76% increase.
IAA
IAA's SG&A expenses increased to $7,541,000 in fiscal 2003 from $761,000
in fiscal 2002, or an 891% increase. The increase in SG&A expenses is primarily
attributable to the growth in IAA's branded apparel business and the acquisition
of the Blue Concept Division.
IAA had higher employee costs associated with the expansion of its branded
apparel business and the acquisition of the Blue Concept Division, increasing
its employee count by adding 80 new employees. The expansion into the branded
apparel business required us to fill certain positions such as designers for
Shago(R) and Fetish(TM), which were necessary to bring the products to
production and, ultimately, to the marketplace. As a result, employee wages and
benefits increased to $2,362,000 in fiscal 2003 from $522,000 in fiscal 2002, or
a 352% increase. Of the $2,362,000 in total wages, $1,082,000, or 46%, was
associated with employees working on branded apparel products; $708,000, or 30%,
was associated with employees joining the private label division in connection
with the Blue Concept Division acquisition, with the remaining 24% of the total
wages associated with the private label division's existing operations.
31
During fiscal 2003, we incurred $989,000 of expense to market and promote
our branded apparel products, including: (i) $498,000 spent on billboard
advertising, photo shoots in connection with Fetish(TM) and Shago(R), and
national print publications, such as Vibe, Honey and Women's Wear Daily, from no
advertising expenses incurred in fiscal 2002; and (ii) $491,000 incurred in
connection with the semi-annual trade show MAGIC held in Las Vegas, Nevada to
build and erect the booth used to launch the Fetish(TM), Shago(R) and Hot
Wheels(R) lines; and (iii) $431,000 for samples, production and development of
its apparel products, compared to no expenses for these sample and development
costs in fiscal 2002.
During fiscal 2003, we incurred $1,061,000 of royalties and commissions
for Shago(R) and Fetish(TM) branded apparel sales, which commenced shipping in
the second and fourth quarters of fiscal year 2003, respectively. In future
periods we anticipate that royalties and commissions will increase as we expect
sales of branded apparel to increase. With the exception of $21,000 spent in
fiscal 2002 allocated toward minimum royalty guarantees in connection with the
Hot Wheels(R) and Shago(R) lines, no commissions were expensed during fiscal
2002 since we generated no sales from branded apparel during fiscal 2002.
Factoring expenses under IAA's inventory- and receivables-based line of
credit agreements with CIT increased to $342,000 in fiscal 2003 from $130,000 in
fiscal 2002, or a 163% increase. This increase was due to the increase in sales.
Travel, meals and entertainment expense increased to $408,000 in fiscal
2003 from $18,000 in fiscal 2002, or a 2,167% increase, as a result of the
larger employee and customer base.
Legal expenses increased $161,000 in fiscal 2003 from $2,000 in fiscal
2002, or a 7,950% increase, as a result of increased costs associated with the
development of the branded apparel business.
IAA incurred $231,000 of bad debt expense for uncollectible accounts in
fiscal 2003 compared to no bad debt expense in fiscal 2002.
As a part of the acquisition of the Blue Concept Division, IAA pays to
Azteca a fee for allocated expenses associated with the use of its office space
and expenses incurred in connection with maintaining office space. These
allocated expenses include, but are not limited to: rent, security, office
supplies, machine leases and utilities. During fiscal 2003, we incurred $694,000
of expense to Sweets Sportswear LLC pursuant to an earn-out agreement associated
with the Blue Concept Division acquisition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Recent Acquisitions
and Licenses" for further discussion regarding the acquisition of the Blue
Concept Division. We expect earn-out expense to increase as we anticipate sales
growth from the Blue Concept Division, particularly as we will benefit from a
full year of sales in fiscal 2004 compared to only four months of sales in
fiscal 2003. As a part of the acquisition of the Blue Concept Division, IAA pays
Azteca Productions International a fee for allocated expenses associated with
the use of its infrastructure. Such allocated expenses include but are not
limited to rent, security, office supplies, machine leases and utilities. In
fiscal 2003, IAA recorded $318,000 for such expenses. The balance of the
approximately $689,000 of additional SG&A in fiscal 2003 is attributable to the
growth of our business from IAA having net sales of $8,358,000 and 7 employees
in fiscal 2002 to $57,627,000 net sales and 87 employees in fiscal 2003.
Other
IGI
IGI, which reflects our corporate expenses and operates under the "other"
segment, does not have sales. IGI's expenses, excluding interest, depreciation
and amortization, increased to $2,812,000 in fiscal 2003 from $1,375,000 in
fiscal 2002, or a 105% increase. IGI's management level wages and related taxes
and benefits increased to $859,000 in fiscal 2003 from $295,000 in fiscal 2002,
or a 191% increase, primarily as a result of hiring five additional management
level employees, including a Chief Financial Officer and a Chief Operating
Officer, to provide the infrastructure necessary to manage our growth. Also,
insurance expense increased to $240,000 in fiscal 2003 from $134,000 in fiscal
2002, or a 79% increase. Legal, accounting and professional fees increased to
$933,000 in fiscal 2003 from $406,000 in fiscal 2002, or a 130% increase, as a
result of the Company's increased
32
business needs in fiscal 2003. Travel, meals and entertainment expense increased
to $266,000 in fiscal 2003 compared to $143,000 in fiscal 2002, or a 86%
increase, as a result of the travel associated with senior management
coordinating the opening of a New York office for the IAA subsidiary and the
commuting and relocation costs associated with the hiring of the Chief Financial
Officer.
Leasall
Leasall's SG&A expense increased to $130,000 in fiscal 2003 from $21,000
in fiscal 2002, or a 519% increase, primarily due to $98,000 of expenses
incurred to maintain and operate our former manufacturing facility and
headquarters located in Springfield, Tennessee, which is now partially leased to
third party tenants. The balance of the $32,000 was spent by Leasall on
Tennessee property taxes and insurance.
IRI
IRI's SG&A expense decreased to $8,000 in fiscal 2003 from $64,000 for
fiscal 2002, or a 700% decrease. IRI's SG&A expense is primarily comprised of
legal and accounting fees.
Depreciation and Amortization Expenses
Our depreciation and amortization expenses increased to $1,227,000 in
fiscal 2003 from $256,000 in fiscal 2002, or a 379% increase. The increase is
primarily attributable to (1) the depreciation and amortization associated with
the purchase of the Blue Concept Division and (2) the purchase of a booth for
the MAGIC tradeshow. More specifically, in connection with the Blue Concept
Division acquisition in fiscal 2003, we amortized $848,000 of the intangible
assets based upon the fair value of the majority of the gross profit associated
with existing purchase orders at closing and the intangible value of the
customer list obtained. We also depreciated $50,000 of the expense related to
the purchase of the booth for the MAGIC tradeshow. The remaining depreciation
and amortization expense of $329,000 is due to (i) deprecation of $76,000 in
connection with the Springfield, Tennessee facility and related leasehold
improvements, (ii) amortization of $48,000 in connection with the licensing
rights to the Joe's(R) and Joe's Jeans(R) marks acquired on February 7, 2001,
(iii) amortization of $95,000 from the purchase of the knit division from Azteca
on August 24, 2001, and (iv) depreciation of $110,000 related to small
operational assets such as furniture, fixtures, machinery and software.
Interest Expense
Our combined interest expense increased to $1,216,000 in fiscal 2003 from
$538,000 in fiscal 2002, or a 126% increase. Our interest expense is primarily
associated with: (i) $359,000 of interest expense from our factoring and
inventory lines of credit and letter's of credit from CIT used to help support
our working capital increases; (ii) $182,000 of interest expense from the knit
acquisition purchase notes issued in connection with the purchase of the knit
division from Azteca in fiscal 2001; (iii) $30,000 of interest expense from two
loans totaling $500,000 provided to us by Marc Crossman, our Chief Financial
Officer, on February 7, 2003 and February 13, 2003; (iv) $26,000 of interest
expense from a $476,000 mortgage on our former manufacturing facility and
headquarters in Springfield, Tennessee; (v) $482,000 of interest expense
incurred as a result of the $21,800,000 convertible note issued as a part of the
purchase of the Blue Concept Division from Azteca in July of 2003. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for a further discussion of these
financing arrangements; (vi) $139,000 of interest expense incurred from
discounts given to customers who paid their invoices early; and (vii) interest
income of $2,000.
Other Income
We had other income, net of other expenses, of $458,000 in fiscal 2003
from $61,000 in fiscal 2002, or a 651% increase.
IRI
Other income in fiscal 2003 included $329,000 of income from a quarterly
sub-asset management fee that IRI received pursuant to a sub-asset management
agreement entered into on April 5, 2002 in connection with the
33
acquisition by IRI of a 30% limited partnership interest in 22 separate limited
partnerships, which acquired 28 apartment complexes at various locations
throughout the United States. Part of the consideration accepted by the sellers
in the Limited Partnership Real Estate Acquisition was 195,000 shares of the
Company's $100 Redeemable 8% Cumulative Preferred Stock, Series A, or the Series
A Preferred Stock. We are not entitled to any cash flow or proceeds from the
sales of the properties until all shares of the Series A Preferred Stock have
been redeemed. Until such time, we only receive the quarterly sub-asset
management fee. IRI generated $173,000 of income from the sub-asset management
fee in fiscal 2002. See "Business - Real Estate Transactions."
Joe's and Leasall
Additionally, we had $153,000 of other income from Joe's in fiscal 2003
compared to $41,000 of other expense in fiscal 2002. The vast majority of Joe's
other income was unrealized Japanese currency translation income of $137,000.
Offsetting a portion of other income was net rental expenses of $21,000 from
tenants who are occupying our former manufacturing facility located in
Springfield, Tennessee.
Net Income
We generated a net loss of $8,317,000 in fiscal 2003 compared to net
income of $572,000 in fiscal 2002. The net loss in fiscal 2003 versus net income
in fiscal 2002 is largely the result of the following factors: (i) lower gross
margins, due to (a) over-estimations by management in its inventory purchases
and (b) significant charges taken against excess inventory; (ii) increased
employee wages of $3,643,000; (iii) increased advertising, marketing, tradeshow
and related costs of $1,241,000 incurred in order to market the Joe's brand and
launch the Shago(R) by Bow Wow and Fetish(TM) by Eve brands; (iv) increased
royalties and commissions associated with our branded products and the earnout
associated with the Blue Concept Division acquisition purchase of $1,539,000;
(v) increases in legal, accounting, and other professional fees and insurance of
$965,000; (vi) an increase in interest expense of $681,000 and depreciation and
amortization costs of $973,000 primarily associated with the acquisition of the
Blue Concept Division from Azteca in fiscal 2003 as discussed in greater detail
above.
34
Results of Operations
The following table sets forth certain statement of operations data for
the years indicated:
Years Ended
(in thousands)
--------------------------------------------
11/30/02 12/01/01 $ Change % Change
-------- -------- -------- --------
Net Sales $ 29,609 $ 9,292 $ 20,317 219%
Cost of Goods Sold 20,072 6,335 13,737 217
-------- -------- -------- --------
Gross Profit 9,537 2,957 6,580 223
Selling, General & Administrative 8,092 3,189 4,903 154
Depreciation & Amortization 256 167 89 53
-------- -------- -------- --------
Income (Loss) from Operations 1,189 (399) 1,588 (398)
Interest Expense (538) (211) (327) 155
Other Income 235 84 151 180
Other Expense (174) (3) (171) (A)
-------- -------- -------- --------
Income (Loss) before Income Taxes 712 (529) 1,241 (235)
Income Taxes 140 89 51 57
Net Income (Loss) $ 572 $ (618) $ 1,190 (A)
(A) Not Meaningful
Comparison of Fiscal Year Ended November 30, 2002 to Fiscal Year Ended December
1, 2001
Overview
In fiscal 2002, we increased our sales and reported an overall profit for
the year ended November 30, 2002. We experienced growth in all three of our main
consumer products operating subsidiaries and moved forward in our efforts to
strengthen our presence in the apparel market.
Our accessory division, Innovo, experienced an increase in sales as a
result of our entry into the private label business, growth from the Bongo(R)
product line and an increase in its legacy craft division. In fiscal 2002,
Innovo focused on strengthening its sourcing capabilities through the
establishment of IHK.
During fiscal 2002, our Joe's subsidiary continued to experience strong
demand for its product lines in the international marketplace. In May of 2002,
Joe's established Joe's Jeans Japan to distribute its products in the Japanese
market. Additionally, we began to distribute our Joe's products in Europe and
Canada.
Our IAA subsidiary increased its sales in fiscal 2002 as a result of
growth in its business with its private label customers such as Target
Corporation and J. Crew, Inc. During the period, in an effort to expand into
branded products, IAA obtained the license rights to Bow Wow from Bravado
International Group, the agency with the master license rights to Bow Wow, and
LBW Entertainment, Inc. and to the Hot Wheels(R) brand from Mattel, Inc.
Our net income for the fiscal year ended 2002 was $572,000, or $0.04 per
share, compared to a loss of $618,000, or $0.04 per share, for the fiscal year
ended 2001, as a result of our ability to increase our revenues, maintain our
gross margins and to control our increase in expenses.
35
Reportable Segments
During fiscal 2002 and fiscal 2001, we operated in two segments,
accessories and apparel. The accessories segment represents our original core
business and is conducted by our Innovo subsidiary. The apparel segment operates
under Joe's and IAA. Our real estate operations and corporate activities are
categorized under "other." The operating segments have been classified based
upon the nature of their respective operations, customer base and the nature of
the products sold.
The following table sets forth certain statement of operations data by
segment for the years indicated (in thousands):
November 30, 2002 Accessories Apparel Other (A) Total
--------------------------------------------------
(in thousands)
Net Sales $ 12,072 $ 17,537 $ -- $ 29,609
Gross Profit 3,393 6,144 -- 9,537
Depreciation & Amortization 21 183 52 256
Interest Expense 140 339 59 538
December 1, 2001 Accessories Apparel Other (A) Total
--------------------------------------------------
(in thousands)
Net Sales $ 5,642 $ 3,650 $ -- $ 9,292
Gross Profit 1,749 1,208 -- 2,957
Depreciation & Amortization 45 35 87 167
Interest Expense 32 79 100 211
2002 to 2001 Accessories Apparel Other (A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
-------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 6,430 114% $13,887 380% $ -- N/A $20,317 219%
Gross Profit 1,644 94 4,936 409 -- N/A 6,580 223
Depreciation & Amortization (24) (53) 148 423 (35) (40) 89 53
Interest Expense 108 338 260 329 (41) (41) 327 155
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
Net Sales
Our net sales increased to $29,609,000 in fiscal 2002 from $9,292,000 for
fiscal 2001, or an increase of 219%. This increase is attributable to sales by
our three main operating subsidiaries, Innovo operating in the accessory segment
and Joe's and IAA operating in the apparel segment.
Accessory
Innovo
Innovo's net sales increased to $12,072,000 in fiscal 2002 from $5,642,000
in fiscal 2001, or an increase of 114%. Innovo's gross sales for fiscal 2002
were $12,216,000. The increase is attributable to our entry into the private
label accessory business, growth in sales of Innovo's craft products, and higher
sales from its Bongo(R) accessory products.
Innovo's accessory craft business increased as a result of Innovo's
ability to sell a greater amount of its new and existing products to new and
existing customers. In fiscal 2002, Innovo focused upon increasing the quality
of
36
its products and improving the marketing strategy associated with the Innovo's
products. Innovo's craft business gross sales increased to $4,577,000 in fiscal
2002 from $2,831,000 in fiscal 2001, or a 62% increase. Innovo's craft business
represented approximately 37% of Innovo's total gross sales for fiscal 2002.
Innovo's Bongo(R) product line experienced an increase in sales partly as
a result of fiscal 2002 being Innovo's first full twelve month cycle of business
with the Bongo(R) product line. Gross sales generated by the Bongo(R) product
line of $3,101,000 represented approximately 25% of Innovo's total gross sales
for fiscal 2002.
Innovo began selling its products to private label customers in fiscal
2002. Innovo's two main private label customers for fiscal 2002 were American
Eagle Outfitters, Inc. and Limited Brands, Inc.'s Express division. Innovo's
private label business gross sales of $3,218,000 represented approximately 26%
of Innovo's gross sales for fiscal 2002.
Apparel
Joe's
Joe's net sales increased to $9,179,000 in fiscal 2002 from $1,519,000 in
fiscal 2001, or an increase of 504%. Joe's product line experienced an increase
in sales partly as a result of fiscal 2002 being Joe's first full 12 month
business cycle. For fiscal 2002, Joe's product mix consisted primarily of
women's denim based jeans, skirts and jackets and men's denim jeans. Joe's is
continuing to diversify its product offerings to meet the changing trends in the
high fashion apparel markets and believes, although there can be no assurances,
that its new product line is designed to meet the current fashion trends and the
expectations of its customers and of consumers.
During fiscal 2002, Joe's experienced increase demand in both the domestic
and international marketplaces. Joe's net sales domestically increased to
$5,398,000 in fiscal 2002 from $1,519,000 in fiscal 2001, or an increase of
255%. This increase is primarily a result of the maturity and development of the
Joe's brands in the marketplace. Joe's continues to attract customer and
consumer awareness as a result of its design and quality characteristics.
Management believes the desirability of products bearing the Joe's(R) brand and
the characteristics associated therewith are resulting in increased demand from
Joe's customers.
In fiscal 2002, Joe's expanded into the international marketplace through
the formation of Joe's Jeans Japan, Inc., or JJJ, and through the use of
international distributors. JJJ is headquartered in Tokyo, Japan where we
operate a showroom and operational offices. Net sales by JJJ in the amount of
$1,902,000 represented approximately 21% of Joe's total net sales. Additionally,
Joe's markets its products in Europe and Canada through the use of international
distributors who purchase Joe's products and then distributed the product to
retailers in the distributor's local markets. Sales in the international market,
excluding sales by JJJ, represented approximately 10% of Joe's total sales for
fiscal 2002.
IAA
IAA's net sales increased to $8,358,000 for fiscal 2002 from $2,130,000
for fiscal 2001, or an increase of 292%. IAA was formed in August 2001 in
connection with the acquisition of the knit division from Azteca. IAA's product
line experienced an increase in sales partly as a result of fiscal 2002 being
IAA first full 12 month business cycle and an increase in sales of IAA's private
label apparel products to its two main customers, J. Crew, Inc. and Target
Corporation's Mossimo division. IAA's products in fiscal 2002 primarily
consisted of denim jeans and knit shirts.
In an attempt to expand its product business, in fiscal 2002, IAA entered
into a license agreements with Bow Wow and Mattel for the creation of apparel
and accessory products bearing the Shago(R) and Hot Wheels(R) brand,
respectively. IAA's branded products did not have any sales in fiscal 2002.
37
Gross Margin
Our overall gross margin remained at 32% for fiscal 2002 compared to 32%
for fiscal 2001.
Accessory
Innovo
Innovo's gross margin decreased to 27% for fiscal 2002 from 31% for fiscal
2001, or a decrease of 2%. Innovo's gross margin is largely a function of
Innovo's product mix for the given period, however, during the fiscal 2002,
Innovo's gross margin was negatively impacted from the west coast dock strike.
As a result of the west coast dock strike, Innovo was obligated to incur
increased airfreight expenses of $303,000, which affected our gross margin by
three percentage points. In addition, we were required to give customer
discounts as a result of the late shipment of products. Innovo's product
categories have historically had a gross margin in the 30% range, with some
product categories being higher and some lower. Innovo's branded products have
traditionally experienced higher margin than its craft and private label
business, which usually have similar gross margins.
Apparel
Joe's
Joe's gross margins decreased to 50% for fiscal 2002 from 57% for fiscal
2001, or a decrease of 7%. The decrease reflects an increase in sales in the
international marketplace, in which goods are often sold at a discount.
Additionally, Joe's gross margin was negatively impacted as a result of an
increase in cost for some of the more fashion-oriented products in Joe's product
line. In an effort to maintain high margins, Joe's usually attempts to pass the
higher cost of certain goods to its customer by charging a higher sales price
for such products.
IAA
IAA's gross margins increased to 20% for fiscal 2002 from 16% for fiscal
2001, or an increase of 4%. IAA's sales in fiscal 2002 primarily consisted of
denim jeans and knit shirts to private label customers. IAA's sales to its
private label customers usually have lower margins than the sales of our other
divisions. We anticipate that IAA's branded apparel will experience higher gross
margins than its private label apparel because it can obtain higher prices for
its branded apparel products.
The increase in IAA's gross margins offset decreases in Joe's and Innovo's
gross margins. This resulted in an overall increase in our collective gross
margin. Our collective gross margin may fluctuate in future periods based upon
which segments operating subsidiary and operating division accounts for a larger
percentage of sales.
Selling, General and Administrative Expense
Our selling, general and administrative, or SG&A, expenses increased to
$8,092,000 in fiscal 2002 from $3,189,000 in fiscal 2001, or approximately a
176% increase. The increase in SG&A expenses is largely a result of an increase
in expenses to support our sales growth during the period. During the period, we
incurred an increase in wages to $2,832,000 in fiscal 2002 from $1,026,000 in
fiscal 2001, or an increase of 176%. We hired new employees to handle the growth
in our accessory and apparel business. In addition, advertising expenses
increased to $287,000 in fiscal 2002 from $114,000 in fiscal 2001, or an
increase of 152%, travel expenses increased to $342,000 in fiscal 2002 from
$152,000 in fiscal 2001, or an increase of 125%, professional fees increased to
$611,000 in fiscal 2002 from $285,000 in fiscal 2001, or an increase of 114%,
and sales shows and samples expenses increased to $389,000 in fiscal 2002 from
$88,000 in fiscal 2001, or an increase of 342%. These increased expenses were
all related to our sales growth in fiscal 2002.
38
Accessory
Innovo
Innovo's SG&A expenses increased to $2,854,000 in fiscal 2002 from
$1,441,000 fiscal 2001, or an increase of 98%. Innovo's increase in SG&A
expenses is largely attributable to expenses which were necessary to support or
associated with Innovo's increase in sales primarily attributable to its
Bongo(R) product. During fiscal 2002, Innovo's wages increased to $842,000 in
fiscal 2002 from $414,000 in fiscal 2001, or an increase of 103% as Innovo added
staff members at its headquarters in Knoxville and to its showroom in New York
City. Additionally, Innovo's wages increased as a result of the addition of
employees at Innovo's sourcing office IHK in Hong Kong. Innovo's commission
expense increased to $292,000 in fiscal 2002 to $126,000 in fiscal 2001 or an
increase of 132% during the period due to the increase in commission-based
sales.
Royalty expenses for fiscal 2002 increased by 215% to $270,000 primarily
due to royalty expense associated with the sales of Bongo(R) related products.
Innovo's distribution costs also increased by approximately 50% during fiscal
2002 because it distributed a greater amount of product.
Nasco Products International, Inc.
Our accessory business in the international marketplace had previously
been conducted through our subsidiary, Nasco Products International, Inc., or
NPII. NPII had international license rights for certain sports-related and
character-related trademarks. In fiscal 1999, NPII ceased operations in the
international accessory market. At such time, NPII was in disagreement with
certain licensors with respect to the terms and royalty commitments under the
license agreements. In 1999, NPII accrued $104,000 against the potential
liability associated with the agreements. For fiscal 2002, NPII reversed into
SG&A expense the accrual due to the fact there has not been material activity
with respect to the agreements over the last three fiscal years.
Apparel
Joe's
Joe's SG&A expenses increased to $3,245,000 in fiscal 2002 from $618,000
in fiscal 2001, or an increase of 425%. Joe's wage expense increased to
$1,140,000 during fiscal 2002 from $201,000 during fiscal 2001, or an increase
of 467%. Joe's wage expense was attributable to its increase in staff to support
Joe's growth. Joe's royalty and commission expenses increased to $981,000 in
fiscal 2002 from $197,000, or an increase of 398%, as a result of Joe's
increasing sales and royalties and commissions associated therewith. During
fiscal 2002, as part of Joe's marketing campaign, Joe's participated in numerous
sales shows and advertised the Joe's brand in national print publications. As a
result, Joe's sales show expense increased by 232% to $166,000 in fiscal 2002
and its advertising expenses increased by 294% to $264,000 in fiscal 2002
compared to fiscal 2001. Joe's factoring expense increased to $41,000 in fiscal
2002 from $8,000 in fiscal 2001, or an increase of 413%, in response to the
increase in the number of receivables Joe's factored. Joe's SG&A expenses for
fiscal 2002 also include the additional expense of $540,000 associated with the
operation of JJJ.
IAA
IAA's SG&A expenses increased to $761,000 in fiscal 2002 from $83,000 in
fiscal 2001, or an increase of 817%, because fiscal 2002 was IAA's first full
twelve-month business cycle. IAA's wage expense increased to $522,000 in fiscal
2002 from $80,000 in fiscal 2001, or an increase of 553%. IAA sales sample
expense increases to $46,000 in fiscal 2002 from no sales sample expense in
fiscal 2001. IAA's factor expense increased to $130,000 in fiscal 2002 as a
result of an increase in the amount of receivables IAA factored and an extra
factor fee charged to IAA for the factoring of one of IAA's significant
customers.
39
Other
IGI
IGI, which reflects our corporate expenses and operates under the "other"
segment, does not have sales. For fiscal 2002, IGI's expenses, excluding
interest, depreciation and amortization, increased to $1,375,000 for fiscal 2002
from $1,171,000 in fiscal 2001, or an increase of 17%. IGI had a large increase
in its professional fees and insurance expenses in fiscal 2002. IGI's
professional fees expense increased approximately 49% in fiscal 2002 compared to
fiscal 2001. The increase in professional fees is largely attributable to
additional legal and accounting fees. IGI's insurance expense increased by 22%
as a result of an increase in the cost of our Director and Officer insurance and
as a result of an increase in the cost of general liability insurance for our
growing operations. IGI's remaining expenses did not differ materially compared
to fiscal 2001.
IRI
During fiscal 2002, IRI had approximately $64,000 of professional fees,
which were represented in the SG&A under our "other" segment. These professional
fees were primarily associated with the formation of IRI and professional fees
necessary for the completion of the investments made by IRI during the period.
See "Business- Real Estate Transactions."
Depreciation and Amortization Expenses
Our depreciation and amortization expenses increased to $256,000 in fiscal
2002 from $167,000 in fiscal 2001, or an increase of 53%. The increase is
primarily attributable to IAA's amortization of the non-compete agreement
entered into in August 2001, pursuant to the terms of the knit acquisition. The
non-compete agreement has been valued at $250,000 and is being amortized over
two years, based upon the term of the agreement. IAA's amortization expense
increased to $120,000 in fiscal 2002 from $35,000 in fiscal 2001, or an increase
of 243%. See Note 3 "Acquisitions," in the Notes to the Consolidated Financials.
Our combined deprecation expense totaled $86,000 in fiscal 2002, with
Leasall's depreciation of the Springfield, Tennessee facility representing
$40,000 of the depreciation total. The remaining depreciation expense in fiscal
2002 is associated with the depreciation of small operational assets such as
furniture, fixtures, leasehold improvements, machinery and software.
Interest Expense
Our combined interest expense increased to $538,000 for fiscal 2002 from
$211,000 for fiscal 2001, or an increase of 155%. Our interest expense is
primarily attributable to our factoring and inventory lines of credit, the
promissory note issued in connection with the acquisition of the knit division
from Azteca and the promissory note associated with our former manufacturing
facility and headquarters in Springfield, Tennessee.
Accessory
Innovo
Innovo's interest expense increased to $140,000 in fiscal 2002 from
$32,000 in fiscal 2001, or an increase of 338%. This increase represents
interest expense incurred from borrowings under Innovo's factoring agreement and
inventory line of credit. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital Resources."
40
Apparel
Joe's
Joe's interest expense was $29,000 in fiscal 2002 because Joe's does not
factor all of its receivables and thus does not borrow against these receivables
under its factoring agreement. Joe's carries these receivables as "house
accounts." Joe's interest expense does include borrowings under its inventory
line of credit. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Liquidity and Capital Resources."
IAA
IAA's interest expense increased to $310,000 in fiscal 2002 compared to
fiscal 2001 or an increase of 377%. This increase is attributable to IAA
factoring a vast majority of its receivables and then borrowing funds against
these receivables. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital Resources."
Additionally, IAA's interest expense increased as a result of interest payments
associated with the promissory note issued as part of the purchase of the knit
division from Azteca and the creation of IAA. See Note 3, "Acquisitions" in the
Notes to Consolidated Financial Statements.
Other Income
Our "other income" decreased to $61,000 in fiscal 2002 from $81,000 in
fiscal 2001, or a decrease of 25%.
Leasall
Our decrease in "other income" in fiscal 2002 is largely attributable to a
$90,000 expense that our Leasall subsidiary incurred as a result of repair
expenses associated with our former manufacturing facility and headquarters in
Springfield, Tennessee. See "Business--Properties." During fiscal 2002,
Leasall's operational expenses did not change materially. Leaseall's main
operational expenses are maintenance and taxes. However, during the year,
Leasall made significant renovations to the Springfield facility that totaled
approximately $425,000, of which $335,000 was capitalized and $90,000 was
expensed during fiscal 2002. Leasall's operations are part of our "other"
segment of business.
IRI
"Other Income" in fiscal 2002 includes $173,000 of income from a
management fee the IRI receives pursuant to an investment that we made through
our IRI subsidiary in the second quarter of fiscal 2002. IRI, which operates
under our "other" business segment was formed during fiscal 2002 and thus did
not have operations during fiscal 2001. During fiscal 2002, IRI had
approximately $61,000 of professional fees which were represented in the SG&A
expense under our "other" segment. These professional fees were primarily
associated with the formation of IRI and professional fees necessary for the
completion of the investments made by IRI during the period. See "Business-Real
Estate Transactions."
The remaining other income is primarily associated with rental income
generated from tenants who are occupying our former manufacturing facility
located in Springfield, Tennessee.
Net Income
Our net income increased to $572,000 for fiscal 2002 from a net loss of
$618,000 in fiscal 2001. Our profitability in fiscal 2002 is attributable to a
significant increase in sales in fiscal 2002 compared sales to fiscal 2001 and
our ability to maintain our gross margins during fiscal 2002. While our expenses
increased in fiscal 2002, our gross profits offset the increase in revenues,
thus, resulting in net income for the period.
41
Liquidity and Capital Resources
Our primary sources of liquidity are cash flows from operations, trade
payables credit from vendors and related parties equity financings and
borrowings from the factoring of accounts receivables and borrowing against
inventory. Cash used for operating activities was $9,857,000 for fiscal 2003
compared to cash provided by operating activities of $1,504,000 for fiscal 2002.
During the period, we used cash to purchase inventory, extend credit to our
customers through accounts receivable, reduce related party payables and fund
operating expenses. Cash used in operating activities combined with cash used in
investing activities and repayment of debt was offset by cash generated through
a related party borrowing of $500,000, factor borrowings of $332,000 and the
proceeds from five equity issuances providing net proceeds of $17,540,000.
During fiscal 2003, we generated $7,026,000 of cash versus a use of cash of
$70,000 for fiscal 2002.
We are dependent on credit arrangements with suppliers and factoring-based
and inventory-based lines of credit agreements for working capital needs. From
time to time, we have obtained short-term working capital loans from senior
members of management and from members of the Board of Directors and have
conducted equity financing through private placements.
Our primary capital needs are for working capital to fund inventory
purchases and extensions of trade credit to our customers. During fiscal 2004,
we anticipate funding working capital through the following: (i) utilizing our
receivables and inventory based line of credit with CIT; (ii) utilizing trade
payables with our domestic and international suppliers; (iii) managing our
inventory levels; and (iv) reducing the trade credit we extend to our customers.
For fiscal 2003, we relied on the following primary sources to fund
operations:
- A financing and inventory based line of credit agreements with
CIT
- Cash balances
- Trade payables credit with our domestic and international
suppliers
- Trade payables credit from related parties
- Five equity financings through private placements
On June 1, 2001, our subsidiaries, Innovo and Joe's, entered into accounts
receivable factoring agreements with CIT which may be terminated with 60 days
notice by CIT, or on the anniversary date, by Innovo or Joe's. Under the terms
of the agreements, Innovo or Joe's has the option to factor receivables with CIT
on a non-recourse basis, provided that CIT approves the receivable in advance.
Innovo or Joe's may, at their option, also factor non-approved receivables on a
recourse basis. Innovo or Joe's continue to be obligated in the event of product
defects and other disputes, unrelated to the credit worthiness of the customer.
Innovo or Joe's has the ability to obtain advances against factored receivables
up to 85% of the face amount of the factored receivables. The agreement calls
for a 0.8% factoring fee on invoices factored with CIT and a per annum rate
equal to the greater of the Chase prime rate plus 0.25% or 6.5% on funds
borrowed against the factored receivables. On September 10, 2001, IAA entered
into a similar factoring agreement with CIT upon the same terms.
On or about August 20, 2002, our Innovo and Joe's subsidiaries each
entered into certain amendments to their respective factoring agreements, which
included inventory security agreements, to permit the subsidiaries to obtain
advances of up to 50% of the eligible inventory up to $400,000 each. According
to the terms of the agreements, amounts loaned against inventory are to bear an
interest rate equal to the greater of the Chase prime rate plus 0.75% or 6.5%
per annum.
On or about June 10, 2003, the existing financing facilities with CIT for
these subsidiaries were amended, to be effective as of April 11, 2003, primarily
to remove the fixed aggregate cap of $800,000 on their inventory security
agreement to allow for Innovo and Joe's to borrow up to 50% of the value of
certain eligible inventory
42
calculated on the basis of the lower of cost or market, with cost calculated on
a first-in-first out basis. In connection with these amendments, IAA, entered
into an inventory security agreement with CIT based on the same terms as Joe's
and Innovo. IAA did not previously have an inventory security agreement with
CIT. Under the factoring arrangements, we, through our subsidiaries, may borrow
up to 85% of the value of eligible factored receivables outstanding. The
factoring rate that we pay to CIT to factor accounts, on which CIT bears some or
all of the credit risk, was lowered to 0.4% and the interest rate associated
with borrowings under the inventory lines and factoring facility were reduced to
the Chase prime rate. We have also established a letter of credit facility with
CIT whereby we can open letters of credit for 0.125% of the face value with
international and domestic suppliers provided we have availability on our
inventory line of credit. In addition, we also may elect to factor our
receivables with CIT by utilizing an adjustment of the interest rate as set on a
case-by-case basis, whereby certain allocation of risk would be borne by us,
depending upon the interest rate adjustment. We record our account receivables
on the balance sheet net of receivables factored with CIT, since the factoring
of receivables is non-recourse to us. Further, in the event our loan balance
with CIT exceeds the face value of the receivables factored with CIT, we record
the difference between the face value of the factored receivables and the
outstanding loan balance as a liability on our balance sheet as "Due to Factor."
Cross guarantees were executed by and among the subsidiaries, Innovo, Joe's, and
IAA and we entered into a guarantee for our subsidiaries' obligations in
connection with the amendments to the existing credit facilities. Our loan
balance as of November 29, 2003 with CIT was $8,786,000 and we had $8,536,000 of
factored receivables with CIT as of November 29, 2003. As of November 29, 2003,
an aggregate amount of $2,149,000 of unused letter of credit was outstanding.
In connection with the agreements with CIT, certain assets are pledged to
CIT. The pledged assets include inventory, merchandise, and/or goods, including
raw materials through finished goods.
Based on our anticipated internal growth for the upcoming fiscal 2004, we
believe that we have the working capital resources necessary to meet the
operational needs associated with such growth in the next twelve months. For the
year ended November 29, 2003, we raised additional working capital through five
equity financings. We believe that with the net proceeds from the equity
financings and the amended financing agreements with CIT, we have addressed our
short-term working capital needs. See "Management's Discussion and Analysis on
Financial Results and Operational Conditions--Equity Financing" for a further
discussion of the equity financings that occurred in fiscal 2003.
However, if we grow beyond our current anticipated expectations, we
believe that it might be necessary to obtain additional working capital through
debt or equity financings. We believe that any additional capital, to the extent
needed, could be obtained from the sale of equity securities or short-term
working capital loans. There can be no assurance that this or other financings
will be available if needed. Our inability to fulfill any interim working
capital requirements would force us to constrict our operations. We believe that
the relatively moderate rate of inflation over the past few years has not had a
significant impact on our revenues or profitability.
Equity Financings
In fiscal 2003, we consummated five private placements of our common stock
to a limited number of "accredited investors" pursuant to Rule 506 of Regulation
D under the Securities Act of 1933, as amended (the "Securities Act"), resulting
in net proceeds of approximately $17,540,000 after all commissions and expenses
(including legal and accounting) to us. Our first private placement, completed
on March 19, 2003 to 17 accredited investors, raised net proceeds of
approximately $407,000 at $2.65 per share. Our second private placement,
completed on March 26, 2003 to 5 accredited investors, raised net proceeds of
approximately $156,000 at $2.65 per share. Our third private placement,
completed on July 1, 2003 to 34 accredited investors, raised net proceeds of
approximately $8,751,000 at $3.33 per share. Our fourth private placement was
completed on August 29, 2003 to 5 accredited investors, and raised net proceeds
of approximately $592,000 at $3.62 per share. Our fifth private placement was
completely funded on or before November 29, 2003, but was not completed until
December 1, 2003, to 14 accredited investors and raised net proceeds of
approximately $10,704,000 at $3.00 per share and warrants at $4.00 per share. We
issued 165,000 shares, or the I Shares, as a result of the first private
placement. Capital Wealth Management, LLC, or Capital Wealth, acted as the
placement agent on a best efforts basis for the first private placement. In
consideration of the services rendered by Capital Wealth, they were paid 7% of
the gross proceeds, plus expenses, for a total of approximately $31,000. We
issued 63,500 shares, or the II Shares, as a result of the
43
second private placement. Capital Wealth acted as the placement agent on a best
efforts basis for the second private placement. In consideration of the services
rendered by Capital Wealth, they were paid 7% of the gross proceeds, plus
expenses, for a total of approximately $12,000. We issued 2,835,481 shares, or
the III Shares, as a result of the third private placement. Sanders Morris
Harris, Inc., or SMH, acted as the placement agent on a best efforts basis for
the third private placement. In consideration of the services rendered by SMH,
SMH was paid 7% of the gross proceeds, plus expenses, for a total of $691,000,
and also received a five year warrant entitling SMH to purchase 300,000 shares
of common stock at $4.50 per share which is exercisable on January 1, 2004. We
issued 175,000 shares, or the IV Shares, as a result of the fourth private
placement. Pacific Summit Securities, Inc., or PSS, acted as the placement agent
on a best efforts basis for the fourth private placement. In consideration of
the services rendered by PSS, PSS was paid 6% of gross proceeds, plus expenses,
for a total of approximately $42,000, and also received a warrant entitling PSS
to purchase 17,500 shares of our common stock at $3.62 per share which is
exercisable on January 1, 2004. We issued 2,996,667 shares and warrants to
purchase an additional 599,333 shares of common stock to these certain investors
at $4.00 per share, or the V Shares, and together with the I Shares, the II
Shares, the III Shares and the IV Shares, we will refer to them as the 2003
Placement Shares. SunTrust Robinson Humphrey Capital Markets Division, or
SunTrust, acted as the placement agent on a best efforts basis for the fifth
private placement. In consideration of the services rendered by SunTrust,
SunTrust was paid 6% of gross proceeds, plus expenses, for a total of
approximately $683,000. Each of the warrants issued to SMH and PSS includes a
cashless exercise option, pursuant to which the holder thereof can exercise the
warrant without paying the exercise price in cash. If the holder elects to use
this cashless exercise option, it will receive a fewer number our shares than it
would have received if the exercise price were paid in cash. The number of
shares of common stock a holder of the warrant would receive in connection with
a cashless exercise is determined in accordance with a formula set forth in the
applicable warrant. We intend to use and have used the proceeds from the
transactions for general corporate purposes.
The buyers of the 2003 Placement Shares have represented to us that they
purchased the 2003 Placement Shares for their own account, with the intention of
holding the 2003 Placement Shares for investment and not with the intention of
participating, directly or indirectly, in any resale or distribution of the 2003
Placement Shares. The 2003 Placement Shares were offered and sold to the buyers
in reliance upon Regulation D, which provides an exemption from registration
under Section 4(2) of the 1933 Act. Each buyer has represented to us that he or
she is an "Accredited Investor," as that term is defined in Rule 501(a) of
Regulation D under said Act.
Short-Term Debt
Crossman Loan
On February 7, 2003 and on February 13, 2003, we entered into a loan
agreement with Marc Crossman, then a member of our board of directors and now
also our Chief Financial Officer. The loan was funded in two phases of $250,000
each on February 7, 2003 and February 13, 2003 for an aggregate loan value of
$500,000. In the event of default, each loan is collateralized by 125,000 shares
of our common stock as well as a general unsecured claim on our assets. Each
loan matures six months and one day from the date of its respective funding, at
which point the principal amount loaned and any unpaid accrued interest is due
and payable in full without demand. Each loan carries an 8% annualized interest
rate with interest payable in equal monthly installments. The loan may be repaid
by us at any time during the term of the loan without penalty. Further, prior to
the maturity of each loan and the original due dates, we elected, at our sole
option, to extend the term of each loan for an additional period of six months
and one day. Our disinterested directors approved each loan from Mr. Crossman.
Subsequent to the year ended November 29, 2003 and prior to the maturity of the
loans in February 2004, the parties agreed to extend the term of each loan for
an additional period of ninety days. Further, pursuant to the extension
amendments, Mr. Crossman has the sole and exclusive option to continue to extend
the terms of the loans for three additional ninety day periods by giving us
notice of such extension on or before the due dates of the loan.
As of November 29, 2003, we had a loan balance with CIT of $8,536,000 the
majority of which was collateralized against non- recourse factored receivables.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for further discussion of our
financing agreements with CIT.
44
Long-Term Debt
Long-term debt consists of the following (in thousands):
2003 2002
--------------------
First mortgage loan on Springfield property $ 476 $ 558
Promissory note to Azteca (Blue Concepts) 21,800 --
Promissory note to Azteca (Knit Div. Note 1) 68 786
Promissory note to Azteca (Knit Div. Note 2) -- 2,043
--------------------
Total long-term debt $ 22,344 $ 3,387
Less current maturities 168 756
--------------------
Total long-term debt $ 22,176 $ 2,631
====================
Springfield Property Loan
The first mortgage loan, held by First Independent Bank of Gallatin, is
collateralized by a first deed of trust on real property in Springfield,
Tennessee (with a carrying value of $1.2 million at November 29, 2003), and by
an assignment of key-man life insurance on our President, Pat Anderson, in the
amount of $1 million. The loan bears interest at 2.75% over the lender's prime
rate per annum and requires monthly principal and interest payments of $9,900
through February 2008. The loan is also guaranteed by the Small Business
Administration, or SBA. In exchange for the SBA guarantee, we, Innovo, Nasco
Products International, Inc., our wholly-owned subsidiary, and our President,
Pat Anderson, have also agreed to act as guarantors for the obligations under
the loan agreement.
Knit Acquisition Notes
In connection with the acquisition of the knit division from Azteca in
2001 (which, as noted below, is controlled by significant stockholders of ours,
Hubert and Paul Guez), we issued two promissory notes in the face amounts of
$1.0 million and $2.6 million, which bear interest at 8.0% per annum and require
monthly payments of $20,000 and $53,000, respectively. The notes have a
five-year term and are unsecured.
The $1.0 million note was subject to adjustment in the event that the
actual net sales of our newly formed knit division did not reach $10.0 million
during the 18-month term following the closing date of them Knit Acquisition.
The principal amount was to be reduced by an amount equal to the sum of $1.5
million less 10% of the net sales of our newly formed knit division during the
18 months following the closing date of the Acquisition. For the 18-month period
following the closing of the knit acquisition, nets sales for the knit division
exceeded the $10 million threshold.
Both notes state that, in the event that we determine, from time to time,
at the reasonable discretion of management, that our available funds are
insufficient to meet the needs of our business, we may elect to defer the
payment of principal due under the promissory notes for as many as six months in
any one year (but not more than three consecutive months) and as many as
eighteen months, in the aggregate, over the term of the notes. The term of the
notes will automatically be extended by one month for each month the principal
is deferred, and interest shall accrue accordingly.
At the election of Azteca, the balance of the promissory notes may be
offset against monies payable by Azteca or its affiliates to us for the exercise
of our issued and outstanding stock warrants that are owned by Azteca or its
affiliates (including the Commerce Investment Group) prior to the closing date
of the acquisition.
45
Blue Concept Acquisition Note
In connection with the purchase of the Blue Concept Division from Azteca,
IAA issued a seven-year convertible promissory note for $21.8 million, or the
Blue Concept Note. The Blue Concept Note bears interest at a rate of 6% and
requires payment of interest only during the first 24 months and then is fully
amortized over the remaining five-year period. The terms of the transaction
further allow us, upon shareholder approval which was obtained on March 5, 2004,
to convert a portion of the Blue Concept Note into equity through the issuance
of 3,125,000 shares of our common stock valued at $4.00 per share, or the
Conversion Price. Since shareholder approval has been obtained, the Blue Concept
Note has been reduced by an amount equal to the product of the Conversion Price
and 3,125,000, so long as the principal amount of the Blue Concept Note is not
reduced below $9.3 million and the shares issued pursuant to the conversion will
be subject to certain lock-up periods. Up to 1,041,667 additional shares may be
issued upon the occurrence of certain future contingencies relating to our stock
price for the 30 day period ending March 6, 2005.
In the event that sales of the Blue Concept Division fall below $70
million during the first 17 month period, or Period I, following the closing of
the acquisition, or $65 million during the 12 month period, or Period II
following Period I, certain terms of the APA allow for a reduction in the
purchase price through a decrease in the principal balance of the Blue Concept
Note and/or the return of certain locked-up shares of our common stock. In the
event the Blue Concept Note is reduced during Period I and the sales of the Blue
Concept Division in Period II are greater than $65 million, the Blue Concept
Note shall be increased by half of the amount greater than $65 million, but in
no event shall the Blue Concept Note be increased by an amount greater than the
decrease in Period I.
In the event the principal amount of the Blue Concept Note needs to be
reduced beyond the outstanding principal balance of such Blue Concept Note, then
an amount of the locked-up shares equal to the balance of the required reduction
shall be returned to us. For these purposes, the locked-up shares shall be
valued at $4.00 per share. Additionally, if during the 12 month period following
the closing, AEO is no longer a customer of IAA, the locked-up shares will be
returned to us, and any amount remaining on the balance of the Blue Concept Note
will be forgiven.
In the event the revenues of the Blue Concept Division decrease to $35
million or less during Period I or Period II, IAA shall have the right to sell
the purchased assets back to Azteca, and Azteca shall have the right to buy back
the purchased assets for the remaining balance of the Blue Concept Note and any
and all Locked Up Shares shall be returned to us.
The following table sets forth our contractual obligations and commercial
commitments as of November 29, 2003 (in thousands):
Contractual Obligations Payments Due by Period
---------------------------------------------------
Total Less than 1-3 years 4-5 years After
1 year 5 years
----------------------------------------------------------------------------------------------------
Long Term Debt 22,344 168 9,674 9,205 3,297
Operating Leases 2,812 616 1,479 717 --
Other Long Term Obligations-Minimum Royalties 3,322 832 2,490 -- --
46
Recent Acquisitions and Licenses
License Agreement for Fetish(TM) by Eve
On February 13, 2003, our IAA subsidiary entered into a 44 month exclusive
license agreement for the United States, its territories and possessions with
the recording artist and entertainer Eve for the license of the Fetish(TM) mark
for use with the production and distribution of apparel and accessory products.
We have guaranteed minimum net sales obligations of $8 million in the first 18
months of the agreement, $10 million in the following 12 month period and $12
million in the 12 month period following thereafter. According to the terms of
the agreement we are required to pay an eight percent royalty and a two percent
advertising fee on the nets sales of products bearing the Fetish(TM) logo. In
the event we do not meet the minimum guaranteed sales, we will be obligated to
make royalty and advertising payments equal to the minimum guaranteed sales
multiplied by the royalty rate of eight percent and the advertising fee of two
percent. We also have the right of first refusal with respect to the license
rights for the Fetish(TM) mark in the apparel and accessories category upon the
expiration of the agreement, subject to us meeting certain sales performance
targets during the term of the agreement. Additionally, we have the right of
first refusal for the apparel and accessory categories in territories in which
we do not currently have the license rights for the Fetish(TM) mark. We entered
into the license agreement of the Fetish mark because we believed it was strong
opportunity to expand and complimented our existing branded and accessory
business.
Itochu Distribution and License Agreement
On July 1, 2003, Joe's entered into a Master Distribution and Licensing
Agreement, or the Distribution and Licensing Agreement, with Itochu, pursuant to
which Itochu obtained certain manufacturing, licensing rights for the "Joe's"
and "Joe's Jeans" marks. The Distribution and Licensing Agreement grants Itochu
certain rights with respect to the manufacture, distribution, sale and/or
advertisement of certain Joe's apparel products, or Joe's Products, including,
but not limited to, (i) a non-exclusive right to use the Joe's and Joe's Jeans
marks in connection with the manufacture of certain licensed Joe's and Joe's
Jeans products, which we will refer to as the Licensed Products, throughout the
world, and an exclusive right to use the Joe's and Joe's Jeans marks to
manufacture the Licensed Products in Japan; and (ii) an exclusive right to
import and distribute certain imported Joe's Products, which we will refer to as
the Imported Products, into Japan. These Imported Products will be purchased
directly from Joe's, with Itochu being obligated to purchase a minimum of $5.75
million of Joe's over the 42 month term of the Agreement. Additionally, Itochu
shall have the right to develop, produce and distribute certain apparel products
bearing the Joe's and Joe's Jeans marks for which Joe 's shall receive a running
royalty payment for each contract year equal to the aggregate amount of six
percent of the net sales of all bottoms for both men and women of the Licensed
Products, and five percent of the net sales of all tops for both men and women
of the Licensed Products. As a part of the transaction, Itochu agreed to
purchase the existing inventory of JJJ for approximately $1 million, assume the
management and operations of JJJ's showroom in Tokyo and employ certain
employees of JJJ.
We will continue to operate JJJ until all operations have ceased,
including the fulfillment of existing purchase orders from customers and the
collection of all outstanding accounts receivables. Upon the cessation of all
operating activities, we intend to dissolve the JJJ subsidiary. We will continue
to sell product in Japan through its licensing and distribution agreement with
Itochu.
We believe that the Distribution and License Agreement with Itochu allows
us to more expediently grow the Joe's and Joe's Jeans brand and business in
Japan because Itochu, as a local Japanese corporation, is better suited to
market and distribute the Joe's and Joe's Jeans products in accordance with
cultural tastes and norms compared to JJJ which was controlled and operated out
of Los Angeles, California. We further believe that Itochu is well suited and
capable of developing additional products suited to the local environment, which
we will benefit from through additional royalty payments.
There exists no common ownership between us, our affiliates or
subsidiaries with Itochu, nor was compensation paid in the form of equity
securities for any portion of the Itochu transaction.
47
Blue Concept Division Acquisition
On July 17, 2003, IAA entered into an asset purchase agreement, or APA
with Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the division known
as the Blue Concept division, or the Blue Concept Division, of Azteca. The Blue
Concept Division sells primarily denim jeans to American Eagle Outfitters, Inc,
or AEO, a national retailer. Hubert Guez and Paul Guez, two of our substantial
stockholders and parties to the APA, together have a controlling interest in
Azteca. Based upon the Schedule 13D/A filed on March 9, 2004, Hubert Guez, Paul
Guez and their affiliates beneficially owned in the aggregate approximately
26.47% of our common stock on a fully diluted basis.
Pursuant to the terms of the APA, IAA paid $21.8 million for the Blue
Concept Division, subject to adjustment as noted below. Pursuant to the APA, IAA
employed all of the existing employees of the Blue Division but did not assume
any of the Blue Concept Division's or Azteca's existing liabilities. The
purchase price was paid through the issuance of a seven-year convertible
promissory note, or the Blue Concept Note. See "Management's Discussion &
Analysis--Long Term Debt" for further discussion of the terms of the Blue
Concept Note.
As part of the transaction, IAA and AZT International SA de CV, a Mexico
corporation and wholly-owned subsidiary of Azteca, or AZT, entered into a
two-year, renewable, non-exclusive supply agreement, or Supply Agreement, for
products to be sold by our Blue Concept Division. Under the terms of the Supply
Agreement, we have agreed to market and sell the products to be purchased from
AZT to certain of our customers, more particularly the customers of our Blue
Concept Division. In addition to the customary obligations, the Supply Agreement
requires that: (i) the we will submit written purchase orders to AZT on a
monthly basis specifying (x) the products to be supplied and (y) a specified
shipping date for products to be shipped; (ii) we will give AZT reasonable time
allowances upon placing its purchase orders with AZT prior to delivery of the
products by AZT; (iii) AZT will receive payment immediately upon receipt by us
of invoices for our purchase orders; (iv) we will have a guaranteed profit
margin on a "per unit" basis; and (v) the products to be supplied shall be
subject to quality control measures by us and by the customer of the Blue
Concept Division.
Management and the board of directors entered into the acquisition of the
Blue Concept Division for the following reasons: (i) the ability to enter into
an acquisition with a seller with which we have a long-standing relationship;
(ii) the ability to acquire a profitable business that has a financial history
of producing conservative profit margins with significant revenues; (iii) a
strong customer relationship with AEO; (iv) the manufacturing relationships to
produce products effectively and efficiently; and (v) the ability to acquire the
personnel and talent of a profitable business. Further, although there can be no
assurance the Blue Concept Division is expected to increase our revenue growth
and is expected to maintain positive cash flows. For the year ended November 29,
2003, our Blue Concept Division accounted for $27,760,000, or 33% of our net
revenue. Furthermore, the APA protects us if revenue expectations are not
realized by providing "downside" protections, such as guaranteed sales minimums,
and a buy-sell provision that allows for the sale of the business if revenues do
not reach $35 million. See "Management's Discussion & Analysis--Long Term Debt"
for further discussion of the above referenced "downside" protections.
As noted above, Azteca is controlled by our significant stockholders,
Hubert Guez and Paul Guez, brothers who were also individual parties to the
transaction.
Seasonality
Our business is seasonal. The majority of the marketing and sales
activities take place from late fall to early spring. The greatest volume of
shipments and sales are generally made from late spring through the summer,
which coincides with our second and third fiscal quarters and our cash flow is
strongest in its third and fourth fiscal quarters. Due to the seasonality of our
business, often our quarterly or yearly results are not necessarily indicative
of the results for the next quarter or year.
48
Management's Discussion of Critical Accounting Policies
We believe that the accounting policies discussed below are important to
an understanding of our financial statements because they require management to
exercise judgment and estimate the effects of uncertain matters in the
preparation and reporting of financial results. Accordingly, we caution that
these policies and the judgments and estimates they involve are subject to
revision and adjustment in the future. While they involve less judgment,
management believes that the other accounting policies discussed in Note 2 -
"Summary of Significant Accounting Polices" of the Consolidated Financial
Statements included in this Registration Statement on Form S-1 for the year
ended November 29, 2003 are also important to an understanding of our financial
statements. We believe the following critical accounting policies affect our
more significant judgments and estimates used in the preparation of our
consolidated financial statements.
Revenue Recognition
Revenues are recorded on the accrual basis of accounting when title
transfers to the customer, which is typically at the shipping point. Innovo
Group records estimated reductions to revenue for customer programs, including
co-op advertising, other advertising programs or allowances, based upon a
percentage of sales. Innovo Group also allows for returns based upon
pre-approval or in the case of damaged goods. Such returns are estimated and an
allowance is provided at the time of sale.
Accounts Receivable--Allowance for Returns, Discounts and Bad Debts
We evaluate our ability to collect on accounts receivable and charge-backs
(disputes from the customer) based upon a combination of factors. In
circumstances where we are aware of a specific customer's inability to meet its
financial obligations (e.g., bankruptcy filings, substantial downgrading of
credit sources), a specific reserve for bad debts is taken against amounts due
to reduce the net recognized receivable to the amount reasonably expected to be
collected. For all other customers, we recognize reserves for bad debts and
charge-backs based on our historical collection experience. If collection
experience deteriorates (i.e., an unexpected material adverse change in a major
customer's ability to meet its financial obligations to us ), the estimates of
the recoverability of amounts due us could be reduced by a material amount.
For the year ended November 29, 2003, the balance in the allowance for
returns, discounts and bad debts reserves was $2,158,000 compared to $383,000 at
November 30, 2002.
Inventory
We continually evaluate the composition of our inventories, assessing
slow-turning, ongoing product as well as product from prior seasons. Market
value of distressed inventory is valued based on historical sales trends of our
individual product lines, the impact of market trends and economic conditions,
and the value of current orders relating to the future sales of this type of
inventory. Significant changes in market values could cause us to record
additional inventory markdowns.
Valuation of Long-lived and Intangible Assets and Goodwill
We assess the impairment of identifiable intangibles, long-lived assets
and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include the following:
o a significant underperformance relative to expected historical or
projected future operating results;
o a significant change in the manner of the use of the acquired asset or the
strategy for the overall business; or
o a significant negative industry or economic trend.
49
When we determine that the carrying value of intangibles, long-lived assets
and goodwill may not be recoverable based upon the existence of one or more of
the above indicators of impairment, we will measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our
management. No impairment indicators existed as of November 29, 2003. Changes in
estimated cash flows or the discount rate assumptions in the future could
require us to record impairment charges for the assets.
Income Taxes
As part of the process of preparing our consolidated financial statements,
management is required to estimate income taxes in each of the jurisdictions in
which we operate. The process involves estimating actual current tax expense
along with assessing temporary differences resulting from differing treatment of
items for book and tax purposes. These timing differences result in deferred tax
assets and liabilities, which are included in our consolidated balance sheet.
Management records a valuation allowance to reduce its deferred tax assets to
the amount that is more likely than not to be realized. Management has
considered future taxable income and ongoing tax planning strategies in
assessing the need for the valuation allowance. Increases in the valuation
allowance result in additional expense to be reflected within the tax provision
in the consolidated statement of income. Reserves are also estimated for ongoing
audits regarding Federal, state and international issues that are currently
unresolved. We routinely monitor the potential impact of these situations and
believe that it is properly reserved.
Contingencies
We account for contingencies in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies". SFAS No. 5
requires that we record an estimated loss from a loss contingency when
information available prior to issuance of our financial statements indicates
that it is probable that an asset has been impaired or a liability has been
incurred at the date of the financial statements and the amount of the loss can
be reasonably estimated. Accounting for contingencies such as legal and income
tax matters requires management to use judgment. Many of these legal and tax
contingencies can take years to be resolved. Generally, as the time period
increases over which the uncertainties are resolved, the likelihood of changes
to the estimate of the ultimate outcome increases. Management believes that the
accruals for these matters are adequate. Should events or circumstances change,
we could have to record additional accruals.
Recently Issued Financial Accounting Standard
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. This Statement is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003 and is not expected to have a material impact on Innovo
Groups' consolidated results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. In particular, SFAS No. 149 clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a derivative
and when a derivative contains a financing component that warrants special
reporting in the statement of cash flows. SFAS No. 149 is generally effective
for contracts entered into or modified after June 30, 2003 and is not expected
to have a material impact on Innovo Group's consolidated results of operations
or financial position.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities." FIN 46 requires companies to
evaluate variable interest entities to determine whether to apply the
consolidation provisions of FIN 46 to those entities. Companies must apply FIN
46 to entities created after January 31, 2003, and to variable interest entities
in which a company obtains an interest after that date. It applies in the first
fiscal year or interim period endings after December 15, 2003, to variable
interest entities in which a company holds
50
a variable interest that it acquired before February 1, 2003. Adoption of FIN 46
is not expected to have a material impact on Innovo Group's consolidated results
of operations or financial position.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks arising from transactions in the
normal course of our business, and from debt incurred in connection with the
knit acquisition and the acquisition of the Blue Concept Division form Azteca we
have made. See Note 3 "Acquisitions" in the Notes to the Consolidated Financial
Statements. Such risk is principally associated with interest rate and foreign
exchange fluctuations, as well as changes in our credit standing.
Interest Rate Risk
Our long-term debt bears a fixed interest rate. However, because our
obligation under our receivable and inventory financing agreements bear interest
at floating rates (primarily JP Morgan Chase prime rate), we are sensitive to
changes in prevailing interest rates. A 10% increase or decrease in market
interest rates that affect our financial instruments would have a immaterial
impact on earning or cash flows during the next fiscal year.
Foreign Currency Exchange Rates
Foreign currency exposures arise from transactions, including firm
commitments and anticipated contracts, denominated in a currency other than an
entity's functional currency, and from foreign-denominated revenues translated
into U.S. dollars. Our primary foreign currency exposures relate to the Joe's
Jeans Japan subsidiary and resulting Yen Investments. We believe that a 10%
adverse change in the Yen rate with respect to the US dollar would not have a
material impact on earning or cash flows during the next fiscal year because of
the relatively small size of the subsidiary compared to the rest of us.
We generally purchase our products in U.S. dollars. However, we source
most of our products overseas and, as such, the cost of these products may be
affected by changes in the value of the relevant currencies. Changes in currency
exchange rates may also affect the relative prices at which we and our foreign
competitors sell products in the same market. We currently do not hedge our
exposure to changes in foreign currency exchange rates. We cannot assure you
that foreign currency fluctuations will not have a material adverse impact on
our financial condition and results of operations.
Manufacturing and Distribution Relationships
We purchase a significant portion of finished goods and obtain certain
warehousing and distribution services from Commerce and its affiliates and
obtain credit terms which we believe are favorable. The loss of Commerce as a
vendor, or material changes to the terms, could have an adverse impact on our
business. Commerce and its affiliates are controlled by two of our significant
stockholders, Hubert Guez and Paul Guez.
Our products are manufactured by contractors located in Los Angeles,
Mexico and/or Asia, including, Hong Kong, China, Korea, Vietnam and India. The
products are then distributed out of Los Angeles or directly from the factory to
the customer. For the year ended 2003, 22% of our apparel and accessory products
were manufactured outside of North America. The rest of our accessory and
apparel products were manufactured in the United States (21%) and Mexico (57%).
All of our products manufactured in Mexico are manufactured by an affiliate of
Commerce, Azteca or its affiliates.
51
BUSINESS
Overview
Our principal business activity involves the design, development and
worldwide marketing of high quality consumer products for the apparel and
accessory markets. We do not manufacture any apparel or accessory products but
outsource the manufacturing to third parties. We sell our products to a large
number of different retail, distributors and private label customers around the
world. Retail customers and distributors purchase finished goods directly from
us. Retail customers then sell the product through their retail stores and
distributors sell our products to retailers in the international market place.
Private label customers outsource the production and sourcing of their private
label products to us and then sell through their own distribution channels.
Private label customers are generally retail chains who desire to sell apparel
and accessory products under their own brand name. We work with our private
label customers to create their own brand image by custom designing products. In
creating a unique brand, our private label customers may provide samples to us
or may select styles already available in our showrooms. We believe we have
established a reputation among these private label buyers for the ability to
arrange for the manufacture of apparel and accessory products on a reliable,
expeditious and cost-effective basis. Our branded label products, which include
accessories and apparel, are designed, developed and marketed by us internally
pursuant to the license agreement under which we have licensed the brand and/or
mark. We then outsource the manufacturing and distribution of the branded
products. We sell our branded products to the retail customers or distributors.
We are then obligated to pay a certain percentage of royalties on our net sales
of the branded products to the licensor. We believe that we have established a
reputation for our ability to produce a quality branded product in the
marketplace.
We operate our consumer products business through three wholly-owned,
operating subsidiaries, Innovo, Inc., or Innovo, Joe's Jeans, Inc., or Joe's,
and Innovo Azteca Apparel, Inc., or IAA. Our products are currently manufactured
by independent contractors located in Los Angeles, California, Mexico and Asia,
including, Hong Kong, China, Korea, Vietnam and India. The products are then
distributed out of our warehouse facilities located in Los Angeles or directly
from the factory to the customer. For the fiscal year ended November 29, 2003,
or fiscal 2003, approximately 22% of our apparel and accessory products were
manufactured outside of North America. The rest of our accessory and apparel
products for fiscal 2003 were manufactured in the United States (approximately
21%) and Mexico (approximately 57%). All of our products manufactured in Mexico
are manufactured by Azteca Productions International, Inc., or Azteca, and/or
its affiliates, as discussed below. Azteca is controlled by two of our
significant stockholders, Hubert Guez and Paul Guez.
Our operations are comprised of two reportable segments: apparel and
accessory, with the operations of our Joe's and IAA subsidiaries representing
the apparel segment and our Innovo subsidiary conducting business in the
accessory segment. Segment revenues are generated from the sale of consumer
products by Joe's, IAA and Innovo. Our corporate activities are represented by
the operations of Innovo Group Inc., our parent company, or IGI, and our real
estate operations are conducted through our wholly-owned subsidiaries, Leasall
Management, Inc., or Leasall, and Innovo Realty, Inc., or IRI. Our real estate
operations do not currently require a substantial allocation of our resources
and are not a significant part of our management's daily operational functions.
Thus, our real estate operations are not currently defined as a distinct
operating segment, but are classified as "other" along with our other corporate
activities.
Strategic Relationship with two of our significant stockholders, Hubert Guez and
Paul Guez, and affiliated companies
Beginning in the summer of 2000, we entered into a series of transactions
with two of our significant stockholders, Hubert Guez and Paul Guez, and their
affiliated companies, such as Azteca and/or Commerce Investment Group LLC, or
Commerce. The Guez brothers and their affiliated companies have in the aggregate
more than 50 years of experience in the apparel industry with a specialty in
denim apparel and related products. As discussed in greater detail below, our
strategic relationship with the Guez brothers and their affiliated companies has
had many tangible benefits for us.
Our relationship with the Guez brothers began in the summer of 2000, when
the Guez brothers through their affiliated company, Commerce, which the Guez
brothers control, invested in our company. Pursuant to a stock
52
and warrant purchase agreement, Commerce acquired 2,863,637 shares of our common
stock and 3,300,000 common stock purchase warrants. An investor rights agreement
also provides Commerce with a contractual right to nominate three individuals to
our board of directors. Commerce has not exercised this right at this time.
Based on a Schedule 13D/A filed by Commerce, the Guez brothers and their
affiliates with the Securities and Exchange Commission on March 9, 2004,
Commerce, the Guez brothers and their affiliates beneficially own in the
aggregate approximately 26.47% of our common stock.
As part of Commerce's equity investment in our company, we entered into
several other arrangements with Commerce in order to reduce our manufacturing
and distribution costs and to increase the effectiveness and capacity of our
distribution network. Pursuant to a supply agreement and a distribution
agreement with Commerce, we agreed to purchase all of our accessory products,
which at the time primarily consisted of denim tote bags and aprons, from
Commerce and to have Commerce distribute these products out of its Los Angeles
distribution facility. Commerce manufactures our accessory products out of its
facilities located in Mexico. These agreements were renewed in August 2002 for
an additional two year term and are automatically renewed for additional two
year terms unless terminated by either party with 90 days notice. See "Note 1 -
Business Description - Restructuring of Operations" in the Notes to Consolidated
Financial Statements for a further discussion of the equity investment by and
the terms of the supply and distribution agreements with Commerce.
The strategic relationship entered into with Commerce allowed us to close
our domestic manufacturing and distribution facilities and to move forward with
diversifying our product mix and offerings to include apparel products as
opposed to only accessory products. In an effort to enter into the apparel
market quickly and efficiently we, through IAA, acquired Azteca's knit apparel
division in August 2001 in exchange for 700,000 shares of our common stock and
promissory notes in the amount of $3.6 million. See "Note 3 - Acquisitions -
Azteca Production International, Inc. Knit Division" in the Notes to
Consolidated Financial Statements for a further discussion of this acquisition.
In February 2001, we continued to expand our apparel business by acquiring
a ten-year license for the "Joe's" and "Joe's Jean's" brands from JD Design, LLC
and forming our Joe's subsidiary. See "Business - License Agreements and
Intellectual Property" for a further discussion of this license agreement. Joe's
has exploited this license agreement by creating, designing and marketing
high-end denim apparel products. Our strategic relationship with the Guez
brothers allowed us to quickly and efficiently exploit this license and enter
into the denim apparel market by outsourcing the manufacture and distribution of
the denim apparel products created pursuant to the license to Commerce and its
affiliates.
During fiscal 2001 and 2002, the combined accessory and denim apparel
products purchased from and other services provided by Commerce and/or its
affiliates were approximately $5.7 million and $16.0 million, respectively, or
90% and 80%, respectively, of our manufacturing and distribution costs for such
periods. During fiscal 2003, our dependence on Commerce and its affiliates
decreased for these services but still constituted 68% of our manufacturing and
distribution costs for fiscal 2003, or approximately $47.9 million of accessory,
craft and denim apparel products from and other services provided by Commerce
and/or its affiliates. While we now use additional suppliers to meet our needs,
we intend to continue to take advantage of Commerce's expertise with denim
products so long as we believe it is in our best interest.
On July 17, 2003, we, through IAA, entered into an asset purchase
agreement, or Blue Concept APA, with Azteca and the Guez brothers. Pursuant to
the Blue Concept APA, we acquired Azteca's Blue Concept division, or the Blue
Concept Division, for a $21.8 million seven-year convertible promissory note,
subject to adjustment, or Blue Concept Note. See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations - Recent Acquisitions
and Licenses and - Long Term Debt" and "Note 9 - Long Term Debt - Promissory
Note to Azteca in connection with Blue Concept Division Acquisition" in the
Notes to Consolidated Financial Statement" for a further discussion of certain
terms of this acquisition and the Blue Concept Note. In accordance with the APA
and Nasdaq rules, we conducted a special stockholders meeting on March 5, 2004,
to approve the conversion of approximately $12.5 million of the Blue Concept
Note into a maximum of 4,166,667 shares of our common stock. The conversion was
approved by our stockholders and as a result, Azteca and the Guez brothers were
initially issued 3,125,000 shares of our common stock with the possible issuance
of up to 1,041,667 additional shares of common stock upon the occurrence of
certain contingencies as described in the Blue Concept APA. In addition, as part
of the transaction, we entered into another supply agreement with an Azteca
53
affiliate to purchase products to be sold by our Blue Concept Division. See
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of
certain terms of this supply agreement.
We have continued to expand our denim product mix by entering into an
assignment with Blue Concept LLC, which is controlled by Paul Guez, for all the
rights benefits and obligations of a license agreement between Blue Concept LLC
and B.J. Vines, Inc., the owner of the Betsey Johnson(R) brand, for exclusive
right to design, market and distribute women's jeans and coordinating denim
related apparel, such as t-shirts and tops under the Betsey Johnson(R) brand
name in the United States, its territories and possessions, and Canada. We did
not compensate Paul Guez for this assignment.
During fiscal 2003, we moved our headquarters and principal executive
offices from 5900 S. Eastern Avenue, Suite 120, Commerce, California 90040 to
5804 East Slauson Avenue, Commerce, California 90040. The 5804 East Slauson
Avenue space is utilized under a verbal agreement with Azteca, pursuant to which
we pay to Azteca a fee for allocated expenses associated with our use of office
and warehouse space and expenses incurred in connection with maintaining such
office and warehouse space. These allocated expenses include, but are not
limited to: rent, security, office supplies, machine leases and utilities. In
addition, we have verbal agreements with Azteca and/or its affiliates regarding
the supply and distribution of other apparel products we sell.
Other Third Party Manufacturers
As discussed above, historically, we have primarily used Commerce and its
affiliates for our manufacturing needs. In fiscal 2003, we significantly
diversified our apparel products to include a wider array of products,
including, but not limited to, denim products. These non-denim products,
however, including some denim products, are purchased from third party
independent suppliers, including, Commerce and/or its affiliates. While we now
use numerous suppliers to meet our needs, we intend to continue to take
advantage of Commerce's and its affiliate's expertise with denim products if it
is in our best interest.
Headquarters
As discussed above, our headquarters and principal executive offices are
located at 5804 East Slauson Avenue, Commerce, California 90040 and our
telephone number at this location is (323) 725-5516. We also have operational
offices and/or showrooms in Los Angeles, New York, Knoxville, and Hong Kong and
third party showrooms in New York, Los Angeles, Tokyo and Paris.
General Development of Business
Innovo, a Texas corporation, was formed in April 1987 to manufacture and
domestically distribute cut and sewn canvas and nylon consumer products for the
utility, craft, sports licensed and advertising specialty markets. In 1990,
Innovo merged into Elorac Corporation, a "blank check" company, which was
renamed Innovo Group Inc., a Delaware corporation.
In 1991, we acquired the business of NASCO, Inc., or NASCO, a Tennessee
corporation, a manufacturer, importer and distributor of sports-licensed sports
bags, backpacks, and other sporting goods, located in Springfield, Tennessee.
NASCO, subsequently renamed Spirco, Inc., or Spirco, was also engaged in the
marketing of fundraising programs to school and youth organizations. The
fundraising programs involved the sale of magazines, gift wraps, food items and
seasonal gift items.
In 1992, we formed NASCO Products International, Inc., or NPII, a
Tennessee corporation. NPII was formed to focus on the distribution of Innovo
Group's accessory products in the international marketplace. NPII does not
currently have any business activities and we are in the process of dissolving
NPII.
In 1993, we sold the youth and school fundraising business of Spirco to
QSP, Inc. During its fiscal year ending 1992, Spirco had incurred significant
trade debt from the losses it incurred in marketing fundraising programs and
from liabilities incurred by NASCO prior to its acquisition by us that were not
disclosed at that time. On August 27, 1993, Spirco filed for reorganization
under Chapter 11 of the U.S. Bankruptcy Code. Neither we, nor
54
Innovo, nor NPII were a party to such bankruptcy filing by Spirco. Spirco's plan
of reorganization was confirmed by the court on August 5, 1994, and became
effective on November 7, 1994.
In 1994, we formed Leasall, a Tennessee corporation. Leasall acquired
Spirco's equipment and plant and assumed the related equipment and mortgage
debt. Leasall still owns and leases to third parties the plant purchased from
Spirco, which served as our former headquarters in Springfield, Tennessee.
Subsequent to the bankruptcy reorganization, we merged Spirco into us. This
merger resulted in us acquiring direct ownership in the remaining assets of
Spirco that Leasall did not purchase. The Spirco claims, which we had
guaranteed, received full payment through the issuance of shares of our common
stock.
In the latter part of 1998, we closed our domestic manufacturing and
distribution facilities in Springfield, Tennessee and relocated our corporate
headquarters, manufacturing and distribution facilities to Knoxville, Tennessee.
We closed the Springfield facility based on our need for a more suitable
facility for our manufacturing needs as well as our need, at that particular
time, for a more skilled labor force to meet our production requirements.
Additionally, in 1998, we brought in additional investors and new management,
and these individuals resided in Knoxville, Tennessee.
During fiscal 2000, we restructured our operations by closing our domestic
manufacturing and distribution facilities in Knoxville, Tennessee and realigning
our operational structure to focus on sales and marketing. We also raised
additional working capital and converted certain indebtedness into equity. The
restructuring was undertaken as a condition to the equity investment by
Commerce. In an effort to reduce product costs and increase gross profit, we
shifted our manufacturing to third-party foreign manufacturers, a majority of
which included Commerce's affiliates, and outsourced our distribution to
Commerce's affiliates in an effort to increase the effectiveness and capacity of
our distribution network. See "Business - Strategic Relationship with two of our
significant stockholders, Hubert Guez and Paul Guez, and affiliated companies"
and "Note 1 - Business Description - Restructuring of Operations" in our Notes
to Consolidated Financial Statements for a further discussion of our
relationship with the Guez brothers and the equity investment by and the terms
of the supply and distribution agreements with Commerce.
In February of 2001, we acquired from JD Design LLC, or JD Design, the
license rights to the JD logo and the Joe's Jeans(R) mark for all apparel and
accessory products. In connection with this acquisition, in March of 2001, we
formed Joe's Jeans, Inc., or Joe's, a Delaware corporation, to focus on the
design, production and worldwide marketing of high fashion apparel products
bearing the "Joe's Jeans" brand. See "Note 3 - Acquisitions - Joe's Jeans
License" in the Notes to the Consolidated Financial Statements.
In August of 2001, we, through our newly formed wholly-owned subsidiary,
IAA, acquired Azteca's knit apparel division in order to enter into the apparel
and design business for the private label and retail market. See "Note 3 -
Acquisitions - Azteca Productions International, Inc. Knit Division" in the
Notes to the Consolidated Financial Statements.
In April 2002, we, through our newly formed wholly-owned subsidiary, IRI,
to facilitate the purchase of limited partnership interests, which limited
partnerships were investing in real estate apartment complexes located
throughout the United States. See "Business-Real Estate Transactions" for a
further discussion of IRI's limited partnership interests.
In May 2002, Joe's formed Joe's Jeans Japan, Inc., or JJJ, a Japanese
corporation, to facilitate the distribution of the Joe's(R) and Joe's Jeans(R)
brand in Japan. On July 1, 2003, Joe's entered into a Master Distribution and
Licensing Agreement, or Distribution and Licensing Agreement, with Itochu
Corporation, or Itochu, pursuant to which Itochu obtained certain manufacturing
and licensing rights for the Joe's(R) and Joe's Jeans(R) marks. See "Business
-License Agreements and Intellectual Property" for a further discussion of the
Distribution and Licensing Agreement with Itochu.
Additionally, in May 2002, Innovo formed Innovo Hong Kong Limited, or IHK,
a Hong Kong corporation. IHK was formed to assist our accessory division with
the design, development and sourcing of accessory products out of East Asia. IHK
also acts as the overseas base for apparel sourcing by virtue of its location in
Hong Kong.
55
On August 1, 2002, IAA entered into an exclusive 42-month worldwide
agreement for the Bow Wow license, granting IAA the right to produce and market
products bearing the mark and likeness of the popular stage and screen
performer, Bow Wow, formerly known as Lil' Bow Wow. See "Business -License
Agreements and Intellectual Property" for a further discussion of the Bow Wow
License.
On February 13, 2003, IAA entered into a 44 month exclusive license
agreement for the United States, its territories and possessions with the
recording artist and entertainer Eve for the license of the Fetish(TM) mark for
use with the production and distribution of apparel and accessory products. See
"Business -License Agreements and Intellectual Property" for a further
discussion of the Fetish(TM) license.
On July 17, 2003, IAA entered into the Blue Concept APA, with Azteca,
Hubert Guez and Paul Guez, whereby IAA acquired the Blue Concept Division from
Azteca. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations - Recent Acquisitions and Licenses" and "Management's
Discussion and Analysis of Financial Conditions and Results of Operations - Long
Term Debt" for further discussion of the terms of the acquisition of the Blue
Concept Division from Azteca.
During fiscal 2003, we consummated five private placements of our common
stock resulting in net proceeds of approximately $17,540,000 after deducting
commissions. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations - Equity Financings" and Item 5 "Market for
Registrant's Common Equity and Related Stockholder Matters" for a further
discussion of the terms of our equity financings.
Due to our growth during the past three years, in addition to the five
private placements of our common stock discussed above, we entered into a series
of transactions to provide us with additional working capital. On June 1, 2001
and September 10, 2001, we, through our three main operating subsidiaries,
Joe's, Innovo, and IAA, entered into a financing agreement with CIT Commercial
Services, a unit of CIT Group, Inc., or CIT for the factoring of our account
receivables. In August 2002, Joe's and Innovo entered into inventory and
security agreements with CIT which established inventory based lines of credit
for Joe's and Innovo. As a result of the need for additional working capital, on
or about June 10, 2003, we amended our existing financing facilities, to be
effective as of April 11, 2003, with CIT. We have also established a letter of
credit facility with CIT. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" for
further discussion of our financing agreements with CIT.
Summary of Significant Fiscal 2003 Developments
General Overview
Our net sales increased to $83,129,000 in fiscal 2003 from $29,609,000 in
fiscal 2002, or a 181% increase. This increase is primarily attributable to the
following factors: (i) first time sales of our Fetish(TM) and Shago(R) branded
products; (ii) sales generated from the Blue Concept Division that we acquired
in July 2003; and (iii) continued growth in the developing, sourcing and
distributing of our existing products, such as Joe's Jeans, to new and existing
customers. Our significant net sales increase of 181% was substantially offset
by the initial expenses incurred for this growth, such as: (i) wages from new
hiring needs to support the development of the Fetish(TM) by Eve and Shago(R) by
Bow Wow lines; (ii) increased payroll expenses from the employees we absorbed in
connection with the Blue Concept Division acquisition; (iii) excess inventory
purchased for Fetish(TM) and Shago(R) products; and (iv) inventory writedowns
within Joe's and Innovo caused by operational and distribution inefficiencies.
As a result of these and other costs, as well as the necessity to write off
excess inventory, the result was a net loss of $8,255,000 for fiscal 2003. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a discussion of our financial performance in fiscal 2003.
Accessory
During fiscal 2003, Innovo, which is responsible for our accessory
products, grew its business significantly compared to fiscal 2002. The growth is
a result of Innovo's increased private label and craft sales, initial
distribution of our Fetish(TM) brand of accessories in November 2003. Prior to
fiscal 2002, Innovo did not produce fashion accessory products for the private
label market. In fiscal 2003, Innovo experienced an increase in net sales to
$14,026,000 in fiscal 2003 from $12,072,000 in fiscal 2002, or a 16% increase.
See "Management's Discussion and
56
Analysis of Financial Condition and Results of Operations" for further
discussion of Innovo's financial performance for fiscal 2003.
Apparel
Joe's
During fiscal 2003, Joe's continued to establish domestic and
international brand recognition in the high-end fashion apparel industry. In
fiscal 2003, sales of Joe's products increased to $11,476,000 in fiscal 2003
from $9,179,000 in fiscal 2002, or a 25% increase. On July 1, 2003, Joe's
entered into a Distribution and Licensing Agreement with Itochu pursuant to
which Itochu obtained certain manufacturing and licensing rights for the
Joe's(R) and Joe's Jeans(R) marks. As a part of the transaction, Itochu agreed
to purchase the existing inventory of JJJ for approximately $1 million, assume
the management and operations of JJJ's showroom in Tokyo and employ certain
employees of JJJ. As of November 29, 2003, we continued to operate JJJ and will
continue to do so until all operations have ceased. Upon the cessation of all
operating activities, we intend to dissolve the JJJ subsidiary. We will continue
to sell product in Japan through the Distribution and Licensing Agreement with
Itochu. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations - Recent Acquisitions and Licenses." See "Management's
Discussion and Analysis of Financial Conditions and Results of Operations" for
further discussion of Joe's financial performance for fiscal 2003.
IAA
IAA increased its sales to $57,627,000 in fiscal 2003 from $8,358,000 in fiscal
2002, or a 589% increase. The growth is primarily a result of an increase in
revenues from IAA's private label division and in part from first time sales of
Shago(R) and Fetish(TM) apparel products. See "Business - License Agreements and
Intellectual Property" for a further discussion of our license agreements with
Bravado International, Inc. for Shago(R) which we entered into in October 2002,
and with Blondie Rockwell, Inc. for Fetish(TM) which we entered into in February
2003. A substantial amount of the increase in the revenue from our private label
business was a result of our sales subsequent to our acquisition of the Blue
Concept Division by IAA. See "Management's Discussion and Analysis of Financial
Conditions and Results of Operations - Recent Acquisitions and Licenses.
Additionally, on July 17, 2003, our IAA subsidiary entered into an APA with
Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the Blue Concept
Division from Azteca. Pursuant to the terms of the APA, IAA paid $21.8 million
for the Blue Concept Division, subject to adjustment as discussed further in
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for a further discussion of the
acquisition of the Blue Concept Division from Azteca. The purchase price was
paid through the issuance of the Blue Concept Note which is a seven-year
convertible promissory note. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations - Long Term Debt" for further
discussion of the terms of the Blue Concept Note. Also, see "Management's
Discussion and Analysis of Financial Conditions and Results of Operations" for
further discussion of IAA's financial performance for fiscal 2003.
Principal Products and Revenue Sources
Our products are created and our revenues are derived through sales from
our Innovo, IAA, and Joe's subsidiaries in the accessory segment and apparel
segment, respectively.
Our net sales by segment for the last three years are shown in the table
below:
2003 2002 2001
-------------------------------
Accessories 17% 41% 61%
Apparel 83% 59% 39%
-------------------------------
Total 100% 100% 100%
===============================
57
Accessory
Innovo
Innovo, headquartered in Knoxville, Tennessee, designs, develops and
markets accessory consumer products such as fashion handbags, purses, wallets,
backpacks, duffle bags, sports bags, belts, hats and scarves for department
stores, mass merchandisers, specialty chain stores and private label customers.
Additionally, Innovo markets craft products including tote bags and aprons to
mass merchandisers and craft specialty stores. Innovo's products generally are
accompanied by one of Innovo's own logos such as Daily Denim(TM), Dragon Fly
Denim(TM), Clear Gear(TM), Friendship(TM) and Tote Works(TM), the brand of a
private label customer, or the brand of a third party licensor such as Bongo(R),
Shago(R) and Fetish(TM). Innovo's net sales in the accessory segment increased
to $14,026,000 in fiscal 2003 from $12,072,000 for fiscal 2002, or a 16%
increase. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Net Sales" for a further discussion of Innovo's sales in
the accessory segment.
In fiscal 2002, Innovo entered the private label accessory business. As of
November 29, 2003, Innovo produced private label products primarily for American
Eagle Outfitters, Inc. and Limited Brands, Inc.'s Express division. Private
label business accounted for approximately 35% of Innovo's net sales in fiscal
2003 compared to 27% in fiscal 2002. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" for a further discussion of
Innovo's accessory sales. Innovo anticipates continued growth in the private
label market as a result of Innovo's ability to provide quality accessory
products that are fashionably desirable at competitive prices; however, there
can be no assurances that Innovo will be able to increase its market share in
the private label business.
While Innovo initially obtained the license rights to the Bongo(R) mark in
the second quarter of fiscal 2001, in November 2002, Innovo solidified and
extended its relationship with the owner of the Bongo(R) brand, by signing a
four-year license agreement with IP Holdings LLC for the Bongo(R) mark. The
agreement gives Innovo multi-year extension options based on certain performance
criteria for the bag and small pvc/leather goods categories. See "Business -
License Agreements and Intellectual Property" for a further discussion of the
License Agreement for the Bongo (R) mark. Since that time, Innovo has launched
the Bongo(R) line to department stores and specialty stores across the United
States, including Sears, Roebuck and Co., Beall's, Inc., Hecht's, Foley's, and
Robinsons-May. In fiscal 2003, Innovo's Bongo(R) accessory product line
experienced growing demand in the retail marketplace. Gross sales associated
with the Bongo(R) product line continued to grow significantly in fiscal 2003
and represented approximately 21% of Innovo's total gross sales for fiscal 2003.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Net Sales" for a further discussion of Innovo's net sales for its
Bongo(R) product line.
Innovo's IHK subsidiary is headquartered in Hong Kong and assists Innovo
with the development, design and sourcing of the products sold by Innovo to its
customers. IHK allows Innovo to minimize the amount of time required to design,
develop and source its products, thus allowing Innovo to react quickly to
changing markets conditions and to deliver its products in a timely manner.
In addition, in fiscal 2003, as part of our license agreement for the
license of the Fetish(TM) brand, our Innovo subsidiary produced Fetish(TM)
branded accessories such as purses and wallets. The Fetish(TM) branded
accessories accounted for a small percentage of Innovo's overall net sales in
fiscal 2003. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations - Net Sales" for a further discussion regarding sales
associated with Fetish(TM) products. See "Business - License Agreements and
Intellectual Property" for further discussion of this license agreement.
In fiscal 2003, Innovo experienced increased demand for its craft product
lines due to Innovo's ability to increase its business with its existing
customers such as Wal-Mart, Michaels Stores, Inc., A.C. Moore Arts & Crafts and
added an additional customer, Hobby Lobby. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Net Sales" for a
further discussion of Innovo's sales for its craft product line.
58
The following are the principal products that Innovo distributes in the
United States to the accessory and craft market:
FASHION ACCESSORY GENERAL ACCESSORIES CRAFTS
----------------- ------------------- ------
Purses Travel and Tote Bags Tote Bags
Hand Bags Waist Packs Adult and Children's Aprons
Duffle Bags Duffle Bags Christmas Stockings
Wallets Stadium Totes/Cushions Gourmet/BBQ Aprons
Beach Bags Insulated Lunch Bags
Tote Bags Soft Coolers
Gloves Pencil Cases
Backpacks
Waist Packs
Hats
Scarves
Apparel
Joe's
Joe's, headquartered in Commerce, California was formed in 2001 to design,
develop, and market high-fashion apparel products under the Joe's(R) and Joe's
Jeans(R) brand. Joe's products are typically part of a collection that includes
pants, denim jeans, shirts, sweaters, jackets and other apparel products. In
fiscal 2002, Joe's focused its efforts on establishing the Joe's brand in both
the domestic and international marketplace by continuing to offer its customers
and consumers a fashion forward, quality product. In fiscal 2002, Joe's created
JJJ in an effort to establish the Joe's brand in the Japanese marketplace.
Additionally, in fiscal 2002, Joe's successfully entered the Canadian and
European markets through the use of international distributors, and contributed
to expand within these markets in fiscal 2003 and expanded distribution to other
countries such as Australia and Korea. On July 1, 2003, Joe's entered into a
Distribution and Licensing Agreement with Itochu ("Itochu Agreement"), pursuant
to which Itochu obtained certain manufacturing and licensing rights for the
"Joe's" and "Joe's Jeans" marks. As a part of the transaction, Itochu agreed to
purchase the existing inventory of JJJ for approximately $1 million, assume the
management and operations of JJJ's showroom in Tokyo and employ certain
employees of JJJ. As of November 29, 2003, we continue to operate JJJ and will
continue to do so until all operations have ceased. Upon the cessation of all
operating activities, we intend to dissolve the JJJ subsidiary. We will continue
to sell our products in Japan through our Distribution and Licensing Agreement
with Itochu. See "Management's Discussion and Analysis of Financial Conditions
and Results of Operations -Recent Acquisitions and Licenses."
Joe's believes that it has developed a customer base upon which Joe's can
grow its business going forward. Joe's products are sold in the United States
and abroad to upscale retailers and boutiques such as Barneys New York, Inc.,
Bloomingdale's, Inc., Loehmann's, Inc., Nordstrom, Inc., Saks Incorporated,
Intermix and Fred Segal in the United States and other complimentary retailers
in the international market.
Joe's products are primarily marketed to retailers through third party
showrooms located in New York, Los Angeles, and Paris and through its own
showroom in Tokyo. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Net Sales" for a further discussion of
Joe's sales.
59
Joe's product lines include, but are not limited to, the following:
WOMEN MEN
----- ---
Denim Jeans Denim Jeans
Denim Skirts Knit Shirts
Denim Jackets
Leather Jackets
Knit Shirts
Sweaters
Handbags
IAA
IAA, headquartered in Commerce, California, was formed in August 2001 to
focus on marketing products to the private label apparel market. IAA has since
diversified to focus not only on its private label business but also the
development of branded apparel products.
As of November 29, 2003, IAA's private label business primarily designed,
sourced and marketed denim jeans for Warnaco, Target Corporation's Mossimo
brand, and, as part of its acquisition of the Blue Concept Division, to American
Eagle Outfitters, Inc., or AEO. Through the Blue Concept Division, IAA sells
primarily denim jeans to AEO, a national retailer. IAA's sales increased to
$57,627,000 in fiscal 2003 from $8,358,000 in fiscal 2002, or a 589% increase. A
large portion of the increase in IAA's sales during fiscal 2003 is attributable
to sales generated from AEO since July 2003, the date of the Blue Concepts
Division acquisition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Net Sales" for a further discussion of
IAA's sales.
IAA's private label product lines primarily consist of knit tops and denim
bottoms for both the men's and women's market. The branded sportswear product
lines are focused around fashion oriented tops and bottoms. The product lines
include, but are not limited to the following:
TOPS BOTTOMS
---- -------
Knit Fashion Shirts Fleece Sweatpants
Fashion T-Shirts Knit Pants
Basic T-Shirts Denim Jeans
Fleece Sweatshirts Velour Pants
Thermal Pullovers Sweat Suits
Velour Shirts
Sports Jersey's
Dresses
Blouses
Since establishing IAA's branded division and through year ended November
29, 2003, IAA has entered into license agreements with: (1) recording artist and
entertainer Bow Wow for the right to produce apparel and accessory products
under the Shago(R) mark; (2) the recording artist and entertainer Eve for the
right to produce apparel and accessory products under the Fetish(TM) mark; and
(3) Mattel, Inc. for the right to produce apparel and accessory products under
the Hot Wheels(R) mark. IAA entered into the license agreement for the Bow Wow
license in October of fiscal 2002; the license agreement with Eve in February of
2003; and the license agreement with Mattel in August of 2002. IAA began
shipping its Shago(R) apparel and accessory products in May 2003, and its
Fetish(TM) apparel and accessory products in August 2003. To date, IAA has not
shipped any of its Hot Wheels apparel or accessory products, primarily in
response to feedback from retail buyers at the time of the line's launch in
August 2003 suggesting that consumer demand for the proposed Hot Wheels(R)
product line was insignificant. Pursuant to these license agreements, IAA has
the right to sublicense the accessory category to its affiliated subsidiary
Innovo. See "Business - License Agreements and Intellectual Property" for a
further discussion of the license agreements with Bow Wow, Eve, and Mattel, Inc.
60
Product Development and Sourcing
Accessory
Innovo
Innovo develops the designs and artwork for all products through its
in-house design staff. Innovo's fashion and licensed accessory products are
produced with the logos or other designs licensed from licensors or produced
bearing the Innovo's own private brands such as Daily Denim(TM), Clear Gear(TM),
Friendship(TM) and Tote Works(TM). See "Business-License Agreements and
Intellectual Property" for a further discussion of Innovo's fashion and licensed
accessory products.
Innovo markets its craft products, without artwork, to be sold for
finishing by retail craft customers. Innovo's craft products are purchased from
Commerce or its affiliates. They manufacture our craft products in Mexico and we
also import some of our craft products from China. Innovo is obligated, as
defined in the supply agreement with Commerce, to purchase all of its craft
products from Commerce through August 2004. In fiscal 2003, Innovo purchased
approximately $2.7 million of craft products from Commerce.
Innovo's sourcing office, IHK, manages much of the design and development
of its products that are sourced out of East Asia. Innovo's products are
distributed out of Los Angeles through an agreement with an affiliate of
Commerce or the products may be shipped directly to Innovo's customers from the
country of origin of the manufactured products.
Innovo obtains its fashion accessory products from overseas suppliers
located mainly in China through short term manufacturing agreements. The
independent contractors that manufacture our products are responsible for
obtaining the necessary supply of raw materials and for manufacturing the
products to our specifications. See "Business-Import and Import Restrictions"
for further discussion of supply of raw materials and manufacturing.
We primarily utilize overseas contractors that employ production
facilities located in China. As a result, our products are subject to certain
restrictions imposed by the Chinese government. To date, we have not been
adversely affected by such restrictions; however, there can be no assurance that
future changes in such restrictions by the Chinese government would not
adversely affect us, even if only temporarily, while we shifted production to
other countries or regions such as Mexico, Korea, Taiwan or Latin America. As
anticipated, in fiscal 2003, all of our sales were derived from imported
products that are subject to United States import quotas, inspection or duties.
See "Business--Import and Import Restrictions."
Apparel
Joe's
Joe's product development is managed internally by a team of designers led
by Joe Dahan, which is responsible for the creation, development and
coordination of the product group offerings within each collection. Joe's
typically develops four collections per year for spring, summer, fall and
holiday, with certain basic styles offered throughout the year. Joe Dahan is an
instrumental part of Joe's design process. The loss of Joe Dahan could
potentially have a material adverse impact on Joe's. In the event of the loss of
Joe Dahan, Joe's believes it could find alternative sources for the development
and design of Joe's products, although there can be no assurances. See "Risk
Factors-- The loss of the services of Mr. Joe Dahan could have a material
adverse effect on Joe's business."
Joe's products are sourced through Commerce or its affiliates or from
domestic contractors generally located in the Los Angeles area. Joe's is not
contractually obligated to purchase its products from Commerce. Joe's staff,
however, controls the production schedules in order to ensure quality and timely
deliveries. Commerce is responsible for the acquisition of the raw materials
necessary for the production of Joe's goods. In the event that Commerce is
unable to acquire the necessary raw materials, Joe's believes that there are
alternative sources from which the raw materials could be acquired. We are
currently reviewing the option of sourcing products from international sources
and/or directly sourcing the products from domestic suppliers. During fiscal
2003, Joe's
61
purchased approximately $2.2 million of goods from Commerce. See "Business -
Strategic Relationship with two of our significant stockholders, Hubert Guez and
Paul Guez, and affiliated companies" for a further discussion of the supply
agreement with Commerce. In fiscal 2003, Joe's changed its inventory strategy
from buying finished goods to buying raw materials and outsourcing the
manufacturing of its own goods as a result of no longer being able to purchase
finished goods from our domestic supplier. Joe's cost to buy raw materials and
outsource the manufacturing of its own goods was significantly higher than its
cost to buy finished goods. In the long term, Joe's believes that this
alteration in inventory strategy will be beneficial since this inventory
strategy should decrease the defects associated second quality goods, which have
a lower cost per unit than first quality goods. Sales of second quality goods
lead to lower gross margins.
While Joe's believes that there are currently alternative sources from
which to outsource the production of Joe's products, in the event the economic
climate or other factors resulted in significant reduction in the number of
local contractors in the Los Angeles area, Joe's business could be negatively
impacted. At this time, Joe's believes that it would be able to find alternative
sources for the production of its products if this was to occur, however, no
assurances can be given that a transition could be completed without a
disruption to Joe's business.
IAA
IAA's private label product development is managed by IAA's internal
design and merchandising staff or in conjunction with the design teams of the
customer. IAA's products are sourced from Mexico through independent
contractors, through Commerce and its affiliates or through independent overseas
contractors. During fiscal 2003, IAA purchased approximately $18.2 million of
goods from Commerce and its affiliates. See "Business - Strategic relationship
with two of our significant stockholders, Hubert Guez and Paul Guez, and
affiliated companies."
IAA's branded division's products are developed by its in-house design
team or through the use of independent freelance designers. IAA's branded
division sources a majority of its products from Mexico and the Far East,
including countries such as China, South Korea, Vietnam and India. IAA's
purchases in the international markets will be subject to the risks associated
with the importation of these type products. See "Business-Import and Import
Restrictions."
IAA relies on Commerce and its affiliates' ability to source and supply
its products. IAA expects its reliance on Commerce and its affiliates to
decrease in the future as it begins to purchase more of its products from third
party suppliers. During fiscal 2003, IAA purchased from Commerce and its
affiliates approximately $41.8 million, or 76%, of its products compared to
$16.0 million, or 80%, of its products in fiscal 2002.
IAA and AZT International SA de CV, a Mexico corporation and wholly-owned
subsidiary of Azteca, or AZT, entered into a two-year, renewable, non-exclusive
supply agreement, or Supply Agreement, for products to be sold by IIA through
the Blue Concept Division. Under the terms of the Supply Agreement, we have
agreed to market and sell the products to be purchased from AZT to certain of
our customers, more particularly IAA customers of the Blue Concept Division. See
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Recent Acquisitions and Licenses" for further discussion regarding
this supply agreement.
We generally purchase our products in U.S. dollars. However, as a result
of using overseas suppliers, the cost of these products may be affected by
changes in the value of the relevant currencies. See "Risk Factors - Our
business is exposed to domestic and foreign currency fluctuations."
Notwithstanding the supply agreement for craft products with Commerce, we
do not have any long-term supply agreements with independent overseas
contractors, but we believe that there are a number of overseas and domestic
contractors that could fulfill our requirements. See "Item 1 - Business
Description - Restructured Operations" in the Notes to the Consolidated
Financial Statements for a further discussion of the supply agreement with
Commerce and its affiliates.
While we attempt to mitigate our exposure to manufacturing, the use of
independent contractors does reduce our control over production and delivery and
exposes us to the other usual risks of sourcing products from independent
suppliers. Our transactions with our foreign manufacturers and suppliers are
subject to the risks of doing business abroad. Imports into the United States
are affected by, among other things, the cost of transportation
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and the imposition of import duties and restrictions. The United States and the
countries in which our products are manufactured may, from time to time, impose
new quotas, duties, tariffs or other restrictions, or adjust presently
prevailing quotas, duty or tariff levels, which could affect our operations and
our ability to import products at current or increased levels. We cannot predict
the likelihood or frequency of any such events occurring. See "Business - Import
and Import Restrictions."
License Agreements and Intellectual Property
Accessory
Innovo
On March 26, 2001, Innovo entered into a two-year exclusive license
agreement with Michael Caruso & Company, the original owner of the rights to the
Bongo(R) mark, pursuant to which Innovo obtained the right to design,
manufacture and distribute bags and small leather/pvc goods bearing the Bongo(R)
mark. According to the original terms of the license agreement, the license was
to expire on March 31, 2003. However, in November 2002, Innovo entered into an
amendment effective April 1, 2003 with IP Holdings LLC, the assignee of the
Bongo(R) mark, to extend the term of the license agreement to March 31, 2007.
The extended agreement offers Innovo the potential for multi-year extensions
tied to certain performance criteria.
Innovo pays a five percent royalty and a two percent advertising fee on
the net sales of Innovo's goods bearing the Bongo(R) mark. Pursuant to the terms
of the license agreement, Innovo is required to pay minimum royalties in the
amount of $312,500 prior to the expiration of the license agreement. In
accordance with the terms of the agreement, Innovo has the exclusive right to
sell, market, distribute, advertise and promote the Bongo(R) products in the
United States, including its territories and possessions, Mexico, Central and
South America and Canada. The licensor has the right to terminate the agreement
in the event Innovo breaches any material terms of the agreement.
In fiscal 2003, Innovo's collegiate and Major League Baseball
sports-licensed accessory products were discontinued because we are placing more
time and resources towards developing more fashion oriented product lines that
we believe will have greater potential in the marketplace. This cancellation has
not had a material adverse effect on Innovo's products or revenues for fiscal
2003, as they represented a small portion of products and revenues in prior
years.
Due to the cancellation of its sports-licensed accessory products, Innovo
has placed more time and resources towards developing more fashion oriented
product lines that Innovo believes will have greater potential in the
marketplace. Innovo's craft line includes tote bags imprinted with the
E.A.R.T.H. ("EVERY AMERICAN'S RESPONSIBILITY TO HELP") BAG(R) mark. E.A.R.T.H.
Bags(R) are marketed as a reusable bag that represents an environmentally
conscious alternative to paper or plastic bags. Sales of E.A.R.T.H. Bags(R),
while significant in Innovo's early years, have not been significant in the last
five years. Innovo still considers the mark to be an asset.
Furthermore, pursuant to the license agreements entered into by IAA,
Innovo, as a sublicensee, has the right to produce accessories for the branded
label market bearing the Shago(R), Fetish(TM) and Hot Wheels(R) marks pursuant
to the terms of those license agreements. See "License Agreements and
Intellectual Property - IAA" for a further discussion of the Shago(R),
Fetish(TM) and Hot Wheels(R) license agreements.
Apparel
Joe's
In February 2001, Joe's acquired the license rights to the JD logo and the
Joe's Jeans(R) mark for all apparel and accessory products. The license
agreement with JD Design, LLC, or JD Design, has a ten-year term with two
ten-year renewal periods upon there being no material default at the end of each
period. Additionally, pursuant to the terms of the agreements, Joe Dahan is to
receive a three percent royalty on the net revenues of sales of Joe's(R) and
Joe's Jeans(R) products, subject to additional royalty amounts in the event
certain sales and gross profit thresholds are met on an annual basis.
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On July 1, 2003, Joe's entered into a Distribution and Licensing Agreement
with Itochu, pursuant to which Itochu obtained certain manufacturing and
licensing rights for the "Joe's" and "Joe's Jeans" marks. As a part of the
transaction, Itochu agreed to purchase the existing inventory of JJJ for
approximately $1 million, assume the management and operations of JJJ's showroom
in Tokyo and employ certain employees of JJJ. As of November 29, 2003, we
continue to operate JJJ and will continue to do so until all operations have
ceased. Upon the cessation of all operating activities, we intend to dissolve
the JJJ subsidiary. We will continue to sell product in Japan through our
Distribution and Licensing Agreement with Itochu. See "Management's Discussion
and Analysis of Financial Conditions and Results of Operations -Recent
Acquisitions and Licenses" for further discussion regarding this license and
distribution agreement.
As the licensee and on behalf of JD Design, we have applied for protection
with the United States Patent and Trademark Office, as well as with various
foreign jurisdictions, such as Australia, Canada, the European Union, Japan,
Korea and New Zealand, for trademark protection for certain of "Joe's" logos and
"Joe's Jeans" marks for apparel and accessory products. As of November 29, 2003,
two trademark registrations have been issued in the United States and five
trademark registrations have been issued internationally. We continue to
prosecute two pending trademark applications in the United States and 24 pending
trademark applications internationally that we believe are necessary to protect
these trademarks fully.
IAA
On August 1, 2002, IAA entered into an exclusive 42-month worldwide
agreement for the Bow Wow license, granting IAA the right to produce and market
products bearing the Shago(R) mark and likeness of the popular stage and screen
performer. The IAA division has created and marketed a wide range of apparel for
boys and plans on doing the same for girls. The license agreement between IAA,
Bravado International Group, the agency with the master license and rights to
Bow Wow, and LBW Entertainment, Inc. calls for the performer to make at least
one public appearance every six months during the term of the agreement to
promote the Bow Wow products, as well as use his best efforts to promote and
market these products on a daily basis. Additional terms of the license
agreement allows IAA to market boys and girls products bearing the Bow Wow brand
to all distribution channels, the right of first refusal on all other Bow Wow
related product categories during the term of the license agreement, and the
right of first of refusal on proposed transactions by the licensor with third
parties upon the expiration of the agreement. The agreement calls for IAA to pay
an eight percent royalty on the nets sales of goods bearing Bow Wow related
marks. IAA is obligated to pay a minimum net royalty in the amount of $75,000 on
or before January 31, 2005. In the event IAA defaults upon any material terms of
the agreement, the licensor shall have the right to terminate the agreement.
Furthermore, IAA has the right to sublicense the accessory product's category to
Innovo.
On February 13, 2003, our IAA subsidiary entered into a 44 month exclusive
license agreement for the United States, its territories and possessions with
the recording artist and entertainer Eve for the license of the Fetish(TM) mark
for use with the production and distribution of apparel and accessory products.
We have guaranteed minimum net sales obligations for apparel and accessories of
$8 million in the first 18 months of the agreement, $10 million in the following
12 month period and $12 million in the 12 month period following thereafter.
According to the terms of the agreement we are required to pay an eight percent
royalty and a two percent advertising fee on the nets sales of products bearing
the Fetish(TM) logo. In the event we do not meet the minimum guaranteed sales,
we will be obligated to make royalty and advertising payments equal to the
minimum guaranteed sales multiplied by the royalty rate of eight percent and the
advertising fee of two percent. Such minimum royalty payments will equal $2.4
million in the aggregate over the term of the license agreement. We also have
the right of first refusal with respect to the license rights for the Fetish(TM)
mark in the apparel and accessories category upon the expiration of the
agreement, subject to us meeting certain sales performance targets during the
term of the agreement. Additionally, we have the right of first refusal for the
apparel and accessory categories in territories in which we do not currently
have the license rights for the Fetish(TM) mark.
In July 2002, IAA entered into a five-year license agreement with Mattel,
Inc. to produce Hot Wheels(R) branded adult apparel and accessories in the
United States, Canada and Puerto Rico to be targeted to men and women in the
junior and contemporary markets, or the Hot Wheels(R) License. IAA may terminate
the Hot Wheels(R) License in any year by paying the remaining balance of that
year's minimum royalty guarantees plus the subsequent year's minimum royalty
guarantees. The total minimum royalties due for the entire 5 years term is $1.05
million in the aggregate. Royalties paid by IAA earned in excess of the minimum
royalty requirements for any one
64
given year may be credited towards the shortfall amount of the minimum required
royalties in any subsequent period during the term of the license agreement.
According to the terms of the Hot Wheels(R) License, IAA has the right to
sublicense the accessory product's category to Innovo. The Hot Wheels(R) License
calls for a royalty rate of seven percent royalty and a two percent advertising
fee on the net sales of goods bearing the Hot Wheels(R) mark. In the event IAA
defaults upon any material terms, the licensor shall have the right to terminate
the agreement. In fiscal 2003, IAA had no sales under this license agreement.
The absence of sales from the Hot Wheels(R) License was primarily due to
insignificant orders placed for the product at the initial launch of the line at
the MAGIC apparel trade show in Las Vegas in August 2003 as a result of apparent
interest in the consumer marketplace. While, as of November 29, 2003, we are
still contractually obligated under the Hot Wheels(R) License, we have been in
discussion with Mattel regarding these and other concerns surrounding the
consumer demand for the product.
On February 6, 2004, through IAA, we entered into an assignment with Blue
Concept LLC, which is controlled by Paul Guez, for all the rights benefits and
obligations of a license agreement between Blue Concept LLC and B.J. Vines,
Inc., the licensor of the Betsey Johnson(R) apparel brand. The license agreement
provides for the exclusive right to design, market and distribute women's jeans
and coordinating denim related apparel, such as t-shirts and tops, under the
Betsey Johnson(R) brand name in the United States, its territories and
possessions, and Canada. The license agreement allows for an initial four-year
term with a renewal option subject to certain sales levels being met. We are
required to pay royalties of eight percent on net sales and spend two percent of
net sales on advertising. The license agreement provides that certain minimum
guaranteed royalties and minimum net sales must be met in each annual period.
The minimum royalties to be paid in the aggregate are $1.28 million and minimum
net sales range form $2.5 million to $5.5 million. The agreement may be renewed
upon expiration of the initial 4 year term for an additional three years. We
anticipate introducing the Betsey Johnson(R) products in the third quarter of
2004.
The following sets forth certain information concerning the license
agreements currently held by us:
Minimum Expiration
Licensor/Mark Types of Products Geographical Areas Royalties Date
------------- ----------------- ------------------ --------- ----
JD Design LLC Apparel and Worldwide N/A 2/11/31
(Joe's Jeans) accessories
Blondie Rockwell, Inc. Apparel and United States, its $2.4 million in 7/31/06
(Eve, Fetish(TM)) accessories territories and the aggregate
possessions
Bravado International Apparel and United States $75,000 prior to 2/1/06
Group, Inc. accessories 1/31/05
(Bow Wow, Shago(R))
B.J. Vines, Inc. Apparel United States, its $1.28 million in 1/7/08
(Betsey Johnson(R)) territories and the aggregate
possessions and Canada
IP Holdings LLC Bags, small United States, its $312,500 prior to 3/31/07
(Bongo(R)) leather/pvc goods territories and expiration
possessions, Mexico,
Central and South
America, Canada
Mattel, Inc. Apparel and United States, Canada $1.05 million in 12/31/07
(Hot Wheels(R)) accessories and Puerto Rico the aggregate
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We believe that we will continue to be able to obtain the renewal of all
material licenses; however, there can be no assurance that competition for an
expiring license from another entity, or other factors will not result in the
non-renewal of a license. As we continue to expand our business in the
international marketplace, our trademarks or the trademarks we license may not
be able to be adequately protected. See "Risk Factors -- Our trademark and other
intellectual property rights may not be adequately protected outside the United
States."
Customers
Accessory
Innovo
During fiscal 2003, Innovo sold products to a mix of mass merchandisers,
department stores, craft chain stores and other retail accounts. We estimate
that Innovo's products are carried by over 548 customers in over 6,000 retail
outlets in the United States. In marketing Innovo's products, Innovo attempts to
emphasize the competitive pricing and quality of its products, its ability to
assist customers in designing marketing programs, its short lead times and the
high success rate our customers have had with our products. Generally, Innovo's
accounts are serviced by Innovo's sales personnel working with marketing
organizations that have sales representatives that are compensated on a
commission basis. Innovo's New York City showroom is used to showcase all
product lines developed by Innovo and to help facilitate sales for all accounts.
In fiscal 2003, Innovo sold its products to private label customers such
as American Eagle Outfitters, Inc., Claire's Stores, Inc. and Hot Topic. Innovo
currently sells it products to retailers such as Wal-Mart, Inc., A.C. Moore Arts
& Crafts, Hobby Lobby, Joanne's, Inc., Michaels Stores, Inc., Sears, Roebuck and
Co., 579 Stores, Beall's, Inc., The May Department Stores Company, which
includes, Hecht's, Foley's, and Robinsons-May, J. C. Penney Company, Inc.,
Claire's Stores, Inc., The Wet Seal, Inc., and Federated Department Stores,
Inc., which includes Macy's East and Macy's West.
For fiscal 2003, Innovo's three largest customers, American Eagle
Outfitters, Inc., Wal-Mart, Inc. and Michaels Stores, Inc. accounted for
approximately 62% of its net sales. The loss of any of these three customers
would have a material adverse effect on Innovo.
Apparel
Joe's
Joe's products are sold to consumers through high-end department stores
and boutiques located throughout the world. For Joe's domestic sales, Joe's has
entered into sales agreements with third party showrooms where retailers review
the latest collections offered by Joe's and place orders. The showrooms provide
Joe's with purchase orders from the retailers. Joe's then distributes the
products from its Los Angeles distribution facility. Joe's currently has
domestic agreements with showrooms in Los Angeles and New York and these
showrooms have representatives throughout the United States.
Joe's products are sold in Japan through its subsidiary JJJ. JJJ operates
a company-operated showroom in Tokyo through which Joe's products are sold to
retailers. On July 1, 2003, Joe's entered into a Distribution and Licensing
Agreement with Itochu, pursuant to which Itochu obtained certain distribution
and licensing rights for the "Joe's" and "Joe's Jeans" marks. We will continue
to sell product in Japan through our Distribution and Licensing Agreement with
Itochu. See "Management's Discussion and Analysis of Financial Conditions and
Results of Operations -Recent Acquisitions and Licenses" for further discussion
regarding this license and distribution agreement. Additionally, Joe's is
currently selling its products in Europe, Canada, Australia and Korea through
distributors who purchase the product directly from Joe's and then distribute
the product in to the local markets. Revenues generated by JJJ represented
approximately 26% of Joe's total net sales in fiscal 2003. See Management's
Discussion and Analysis of Financial Conditions and Results of Operations - Net
Sales" for further discussion of Joe's net sales.
66
We currently sell to domestic retailers such as Barneys New York, Inc.,
Saks Incorporated, Federated Department Stores, Inc. which includes,
Bloomingdale's, Inc. and Macy's, Inc., Intermix, Fred Segal and Loehmann's and
in Japan to retailers such as Sanei International, Interplanet, Free's Shops,
Isetan, Mitsukoshi New York Runway and Barneys New York, Inc.
Also, on February 16, 2004, Joe's entered into a Master Distribution
Agreement, or MDA, with Beyond Blue, Inc., or Beyond Blue, whereby Joe's granted
Beyond Blue exclusive distribution rights for Joe's products outside the United
States. Beyond Blue, a Los Angeles-based company that specializes in
international consulting, distribution and licensing for apparel products,
secured an exclusive right to distribute Joe's products outside the United
States, subject to current license agreements such as the license with Itochu
and Joe's Canadian distributor remaining in place. Under the MDA, Beyond Blue
will be establishing sub-distributors and sales agents in certain international
markets through sub-distribution agreements. These sub-distribution agreements
shall govern, but not be limited to, such items as: (i) minimum sample charges
paid by each sub-distributor; (ii) minimum advertising requirements to be borne
by each sub-distributor; and (iii) an assignment provision that allows Joe's to
take over the sub-distribution agreements in the event that Beyond Blue defaults
under the MDA. The MDA also provides for the continuation of existing
distribution agreements, such as the Itochu Agreement. The term of the MDA shall
be for three years, subject to Beyond Blue purchasing certain minimum amounts of
product from Joe's during three annual periods, with the first annual period
being for 18 months. The MDA was entered into in an effort to capitalize upon
Joe's international brand recognition, to utilize Beyond Blue's experience in
international distribution of high-end fashion denim apparel lines and to manage
international distribution through the use of sub-distributors and sales agents
in foreign markets.
The Joe's Jeans website (www.joesjeans.com) has been built to advance the
brand's image and to allow consumers to review the latest collection of
products. Joe's currently uses both online and print advertising to create brand
awareness with customers as well as consumers.
For fiscal 2003, Joe's three largest customers accounted for approximately
21% of its net sales. The loss of any of these customers would not have a
material adverse affect on Joe's.
IAA
IAA develops apparel products for the private label and branded product
markets. At year ended November 29, 2003, IAA primarily distributed its private
label products primarily to Target Corporation's Mossimo division, or Target,
and American Eagle Outfitters, Inc., or AEO.
During fiscal 2003, sales to Target Corporation, AEO, and Warnaco, which
IAA ceased selling products to in fiscal 2003, represented approximately 18%,
48% and 10%, respectively, of IAA's net sales.
Pursuant to the license agreements for Shago(R), Fetish(TM) and Hot
Wheels(R), IAA may sell apparel and accessory products to certain agreed upon
channels of distribution set forth in the various license agreements. Currently,
IAA distributes its Shago(R) apparel and accessory products to Federated
Department Stores, Inc., which includes Macy's East and Macy's West, Jimmy Jazz
and City Blues. IAA distributes its Fetish(TM) apparel and accessory products to
Federated Department Stores, Inc., which includes Macy's East and Macy's West,
Robinsons-May, Demo, Up Against the Wall, Epic and Man Alive.
We do not enter into long-term agreements with any of our customers.
Instead, we receive individual purchase order commitments from our customers. A
decision by the controlling owner of a group of stores or any other significant
customer, whether motivated by competitive conditions, financial difficulties or
otherwise, to decrease the amount of merchandise purchased from us, or to change
their manner of doing business with us, could have a material adverse effect on
our financial condition and results of operations. See "Risk Factors--A
substantial portion of our net sales and gross profit is derived from a small
number of large customers."
Our business has historically been seasonal by nature. While we believe
that as a result of our growing product lines and expanding business model, our
business should be less seasonal in future periods. Furthermore, a majority of
our revenues are generated during our third and fourth quarters. See
"Business-Seasonality of Business and Working Capital" for a further discussion
of the seasonality of our business.
67
Seasonality of Business and Working Capital
We have historically experienced and expect to continue to experience
seasonal fluctuations in sales and net earnings. Historically, a significant
amount of our net sales and a majority of our net earnings have been realized
during the third and fourth quarter. In the second quarter in order to prepare
for peak sales that occur during the third quarter, we build inventory levels,
which results in higher liquidity needs as compared to the other quarters in the
fiscal year. If sales were materially different from seasonal norms during the
third quarter, our annual operating results could be materially affected.
Accordingly, our results for the individual quarters are not necessarily
indicative of the results to be expected for the entire year.
Due to our growth during fiscal 2003, we entered into a series of
transactions to provide us with additional working capital. On June 1, 2001 and
September 10, 2001, we, through our three main operating subsidiaries, Joe's,
Innovo, and IAA, entered into financing agreements with CIT Commercial Services,
a unit of CIT Group Inc, or CIT for the factoring of our account receivables. In
August 2002, Joe's and Innovo each entered into certain amendments to their
respective factoring agreements, which included inventory security agreements,
to permit each subsidiary to obtain advances of up to 50% of the eligible
inventory up to $400,000 each. As a result of necessity for additional working
capital, on or about June 10, 2003, the existing financing facilities with CIT
for our subsidiaries were amended, to be effective as of April 11, 2003,
primarily to remove the fixed aggregate cap of $800,000 on their inventory
security agreements to allow for Innovo and Joe's to borrow up to 50% of the
value of certain eligible inventory. In connection with these amendments, IAA
entered into an inventory security agreement with CIT based upon the same terms
as Joe's and Innovo. Cross guarantees were executed by and among the
subsidiaries and we also entered into a guarantee for our subsidiaries'
obligations in connection with the amendments to the existing credit facilities.
We have also established a letter of credit facility with CIT. As of November
29, 2003, we had a loan balance with CIT of $8,786,000, the majority of which
was collateralized against non-recourse factored receivables. As of November 29,
2003, we had $8,536,000 of factored receivables with CIT and an aggregate amount
of $2,149,000 of unused letters of credit outstanding. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for further discussion of our
financing agreements with CIT.
Additionally, in fiscal 2003, we consummated five private placements of
our common stock resulting in net proceeds of approximately $17,540,000 after
deducting commissions. During our first private placement completed on March 19,
2003 we issued 165,000 shares of our common stock to 17 accredited investors at
$2.65 per share, raising net proceeds of approximately $407,000. During our
second private placement completed on March 26, 2003, we issued 63,500 shares of
our common stock to 5 accredited investors at $2.65 per share, raising net
proceeds of approximately $156,000. During our third private placement completed
on July 1, 2003, we issued 2,835,481 shares to 34 accredited investors at $3.33
per share, raising net proceeds of approximately $8,751,000. As part of this
private placement, and in addition to commissions paid, warrants to purchase
300,000 shares of our common stock at $4.50 were issued to the placement agent,
Sanders Morris Harris, Inc. During our fourth private placement completed on
August 29, 2003, we issued 175,000 shares of our common stock to 5 accredited
investors at $3.62 per share, raising net proceeds of approximately $592,000. As
part of this private placement, and in addition to commissions paid, warrants to
purchase 17,500 shares of our common stock at $3.62 were issued to the placement
agent, Pacific Summit Securities. During our fifth private placement which was
completely funded on or before November 29, 2003, but completed on December 1,
2004, we issued 2,996,667 shares of our common stock to 14 accredited investors
at $3.00 per share, and warrants to purchase 599,333 shares of our common stock
to certain of these investors at $4.00 per share raising net proceeds of
approximately $10,704,000. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations -Equity Financings" and "Risk
Factors - Equity Financings" and Item 5 "Market for Registrant's Common Equity
and Related Stockholder Matters" for a further discussion of our equity
financings.
These equity financings and amended financing agreements with CIT were
necessary to support our growth in fiscal 2003. Such growth is associated with
our obligations pursuant to the license agreements for the Shago(R) and
Fetish(TM) marks, respectively. Based upon our historical growth, we may need to
obtain additional working capital in order to meet our operational needs in
fiscal 2004. We believe that we will be able to address these needs by
increasing the availability of funds offered to us under our financing
agreements with CIT or other financial institutions or by obtaining additional
capital through debt or equity financing. See "Managements Discussion and
68
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources." We believe that any additional capital, to the extent needed, may be
obtained from the sale of equity securities or through short-term working
capital loans. However, there can be no assurance that this or other financing
will be available if needed. The inability of us to be able to fulfill any
interim working capital requirements would force us to constrict our operations.
Backlog
Although we may, at any given time, have significant business booked in
advance of ship dates, customers' purchase orders are typically filled and
shipped within two to six weeks. As of November 29, 2003, there were no
significant backlogs.
Competition
The industries in which we operate are fragmented and highly competitive
in the United States and on a worldwide basis. We compete for consumers with a
large number of apparel and accessory products similar to ours. We do not hold a
dominant competitive position, and our ability to sell our products is dependent
upon the anticipated popularity of our designs, the brands our products bear,
the price and quality of our products and our ability to meet our customers'
delivery schedules.
We believe that we are competitive in each of the above- described
segments with companies producing goods of like quality and pricing, and that
new product development, product identity through marketing, promotions and low
price points will allow us to maintain our competitive position. However, many
of our competitors possess substantially greater financial, technical and other
resources than us , including the ability to implement more extensive marketing
campaigns. Furthermore, the intense competition and the rapid changes in
consumer preferences constitute significant risk factors in our operations. As
we expand globally, we continue to encounter additional sources of competition.
See "Risk Factors--We face intense competition in the worldwide apparel and
accessory industry."
Imports and Import Restrictions
Our transactions with our foreign manufacturers and suppliers are subject
to the risks of doing business abroad. Imports into the United States are
affected by, among other things, the cost of transportation and the imposition
of import duties and restrictions. The countries in which our products might be
manufactured may, from time to time, impose new quotas, duties, tariffs or other
restrictions, or adjust presently prevailing quotas, duty or tariff levels,
which could affect our operations and our ability to import products at current
or increased levels. We cannot predict the likelihood or frequency of any such
events occurring. The enactment of any additional duties, quotas or restrictions
could result in increases in the cost of our products generally and might
adversely affect our sales and profitability.
Our import operations are subject to constraints imposed by bilateral
textile agreements between the United States and a number of foreign countries,
including Hong Kong, China, Taiwan and Korea. These agreements impose quotas on
the amount and type of goods that can be imported into the United States from
these countries. Such agreements also allow the United States to impose, at any
time, restraints on the importation of categories of merchandise that, under the
terms of the agreements, are not subject to specified limits. Our imported
products are also subject to United States customs duties and, in the ordinary
course of business, we are from time to time subject to claims by the United
States Customs Service for duties and other charges.
We monitor duty, tariff and quota-related developments and continually
seek to minimize its potential exposure to quota- related risks through, among
other measures, geographical diversification of our manufacturing sources, the
maintenance of overseas offices, allocation of overseas production to
merchandise categories where more quota is available and shifting of production
among countries and manufacturers.
Because our foreign manufacturers are located at greater geographic
distances from us than our domestic manufacturers, we are generally required to
allow greater lead time for foreign orders, which reduces our manufacturing
flexibility. Foreign imports are also affected by the high cost of
transportation into the United States.
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In addition to the factors outlined above, our future import operations
may be adversely affected by political instability resulting in the disruption
of trade from exporting countries, any significant fluctuation in the value of
the dollar against foreign currencies and restrictions on the transfer of funds.
Human Resources
As of February 1, 2004, we had 201 full-time employees. IGI employed 11
individuals, Innovo employed 65 individuals, Joe's employed 38 individuals, and
IAA employed 87 individuals located in our various offices.
Real Estate Transactions
IRI
In April 2002, IRI acquired a 30% limited partnership interest in each of
22 separate partnerships. These partnerships simultaneously acquired 28
apartment complexes at various locations throughout the United States consisting
of approximately 4,000 apartment units, or Properties. A portion of the
aggregate $98,080,000 purchase price was paid through the transfer of 195,295
shares of our $100, 8% Series A Redeemable Cumulative Preferred Stock, or the
Series A Preferred Shares, to the sellers of the Properties. The balance of the
purchase price was paid by Metra Capital, LLC, or Metra Capital, in the amount
of $5,924,000, or the Metra Capital Contribution, and through proceeds from a
Bank of America loan, in the amount $72,625,000.
We had originally issued the Series A Preferred Shares to IRI in exchange
for all shares of its common stock. IRI then acquired a 30% limited partnership
interest in each of the 22 separate limited partnerships in exchange for the
Series A Preferred Stock, which then transferred the Series A Preferred Shares
to the sellers of the Properties.
Some of our stockholders, including one of our substantial stockholders,
Messrs. Paul Guez, and Simon Mizrachi and their affiliates have invested in each
of the 22 separate partnerships. Each of Messrs. Guez and Mizrachi, together
with their respective affiliates, own 50% of the membership interests of Third
Millennium. Third Millennium is the managing member of Metra Capital, which owns
100% of the membership interest in each of the 22 separate limited liability
companies, or collectively, the General Partners and together with Metra
Capital, the Metra Partners, that hold a 1% general partnership interest in each
of the 22 separate limited partnerships that own the Properties. Metra Capital
also owns 69% of the limited partnership interest in each of the 22 separate
limited partnerships. Messrs. Guez and Mizrachi and their affiliates own 19% of
the membership interest of Metra Capital. Based on the Schedule 13D/A filed by
Messrs. Simon Mizrachi and Joseph Mizrachi on October 30, 2003, and the Schedule
13D/A filed by Hubert Guez and Paul Guez on March 9, 2004, the Mizrachi's
beneficially owned approximately 1% of our shares and the Guez's beneficially
own 26.47% of our shares in the aggregate. Effective February 21, 2003, the
Mizrachi's ceased to be the beneficial owners of more than five percent of our
securities. Furthermore, in connection with investments made by (1) Commerce and
other investors affiliated with Hubert Guez and Paul Guez, or collectively, the
Commerce Group, and (2) Mr. Joseph Mizrachi and Simon Mizrachi through three
entities controlled by the Mizrachi's, in 2000, each of the Commerce Group and
Mr. Joseph Mizrachi have the right to designate three individuals or one
individual, respectively, for election to our board of directors.
Pursuant to each of the limited partnership agreements, the Metra Partners
receive at least quarterly (either from cash flow and/or property sale proceeds)
an amount sufficient to provide the Metra Partners (1) a 15% cumulative compound
annual rate of return on the outstanding amount of the Metra Capital
Contribution that has not been previously returned to them through prior
distributions of cash flow and/or property sale proceeds and (2) a cumulative
annual amount of .50% of the average outstanding balance of the average
outstanding balance of the mortgage indebtedness secured by any of the
Properties. In addition, in the event of a distribution solely due to a property
sale proceeds after the above distributions have been made to the Metra
Partners, Metra Partners also receive an amount equal to 125% of the amount of
the Metra Capital Contribution allocated to the Property sold until the Metra
Partners have received from all previous cash flow or property sale
distributions an amount equal to its Metra Capital Contribution.
70
Third Millennium receives on a quarterly basis from cash flows and/or
property sale proceeds an amount equal to $63,000 until it receives an aggregate
of $252,000.
After the above distributions have been made, and if any cash is available
for distribution, IRI is to receive at least quarterly in the case of cash flow
distributions and at the time of property sale distributions an amount
sufficient for it to pay the 8% coupon on the Series A Preferred Shares and then
any remaining amounts left for distribution to redeem a portion or all of the
Series A Preferred Shares.
After all of the Series A Preferred Shares have been redeemed ($19.5
million), future distributions are split between Metra Partners and IRI, with
Metra Partners receiving 70% of such distribution and IRI receiving the balance.
In addition, IRI receives a quarterly sub-asset management fee of $85,000.
The 8% Series A Preferred Shares coupon is funded entirely and solely
through partnership distributions as discussed above. If sufficient funds are
not available for the payment of a full quarterly 8% coupon, then partial
payments shall be made to the extent funds are available. Unpaid dividends
accrue. Partnership distribution amounts remaining after the payment of all
accrued dividends must be used by us to redeem outstanding the Series A
Preferred Shares. The Series A Preferred Shares have a redemption price of $100
per share. In the event that the partnership distributions received by us are
insufficient to cover the 8% coupon or the redeem the Series A Preferred Shares,
we will have no obligation to cover any shortcomings so long as all
distributions from the partnership are properly applied to the payment of
dividends and the redemption of the Series A Preferred Shares. We may however be
liable to the holders of the Series A Preferred Shares for the breach of certain
covenants, including, but not limited to, if IRI fails (i) to deposit
distributions from the partnerships into a sinking fund which funds are to be
distributed to the holders of the Series A Preferred Shares as a dividend or
redemption of the Series A Preferred Shares or (ii) to enforce its rights to
receive distributions from the limited partnerships.
If, after all of the Properties are sold and the proceeds of the sale of
the Properties and cash flow derived from such Properties have either been
applied to the payment of the 8% coupon and the redemption of the Series A
Preferred Shares or deposited into the sinking fund for that purpose, and the
total amount of funds remaining in the Sinking Fund is insufficient to pay the
full 8% coupon and the full Redemption Price for all then outstanding the Series
A Preferred Shares, then we, or IRI, must pay $1.00 in total into the Sinking
Fund and the Redemption Price will be adjusted so that it equals (x) the total
amount in the sinking fund available for distribution, minus (y) all direct
costs of maintaining the Sinking Fund and making distributions therefrom,
divided by (z) the number of then outstanding Preferred Shares. The adjusted
Redemption Price will represent full and final payment for the redemption of all
the Series A Preferred Shares.
We have not given accounting recognition to the value of our investment in
the limited partnerships, because we have determined that the asset is
contingent and will only have value to the extent that cash flow from the
operations of the properties or from the sale of underlying assets is in excess
of the 8% coupon and redemption of the Series A Preferred Shares. As discussed
above, we are obligated to pay the 8% coupon and redeem the Series A Preferred
Shares from our partnership distributions, prior to us being able to recover the
underlying value of our investment. Additionally, we have determined that the
Series A Preferred Shares will not be accounted for as a component of equity as
the shares are redeemable outside of our control. No value has been ascribed to
the Series A Preferred Shares for financial reporting purposes as we are
obligated to pay the 8% coupon or redeem the shares only if we receive cash flow
from the limited partnerships adequate to make the payments. We have included
the quarterly management fee paid to IRI in other income using the accrual basis
of accounting.
During fiscal 2003, IRI had no operations or transactions other than its
quarterly sub-asset management fee as discussed above.
Financial Information about Geographical Areas
See "Note 13 - Segment Disclosures - Operations by Geographic Area" in the
Notes to Consolidated Financial Statements for further discussion of financial
information about geographical areas.
71
Properties
Our headquarters for our Innovo subsidiary is located in approximately
5,000 square feet of office space located near downtown Knoxville, Tennessee.
The space leased in Knoxville is owned by an entity that is controlled by the
Chairman of Innovo Group's Board of Directors, Sam Furrow. See "Certain
Relationships and Related Transactions - Facility Lease Arrangements."
Our Los Angeles offices are located in an office complex in Commerce,
California. We utilize office space and office equipment under a cost sharing
arrangement with Commerce and its affiliates. Under the terms of the verbal
agreement, we are allocated a portion of costs incurred by Commerce and its
affiliates for rent, security, office supplies, machine leases and utilities. In
fiscal 2003, IAA recorded $318,000 for such expenses.
We currently lease office space for our accessory showroom in New York
City, New York on an annual basis.
Joe's products are displayed in showrooms in New York City and Los Angeles
through a sales representation arrangement. Therefore, we do not lease or own
the space in which Joe's products are sold in the United States.
Our Joe's Jeans Japan subsidiary currently rents office/showroom space
located in Tokyo, Japan. Under the arrangement, JJJ paid for the entire year in
advance. On June 30, 2003, JJJ terminated its former lease for two additional
spaces that served as JJJ's operational office and the other served as a
showroom to market Joe's products and consolidated into one space.
In July, 2003, we entered into a sublease for approximately 10,886 square
feet of office space in New York City, New York located at 512 7th Avenue, 23rd
Floor, New York, New York. This sublease expires on July 31, 2009. We may elect
to renew this lease for an additional period that ends on February 28, 2015. We
believe that there will be suitable facilities available to us should additional
space be needed in any or all of our facilities.
Our previous headquarters and manufacturing facilities were located in
Springfield, Tennessee. The Springfield facilities are currently owned by
Leasall. The main Springfield complex is situated on seven acres of land with
approximately 220,000 square feet of usable space, including 30,000 square feet
of office space and 35,000 square feet of cooled manufacturing area. The
Springfield facilities are currently being leased to third party tenants. As of
February 18, 2004, approximately 28.2% of the facilities were leased to a third
party, for an aggregate monthly income of approximately $4,500. During fiscal
2002, Innovo Group made several capital improvements to the Springfield
facility, including but not limited to, putting a new roof on the facility.
While the rental income during the year decreased as a result of the
renovations, we are anticipating an increase in demand for rental space within
the facility.
On April 5, 2002, we, through IRI, we closed on a transaction pursuant to
which IRI purchased limited partner interests in 22 limited partnerships.
Subsequently, the limited partnerships purchased 28 apartment buildings
consisting of approximately 4,000 apartment units located in various states
throughout the United States. See "Business - Real Estate Transactions" for a
further discussion of this real estate transaction.
Legal Proceedings
Although we may be subject to litigation from time to time in the ordinary
course of our business, we are not party to any pending legal proceedings that
we believe will have a material adverse impact on our business. We do not
believe that it is probable that the outcome of any individual action would have
a material adverse effect in the aggregate on our financial condition. We do not
believe that it is likely that an adverse outcome of individually insignificant
actions in the aggregate would be sufficient enough, in number or magnitude, to
have a material adverse effect in the aggregate on our financial condition.
72
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors and their ages and positions as of
March 5, 2004 are as follows:
Name Age Position
---- --- --------
Samuel J. (Jay) Furrow, Jr ........ 30 Chief Executive Officer and Director
Patricia Anderson ................. 43 President and Director
Marc B. Crossman .................. 32 Chief Financial Officer and Director
Shane Whalen ...................... 33 Chief Operating Officer
Samuel (Sam) J. Furrow ............ 62 Chairman of the Board of Directors
John G. Looney, MD(1)(2)(3) ....... 62 Director
Daniel A. Page(1)(3) .............. 52 Director
Suhail R. Rizvi(1)(2)(3) .......... 38 Director
Vincent Sanfilipo ................. 38 Director
Kent Savage ....................... 42 Director
(1) Member of the Audit Committee
(2) Member of the Compensation and Stock Option Committee
(3) Member of the Nominating and Governance Committee
Samuel J. (Jay) Furrow, Jr. has served as our Chief Executive Officer
since July 2002 and a member of our Board of Directors since January 1999. Prior
to that, Mr. Furrow served as our President from December 2000 until July 2002,
served as our Chief Operating Officer from April 1999 until March 2003, our
Acting Chief Financial Officer from August 2000 until March 2003, and our
Vice-President for Corporate Development and In-House Counsel from August 1998
until April 1999. Mr. Furrow currently serves on the Board of Directors of
Northgate Innovations, Inc. (NGTE.OB). Mr. Furrow received his J.D. degree from
Southern Methodist University School of Law and a B.S. Political Science degree
from Vanderbilt University. Jay Furrow is Sam Furrow's son.
Patricia Anderson has served as our President since July 2002 and a member
of our Board of Directors since August 1990. Ms. Anderson served as our Chief
Executive Officer from December 2000 until July 2002, our President from August
1990 until December 2000, and Chairman of our Board of Directors from August
1990 until August 1997. Prior to founding Innovo, Inc., Ms. Anderson worked as
Vice President of Sales and Marketing for Lexem, Inc., an import wholesale
houseware gift company located in Houston, Texas, from August 1985 until July
1987. Prior to that, Ms. Anderson owned and operated three retail stores
focusing on home decorating/gift shops all under the name of Basket Case from
November 1979 until April 1983. Ms. Anderson attended the University of Texas
and the University of Houston, with a focus on Accounting and Food Management.
Marc B. Crossman has served as our Chief Financial Officer since March
2003 and a member of our Board of Directors since January 1999. Prior to joining
our company, Mr. Crossman served as a Vice President and Equity Analyst with
J.P. Morgan Securities Inc., New York City, New York, from January 1999 until
March 2003. Prior to joining J.P. Morgan Securities, Inc., Mr. Crossman served
as a Vice President and Equity Analyst with CIBC Oppenheimer Corporation from
September 1997 until January 1999. Mr. Crossman also serves on the Board of
Directors of Northgate Innovations, Inc. (NGTE.OB). Mr. Crossman received a B.S.
degree in Mathematics from Vanderbilt University.
Shane Whalen has served as our Chief Operating Officer since April 2003.
Prior to that, Mr. Whalen served as our Vice President of Corporate Development
from October 2002 until April 2003. Prior to joining our company, Mr. Whalen was
an independent business consultant from November 2000 until September 2002.
Prior to that, Mr. Whalen served as Chief Operating Officer for Next Generation,
LLC, an entertainment production company, from
73
August 1998 until November 2000. Prior to that, Mr. Whalen served as Manager of
Financial Services & Transportation for Accenture Consulting from January 1994
until August 1998. Mr. Whalen received a B.A. degree in Economics from
Vanderbilt University.
Samuel J. (Sam) Furrow has served as Chairman of our Board of Directors
since October 1998. Mr. Furrow became a member of our Board of Directors in
April 1998 and served as our Chief Executive Officer from October 1998 until
December 2000, after which Patricia Anderson resumed the position. Mr. Furrow
also has been Chairman of the Board of Furrow Auction Company, a real estate and
equipment sales company with its headquarters in Knoxville, Tennessee, since
April 1968; Chairman of Furrow-Justice Machinery Corporation, a six-branch
industrial and construction equipment dealer, since 1983; owner of Knoxville
Motor Company-Mercedes Benz and Land Rover of Knoxville since December 1980 and
July 1997; respectively. Mr. Furrow has been a Director of Southeastern
Advertising Inc., an advertising agency, since April 1968; a Director of First
American National Bank since September 1993; and a Director of Goody's Family
Clothing, Inc. (Nasdaq: GDYS), a publicly traded retail clothing chain, since
1995. Mr. Furrow received his undergraduate and J.D. degree from the University
of Tennessee. Sam Furrow is the father of our Chief Executive Officer, Samuel J.
Furrow, Jr.
John Looney, M.D. has served as a member of our Board of Directors since
August 1999. Dr. Looney is a tenured Professor of Psychiatry and an Associate
Professor of Pediatrics at Duke University Medical Center. Dr. Looney has been
in the Duke University faculty since 1986. Dr. Looney serves on the Investment
Oversight Committee of the American Psychiatric Association (APA), which manages
the investments of the assets of the APA. In addition to his numerous
professional appointments within his field, Dr. Looney serves as Consultant to
the Board of Directors for Eieico, Inc., a private agricultural biotechnology
company that holds exclusive rights to bring to the marketplace patents from the
School of Agriculture and College of Veterinary Medicine at Pennsylvania State
University. Dr. Looney also serves as a consultant to the Board of Directors for
Piper Plastics, one of the nation's largest manufacturers of plastic crates for
the dairy and beverage industries. Dr. Looney received a B.A. degree from
Cornell University, a B.M.S. degree from Dartmouth Medical School, his M.D.
degree from Southwestern Medical School, and an M.B.A. degree from Southern
Methodist University.
Daniel A. Page has served as a member of our Board of Directors since
August 1997. Mr. Page served as our Chief Operating Officer from August 1997
until April 1999. From June 1993 until August 1997, Mr. Page was the principal
operating and executive officer of Southeast Mat Company, a privately held
manufacturer of automobile floor mats. Prior to that, Mr. Page was the president
of Tennessee Properties Company, a privately held real estate development
company, from 1980 until 1993.
Suhail Rizvi has served as a member of our Board of Directors since April
2003. Mr. Rizvi has served as Chairman of the Board of Directors for the Avatar
Group, formerly known as Electronic Manufacturing Services, Inc. a Puerto
Rico-based manufacturing company, since December 1995. Mr. Rizvi also serves as
a member of the Board of Directors for Varsity Television, a TV network
dedicated to teens; Northgate Innovations, Inc. (NGTE.OB), a publicly traded
manufacturer and distributor of personal computers; Doublespace Holdings, a
brand strategy and web development firm based in New York; and International
Sourcing Group, a distributor of electronic components. Mr. Rizvi received his
B.S. degree in Economics from the Wharton School of the University of
Pennsylvania.
Vincent Sanfilippo has served as a member of our Board of Directors since
July 2003. Mr. Sanfilippo is the Chief Investment Officer and Principal of
Urdang & Associates Real Estate Advisors, Inc., a real estate investment
management firm with a portfolio of real estate investments valued at
approximately $2 billion. Mr. Sanfilippo has been responsible for originating or
overseeing the acquisition of approximately $3 billion of real estate assets
during his 15 years with Urdang & Associates. Mr. Sanfilippo received his B.S.
degree in Economics from the University of Pennsylvania's Wharton Business
School.
Kent Savage has served as a member of our Board of Directors since July
2003. Mr. Savage currently serves as Chief Executive Officer for Northgate
Innovations, Inc. (NGTE:OB). Prior to joining Northgate in January 2004, Mr.
Savage served as co-founder, Chief Sales and Marketing Officer for TippingPoint,
Technologies (Nasdaq: TPTI) from September 2002 until February 2003. Prior to
joining TippingPoint, Mr. Savage served as co-founder, CEO and President for
Netpliance, Inc., from February 1999 until August 2001. Prior to joining
Netpliance, Mr. Savage served as General Manager, Broadband for Cisco Systems
Inc. Service Provider Line of Business from April
74
1998 until February 1999. Prior to joining Cisco, Mr. Savage served as an
officer and Vice President, Sales and Marketing for NetSpeed, Inc., from July
1996 until April 1998. Mr. Savage received his B.S. in Business from Oklahoma
State University, attended University of Virginia's Executive Leadership
Program, and earned his MBA from Southern Methodist University.
Board of Directors
Each of our Board of Directors is elected at the annual meeting of
stockholders and serves until the next annual meeting of stockholders and until
a successor has been elected and qualified or their earlier death, resignation
or removal. Vacancies on the Board of Directors are filled by a majority vote of
the remaining Board of Directors.
Board
Our board has an Audit Committee, Compensation and Stock Option Committee
and Nominating and Governance Committee.
Audit Committee. The Audit Committee is currently comprised of Messrs.
Rizvi, Looney and Page. Mr. Rizvi serves as Chairman of the Audit Committee. The
Audit Committee has been established to: (a) assist our Board of Directors in
its oversight responsibilities regarding (1) the integrity of our financial
statements, (2) our compliance with legal and regulatory requirements, (3) the
independent accountant's qualifications and independence and (4) the performance
of the our internal audit function; (b) prepare the report required by the U.S.
Securities and Exchange Commission for inclusion in the our annual proxy
statement; (c) retain and terminate our independent accountant; (d) approve
audit and non-audit services to be performed by the independent accountant; and
(e) perform such other functions as our Board of Directors may from time to time
assign to the Audit Committee. The Audit Committee has a charter that details
its duties and responsibilities, which was adopted by our Board of Directors on
May 22, 2003. Currently, all Audit Committee members are "independent" under
Nasdaq listing standards and as such term is defined in the rules and
regulations of the SEC and Mr. Rizvi has also been designated to be an "audit
committee financial expert" as such term is defined in the rules and regulations
of the SEC.
Compensation and Stock Option Committee. The Compensation and Stock Option
Committee is currently comprised of Messrs. Rizvi and Looney. Mr. Rizvi serves
as Chairman of the Compensation and Stock Option Committee. The principal
responsibilities of the Compensation and Stock Option Committee are to (a)
assist our Board of Directors in ensuring that a proper system of long-term and
short-term compensation is in place to provide performance-oriented incentives
to management, and that compensation plans are appropriate and competitive and
properly reflect the objectives and performance of management and the company;
(b) discharge our Board of Director's responsibilities relating to compensation
of our executive officers; (c) evaluate our Chief Executive Officer and set his
remuneration package; (d) prepare an annual report on executive compensation for
inclusion in our annual proxy statement; (e) make recommendations to our Board
of Directors with respect to incentive-compensation plans and equity-based
plans; and (f) perform such other functions as our Board of Directors may from
time to time assign. The Compensation and Stock Option Committee has a charter
that details its duties and responsibilities, which was adopted by our Board of
Directors on May 22, 2003. Currently, all Compensation and Stock Option
Committee members are "independent" under Nasdaq listing standards.
Nominating and Governance Committee. The Nominating and Governance
Committee is currently comprised of Messrs. Looney, Page and Rizvi. Dr. Looney
serves as Chairman of the Nominating and Governance Committee. The principal
responsibilities of the Nominating and Governance Committee are to (a) assist
our Board of Directors in determining the desired experience, mix of skills and
other qualities to assure appropriate Board composition, taking into account the
current Board members and the specific needs of the company and the Board of
Directors; (b) identifying highly qualified individuals meeting those criteria
to serve on our Board of Directors; (c) proposing to our Board of Directors a
slate of nominees for election by the stockholders at the Annual Meeting of
Stockholders and prospective director candidates in the event of the
resignation, death, removal or retirement of directors or a change in our Board
of Directors composition requirements; (d) developing plans regarding the size
and composition of our Board of Directors and its committees; (e) reviewing
management succession plans; (f) reviewing the Corporate Governance Guidelines
of our Board of Directors at least annually and monitoring and making
recommendations with respect to the corporate governance principles applicable
to the company; and (g) such other functions as the Board of Directors may from
time to time assign to the Nominating and Governance
75
Committee. Currently, all Nominating and Governance Committee members are
"independent" under Nasdaq listing standards.
Compensation Committee Interlocks and Insider Participation
During 2003, the Compensation and Stock Option Committee of the Board of
Directors was comprised of Dr. Looney and Mr. Rizvi. Our Compensation and Stock
Option Committee is responsible for determining the salaries and incentive
compensation of the executive officers and for providing recommendations for the
salaries and incentive compensation of all other employees and consultants. The
Compensation and Stock Option Committee also administers our benefit plans,
including the 2000 Employee Stock Incentive Plan. Mr. Rizvi serves as Chairman
of the Compensation and Stock Option Committee. Neither Mr. Rizvi nor Dr. Looney
has served as an executive officer or employee of Innovo Group. However,
beginning in December 2003, Messrs. Furrow and Crossman, two of our executive
officers and members of our Board of Directors, both became members of the Board
of Directors for Northgate Innovations, Inc. (NGTE.OB), which Mr. Savage
currently serves as its Chief Executive Officer. Furthermore, one additional
member of our Board of Directors, Mr. Rizvi, also serves as a member of the
Board of Directors for Northgate Innovations, Inc. (NGTE.OB). Neither Mr. Furrow
nor Mr. Crossman is a member of the Compensation Committee of the Board of
Directors for Northgate Innovations, Inc. (NGTE.OB).
Director Compensation
Pursuant to our 2000 Director Stock Incentive Plan, or the 2000 Director
Plan, each non-employee director receives annual compensation at the first
Annual Meeting of Stockholders following his or her appointment and annually
thereafter a grant in the form of options to buy common stock with an aggregate
fair market value of $10,000. These options are exercisable beginning one year
from the date of grant and expire in ten years. The exercise price is set at 50%
of the fair market value of the common stock on the date of grant. The discount
is in lieu of director fees. A member of our Board of Directors who is also an
employee of ours receives no additional compensation for his or her service as
member of our Board of Directors. Members of our Board of Directors who also
serve on one or more committees of the Board of Directors do not receive any
additional compensation for such service. In addition to this stock option
compensation, at the Annual Meeting of Stockholders on May 22, 2003, our Board
of Directors voted to compensate in cash all non-employee directors at an annual
rate of $12,500 for service as a member of our Board of Directors.
Executive Compensation
The following table sets forth certain information with respect to
compensation for the year ended November 29, 2003, November 30, 2002 and
December 1, 2001 paid to our chief executive officer and our other most highly
compensated executive officers as of November 29, 2003. In this prospectus, we
refer to these individuals as our named executive officers.
76
Summary Compensation Table
Annual Compensation Long-Term Compensation
Name and
-------- Other Annual Options/
Principal Position Year Salary Bonus Compensation SARs(1)
------------------ ---- ------ ----- ------------ -------
Samuel J. Furrow, Jr. 2003 $275,000 -- -- 100,000
Chief Executive Officer 2002 160,000 -- -- --
2001 143,000 -- -- 150,000
Patricia Anderson 2003 $275,000 -- 100,000
President 2002 206,000 -- -- --
2001 200,000 -- -- 300,000
Marc Crossman 2003 $275,000 -- $12,000(2) 1,000,000
Chief Financial Officer 2002 -- -- -- 10,000(3)
2001 -- -- --
Shane Whalen 2003 $125,000 -- $ 1,000(2) 50,000
Chief Operating Officer 2002 9,170(4) -- -- --
2001 -- -- -- --
-------------
(1) No executive officer received restricted stock awards or option grants
during the fiscal year ending November 30, 2002.
(2) This amount represents payments made in connection with relocation
expenses.
(3) These options were issued in connection with Mr. Crossman's service as a
member of our Board of Directors.
(4) Mr. Whalen commenced employment with us in October 2002 as our Vice
President of Corporate Development.
Employment Contracts, Termination of Employment and Change in Control
We have not entered into any employment or severance agreements with any
of our Named Executive Officers. However, in connection with Mr. Crossman's
option agreement, in the event of a change in control of the company, all of Mr.
Crossman's options, to the extent not otherwise exercisable, will immediately
become exercisable.
Stock Option Grants
The following table sets forth the stock options we granted during the
fiscal year ended November 29, 2003 to each of our named executive officers.
Amounts shown as potential realizable values are based on compounded
annual rates of share price appreciation of five and ten percent over the
10-year term of the options, as mandated by rules of the Securities and Exchange
Commission, and are not indicative of expected share price performance. Actual
gains, if any, on share option exercises are dependent on future performance of
the overall market conditions, as well as the option holders' continued
employment through the vesting period. The amounts reflected in this table may
not necessarily be achieved or may be exceeded. The indicated amounts are net of
the option exercise price but before taxes that may be payable upon exercise.
77
Option/SAR Grants in Last Fiscal Year
Potential Realizable Value
at Assumed Annual Rates
of Stock Price
Appreciation for Option
Individual Grants Term
--------------------------------------------------------------------------------------- ---------------------------------
Number of (1) (2)
Securities % of Total
Underlying Options/SARs Exercise
Options/SARs Granted to or Base
Granted Employees in Price Expiration
Name (#) Fiscal Year ($/Sh) Date 5% ($) 10% ($)
-------------------------- -------------- -------------- ---------- ------------ -------------- --------------
Samuel J. Furrow, Jr 100,000 8% $2.40 12/02/07 $ 66,000 $ 147,000
Patricia Anderson 100,000 8% $2.40 12/02/07 $ 66,000 $ 147,000
Marc Crossman 1,000,000 77% $2.86 3/25/13 $1,800,000 $4,560,000
Shane Whalen 50,000 4% $2.60 5/22/13 $ 82,000 $ 207,000
----------------
Fiscal Year End Option Values
The following table sets forth certain information with respect to stock
options exercised by the Named Executive Officers during the fiscal year ended
November 29, 2003. In addition, the table sets forth the number of shares
covered by unexercised stock options held by the Named Executive Officers as
November 29, 2003, and the value of "in-the-money" stock options, which
represents the positive spread between the exercise price of a stock and the
market price of the shares subject to such option as of November 29, 2003.
Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End
Option/SAR Values
Number of Securities Value of
Underlying Unexercised In- the-
Unexercised Money
Options/SARs at FY- Options/SARs at
End (#) FY-End ($)(1)
Shares Acquired Value Realized Exercisable/ Exercisable/
Name on Exercise (#) ($) Unexercisable Unexercisable
--------------------- ---------------- --------------- -------------------- ----------------------
Samuel J. Furrow, Jr. 0 $0 350,000(2)/0 $597,500/$0
Patricia Anderson 0 $0 400,000/0 $1,025,000/$0
Marc Crossman 0 $0 468,974(2)/666,667 $539,461/$826,667
Shane Whalen 0 $0 25,000/25,000 $37,500/$37,500
-----------------
(1) Based on a closing price per share of $4.10 for the Common Stock on
Friday, November 28, 2003, as reported by the Nasdaq SmallCap Market.
(2) Includes 100,000 shares that expired unexercised on February 24, 2004 at
an exercise price of $4.75.
78
The following table sets forth information concerning the repricing of
options held by Marc Crossman, our Chief Financial Officer with respect to
options that were originally granted in connection with commencement of his
employment as our Chief Financial Officer. However, on the original date of the
grant of the options to Mr. Crossman, there were not enough shares authorized
under the 2000 Employee Stock Incentive Plan to grant Mr. Crossman the options.
As a result, Mr. Crossman's options were cancelled and reissued upon stockholder
approval of an increase in shares authorized and available for grant under the
2000 Employee Stock Incentive Plan. The term of the reissued option was 10 years
unlike the 20 year term of the original option.
Ten Year Option/SAR Repricings
Length of
Number of Original
Securities Option Term
Underlying Market Price of Exercise Price Remaining at
Options/SARs Stock at Time of at Time of New Date of
Name and Repriced or Repricing or Repricing or Exercise Repricing or
Position Date Amended (#) Amendment ($) Amendment ($) Price ($) Amendment
-------- ---- ----------- ------------- ------------- --------- ---------
Marc
Crossman, 5/22/03 1,000,000 $2.60 $2.86 $2.86 19.8 years
CFO
401(k) Plan
On December 1, 2002, we established a tax qualified defined contribution
401(k) Profit Sharing Plan (the "Plan"). All employees who have worked for us
for 30 consecutive days may participate in the Plan and may contribute up to
100% of their salary to the plan. Our elective matching contributions may be
made on a discretionary basis. All employees who have worked 500 hours qualify
for profit sharing in the event at the end of each year we decide to do so.
Costs of the plan charged to operations were $20,000 for the year ended November
29, 2003.
Equity Compensation Plan Information
The following table sets forth certain information about our common stock
that may be issued upon the exercise of options, warrants and rights under all
of the our compensation plans (including individual compensation arrangements)
under which our equity securities are authorized for issuance, which includes
our 2000 Employee Stock Incentive Plan and 2000 Director Stock Incentive Plan.
Number of Securities
Remaining Available for
Number of Securities to Weighted Average Issuance Under Equity
be Issued Upon Exercise Exercise Price of Compensation Plan
of Outstanding Options, Outstanding Options, (excluding securities
Plan Category Warrants and Rights Warrants and Rights reflected in column (a))
------------- ------------------- ------------------- ------------------------
Equity Compensation (a) (b) (c)
Plans approved by security
holders (1):
2000 Employee Plan 1,530,000 $2.48 1,470,000
2000 Director Plan 173,332 $0.69 326,668
Equity Compensation
Plans not approved by
security holders:
Patricia Anderson (2) 300,000 $1.25 0
Samuel J. Furrow, Jr. (3) 250,000 $2.65 0
Marc B. Crossman (4) 100,000 $4.75 0
---------
TOTAL 2,353,332
=========
79
(1) See "2000 Employee Stock Incentive Plan" and "2000 Director Stock
Incentive Plan" described herein.
(2) Includes 300,000 shares subject to exercisable options pursuant to a
400,000 option grant of nonqualified options made in June 2001 with an
exercise price of $1.25 per share and expiring June 5, 2005.
(3) Includes 150,000 shares subject to exercisable options pursuant to a
200,000 option grant of nonqualified options made in June 2001 with an
exercise price of $1.25 per share expiring June 5, 2005 and 100,000 shares
subject to exercisable options pursuant to an option grant made in
February 1999 with an exercise price of $4.75 per share that expired
unexercised in February 2004.
(4) Includes 100,000 shares subject to exercisable options pursuant to an
option grant made in February 1999 with an exercise price of $4.75 per
share that expired unexercised in February 2004.
STOCK PLANS
2000 Employee Stock Incentive Plan
The 2000 Employee Stock Incentive Plan, or the 2000 Employee Plan,
provides for the grant of options to our officers, employees and consultants and
our affiliates. The 2000 Employee Plan continues in effect until March 2010,
unless terminated earlier and was amended at the Annual Meeting of Stockholders
held on May 22, 2003, to increase the number of shares available for issuance
under the 2000 Employee Plan from 1,000,000 to 3,000,000, as well as increase
the number of shares that may be issued to any one individual under the 2000
Employee Plan in any calendar year from 500,000 to 1,250,000. Options granted
under the 2000 Employee Plan may be either "incentive stock options" ("ISOs")
within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended (the "Code"), or nonqualified stock options ("NQSOs").
The 2000 Employee Plan is administered by the Compensation and Stock
Option Committee of our Board of Directors. The Compensation and Stock Option
Committee of our Board of Directors has been delegated the full authority in its
discretion to determine our officers and key employees or our affiliates to whom
stock incentive options will be granted and the terms and provisions of stock
incentive options, subject to the requirements and limitations of the 2000
Employee Plan. Subject to the provisions of the 2000 Employee Plan, the
Compensation and Stock Option Committee of our Board of Directors has full and
conclusive authority to interpret the 2000 Employee Plan; to prescribe, amend
and rescind rules and regulations relating to the 2000 Employee Plan, to
determine the terms and provisions of the respective stock incentive agreements
and to make all other determinations necessary or advisable for the proper
administration of the 2000 Employee Plan.
The 2000 Employee Plan is intended to: (a) provide incentive to our
officers and key employees and our affiliates to stimulate their efforts toward
our continued success and to operate and manage the business in a manner that
will provide for our long-term growth and profitability; (b) encourage stock
ownership by officers and key employees by providing them with a means to
acquire a proprietary interest in us, acquire shares of stock, or to receive
compensation which is based upon appreciation in the value of the stock; and (c)
provide means of obtaining, rewarding and retaining key personnel and
consultants.
The number of shares of stock as to which a stock incentive may be granted
will be determined by our Compensation and Stock Option Committee of Board of
Directors, in its sole discretion, subject to the limitations of the 2000
Employee Plan. To the extent required under Section 162(m) of the Code and the
regulations thereunder for compensation to be treated as qualified performance
based compensation, the maximum number of shares of stock with respect to which
options may be granted during any one year period to any employee may not exceed
1,250,000.
Stock option grants issued under the 2000 Employee Plan may be granted
only to our officers, key employees and consultants, or any of our affiliates.
The aggregate fair market value (determined as at the date an ISO is granted) of
stock with respect to which stock options intended to meet the requirements of
the Code Section 422 become exercisable for the first time by an individual
during any calendar year under all of our plans and our subsidiaries may not
exceed $100,000; provided further, that if the limitation is exceeded, the ISOs
which cause the limitation to be exceeded will be treated as NQSOs.
80
The 2000 Employee Plan was adopted by our Board of Directors on March 12,
2000 and approved by stockholders at the 2000 Annual Meeting of Stockholders and
amended at the at the Annual Meeting of Stockholders held on May 22, 2003. Up to
3,000,000 shares of Common Stock, subject to adjustment as provided in the 2000
Employee Plan, may be issued under the 2000 Employee Plan. As of March 5, 2004,
1,530,000 shares have been issued under our 2000 Employee Plan. Awards under the
2000 Employee Plan are discretionary. Therefore, it is not possible to determine
the benefits that will be received in the future by participants in the 2000
Employee Plan.
Federal Income Tax Consequences of Options
The following is a brief summary of certain Federal income tax aspects of
awards of options to our employees under the 2000 Employee Plan and otherwise
based upon the Federal income tax laws in effect on the date hereof. This
summary is not intended to be exhaustive and does not describe state or local
tax consequences.
An optionee will not realize taxable income upon the grant of an ISO. In
addition, an optionee will not realize taxable income upon the exercise of an
ISO, provided that such exercise occurs no later than three months after the
optionee's termination of employment with us (one year in the event of a
termination on account of death or disability). However, an optionee's
alternative minimum taxable income will be increased by the amount that the fair
market value of the shares acquired upon exercise of an ISO, generally
determined as of the date of exercise, exceeds the exercise price of the option.
If an optionee sells the shares of common stock acquired upon exercise of an
ISO, the tax consequences of the disposition depend upon whether the disposition
is qualifying or disqualifying. The disposition of the shares is qualifying if
made more than two years after the date of the ISO was granted and more than one
year after the date the ISO was exercised. If the disposition of the shares is
qualifying, any excess of the sale price of the shares over the exercise price
of the ISO would be treated as long-term capital gain taxable to the option
holder at the time of the sale. If the disposition is not qualifying, i.e., a
disqualifying disposition, the optionee will recognize ordinary compensation
income in an amount equal to the lesser of the difference between (a) the
exercise price and the fair market value of the shares on the date of exercise
or (b) the exercise price and the sales proceeds. Any remaining gain or loss
will be treated as a capital gain or loss. Unless an optionee engages in a
disqualifying disposition, we will not be entitled to a deduction with respect
to an ISO. However, if an optionee engages in a disqualifying disposition, we
generally will be entitled to a deduction in the same amount and at the same
time as compensation income is taxable to the optionee.
An optionee will not realize taxable income upon the grant of an NQSO.
However, when the optionee exercises the NQSO, the difference between the
exercise price of the NQSO and the fair market value of the shares acquired upon
exercise of the NQSO on the date of exercise is ordinary compensation income
taxable to the optionee. We generally will be entitled to a deduction in the
same amount and at the same time as compensation income is taxable to the
optionee.
2000 Director Plan
The purpose of the 2000 Director Plan is to permit the granting of stock
options to our Directors who are not our employees at an exercise price less
than market value at the date of grant in lieu of paying Directors' fees in
cash, thereby advancing our interests by encouraging and enabling the
acquisition of our common stock by Directors whose judgment and ability are
relied upon by us for the attainment of its long-term growth and development.
Accordingly the 2000 Director Plan is intended to promote a close identity of
interest among us, our Directors, and our stockholders, as well as to provide a
means to attract and attain well-qualified Directors. The 2000 Director Plan was
adopted by our Board of Directors on September 13, 2000 and approved by
stockholders at the 1999 annual meeting of stockholders.
There are authorized for issuance or delivery upon the exercise of options
to be granted from time to time under the 2000 Director Plan an aggregate of
500,000, subject to adjustment as provided in the 2000 Director Plan. As of
March 5, 2004, 173,332 shares have been issued under the 2000 Director Plan. The
2000 Director Plan is administered by the Compensation and Stock Option
Committee, which shall consist of not less than three members, all of whom shall
be deemed to be independent, and appointed by the Board.
81
Pursuant to our 2000 Director Stock Incentive Plan, or the 2000 Director
Plan, each non-employee director receives annual compensation at the first
Annual Meeting of Stockholders following his or her appointment and annually
thereafter a grant in the form of options to buy common stock with an aggregate
fair market value of $10,000. These options are exercisable beginning one year
from the date of grant and expire in ten years. The exercise price is set at 50%
of the fair market value of the common stock on the date of grant. The discount
is in lieu of director fees. A member of our Board of Directors who is also an
employee of ours receives no additional compensation for his or her service as
member of our Board of Directors. Members of our Board of Directors who also
serve on one or more committees of the Board of Directors do not receive any
additional compensation for such service. In addition to this stock option
compensation, at the Annual Meeting of Stockholders on May 22, 2003, our Board
of Directors voted to compensate in cash all non-employee directors at an annual
rate of $12,500 for service as a member of our Board of Directors.
Each option has an exercise price equal to one-half of the market price on
the date of grant, and covers a number of shares equal to $10,000 divided the
exercise price per share. The market price is determined as of the close of
business on the day of our Board meeting immediately following our annual
shareholder meeting. The 2000 Director Plan will continue in effect until
September 2010, unless terminated earlier. Options granted under the 2000
Director Plan are nonqualified stock options.
During 2003, all of our non-employee directors received an option to
purchase up to 7,692 shares of our common stock with an exercise price of $1.30
per share vesting on a monthly basis beginning May 22, 2003 under the Company's
2000 Director Plan in lieu of cash directors' fees. These options have a ten
year term and expire on May 22, 2013.
82
PRINCIPAL AND SELLING STOCKHOLDERS
The following table presents information regarding beneficial ownership of
our common stock as of March 5, 2004, and as adjusted to reflect the sale of
common stock in this offering by:
o each of the selling stockholders;
o each stockholder known by us to beneficially hold five percent or
more of our common stock;
o each of our directors;
o each of our named executive officers; and
o all of our executive officers and directors as a group.
Beneficial ownership is determined under the rules of the Securities and
Exchange Commission and generally includes voting or investment power with
respect to securities. Unless indicated below, to our knowledge, the persons and
entities named in the table have sole voting and sole investment power with
respect to all shares beneficially owned, subject to community property laws
where applicable. Shares of common stock subject to options that are currently
exercisable or exercisable within 60 days of March 5, 2004 are deemed to be
outstanding and to be beneficially owned by the person holding the options for
the purpose of computing the percentage ownership of that person but are not
treated as outstanding for the purpose of computing the percentage ownership of
any other person.
Shares Beneficially Owned Shares Beneficially Owned
Prior to the After
Offering(1) Number of Offering
----------------------------------- Shares to be -------------------------------
Number of Percent of Sold in the Number of Percent of
Name and Address Shares Class Offering Shares Class
------------------------------------- ------------------ ------------- ------------- --------------- ------------
DIRECTORS, OFFICERS AND
OVER 5% STOCKHOLDERS:
Samuel (Sam) J. Furrow 3,134,164(2) 10.84% -- 3,134,164 10.84%
Chairman of Board of Directors
Samuel (Jay) J. Furrow, Jr 1,369,104(3) 4.73% -- 1,369,104 4.73%
Chief Executive Officer and Director
Patricia Anderson 683,146(4) 2.36% -- 683,146 2.36%
President and Director
Marc Crossman 600,807(5) 2.08% -- 600,807 2.08%
Chief Financial Officer and Director
Shane Whalen 45,833(6) *% -- 45,833 *%
Chief Executive Officer
John G. Looney, MD 195,566(7) *% -- 195,566 *%
Director
Daniel A. Page 367,699(8) 1.27% -- 367,699 1.27%
Director
Suhail Rizvi 7,051(9) *% -- 7,051 *%
Director
83
Shares Beneficially Owned Shares Beneficially Owned
Prior to the After
Offering(1) Number of Offering
----------------------------------- Shares to be -------------------------------
Number of Percent of Sold in the Number of Percent of
Name and Address Shares Class Offering Shares Class
------------------------------------- ------------------ ------------- ------------- --------------- ------------
Vincent Sanfilippo 0 *% -- 0 *%
Director
Kent A. Savage 0 *% -- 0 *%
Director
Azteca Production International, Inc. 3,825,000(10) 13.23% -- 3,825,000 13.23%
Over 5% Stockholder
5804 East Slauson Avenue
Commerce, California 90040
Commerce Investment Group LLC 2,069,690(11) 7.16% -- 2,069,690 7.16%
Over 5% Stockholder
5804 East Slauson Avenue
Commerce, California 90040
Hubert Guez 5,218,590(12) 18.05% -- 5,218,590 18.05%
Over 5% Stockholder
5804 East Slauson Avenue
Commerce, California 90040
Paul Guez 5,560,714(13) 19.23% -- 5,560,714 19.23%
Over 5% Stockholder
5804 East Slauson Avenue
Commerce, California 90040
Seymour Braun, Innavation LLC, 2,547,820(14) 8.81% -- 2,547,820 8.81%
Yardworth Mortgage Corp., and
Praha Trust
Over 5% Stockholder
Braun & Goldberg
110 East 59th Street, Suite 3201
New York, New York 10022
All directors and executive officers, 6,403,370 22.14% -- 6,403,370 22.14%
as a group (10 persons) --------- ---------
(2)(3)(4)(5) (2)(3)(4)(5)
(6)(7)(8)(9) (6)(7)(8)(9)
SELLING STOCKHOLDERS:
Basic Investors, Inc. 39,745(15) *% 39,745 0 *%
Richard Belz 205,822(16) *% 93,025 112,797 *%
JAS Securities, LLC 27,625(17) *% 27,625 0 *%
IRA FBO Don A. Sanders - Pershing 30,030(18) *% 30,030 0 *%
LLC Custodian
Gary Purcell 245,704(19) *% 108,165 137,539 *%
------- -------
TOTAL for Selling Stockholders: 548,926 298,590
======= =======
84
--------------
* Represents beneficial ownership of less than 1%.
(1) Pursuant to the rules of the Securities and Exchange Commission
("SEC"), certain shares of our common stock that a beneficial owner
set forth in this table has a right to acquire within 60 days of the
date hereof pursuant to the exercise of options or warrants for the
purchase of shares of common stock are deemed to be outstanding for
the purpose of computing the percentage ownership of that owner but
are not deemed outstanding for the purpose of computing percentage
ownership of any other beneficial owner shown in the table.
Percentages are calculated based on 28,917,850 shares outstanding as
of March 5, 2004.
The address for the officers and directors is our corporate office
located at 5804 East Slauson Avenue, Commerce, California, 90040.
(2) Includes (i) 3,083,598 shares held for the personal account of Sam
Furrow; and (ii) 50,566 shares issuable upon the exercise of
currently exercisable (or exercisable within 60 days) options held
for Mr. Furrow's personal account.
(3) Includes (i) 1,119,104 shares held for the personal account of Jay
Furrow; and (ii) 250,000 shares issuable upon the exercise of
currently exercisable (or exercisable within 60 days) options held
for Mr. Furrow's personal account.
(4) Includes (i) 283,146 shares held for Ms. Anderson's personal
account; and (ii) 400,000 shares issuable upon the exercise of
currently exercisable (or exercisable within 60 days) options held
for Ms. Anderson' personal account.
(5) Includes (i) 23,500 shares held for Mr. Crossman's personal account;
and (ii) 577,307 shares issuable upon the exercise of currently
exercisable (or exercisable within 60 days) options held for Mr.
Crossman's personal account.
(6) Includes 45,833 shares issuable upon the exercise of currently
exercisable (or exercisable within 60 days) options held for Mr.
Whalen's personal account.
(7) Includes (i) 145,000 shares held for Mr. Looney's personal account;
and (ii) 50,566 shares issuable upon the exercise of currently
exercisable (or exercisable within 60 days) options held for Mr.
Looney's personal account.
(8) Includes (i) 317,133 shares held for Mr. Page's personal account;
and (ii) 50,566 shares issuable upon the exercise of currently
exercisable (or exercisable within 60 days) options held for Mr.
Page's personal account.
(9) Includes 7,051 shares issuable upon the exercise of currently
exercisable (or exercisable within 60 days) options held for Mr.
Rizvi's personal account.
(10) Includes (i) 3,125,000 shares offered hereby and held for the
account of Azteca Production International, Inc. ("Azteca"), an
entity jointly owned by Mr. Hubert Guez and Mr. Paul Guez, as to
which such shares Mr. Hubert Guez and Mr, Paul Guez exercise shared
voting and investment control; and (ii) 700,000 shares held for the
account of Azteca, an entity jointly owned by Mr. Hubert Guez and
Mr. Paul Guez and as to which such shares Mr. Paul Guez exercises
sole voting and investment control.
(11) Includes (i) 1,769,690 shares held for the account of Commerce
Investment Group, LLC, a California limited liability company
("CIG"), an entity jointly owned by Mr. Hubert Guez and Mr. (12)
Paul Guez, as to which such shares Mr. Hubert Guez exercises sole
voting and investment control; and (ii) 300,000 shares issuable upon
exercise of currently exercisable warrants held for CIG's account,
as to which such shares Mr. Hubert Guez exercises sole voting and
investment control.
85
(12) Includes (i) 23,900 shares held for the personal account of Hubert
Guez; (ii) 1,769,690 shares held for the account of CIG, an entity
jointly owned by Mr. Hubert Guez and Mr. Paul Guez, as to which such
shares Mr. Hubert Guez exercises sole voting and investment control;
(iii) 300,000 shares issuable upon exercise of currently exercisable
warrants held for the account of CIG, as to which such shares Mr.
Hubert Guez exercises sole voting and investment control; and (iv)
3,125,000 shares offered hereby and held for the account of Azteca,
an entity jointly owned by Mr. Hubert Guez and Mr. Paul Guez, as to
which such shares Mr. Hubert Guez exercises shared voting and
investment control.
(13) Includes (i) 3,125,000 shares offered hereby and held for the
account of Azteca, an entity jointly owned by Mr. Hubert Guez and
Mr. Paul Guez, as to which such shares Mr. Paul Guez exercises
shared voting and investment control; (ii) 700,000 shares held for
the account of Azteca, an entity jointly owned by Mr. Hubert Guez
and Mr. Paul Guez and as to which such shares Mr. Paul Guez
exercises sole voting and investment control; (iii) 285,714 shares
held for the account of S.H.D. Investments, LLC, a California
limited liability company for which Mr. Paul Guez serves as
President and as to which such shares Mr. Paul Guez exercises sole
voting and investment control; and (iv) 1,450,000 shares held for
the account of Integrated Apparel Resources, LLC, a California
limited liability an entity jointly owned by Mr. Hubert Guez and Mr.
Paul Guez, as to which such shares Mr. Paul Guez exercises sole
voting and investment control.
(14) Innavation, LLC, a Delaware limited liability company, is owned 85%
by Yardworth Mortgage Corp. ("Yardworth"), a corporation organized
under the laws of Aruba. The beneficial owner of Yardworth is Praha
Trust, a trust organized under the laws of Canada. As sole trustee
of Praha Trust, Mr. Seymour Braun has the right to vote all shares
owned by Innavation, LLC. This information is based upon Form 4
filed with the SEC on February 9, 2004.
(15) Includes 39,745 shares issuable upon the exercise of currently
exercisable warrants. Basic Investors, Inc. is an NASD member firm
and is a registered broker-dealer. In their capacities as principals
of Basic Investors, Inc., Richard Belz and Gary Purcell exercise
voting and investment control over the shares held for the account
of Basic Investors, Inc. Basic Investors, Inc. is not an underwriter
or related person with respect to the securities being registered
pursuant to this registration statement.
(16) Includes 93,025 shares issuable upon the exercise of currently
exercisable warrants. Mr. Belz is a principal of Basic Investors,
Inc., which is an NASD member firm and a registered broker-dealer.
These shares were purchased and are held in the ordinary course of
business for the separate account of Mr. Belz. Basic Investors, Inc.
is not an underwriter or related person with respect to the
securities being registered pursuant to this registration statement.
(17) JAS Securities, LLC is an NASD member firm and a registered
broker-dealer. In his capacities as managing member and principal of
JAS Securities, LLC, Andrew Smukler exercises voting and investment
control over the shares held for the account of JAS Securities, LLC.
JAS Securities, LLC is not an underwriter or related person with
respect to the securities being registered pursuant to this
registration statement.
(18) Don A. Sanders is a principal of Sanders Morris Harris, Inc., which
is an NASD member firm and a registered broker-dealer. These shares
were purchased and are held in the ordinary course of business for
the separate account of Mr. Sanders. Sanders Morris Harris, Inc. is
not an underwriter or related person with respect to the securities
being registered pursuant to this registration statement.
86
(19) Includes 108,165 shares issuable upon the exercise of currently
exercisable warrants. Gary Purcell is a principal of Basic
Investors, Inc., which is an NASD member firm and a registered
broker-dealer. These shares were purchased and are held in the
ordinary course of business for the separate account of Mr. Purcell.
Basic Investors, Inc. is not an underwriter or related person with
respect to the securities being registered pursuant to this
registration statement.
Except as otherwise disclosed above or in documents incorporated herein by
reference, the selling stockholders, have not within the past three years had
any position, office or other material relationship with us or any of our
predecessors or affiliates. Because the selling stockholders may sell all or
some portion of the shares of common stock beneficially owned by them, only an
estimate (assuming the selling stockholders sell all of the shares offered
hereby) can be given as to the number of shares of common stock that will be
beneficially owned by the selling stockholders after this offering. In addition,
the selling stockholders may have sold, transferred or otherwise disposed of, or
may sell, transfer or otherwise dispose of, at any time or from time to time
since the dates on which they provided the information regarding the shares
beneficially owned by them, all or a portion of the shares beneficially owned by
them in transactions registered under other effective registration.
The preceding table has been prepared based upon the information furnished
to us by the selling stockholders. The selling stockholders identified above may
have sold, transferred or otherwise disposed of some or all of their common
stock in transactions exempt from the registration requirements of the
Securities Act since the dates on which they provided the information regarding
the common stock beneficially owned by them. Information concerning the selling
stockholder may change from time to time and, if necessary, we will supplement
this prospectus accordingly.
PLAN OF DISTRIBUTION
The selling stockholders may offer their shares of common stock at various
times in one or more of the following transactions:
o on any U.S. securities exchange on which our common stock may be
listed at the time of such sale;
o in the over-the-counter market;
o in transactions other than on such exchanges or in the
over-the-counter market;
o in connection with short sales; or
o in a combination of any of the above transactions.
The selling stockholders may offer their shares of common stock at
prevailing market prices, at prices related to the prevailing market prices, at
negotiated prices or at fixed prices. The selling stockholders may transfer
shares to discharge indebtedness, as payment for goods or services, or for other
non-cash consideration.
The selling stockholders may use broker-dealers to sell their shares of
common stock. If this occurs, broker-dealers will either receive discounts or
commission from the selling stockholder, or they will receive commissions from
the purchasers of shares of common stock for whom they acted as agents. These
brokers may act as dealers by purchasing any and all of the shares covered by
this prospectus either as agents for others or as principals for their own
accounts and reselling these securities under the prospectus.
The selling stockholders and any broker-dealers or other persons acting on
the behalf of parties that participate in the distribution of the shares may be
considered underwriters under the Securities Act. As such, any
87
commissions or profits they receive on the resale of the shares may be
considered underwriting discounts and commissions under the Securities Act.
As of the date of this prospectus, we are not aware of any agreement,
arrangement or understanding between any broker or dealer and any of the selling
stockholders with respect to the offer or sale of the shares under this
prospectus. Each of Basic Investors, Inc., Richard Belz, JAS Securities, LLC,
Don A. Sanders and Gary Purcell are affiliated with an NASD member firm which is
a registered-broker dealer (collectively, the "Broker-Dealer Affiliates"). Each
Broker-Dealer Affiliate has represented to us that it purchased the shares
registered for resale under this prospectus in the ordinary course of business
and for its own account, and that at the time of the purchase of these shares,
each Broker-Dealer Affiliate had no agreements or understandings, directly or
indirectly, with any person to distribute these shares. If we become aware of
any agreement, arrangement or understanding, to the extent required under the
Securities Act, we will file a supplemental prospectus to disclose:
o the name of any of the broker-dealers;
o the number of shares involved;
o the price at which the shares are to be sold;
o the commissions paid or discounts or concessions allowed to
broker-dealers, where applicable;
o that the broker-dealers did not conduct any investigation to verify
the information set out in this prospectus, as supplemented; and
o other facts material to the transaction.
Certain of the agreements with the selling stockholders contain reciprocal
indemnification provisions between us and the selling stockholder to indemnify
each other against certain liabilities, including liabilities under the
Securities Act, which may be based upon, among other things, any untrue
statement or alleged untrue statement of a material fact or any omission or
alleged omission of a material fact.
88
RELATED PARTY TRANSACTIONS
We have adopted a policy requiring that any material transaction between
us and persons or entities affiliated with officers, directors or principal
stockholders of our company be on terms no less favorable to us than reasonably
could have been obtained in arms' length transactions with independent third
parties.
Anderson Stock Purchase Agreement
Pursuant to a Stock Purchase Right Award granted in February 1997, our
President, Pat Anderson, purchased 250,000 shares of common stock, or the Award
Shares, with payment made by the execution of a non-recourse note, or the
Anderson Note, for the exercise price of $2.81 per share, or $703,125 in the
aggregate. The Anderson Note was due, without interest, on April 30, 2002, and
was collateralized by the 1997 Award Shares. The Anderson Note may be paid or
prepaid (without penalty) by (i) cash, or (ii) the delivery of our common stock
(other than the Award Shares) held for a period of at least six months, which
shares would be credited against the Anderson Note on the basis of the closing
bid price for the common stock on the date of delivery.
On July 18, 2002, our Board of Directors voted in favor of extending the
term of the Anderson Note until April 30, 2005. The remaining provisions of the
Anderson Note remained the same. As of November 29, 2003, $703,125 remains
outstanding under the Anderson Note.
Crossman Loan
On February 7, 2003 and on February 13, 2003, we entered into a promissory
note loan agreement with Marc Crossman, then a member of our Board of Directors
and now also our Chief Financial Officer. The loan was funded in two phases of
$250,000 each on February 7, 2003 and February 13, 2003 for an aggregate loan
value of $500,000. In the event of default, each loan is collateralized by
125,000 shares of our common stock as well as a general unsecured claim on our
assets, subordinate to existing lenders. Each loan matures six months and one
day from the date of its respective funding, at which point the principal amount
loaned and any unpaid accrued interest is due and payable in full without
demand. The loan carries an 8% annualized interest rate with interest payable in
equal monthly installments. The loan may be repaid by us at any time during the
term of the loan without penalty. Further, prior to the maturity of the loan and
the original due dates, we elected, at our sole option, to extend the term of
the loan for an additional period of six months and one day. A majority of our
disinterested directors approved the loan from Mr. Crossman. Subsequent to the
year ended November 29, 2003 and prior to the maturity of the loans in February
2004, the parties agreed to extend the term of the loan for an additional period
of ninety days. Further, pursuant to the extension of the loan, the loan was
amended to provide Mr. Crossman with the sole and exclusive option to continue
to extend the term of the loan for three additional ninety day periods by giving
notice of such extension on or before the due date of the loan.
Purchases of Goods and Services
As required under the terms of the investment by Commerce and its
affiliates, our Innovo, Joe's and IAA subsidiaries each purchased its craft
goods and distribution and operational services from Commerce and its affiliates
in fiscal 2003, fiscal 2002 and fiscal 2001. The services purchased included but
were not limited to accounts receivable collections, certain general accounting
functions, inventory management and distribution logistics. The following
schedule represents Innovo's, Joe's and IAA's purchases from Commerce and its
affiliates during fiscal 2003, fiscal 2002 and fiscal 2001 (in thousands):
Innovo
---------------------------------
Year Ended
(in thousands)
---------------------------------
2003 2002 2001
---------------------------------
Goods $ 2,898 $ 3,317 $ 2,320
Distribution Services 615 644 362
Operational Services 228 203 112
---------------------------------
Total $ 3,741 $ 4,164 $ 2,794
=================================
89
Joe's IAA
-------------------------------- --------------------------------
Year Ended Year Ended
(in thousands) (in thousands)
-------------------------------- --------------------------------
2003 2002 2001 2003 2002 2001
-------------------------------- --------------------------------
Goods $ 2,195 $ 6,102 $ 1,102 $ 41,798 $ 6,171 $ 1,794
Distribution Services 127 107 20 -- -- --
-------------------------------- --------------------------------
Total $ 2,322 $ 6,209 $ 1,122 $ 41,798 $ 6,171 $ 1,794
================================ ================================
Additionally, we are charged an allocation expense from Commerce and its
affiliates for expenses associated with us occupying space in Commerce's
Commerce, California facility and the use of general business machines and
communication services. These expenses totaled approximately $343,000 for fiscal
2003 and $25,000 for fiscal 2002 and fiscal 2001. We also utilizes office space
and office equipment under a cost sharing arrangement with Commerce and its
affiliates.
We believe that all the transactions conducted between us and Commerce and
its affiliates were completed on terms that were competitive and at market
rates. Included in due to related parties is $390,000 and $4,159,000 at November
29, 2003 and November 30, 2002, respectively, relating to amounts due to
Commerce and affiliated entities for goods and services described above.
Azteca Productions International, Inc.
In the third quarter of fiscal 2001, we acquired Azteca Productions
International, Inc.'s Knit Division and formed the subsidiary Innovo Azteca
Apparel, Inc. Pursuant to equity transactions completed in fiscal 2000, the
principals of Azteca Production International, Inc. became our affiliates. We
purchased the Knit Division's customer list, the right to manufacture and market
all of the Knit Division's current products and entered into certain non-compete
and non- solicitation agreements and other intangible assets associated with the
Knit Division. As consideration, we issued to Azteca, 700,000 shares of our
common stock valued at $1.27 per share based upon the closing price of the
common stock on August 24, 2001, and promissory notes in the amount of $3.6
million.
As part of the acquisition of the Blue Concept Division from Azteca in
July 2003, IAA and AZT entered into a two-year, renewable, non-exclusive Supply
Agreement for products to be sold by the Blue Concept Division. In addition to
the customary obligations, the Supply Agreement requires that AZT will receive
payment immediately upon receipt of invoices for our purchase orders and that
AZT will charge a per unit price such that IAA will have a guaranteed profit
margin of 15 percent on a "per unit" basis. In addition, AZT is responsible for
all quality defects in merchandise manufactured.
IAA also utilizes AZT to distribute goods manufactured under the Supply
Agreement, and temporarily has AZT invoice and collect payments from AEO, for
goods manufactured in Mexico, until such time that we can establish a Mexican
subsidiary to invoice and collect payments from AEO.
JD Design, LLC
Pursuant to the license agreement entered into with JD Design, LLC under
which we obtained the license rights to Joe's Jeans, Joe's is obligated to pay a
3% royalty on the net sales of all products bearing the Joe's Jeans or JD
trademark or logo. For fiscal 2003, fiscal 2002 and fiscal 2001, this amount
totaled $339,000, $277,000 and $46,000, respectively. Included in due to related
parties on our balance sheet are accrued royalties of $189,000 and $91,000 for
fiscal 2003 and fiscal 2002, respectively.
Facility Lease Arrangements
We currently lease our Knoxville, Tennessee office and storage space from
a company owned by Sam Furrow, Chairman of our Board of Directors. The office
space is approximately 5,000 square feet consisting of the first floor of a
two-story building located in downtown Knoxville, Tennessee, with a monthly
rental of $3,500 triple
90
net. The storage space is used by us to store our documents and is currently
rented on a month-to month basis for $450 per month.
DESCRIPTION OF CAPITAL STOCK
Common Stock
Pursuant to our Amended and Restated Certificate of Incorporation, we are
authorized to issue 40 million shares of common stock, $.10 par value per share.
As of March 5, 2004, we had outstanding 28,917,850 validly issued, fully paid
and non-assessable shares of common stock.
Holders of the common stock are entitled to one vote for each share held
of record in each matter properly submitted to such holders for a vote. Subject
to the rights of the holders of any other outstanding series of stock our board
of directors may designate from time to time, holders of common stock are
entitled to receive their pro rata share of (i) any dividends that may be
declared by the board of directors out of assets legally available therefore,
and (ii) any excess assets available upon the liquidation, dissolution, or
winding up of our company.
Our Board of Directors may issue the additional shares of common stock, up
to the authorization of 40 million shares, without soliciting additional
stockholder approval. The existence of authorized but unissued shares of the
common stock could tend to discourage or render more difficult the completion of
a hostile merger, tender offer or proxy contest. For example, if in the due
exercise of its fiduciary obligations, the board of directors were to determine
that a takeover proposal was not in the best interest of the company and its
stockholders, the ability to issue additional shares of stock without further
stockholder approval could have the effect of rendering more difficult or costly
the completion of the takeover transaction, by diluting the voting or other
rights of the proposed acquirer or insurgent stockholder group, by creating a
substantial voting block in hands that might support the position of the board
of directors, by effecting an acquisition that might complicate or preclude the
takeover, or otherwise.
Preferred Stock
Our Amended and Restated Certificate of Incorporation authorizes the
issuance of up to 5 million shares of preferred stock with designations, rights
and preferences determined from time to time by the board of directors.
Accordingly, the board of directors is empowered, without stockholder approval,
to issue preferred stock with dividends, liquidation, conversion, voting and
other rights that could adversely affect the voting power or other rights of the
holders of common stock. In the event of issuance, the preferred stock could be
used, under certain circumstances, as a method of discouraging, delaying or
preventing a change in control of Innovo. As of March 5, 2004, we had
outstanding 4,806,000 validly issued, fully paid and non-assessable shares of
preferred stock.
Certain Provisions Relating to Share Acquisitions
Section 203 of the Delaware General Corporation Law generally prevents a
corporation from entering into certain business combinations with an interested
stockholder (defined as any person or entity that is the beneficial owner of at
least 15% of a corporation's voting stock) or its affiliates for a period of
three years after the date of the transaction in which the person became an
interested stockholder, unless (i) the transaction is approved by the board of
directors of the corporation prior to such business combination, (ii) the
interested stockholder acquires 85% of the corporation's voting stock in the
same transaction in which it exceeds 15%, or (iii) the business combination is
approved by the board of directors and by a vote of two-thirds of the
outstanding voting stock not owned by the interested stockholder. The Delaware
General Corporation Law provides that a corporation may elect not to be governed
by Section 203. We have made no such election and are therefore governed by
Section 203. Such anti-takeover provision may have an adverse effect on the
market for our securities.
91
Indemnification and Limitation of Liability
Our Amended and Restated Certificate of Incorporation provides that we
shall indemnify our officers and directors to the fullest extent permitted by
Delaware law, including some instances in which indemnification is otherwise
discretionary under Delaware law. The Amended and Restated Certificate of
Incorporation also provides that, pursuant to Delaware law, our directors shall
not be liable for monetary damages for breach of the director's fiduciary duty
of care to the company and its stockholders. This provision does not eliminate
the duty of care, and, in appropriate circumstances, equitable remedies such as
an injunction or other forms of non-monetary relief would remain available under
Delaware law. In addition, each director will continue to be subject to
liability for breach of the director's duty of loyalty to the company, for acts
or omissions not in good faith or involving intentional misconduct, for knowing
violations of law, for actions leading to improper personal benefit to the
director and for payment of dividends or approval of stock repurchases or
redemptions that are unlawful under Delaware law. The provision also does not
affect a director's responsibilities for environmental laws.
At present, there is no pending litigation or proceeding involving any of
our directors or officers as to which indemnification is being sought, nor are
we aware of any threatened litigation that may result in claims for
indemnification by any officer or director.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is North American
Transfer Company located at 147 West Merrick Road, Freeport, New York 11520, and
its telephone number is (516) 379-8501.
LEGAL MATTERS
The validity of the shares of common stock offered by this prospectus will
be passed upon for our company by Akin Gump Strauss Hauer & Feld LLP.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements and schedule at November 29, 2003 and November 30, 2002,
and for each of the three years in the period ended November 29, 2003, as set
forth in their report. We have included our financial statements and schedule in
the prospectus and elsewhere in the registration statement in reliance on Ernst
& Young LLP's report, given on their authority as experts in accounting and
auditing.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
any document we file at the Securities and Exchange Commission's public
reference rooms at 450 Fifth Street, N.W., Washington, DC 20549. Please call the
Securities and Exchange Commission at 1-800-SEC-0330 for further information on
the public reference rooms. Our Securities and Exchange Commission filings are
also available to the public from the Securities and Exchange Commission's
website at "http://www.sec.gov."
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission to register the offering of the shares of common stock
offered pursuant to this prospectus. This prospectus is part of that
registration statement and, as permitted by the Securities and Exchange
Commission's rules, does not contain all
92
of the information included in the registration statement. For further
information about us, this offering and our common stock, you may refer to the
registration statement and its exhibits and schedules as well as the documents
described herein. You can review and copy these documents at the public
reference facilities maintained by the Securities and Exchange Commission or on
the Securities and Exchange Commission's website as described above.
This prospectus may contain summaries of contracts or other documents.
Because they are summaries, they will not contain all of the information that
may be important to you. If you would like complete information about a contract
or other document, you should read the copy filed as an exhibit to the
registration statement.
You may request a copy of these documents, at no cost, by writing to or
calling Donna Drewrey, Innovo Group Inc., 2633 Kingston Pike, Suite 100,
Knoxville, Tennessee 37919, telephone 865-546-1110.
93
Innovo Group and Subsidiaries
Index to Consolidated Financial Statements
Audited Consolidated Financial Statements: Page
----------------------------------------- ----
Report of Independent Auditors - Ernst & Young LLP F-1
Consolidated Balance Sheets at November 29, 2003 and November 30, 2002 F-2
Consolidated Statement of Operations for the years ended November 29, 2003, November 30, 2002 and F-3
December 1, 2001
Consolidated Statements of Stockholders' Equity for the years ended November 29, 2003, November 30, 2002 F-4
and December 1, 2001
Consolidated Statement of Cash Flows for the years ended November 29, 2003 and November 30, 2002 F-5
Notes to Consolidated Financial Statements F-6
Report of Independent Auditors
Board of Directors
Innovo Group Inc.
We have audited the accompanying consolidated balance sheets of Innovo Group
Inc. and subsidiaries as of November 29, 2003 and November 30, 2002, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended November 29, 2003. These
financial statements are the responsibility of Innovo Group Inc.'s management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Innovo Group Inc.
and subsidiaries as of November 29, 2003 and November 30, 2002 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended November 29, 2003 in conformity with accounting
principles generally accepted in the United States.
/s/ Ernst & Young LLP
Los Angeles, California
February 20, 2004
F-1
INNOVO GROUP INC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
11/29/03 11/30/02
-------- --------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 7,248 $ 222
Accounts receivable, and due from factor net of allowance for
customer credits and allowances of $2,158 (2003) and $383 (2002) 1,683 2,737
Inventories 7,524 5,710
Prepaid expenses & other current assets 2,115 279
-------- --------
TOTAL CURRENT ASSETS 18,570 8,948
-------- --------
PROPERTY, PLANT and EQUIPMENT, net 2,067 1,419
GOODWILL 12,592 4,271
INTANGIBLE ASSETS, NET 13,058 487
OTHER ASSETS 78 18
-------- --------
TOTAL ASSETS $ 46,365 $ 15,143
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 6,128 $ 2,438
Due to factor 332 --
Due to related parties 579 4,250
Note payable to officer 500 --
Current maturities of long-term debt (including related parties) 168 756
-------- --------
TOTAL CURRENT LIABILITIES 7,707 7,444
LONG-TERM DEBT, less current maturities (including related parties) 22,176 2,631
Commitments and Contingencies
8% Redeemable preferred stock, $0.10 par value: Authorized shares-5,000,
194 shares (2003 and 2002) -- --
STOCKHOLDERS' EQUITY
Common stock, $0.10 par - shares, Authorized 40,000
Issued and outstanding 25,785 (2003), and 14,901 (2002) 2,579 1,491
Additional paid-in capital 59,077 40,343
Accumulated deficit (41,824) (33,507)
Promissory note-officer (703) (703)
Treasury stock, 71 shares (2003) and 58 shares (2002) (2,588) (2,537)
Accumulated other comprehensive loss (59) (19)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 16,482 5,068
-------- --------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 46,365 $ 15,143
======== ========
See accompanying notes
F-2
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended
--------------------------------
11/29/03 11/30/02 12/01/01
-------- -------- --------
NET SALES $ 83,129 $ 29,609 $ 9,292
COST OF GOODS SOLD 70,153 20,072 6,335
-------- -------- --------
Gross profit 12,976 9,537 2,957
OPERATING EXPENSES
Selling, general and administrative 19,264 8,092 3,189
Depreciation and amortization 1,227 256 167
-------- -------- --------
20,491 8,348 3,356
INCOME (LOSS) FROM OPERATIONS (7,515) 1,189 (399)
INTEREST EXPENSE (1,216) (538) (211)
OTHER INCOME 526 235 84
OTHER EXPENSE (68) (174) (3)
-------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES (8,273) 712 (529)
INCOME TAXES 44 140 89
-------- -------- --------
NET INCOME (LOSS) $ (8,317) $ 572 $ (618)2
======== ======== ========
NET INCOME (LOSS) PER SHARE:
Basic $ (0.49) $ 0.04 $ (0.04)
Diluted $ (0.49) $ 0.04 $ (0.04)
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 17,009 14,856 14,315
Diluted 17,009 16,109 14,315
See accompanying notes
F-3
INNOVO GROUP INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock Additional Promissory
----------------------- Paid-In Accumulated Note
Shares Par Value Capital Deficit Officer
--------- --------- ---------- ----------- ----------
Balance, November 30, 2000 13,721 $ 1,371 $ 38,977 $ (33,461) $ (703)
Issuance of common stock for acquisitions 1,200 120 1,249 -- --
Common stock offering expenses -- -- (35) -- --
Expense associated with options and warrants -- -- 86 -- --
Treasury Stock Purchased -- -- -- -- --
Net Loss -- -- -- (618) --
--------- --------- --------- --------- ---------
Balance, December 1, 2001 14,921 1,491 40,277 (34,079) (703)
Net Income -- -- -- 572 --
Foreign curreny translation adjustment -- -- -- -- --
Comprehensive income -- -- -- -- --
Common stock offering expenses -- -- (25) -- --
Expense associated with options and warrants -- -- 91 -- --
Cancelled shares (20) -- -- -- --
Treasury stock purchased -- -- -- -- --
--------- --------- --------- --------- ---------
Balance, November 30, 2002 14,901 1,491 40,343 (33,507) (703)
Net loss -- -- -- (8,317) --
Foreign curreny translation adjustment -- -- -- -- --
Comprehensive loss -- -- -- -- --
Proceeds from sale of stock, net 6,236 624 16,916 -- --
Treasury stock purchased -- -- -- -- --
Expense associated with options and warrants -- -- 101 -- --
Exercise of stock options 50 5 77 -- --
Exercise of warrants 4,598 459 1,640 -- --
--------- --------- --------- --------- ---------
Balance, November 29, 2003 25,785 $ 2,579 $ 59,077 $ (41,824) $ (703)
========= ========= ========= ========= =========
Other Total
Treasury Comprehensive Stockholders'
Stock Loss Equity
--------- ------------- ------------
Balance, November 30, 2000 $ (2,426) $ -- $ 3,758
Issuance of common stock for acquisitions -- -- 1,369
Common stock offering expenses -- -- (35)
Expense associated with options and warrants -- -- 86
Treasury Stock Purchased (41) -- (41)
Net Loss -- -- (618)
--------- --------- ---------
Balance, December 1, 2001 (2,467) -- 4,519
Net Income -- -- 572
Foreign curreny translation adjustment -- (19) (19)
---------
Comprehensive income -- -- 553
Common stock offering expenses -- -- (25)
Expense associated with options and warrants -- -- 91
Cancelled shares -- -- --
Treasury stock purchased (70) -- (70)
--------- --------- ---------
Balance, November 30, 2002 (2,537) (19) 5,068
Net loss -- -- (8,317)
Foreign curreny translation adjustment -- (40) (40)
---------
Comprehensive loss -- -- (8,357)
Proceeds from sale of stock, net -- -- 17,540
Treasury stock purchased (51) -- (51)
Expense associated with options and warrants -- -- 101
Exercise of stock options -- -- 82
Exercise of warrants -- -- 2,099
--------- --------- ---------
Balance, November 29, 2003 $ (2,588) $ (59) $ 16,482
========= ========= =========
See accompanying notes
F-4
INNOVO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended
--------------------------------
11/29/03 11/30/02 12/01/01
-------- -------- --------
Net income (loss) $ (8,317) $ 572 $ (618)
Adjustment to reconcile net income (loss)
to cash provided by (used in) operating activities:
Depreciation 232 86 92
Loss on sale of fixed assets 9 90 2
Amortization of intangibles 943 122 35
Amortization of licensing rights 48 48 40
Stock compensation expenses 101 91 86
Provision for uncollectible accounts 1,775 219 128
Changes in current assets and liabilities:
Accounts receivable (721) (1,490) (882)
Inventories (1,814) (3,300) 933
Prepaid expenses and other (1,746) (117) (86)
Due to related parties (3,976) 3,444 698
Other long term assets (61) (3) 4
Accounts payable and accrued expenses 3,670 1,742 (1,064)
-------- -------- --------
Cash (used in) provided by operating activities $ (9,857) $ 1,504 $ (632)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of fixed assets $ 6 $ -- $ 1,082
Proceeds from investment in real estate 1,013 436 --
Redemption of preferred shares (798) (436) --
Purchases of fixed assets (895) (622) (61)
Acquisition costs (62) -- (36)
-------- -------- --------
Cash (used in) provided by investing activities $ (736) $ (622) $ 985
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury stock $ (51) $ (70) $ (41)
Payments on notes payables and long term debt (744) (838) (1,164)
Factor borrowings 332 -- --
Proceeds from note payable to officer 500 -- --
Exercise of stock options 82 -- --
Proceeds from issuance of stock, net 17,540 (25) (35)
-------- -------- --------
Cash provided by (used in) financing activities $ 17,659 $ (933) $ (1,240)
Effect of exchange rate on cash (40) (19) --
NET CHANGE IN CASH AND CASH EQUIVALENTS $ 7,026 $ (70) $ (887)
CASH AND CASH EQUIVALENTS, at beginning of period 222 292 1,179
-------- -------- --------
CASH AND CASH EQUIVALENTS, at end of period $ 7,248 $ 222 $ 292
======== ======== ========
Supplemental Disclosures of Cash Flow Information:
Cash Paid for Interest $ 1,008 $ 519 $ 110
Cash Paid for Taxes $ 89 $ 28 $ --
During fiscal 2002, the Company issued 195,295 shares of its cumulative
non-convertible preferred stock with an 8% coupon in exchange for real estate
partnership interests.
See accompanying notes
F-5
INNOVO GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business Description
Innovo Group Inc.'s (Innovo Group) principle business activity involves the
design, development and worldwide marketing of high quality consumer products
for the apparel and accessory markets. Innovo Group operates its consumer
products business through three wholly-owned, operating subsidiaries, Innovo,
Inc. (Innovo), Joe's Jeans, Inc. (Joe's), and Innovo Azteca Apparel, Inc. (IAA)
with Innovo Group and Joe's having two wholly-owned operating subsidiaries,
Innovo Hong Kong Limited (IHK) and Joe's Jeans Japan, Inc. (JJJ), respectively.
Innovo Group's products are manufactured by independent contractors located in
Los Angeles, Mexico and/or Asia, including, Hong Kong, China, Korea, Vietnam and
India. The products are then distributed out of Los Angeles or directly from the
factory to the customer.
During fiscal year 2001, Innovo Group changed its fiscal year end from November
30 of each year to the Saturday closest to November 30. For fiscal years 2003,
2002 and 2001, the years ended on November 29, 2003, November 30, 2002 and
December 1, 2001, respectively. These fiscal year periods are referred to as
2003, 2002 and 2001, respectively, in the accompanying Notes to Consolidated
Financial Statements.
Restructuring of Operations
In connection with a strategic equity investment by Commerce Investment Group,
LLC (Commerce) in 2000, Innovo Group shifted manufacturing to third-party
foreign manufacturers and outsourced certain distribution functions to Commerce
to increase the effectiveness of its distribution network and to reduce freight
costs. Innovo Group entered into certain supply and distribution agreements with
Commerce. These agreements provide for Commerce or its designated affiliates to
manufacture and supply specified products to Innovo Group at agreed upon prices.
In addition, Commerce provides distribution services to Innovo Group for certain
of its products for an agreed upon fee, including warehousing, shipping and
receiving, storage, order processing, billing, customer service, information
systems, maintenance of inventory records, and direct labor and management
services. These agreements were renewed for a two-year term ending fiscal 2004
and are renewable thereafter for consecutive two-year terms unless terminated by
either party with 90 days notice. There are no minimum purchase or distribution
obligations during these renewal periods.
Pursuant to the Commerce transaction and related agreements, Innovo Group
relocated its headquarters and distribution operations to Los Angeles,
California, and transitioned its manufacturing needs to Mexican production
facilities operated by an affiliate of Commerce. Innovo Group continues to
maintain its Innovo subsidiary operations, which focuses on accessory products,
in Knoxville, Tennessee, the site of its former headquarters.
Innovo Group experienced a significant operating loss and negative cash flow
from operations for the year ended November 29, 2003. Innovo Group historically
has funded operations by equity financing through private placements, credit
arrangements with suppliers and factoring agreements for working capital needs.
From time to time, Innovo Group has obtained short-term working capital loans
from senior members of management and/or members of the Board of Directors.
Other Operations
Innovo Group, through its wholly-owned operating subsidiary Leasall Management,
Inc. (Leasall) owns real property located in Springfield, Tennessee which
formerly served as Innovo Group's headquarters. Leasall currently leases this
property to third parties. In April 2002, Innovo Group, through its wholly owned
operating subsidiary, Innovo Group Realty Inc. (IRI), entered into a real estate
investment transaction by purchasing limited partnership interests in 22 limited
partnerships that subsequently acquired limited partnerships in 28 apartment
buildings consisting of approximately 4,000 apartment units. See Note 5.
F-6
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Innovo Group and its wholly owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The most significant estimates affect the evaluation of
contingencies, and the determination of allowances for accounts receivable and
inventories. Actual results could differ from these estimates.
Revenue Recognition
Revenues are recorded when title transfers to the customer, which is typically
at the shipping point. Innovo Group records estimated reductions to revenue for
customer programs, including co-op advertising, other advertising programs or
allowances which are based upon a percentage of sales. Innovo Group also allows
for returns based upon pre-approval or for damaged goods. Such returns are
estimated and an allowance is provided at the time of sale.
Shipping and Handling Costs
Innovo Group outsources its distribution functions to an affiliate of Commerce
or, in certain cases, to other third party distributors. Shipping and handling
costs include costs to warehouse, pick, pack and deliver inventory to customers.
In certain cases Innovo Group is responsible for the cost of freight to deliver
goods to the customer. Shipping and handling costs were approximately
$1,834,000, $1,023,000 and $408,000 for the years ended 2003, 2002, and 2001,
respectively, and are included in cost of goods sold. Freight billed to
customers that is included in Innovo Group sales for the years ended 2003, 2002
and 2001 were $24,000, $201,000 and $77,000 respectively.
Earnings (loss) Per Share
Net income (loss) per share has been computed in accordance with Financial
Accounting Standard Board (FASB) Statement No. 128, "Earnings Per Share."
Comprehensive Income (loss)
Assets and liabilities of the Japan and Hong Kong divisions are translated at
the rate of exchange in effect on the balance sheet date. Income and expenses
are translated at the average rates of exchange prevailing during the year. The
functional currency in which Innovo Group transacts business is the Japanese yen
and Hong Kong dollar. Comprehensive income (loss) consists of net income (loss)
and foreign currency gains and losses resulting from translation of assets and
liabilities.
Advertising Costs
Advertising costs are expensed as incurred, or, in the case of media ads, upon
first airing, except for brochures and catalogues that are capitalized and
amortized over their expected period of future benefits.
Capitalized costs related to catalogues and brochures are included in prepaid
expenses and other current assets. Advertising expenses included in selling,
general and administrative expenses were approximately $985,000, $287,000, and
$114,000 for the years ended 2003, 2002, and 2001, respectively.
Advertising costs include items incurred in connection with royalty agreements
or amounts paid to licensors pursuant to royalty agreements. Included in prepaid
expenses is $985,000, representing prepaid advertising royalties pursuant to
license agreements for the year ended 2003.
F-7
Financial Instruments
The fair values of Innovo Group's financial instruments (consisting of cash,
accounts receivable, accounts payable, due to factor and notes payable) do not
differ materially from their recorded amounts because of the relatively short
period of time between origination of the instruments and their expected
realization. Management believes it is not practicable to estimate the fair
value of the first mortgage loan as the loan has a fixed interest rate secured
by real property in Tennessee. Innovo Group neither holds, nor is obligated
under, financial instruments that possess off-balance sheet credit or market
risk.
Impairment of Long-Lived Assets and Intangibles
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell.
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142 "Goodwill and Other Intangible
Assets," which establishes financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets. Innovo Group adopted SFAS No. 142 beginning with the first
quarter of fiscal 2002. SFAS No. 142 requires that goodwill and intangible
assets that have indefinite useful lives not be amortized but, instead, tested
at least annually for impairment while intangible assets that have finite useful
lives continue to be amortized over their respective useful lives. Accordingly,
Innovo Group has not amortized goodwill.
SFAS No. 142 requires that goodwill and other intangibles be tested for
impairment using a two-step process. The first step is to determine the fair
value of the reporting unit, which may be calculated using a discounted cash
flow methodology, and compare this value to its carrying value. If the fair
value exceeds the carrying value, no further work is required and no impairment
loss would be recognized. The second step is an allocation of the fair value of
the reporting unit to all of the reporting unit's assets and liabilities under a
hypothetical purchase price allocation. Based on the evaluation performed by
Innovo Group, there is no impairment to be recorded at November 29, 2003.
Cash Equivalents
Innovo Group considers all highly liquid investments that are both readily
convertible into known amounts of cash and mature within 90 days from their date
of purchase to be cash equivalents.
Concentration of Credit Risk
Financial instruments that potentially subject Innovo Group to significant
concentrations of credit risk consist principally of cash, accounts receivable
and amounts due from factor. Innovo Group maintains cash and cash equivalents
with various financial institutions. Its policy is designed to limit exposure to
any one institution. Innovo Group performs periodic evaluations of the relative
credit rating of those financial institutions that are considered in Innovo
Group's investment strategy.
Concentrations of credit risk with respect to accounts receivable are limited
due to the number of customers comprising Innovo Group's customer base. However,
for the years ended November 29, 2003 and November 30, 2002, $1,301,000 and
$1,652,000, respectively of total non-factored accounts receivables, (or 37% and
60%) were due from three and four customers. Innovo Group does not require
collateral for trade accounts receivable, and, therefore, is at risk for up to
$3,388,000 and $2,813,000, respectively, if these customers fail to pay. Innovo
Group provides an allowance for estimated losses to be incurred in the
collection of accounts receivable based upon the ageing of outstanding balances
and other account monitoring analysis. Such losses have historically been within
management's expectations. Uncollectible accounts are written off once
collection efforts are deemed by management to have been exhausted.
F-8
During fiscal 2003, 2002 and 2001, sales to customers representing greater than
10 percent of sales are as follows:
2003 2002 2001
-------- -------- --------
American Eagle Outfitters 38% * *
Target 12% * *
Wal-Mart Stores * * 27%
* Less than 10%.
Manufacturing, Warehousing and Distribution
Innovo Group purchases a significant portion of finished goods and obtains
certain warehousing and distribution services from Commerce and its affiliates
and obtains credit terms which Innovo Group believes are favorable. The loss of
Commerce as a vendor, or material changes to the terms, could have an adverse
impact on the business. Commerce and its affiliates are controlled by two
significant stockholders of Innovo Group.
Innovo Group's products are manufactured by contractors located in Los Angeles,
Mexico and/or Asia, including, Hong Kong, China, Korea, Vietnam and India. The
products are then distributed out of Los Angeles or directly from the factory to
the customer. For the year ended 2003, 22% of its apparel and accessory products
were manufactured outside of North America. The rest of its accessory and
apparel products were manufactured in the United States (21%) and Mexico (57%).
All of its products manufactured in Mexico are manufactured by an affiliate of
Commerce, Azteca Productions International, Inc. (Azteca) or its affiliates.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" (SFAS No. 123), encourages, but does not require, companies to
record compensation cost for stock-based employee compensation plans at fair
value. Innovo Group has chosen to continue to account for employee stock-based
compensation using the method prescribed in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Innovo Group has adopted the disclosure-only provisions of SFAS No. 123.
Accordingly, no compensation expense has been recorded in conjunction with
options issued to employees. Had compensation costs been determined based upon
the fair value of the options at the grant date and amortized over the option's
vesting period, consistent with the method prescribed by SFAS No. 123, Innovo
Group's net income (loss) would have been increased to the pro forma amounts
indicated below for the years ended November 29, 2003, November 30, 2003 and
December 1, 2001 (in thousands, except per share data):
F-9
Year Ended
(in thousands, except per share data)
-------------------------------------
2003 2002 2001
-------------------------------------
Net (loss) income as reported $ (8,317) $ 572 $ (618)
Add:
Stock based employee compensation
expense included in reported net income,
net of related tax effects 101 91 86
Deduct:
Total stock based employee compensation
expense determined under fair market value
based method for all awards, net of related
tax effects 504 140 454
-------------------------------------
Pro forma net (loss) income $ (8,720) $ 523 $ (986)
=====================================
Net (loss) income per share
As reported - basic $ (0.49) $ 0.04 $ (0.04)
As reported - diluted $ (0.49) $ 0.04 $ (0.04)
Pro forma - basic $ (0.51) $ 0.04 $ (0.07)
Pro forma - diluted $ (0.51) $ 0.03 $ (0.07)
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions used for
grants in 2003 and 2002:
2003 2002 2001
---- ---- ----
Estimated dividend yield ......................... 0.0% 0.0% 0.0%
Expected stock price volatility .................. 48% 38% 68%
Risk-free interest rate .......................... 5.0% 6.0% 6.0%
Expected life of options ......................... 4 yrs. 2-4 yrs. 2-4 yrs.
The Black-Scholes model was developed for use in estimating the fair value of
traded options, which have no vesting restrictions and are fully transferable.
In addition, option valuation models require the input of highly subjective
assumptions, including, the expected stock price volatility. Because Innovo
Group's employee stock options have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimates, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
Property, Plant and Equipment
Property, plant and equipment are stated at the lesser of cost or fair value in
the case of impaired assets. Depreciation is computed on a straight-line basis
over the estimated useful lives of the assets and includes capital lease
amortization. Leasehold improvements are amortized over the lives of the
respective leases or the estimated service lives of the improvements, whichever
is shorter. Routine maintenance and repairs are charged to expense as incurred.
On sale or retirement, the asset cost and related accumulated depreciation or
amortization is removed from the accounts, and any related gain or loss is
included in the determination of income.
Reclassifications
Certain reclassifications have been made to prior year consolidated financial
statements to conform to the current year presentation.
F-10
Recently Issued Financial Accounting Standard
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. This Statement is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003 and is not expected to have a material impact on Innovo
Groups' consolidated results of operations or financial position.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. In particular, SFAS No. 149 clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a derivative
and when a derivative contains a financing component that warrants special
reporting in the statement of cash flows. SFAS No. 149 is generally effective
for contracts entered into or modified after June 30, 2003 and is not expected
to have a material impact on Innovo Group's consolidated results of operations
or financial position.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities." FIN 46 requires companies to evaluate variable
interest entities to determine whether to apply the consolidation provisions of
FIN 46 to those entities. Companies must apply FIN 46 to entities created after
January 31, 2003, and to variable interest entities in which a company obtains
an interest after that date. It applies in the first fiscal year or interim
period endings after December 15, 2003, to variable interest entities in which a
company holds a variable interest that it acquired before February 1, 2003.
Adoption of FIN 46 is not expected to have a material impact on Innovo Group's
consolidated results of operations or financial position
3. Acquisitions
Blue Concept Division Acquisition
On July 17, 2003, IAA entered into an asset purchase agreement (APA), with
Azteca, Hubert Guez and Paul Guez, (the Sellers), whereby IAA acquired the
division known as the Blue Concept Division of Azteca (the Blue Concept
Division). The Blue Concept Division sells primarily denim jeans to American
Eagle Outfitters, Inc. (AEO), a national retailer. Pursuant to the terms of the
APA, IAA paid $21.8 million for the Blue Concept Division, subject to adjustment
as noted below. Pursuant to the APA, IAA employed all of the existing employees
of the Blue Concept Division but did not assume any of the Blue Concept
Division's or the Sellers' existing liabilities. In connection with the purchase
of the Blue Concept Division from the Sellers, IAA issued a seven-year
convertible promissory note for $21.8 million (the Blue Concept Note). The Blue
Concept Note bears interest at a rate of 6% and requires payment of interest
only during the first 24 months and then is fully amortizing over the remaining
five-year period. The terms of the transaction further allows Innovo Group, upon
stockholder approval, to convert a portion of the Blue Concept Note into equity
through the issuance of 3,125,000 shares of its common stock valued at the
greater of $4.00 per share or the market value of our common stock on the day
prior to the date of the stockholder meeting at which approval for this
conversion is sought (Conversion Price) and up to an additional 1,041,667 shares
upon the occurrence of certain future contingencies relating to Innovo Group's
stock price for the thirty day period ending March 6, 2005. Presently, a special
stockholder meeting is scheduled for March 5, 2004 to vote on the approval of
this conversion of the Blue Concept Note into equity. In the event stockholder
approval is obtained, the Blue Concept Note will be reduced by an amount equal
to the product of the Conversion Price and 3,125,000 shares, so long as the
principal amount of the Blue Concept Note is not reduced below $9.3 million. The
shares issued pursuant to the conversion will be subject to certain lock-up
periods.
In the event that sales of the Blue Concept Division fall below $70 million
during the first 17 month period, (Period I), following the closing of the
acquisition, or $65 million during the 12 month period (Period II) following
Period I, certain terms of the APA allow for a reduction in the purchase price
through a decrease in the principal balance of the Blue Concept Note and/or the
return of certain locked-up shares of Innovo Group's common stock. In the event
the Blue Concept Note is reduced during Period I and the sales of the Blue
Concept Division in Period II are greater than $65
F-11
million, the Blue Concept Note shall be increased by half of the amount greater
than $65 million, but in no event shall the Blue Concept Note be increased by an
amount greater than the decrease in Period I.
In the event the principal amount of the Blue Concept Note needs to be reduced
beyond the outstanding principal balance, then an amount of the locked-up shares
equal to the balance of the required reduction shall be returned to Innovo
Group. For these purposes, the locked-up shares shall be valued at $4.00 per
share. Additionally, if during the 12 month period following the closing, AEO is
no longer a customer of IAA, the locked-up shares will be returned to Innovo
Group, and any amount remaining on the balance of the Blue Concept Note will be
forgiven.
In the event the revenues of the Blue Concept Division decrease to $35 million
or less during Period I or Period II, IAA shall have the right to sell the
purchased assets back to the Sellers, and the Sellers shall have the right to
buy back the purchased assets for the remaining balance of the Blue Concept Note
and any and all Locked Up Shares shall be returned.
As part of the transaction, IAA and AZT International SA de CV (AZT), a Mexico
corporation and wholly-owned subsidiary of Azteca entered into a two-year,
renewable, non-exclusive supply agreement (Supply Agreement) for products to be
sold by the Blue Concept Division. In addition to the customary obligations, the
Supply Agreement requires that AZT will receive payment immediately upon receipt
of invoices for purchase orders and that AZT will charge a per unit price such
that IAA will have a guaranteed profit margin of 15 percent on a "per unit"
basis. In addition, AZT is responsible for all quality defects in merchandise
manufactured.
The acquisition of the Blue Concept Division was accounted for under the
purchase method of accounting. Of the $21.8 million purchase price, $13.2
million was recorded as an intangible asset representing the value of the
customer relationship, $361,000 was recorded as an intangible asset representing
the fair value of the existing purchase orders at the closing of the acquisition
and the balance of the purchase price of $8.32 million was recorded as goodwill.
The purchase price allocation was based upon a third party valuation. The
results of operations of the Blue Concept Division are included in Innovo
Group's consolidated results of operations beginning July 17, 2003.
The value assigned to the existing purchase orders was amortized during 2003 at
the time the goods were shipped and the value of the customer list is being
amortized over 10 years. The goodwill is expected to be amortizable for income
tax purposes. The acquisition was consummated to enable Innovo Group to expand
its private label operations.
The following table presents the unaudited pro forma consolidated results of
operations for the years ended 2003 and 2002 assuming the Blue Concept Division
had been acquired as of December 2, 2001.
Year Ended
(in thousands, except per share data)
-------------------------------------
2003 2002
---------- ----------
Net sales $ 130,720 $ 105,496
Net income (loss) (4,343) 4,681
Earnings (loss) per share:
Basic $ (0.22) $ 0.26
Diluted $ (0.22) $ 0.24
The pro forma operating results do not reflect any anticipated operating
efficiencies or synergies and are not necessarily indicative of the actual
results which might have occurred had the operations and management of the
companies been combined for the fiscal years included above.
Azteca Production International, Inc. Knit Division
On August 24, 2001, Innovo Group through its subsidiary, IAA, completed the
first phase of a two phase acquisition of Azteca knit apparel division (Knit
Division or Knit Acquisition). As discussed previously, Azteca is an affiliate
of Commerce. Pursuant to the terms of the first phase closing, Innovo Group
purchased the Knit Division's customer list, the right to manufacture and market
all of the Knit Division's current products and entered into certain non-compete
and non-solicitation agreements and other intangible assets associated with the
Knit Division (Phase I Assets). As consideration
F-12
for the Phase I Assets, Innovo Group issued to Azteca, 700,000 shares of its
common stock valued at $1.27 per share based upon the closing price of the
common stock on August 24, 2001, and promissory notes in the amount of $3.6
million.
The second phase of the Knit Acquisition called for Innovo Group to purchase for
cash the inventory of the Knit Division prior to November 30, 2001, with the
consideration not to exceed $3 million. The acquisition of the inventory was
subject to Innovo Group obtaining adequate financing. Upon the mutual agreement
of both parties, Innovo Group did not complete the second phase of the
acquisition prior to the expiration date due to Innovo Group's inability to
obtain the necessary funding.
The Knit Acquisition was accounted for under the purchase method of accounting
for business combinations pursuant to FAS 141. Accordingly, the accompanying
consolidated financial statements include the results of operations and other
information for the Knit Division for the period from August 24, 2001 through
December 1, 2001. The Acquisition was consummated to allow Innovo Group to
continue its expansion into various segments of the apparel industry.
Of the aggregate purchase price of $4,521,000, including acquisition costs of
$36,000, $250,000 has been allocated to the non-compete agreement and the
remaining amount of $4,271,000 has been allocated to goodwill. The non-compete
agreement was amortized over two years, based upon the term of the agreement.
The total amount of the goodwill is expected to be deductible for income tax
purposes.
The following table shows Innovo Group's unaudited pro forma consolidated
results of operations for the fiscal year ended December 1, 2001, assuming the
Knit Acquisition had occurred at the beginning of the year:
Year Ended
(in thousands, except per share data)
-------------------------------------
2001
-------------------------------------
Net sales $17,243
Loss before extraordinary item (406)
Net Loss (406)
Loss per share:
Basic ($0.03)
Diluted ($0.03)
Joe's Jeans License
On February 7, 2001, Innovo Group acquired the license rights to the Joe's Jeans
label from JD Design, LLC (JD Design), along with the right to market the
previously designed product line and existing sales orders, in exchange for
500,000 shares of Innovo Group's common stock and, if certain sales and gross
margin objectives are reached, a warrant with a four year term granting JD
Design the right to purchase 250,000 shares of Innovo Group's common stock at a
price of $1.00 per share. As of November 29, 2003, the sales and gross margin
objectives had not been reached.
Additionally, Joe Dahan, the designer of the Joe's Jeans line joined Innovo
Group as President of its newly formed and wholly owned subsidiary, Joe's Jeans,
Inc. and received an option, with a four-year term, to purchase 250,000 shares
of Innovo Group's common stock at $1.00 per share, vesting over 24 months. These
options were granted pursuant to the employment agreement between Innovo Group
and Joe Dahan. These options vest over the term of employment. Under the terms
of the license, Innovo Group is required to pay a royalty of 3% of net sales,
with additional royalty amounts due in the event Innovo Group exceeds certain
minimum sales and gross profit thresholds. Innovo Group recorded $339,000,
$277,000 and $46,000 in royalty expense for the license in the years ended 2003,
2002 and 2001, respectively.
The purchase price for the Joe's Jeans license of $480,000 was determined based
upon the fair value of the 500,000 shares issued in connection with the
acquisition using the average of the quoted market price of $0.96 for a period
of 5 days prior
F-13
to and 5 days after the commitment date. No value was assigned to the warrant
for 250,000 shares of common stock because the warrant only vests in the event
that Joe's Jeans meets certain sales and gross profit targets. The remaining
sales target for 2004 is $15 million, provided, that the sales have a minimum
gross profit of 55%. In the event that both the net sales and gross margin
target is achieved, JD Design will receive a warrant for 250,000 shares of
Innovo Group common stock with an exercise price of $1.00 per share, with a
4-year term and equal-monthly vesting over the first 24 months. The entire
purchase price was allocated to license rights that are being amortized over the
10-year term of the license.
4. Inventories
Inventories are stated at the lower of cost, as determined by the first-in,
first-out method, or market. Inventories consisted of the following (in
thousands):
2003 2002
----------------------
Finished goods $ 10,189 $ 5,741
Work in progress 199 --
Raw materials 1,329 74
----------------------
$ 11,717 $ 5,815
Less allowance for obsolescence and
slow moving items (4,193) (105)
----------------------
$ 7,524 $ 5,710
======================
5. Real Estate Transactions
In April 2002, Innovo Group's wholly-owned subsidiary IRI acquired a 30% limited
partnership interest in each of 22 separate partnerships. These partnerships
simultaneously acquired 28 apartment complexes at various locations throughout
the United States consisting of approximately 4,000 apartment units (the
Properties). A portion of the aggregate $98,080,000 purchase price was paid
through the transfer of 195,295 shares of our $100, 8% Series A Redeemable
Cumulative Preferred Stock (the Series A Preferred Shares) to the sellers of the
Properties. The balance of the purchase price was paid by Metra Capital, LLC
(Metra Capital) in the amount of $5,924,000 (the Metra Capital Contribution) and
through proceeds from a Bank of America loan, in the amount $72,625,000.
Innovo Group had originally issued the Series A Preferred Shares to IRI in
exchange for all shares of its common stock. IRI then acquired a 30% limited
partnership interest in each of the 22 separate limited partnerships in exchange
for the Series A Preferred Stock, which then transferred the Series A Preferred
Shares to the sellers of the Properties.
Each of Messrs. Hubert Guez and Simon Mizrachi and their affiliates have
invested in each of the 22 separate partnerships. Each of Messrs. Guez and
Mizrachi, together with their respective affiliates, own 50% of the membership
interests of Third Millennium. Third Millennium is the managing member of Metra
Capital, which owns 100% of the membership interest in each of the 22 separate
limited liability companies collectively the General Partners and together with
Metra Capital, the Metra Partners, that hold a 1% general partnership interest
in each of the 22 separate limited partnerships that own the Properties. Metra
Capital also owns 69% of the limited partnership interest in each of the 22
separate limited partnerships. At the time of the transaction, Messrs. Guez and
Mizrachi and their affiliates owned more than 5 percent of Innovo Group's
outstanding shares.
Pursuant to each of the limited partnership agreements, the Metra Partners
receive at least quarterly (either from cash flow and/or property sale proceeds)
an amount sufficient to provide the Metra Partners (1) a 15% cumulative compound
annual rate of return on the outstanding amount of the Metra Capital
Contribution that has not been previously returned to them through prior
distributions of cash flow and/or property sale proceeds and (2) a cumulative
annual amount of .50% of the average outstanding balance of the average
outstanding balance of the mortgage indebtedness secured by any of the
Properties. In addition, in the event of a distribution solely due to a property
sale proceeds after the above distributions have been made to the Metra
Partners, Metra Partners also receive an amount equal to 125% of the amount of
the Metra
F-14
Capital Contribution allocated to the Property sold until the Metra Partners
have received from all previous cash flow or property sale distributions an
amount equal to its Metra Capital Contribution.
Third Millennium receives on a quarterly basis from cash flows and/or property
sale proceeds an amount equal to $63,000 until it receives an aggregate of
$252,000.
After the above distributions have been made, and if any cash is available for
distribution, IRI. is to receive at least quarterly in the case of cash flow
distributions and at the time of property sale distributions an amount
sufficient for it to pay the 8% coupon on the Series A Preferred Shares and then
any remaining amounts left for distribution to redeem a portion or all of the
Series A Preferred Shares.
After all of the Series A Preferred Shares have been redeemed ($19.5 million),
future distributions are split between Metra Partners and IRI, with Metra
Partners receiving 70% of such distribution and Innovo Realty, Inc. receiving
the balance. In addition, IRI. receives a quarterly sub-asset management fee of
$85,000.
IRI may also be liable to the holders of the Series A Preferred Shares for the
breach of certain covenants, including, but not limited to, failure (i) to
deposit distributions from the partnerships into a sinking fund which funds are
to be distributed to the holders of the Preferred Shares as a dividend or
redemption of Series A Preferred Shares or (ii) to enforce its rights to receive
distributions from the partnerships.
Innovo Group has not given accounting recognition to the value of its investment
in the Limited Partnerships, because Innovo Group has determined that the asset
is contingent and will only have value to the extent that cash flows from the
operations of the properties or from the sale of underlying assets is in excess
of the 8% coupon and redemption of the Series A Preferred Shares. Innovo Group
is obligated to pay the 8% coupon and redeem the Series A Preferred Shares from
its partnership distributions, prior to Innovo Group being able to recover the
underlying value of its investment. Additionally, Innovo Group has determined
that the Series A Preferred Shares will not be accounted for as a component of
equity as the shares are redeemable outside of Innovo Group's control. No value
has been ascribed to the Series A Preferred Shares for financial reporting
purposes as Innovo Group is obligated to pay the 8% coupon or redeem the shares
only if Innovo Group receives cash flow from the Limited Partnerships adequate
to make the payments. Innovo Group has included the quarterly management fee
paid to IRI in other income using the accrual basis of accounting. During 2002
and 2003, IRI recorded $329,000 and $173,000, respectively, as management fee
income. As of November 29, 2003, $175,000 was due to Innovo Group representing
unpaid sub-management fees.
194,000 shares of the Series A Preferred Shares remain outstanding and
redeemable at November 29, 2003 and the cumulative amount of the unpaid 8%
coupon aggregated $822,000. Such amount has not been recorded as an obligation
by Innovo Group as the funds had not been received by IRI from the Limited
Partnerships.
6. Accounts Receivable
Accounts receivable consist of the following (in thousands):
2003 2002
--------------------
Nonrecourse receivables assigned to factor, net of advances $ 453 $ 307
Nonfactored accounts receivable 3,388 2,813
Allowance for customer credits and doubtful accounts (2,158) (383)
--------------------
$ 1,683 $ 2,737
====================
As of November 29, 2003, there were $600,000 of client recourse receivables
assigned to factor for which Innovo Group bears collection risk in the event of
non-payment by the customers.
F-15
CIT Commercial Services
On June 1, 2001, Innovo Group's subsidiaries, Innovo and Joe's, entered into
accounts receivable factoring agreements with CIT Commercial Services, a unit of
CIT Group, Inc. (CIT) which may be terminated with 60 days notice by CIT, or on
the anniversary date, by Innovo or Joe's. Under the terms of the agreements,
Innovo or Joe's has the option to factor receivables with CIT on a non-recourse
basis, provided that CIT approves the receivable in advance. Innovo or Joe's
may, at their option, also factor non-approved receivables on a recourse basis.
Innovo or Joe's continue to be obligated in the event of product defects and
other disputes, unrelated to the credit worthiness of the customer. Innovo or
Joe's has the ability to obtain advances against factored receivables up to 85%
of the face amount of the factored receivables. The agreement calls for a 0.8%
factoring fee on invoices factored with CIT and a per annum rate equal to the
greater of the Chase prime rate plus 0.25% or 6.5% on funds borrowed against the
factored receivables. On September 10, 2001, IAA entered into a similar
factoring agreement with CIT upon the same terms.
On or about August 20, 2002, Innovo Group's Innovo and Joe's subsidiaries each
entered into certain amendments to their respective factoring agreements, which
included inventory security agreements, to permit the subsidiaries to obtain
advances of up to 50% of the eligible inventory up to $400,000 each. According
to the terms of the agreements, amounts loaned against inventory are to bear an
interest rate equal to the greater of the bank's prime rate plus 0.75% or 6.5%
per annum.
On or about June 10, 2003, the existing financing facilities with CIT for these
subsidiaries were amended, to be effective as of April 11, 2003, primarily to
remove the fixed aggregate cap of $800,000 on their inventory security agreement
to allow for Innovo and Joe's to borrow up to 50% of the value of certain
eligible inventory calculated on the basis of the lower of cost or market, with
cost calculated on a first-in-first out basis. In connection with these
amendments, IAA, entered into an inventory security agreement with CIT based on
the same terms as Joe's and Innovo. IAA did not previously have an inventory
security agreement with CIT. Under the factoring arrangements, Innovo Group
through its subsidiaries may borrow up to 85% of the value of eligible factored
receivables outstanding. The factoring rate that Innovo Group pays to CIT to
factor accounts, on which CIT bears some or all of the credit risk, was lowered
to 0.4% and the interest rate associated with borrowings under the inventory
lines and factoring facility were reduced to the bank's prime rate. Innovo Group
has also established a letter of credit facility with CIT whereby Innovo Group
can open letters of credit, for 0.125% of the face value, with international and
domestic suppliers provided Innovo Group has availability on its inventory line
of credit. In addition, Innovo Group also may elect to factor with CIT its
receivables by utilizing an adjustment of the interest rate as set on a
case-by-case basis, whereby certain allocation of risk would be borne by Innovo
Group, depending upon the interest rate adjustment. Innovo Group records its
accounts receivables on the balance sheet net of receivables factored with CIT,
since the factoring of receivables is non-recourse to Innovo Group. Further, in
the event Innovo Group's loan balance with CIT exceeds the face value of the
receivables factored with CIT, Innovo Group records the difference between the
face value of the factored receivables and the outstanding loan balance as a
liability on Innovo Group's balance sheet as "Due to Factor". At November 29,
2003, Innovo Group's loan balance with CIT was $8,786,000 and Innovo Group had
$8,536,000 of factored receivables with CIT. At November 29, 2003, an aggregate
amount of $2,149,000 of unused letters of credit were outstanding. Cross
guarantees were executed by and among the subsidiaries, Innovo, Joe's, and IAA
and Innovo Group entered into a guarantee for its subsidiaries' obligations in
connection with the amendments to the existing credit facilities.
In connection with the agreements with CIT, receivables and inventory are
pledged to CIT.
F-16
7. Property, Plant and Equipment
Property, plant and equipment consisted of the following (in thousands):
Useful Lives
(years) 2003 2002
-------------------------------
Building, land and improvements 8-38 $ 1,679 $ 1,582
Machinery and equipment 5-10 394 258
Furniture and fixtures 3-8 760 212
Transportation equipment 5 13 13
Leasehold improvements 5-8 116 14
------------------
2,962 2,079
Less accumulated depreciation and amortization (895) (660)
------------------
Net property, plant and equipment $ 2,067 $ 1,419
==================
Depreciation expense aggregated $232,000, $86,000 and $88,000 for the years
ended 2003, 2002 and 2001, respectively.
8. Intangible Assets
Identifiable intangible assets resulting from acquisitions consist of the
following (in thousands):
2003 2002
--------------------
License rights, net of $136 and $88 accumulated
amortization for 2003 and 2002, respectively $ 344 $ 392
Covenant not to compete, net of $250 and $155
accumulated amortization for 2003 and 2002, respectively -- 95
Customer relationship, net of $486 and $0 accumulated
amortization for 2003 and 2002, respectively 12,714 --
--------------------
$ 13,058 $ 487
====================
Amortization expense related to the license rights, covenant not to compete,
customer relationships and acquired purchase orders total $991,000 $168,000 and
$75,000 for the years ended 2003, 2002 and 2001, respectively. Aggregate
amortization expense will be approximately $1,368,000, $1,368,000, $1,368,000,
$1,368,000, $1,368,000 and $6,218,000 for fiscal years ending November 29, 2004
through November 30, 2008 and thereafter, respectively.
9. Long-Term Debt
Long-term debt consists of the following (in thousands):
2003 2002
---------------------
First mortgage loan on Springfield property $ 476 $ 558
Promissory note to Azteca (Blue Concepts) 21,800 --
Promissory note to Azteca (Knit Div. Note 1) 68 786
Promissory note to Azteca (Knit Div. Note 2) -- 2,043
---------------------
Total long-term debt $ 22,344 $ 3,387
Less current maturities 168 756
---------------------
Total long-term debt $ 22,176 $ 2,631
=====================
F-17
First Mortgage Loan on Springfield, Tennessee property
The first mortgage loan is collateralized by a first deed of trust on real
property in Springfield, Tennessee (with a carrying value of $1.2 million at
November 29, 2003), and by an assignment of key-man life insurance on the
President of Innovo in the amount of $1 million. The loan bears interest at
2.75% over the lender's prime rate per annum (which was 6.75% at November 29,
2003 and 7.50% at November 30, 2002) and requires monthly principal and interest
payments of $9,900 through February 2008. The loan is also guaranteed by the
Small Business Administration (SBA). In exchange for the SBA guarantee, Innovo
Group and certain subsidiaries and the President of Innovo have also agreed to
act as guarantors for the obligations under the loan agreement.
Promissory Note to Azteca in connection with Blue Concept Division Acquisition
In connection with the purchase of the Blue Concept Division from Azteca, IAA
issued a seven-year unsecured, convertible promissory note for $21.8 million.
The Blue Concept Note bears interest at a rate of 6% and requires payment of
interest only during the first 24 months and then is fully amortized over the
remaining five-year period. The terms of the transaction further allow Innovo
Group, upon shareholder approval, to convert a portion of the Blue Concept Note
into equity through the issuance of 3,125,000 shares of common stock valued at
the greater of $4.00 per share or the market value of Innovo Group's common
stock on the day prior to the date of the shareholder meeting at which approval
for this conversion is sought and up to an additional 1,041,667 shares upon the
occurrence of certain future contingencies relating to Innovo Group's stock
price for the thirty day period ending March 6, 2005. Presently, a special
stockholder meeting is scheduled for March 5, 2004 to vote on the approval of
this conversion of the Blue Concept Note into equity. In the event shareholder
approval is obtained, the Blue Concept Note will be reduced by an amount equal
to the product of the Conversion Price and 3,125,000, so long as the principal
amount of the Blue Concept Note is not reduced below $9.3 million and the shares
issued pursuant to the conversion will be subject to certain lock-up periods.
The Blue Concept Note is subject to further reduction as a result of other
events. See Note 3.
Promissory Notes to Azteca in connection with acquisition of Knit Division
In connection with the acquisition of the Knit Division from Azteca (see Note
3), Innovo Group issued promissory notes in the face amounts of $1.0 million and
$2.6 million, which bear interest at 8.0% per annum and require monthly payments
of $20,000 and $53,000, respectively. The notes have a five-year term and are
unsecured.
At the election of Azteca, the balance of the promissory notes may be offset
against monies payable by Azteca or its affiliates to Innovo Group for the
exercise of issued and outstanding stock warrants that are owned by Azteca or
its affiliates, including Commerce. During 2003, Azteca offset $2.1 million in
face amount of the notes in connection with the exercise of 1 million warrants
for Innovo Group common stock.
Principal maturities of long-term debt, assuming none of the Blue Concept Note
is converted into equity, as of November 29, 2003 are as follows (in thousands):
2004 $ 168
2005 1,355
2006 4,035
2007 4,284
2008 4,500
Thereafter 8,002
---------
Total $ 22,344
=========
F-18
10. Income Taxes
The provision (credit) for domestic and foreign income taxes is as follows:
(in thousands)
------------------------------------
2003 2002 2001
-------- -------- --------
Current:
Federal $ -- $ -- $ --
State 27 94 89
Foreign 17 46 --
-------- -------- --------
44 140 89
Deferred:
Federal -- -- --
State -- -- --
Foreign -- -- --
-------- -------- --------
-- -- --
-------- -------- --------
Total $ 44 $ 140 $ 89
======== ======== ========
The source of income (loss) before the provision for taxes is as follows:
Year Ended
(in thousands)
-------------------------------------
2003 2002 2001
-------- -------- --------
Federal $ (7,259) $ 599 $ (529)
Foreign (1,014) 113 --
-------- -------- --------
Total $ (8,273) $ 712 $ (529)
======== ======== ========
F-19
10. Income Taxes (continued)
Net deferred tax assets result from the following temporary differences between
the book and tax bases of assets and liabilities at (in thousands):
2003 2002
---------------------
Deferred tax assets:
Allowance for doubtful accounts $ -- $ 102
Inventory 234 310
Benefit of net operating loss carryforwards: 7,411 13,129
Capital loss carryfowards 280 280
Amortization of intangibles (9) (77)
Other 282 174
-------- --------
Gross deferred tax assets 8,198 13,918
Valuation allowance (8,198) (13,918)
-------- --------
Net deferred tax assets $ -- $ --
======== ========
The reconciliation of the effective income tax rate to the federal statutory
rate for the years ended is as follows:
Year Ended
(in thousands)
----------------------------
2003 2002 2001
------ ------ ------
Computed tax provision (benefit) at the statutory rate (34%) (34%) (34%)
State income tax -- 13 18
Foreign taxes in excess of statutory rate -- 2 --
Utilization of unbenefitted net operating loss carryforwards -- 45 --
Change in valuation allowance 34 16 34
------ ------ ------
0% 20% 18%
====== ====== ======
Innovo Group has consolidated net operating loss carryforwards of approximately
$20.8 million expiring through 2023. Such net operating loss carryforwards have
been reduced as a result of "changes in control" as defined in Section 382 of
the Internal Revenue Code. Such limitation has had the effect of limiting annual
usage of the carryforwards in future years. Additional changes in control in
future periods could result in further limitations of Innovo Groups's ability to
offset taxable income. Management has determined that realization of the net
deferred tax assets does not meet the more likely than not criteria. As a
result, a valuation allowance has been provided for.
11. Stockholders' Equity
Private Placements and Stock Issuances
In fiscal 2003, Innovo Group consummated five private placements of its common
stock resulting in net proceeds of approximately $17,540,000, after deducting
commissions. During its first private placement completed on March 19, 2003,
Innovo Group issued 165,000 shares of common stock to 17 accredited investors at
$2.65 per share, raising net proceeds of approximately $407,000. During its
second private placement completed on March 26, 2003, Innovo Group issued 63,500
shares of common stock to 5 accredited investors at $2.65 per share, raising net
proceeds of approximately $156,000. During its third private placement completed
on July 1, 2003, Innovo Group issued 2,835,000 shares to 34 accredited investors
at $3.33 per share, raising net proceeds of approximately $8,751,000. As part of
this private placement, and in addition to commissions paid, warrants to
purchase 300,000 shares of common stock at $4.50 per share were issued to the
placement agent, Sanders Morris Harris, Inc. During its fourth private placement
completed on August 29, 2003, Innovo Group issued 175,000 shares of common stock
to 5 accredited investors at $3.62 per share, raising net
F-20
proceeds of approximately $592,000. As part of this private placement, and in
addition to commissions paid, warrants to purchase 17,500 shares of common stock
at $3.62 per share were issued to the placement agent, Pacific Summit
Securities. During its fifth private placement funded on or before November 29,
2003, but completed on December 1, 2003, Innovo Group issued 2,997,000 shares of
common stock to 14 accredited investors at $3.00 per share and warrants to
purchase an additional 599,333 shares of common stock at $4.00 per share to
certain of these investors, raising net proceeds of approximately $10,704,000.
During fiscal 2002, Innovo Group did not issue any shares of common stock.
During fiscal 2002, Innovo Group issued preferred shares in association with the
purchase of limited partnerships in certain real estate properties. See Note 5.
During fiscal 2001, in connection with the Acquisition of the Knit Division from
Azteca (see Note 3), Innovo Group issued 700,000 shares of its common stock, and
in connection with the acquisition of the Joe's Jeans license from JD Design,
Innovo Group issued 500,000 shares of its common stock and a warrant to purchase
250,000 shares of its common stock at a price of $1.00 per share, provided
certain sales and gross margin targets are met.
Warrants
Innovo Group has issued warrants in conjunction with various private placements
of its common stock, debt to equity conversions, acquisitions and in exchange
for services. All warrants are currently exercisable. As of November 29, 2003,
outstanding common stock warrants are as follows:
Exercise
Price Shares Issued Expiration
--------------------------------------------------------------------------------
$2.10 300,000 October 2000 October 2005
$1.50 100,000 March 2001 March 2004
$2.00 100,000 March 2001 March 2004
$2.50 50,000 March 2001 March 2004
$0.90 20,000 December 2001 December 2005
$2.75 100,000 May 2002 May 2004
$2.50 75,000 June 2002 May 2004
$3.00 75,000 June 2002 May 2004
$4.50 300,000 June 2003 June 2008
$3.62 17,500 August 2003 August 2008
$4.00 599,333 November 2003 November 2008
------------
1,736,833
============
During fiscal 2000, Innovo Group issued 1,787,365 shares of common stock and
warrants to purchase an additional 1,500,000 shares of common stock at $2.10 per
share to the Sam Furrow and Jay Furrow (collectively, the Furrow Group) in
exchange for the Furrow Group's assumption of $1,000,000 of Innovo Group's debt
and the cancellation of $1,000,000 of indebtedness owed to members of the Furrow
Group. The issuance of the shares of common stock and warrants resulted in a
$1,095,000 charge for the extinguishment of debt. During fiscal 2003, the
warrants issued to the Furrow Group to purchase an additional 1,500,000 shares
were exercised pursuant to a cashless exercise provision contained in the
warrants and the members of the Furrow Group were issued an aggregate of
1,061,892 shares of common stock.
During fiscal 2000, Innovo Group issued warrants to purchase an additional
102,040 shares at $1.75 per share to private investors for $179,000. Commerce
received warrants to purchase an additional 3,300,000 shares of common stock
with warrants for 3,000,000 shares of common stock exercisable over a three-year
period at $2.10 per share and the remaining warrants for 300,000 shares of
common stock subject to a two-year vesting period and exercisable over a
five-year period at $2.10 per share. The proceeds from the sale of these
warrants were used to purchase inventory and services from Commerce and its
affiliates and to repay certain outstanding debt.
F-21
In October and November 2000, Innovo Group issued warrants to purchase an
additional 1,700,000 shares of common stock in private placements to JAML, LLC,
Innovation, LLC and Third Millennium Properties, Inc. (collectively, the
Mizrachi Group) for $1,700,000 in cash. During fiscal 2003, prior to the
scheduled expiration date, the warrants issued to the Mizrachi Group to purchase
an additional 1,696,875 shares were exercised pursuant to cashless exercise
provision contained in the warrants and the members of the Mizrachi Group were
issued an aggregate of 1,195,380 shares of common stock.
During fiscal 2001, Innovo Group issued a warrant related to the Joe's License
to purchase 250,000 shares of common stock at a price of $1.00 per share, in the
event that certain future sales and gross margin performance criteria are met.
The sales targets are $2 million, $4 million, $8 million and $15 million for
each of the years ended December 31, 2001, 2002, 2003, and 2004, respectively,
provided, that the sales have a minimum gross profit of 55%. In the event that
both net sales and gross margin targets are achieved in any one of the scheduled
years, JD Design will receive a warrants for 250,000 shares of Innovo Group
common stock with an exercise price of $1.00 per share, with a 4-year term and
equal-monthly vesting over the first 24 months. When a revenue target is
achieved, the warrants will be issued immediately following the year end of the
year in which the Net Sales Target is achieved and the vesting period and term
will commence immediately upon issuance. JD Designs will not be entitled to any
additional warrants if the Net Sales Targets are reached in more than one of the
scheduled years. This warrant has not been included in the table above as the
performance criteria has not been met.
During fiscal 2001, Innovo Group also issued warrants to a company in exchange
for certain services. Warrants to purchase 20,000, 100,000, 100,000 and 50,000,
shares exercisable at $0.90, $1.50, $2.00 and $2.50 per share, respectively,
which were vested on the date of issuance and have a term of three years, were
issued in exchange for services which are to be rendered over a four-year term.
During fiscal 2002, Innovo Group issued warrants to companies in exchange for
certain services. Warrants to purchase 100,000, 75,000 and 75,000 shares
exercisable at $2.75, $2.50 and $3.00 per share, respectively, which were vested
on the date of issuance and have a term of two years, were issued in exchange
for services to be rendered over three, four and four year terms, respectively.
During fiscal 2003, Innovo Group issued warrants to its placement agents as
compensation pursuant to a private placement in August 2003 and other certain
investors on or before November 29, 2003. Innovo Group issued warrants to
purchase 300,000 shares of common stock at $4.50 per share, warrants to purchase
17,500 shares of common stock at $3.62 per share and warrants to purchase
599,333 shares at $4.00 per share.
During fiscal 2003, warrants to purchase an aggregate of 5,298,915 shares were
exercised pursuant to cashless exercise provisions contained in the warrants and
an aggregate of 3,597,938 shares of common stock was issued in fiscal 2003.
During fiscal 2003, Commerce elected to exercise warrants to purchase 1,000,000
shares and in lieu of payment therefore, Commerce elected to offset $2.1 million
in debt due from Innovo Group pursuant to certain promissory notes.
As of November 29, 2003, 4,500,000 shares of common stock of Innovo Group were
reserved for the exercise of warrants, options, conversion of debt.
Stock Based Compensation
In March 2000, Innovo Group adopted the 2000 Employee Stock Option Plan ("2000
Employee Plan"). In May, 2003, the 2000 Employee Plan was amended to provide for
incentive and nonqualified options for up to 3,000,000 shares of common stock
that may be granted to employees, officers, directors and consultants. The 2000
Employee Plan limits the number of shares that can be granted to any employee in
one year to 1,250,000 and the total market value of common stock that becomes
exercisable for the first time by any grantee during a calendar year. Exercise
price for incentive options may not be less than the fair market value of Innovo
Group's common stock on the date of grant and the exercise period may not exceed
ten years. Vesting periods and option terms are determined by the Board of
Directors. The 2000 Employee Plan will expire in March 2010.
In September 2000, Innovo Group adopted the 2000 Director Stock Incentive Plan
("2000 Director Plan"), under which nonqualified options for up to 500,000
shares of common stock may be granted. At the first annual meeting of
F-22
stockholders following appointment to the board and annually thereafter during
their term, each director will receive options for common stock with aggregate
fair value of $10,000. These options are exercisable beginning one year from the
date of grant and expire in ten years. Exercise price is set at 50% of the fair
market value of the common stock on the date of grant. The discount is lieu of
cash director fees. The 2000 Director Plan will expire in September 2010.
The following summarizes option grants to members of the Board of Directors for
the fiscal years 2001 through 2003:
Number of Exercise
Options Price
--------- --------
2001 102,564 $0.39
2002 40,000 $1.00
2003 30,768 $1.30
Stock option activity, including grants to members of the Board of Directors,
during the periods indicated is as follows:
2003 2002 2001
------------------------- ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
----------- ---------- ----------- ---------- ----------- ----------
Outstanding at beginning of year 1,257,981 $2.07 1,517,981 $2.33 685,417 $3.89
Granted 1,330,768 2.74 40,000 1.00 832,564 1.06
Exercised 50,000 1.64 -- -- -- --
Forfeited (185,417) (3.93) (300,000) (3.28) -- --
----------- ---------- ----------- ---------- ----------- ----------
Outstanding at end of year 2,353,332 $2.31 1,257,981 $2.07 1,517,981 $2.33
Exercisable at end of year 1,686,665 1,220,452 1,305,443
Weighted average per option
fair value of options granted
during the year $1.21 $1.26 $0.59
Weighted average contractual life remaining 6.1 years 3.7 years 3.4 years
Exercise prices for options outstanding as of November 29, 2003 are as follows:
Number of
Options Exercise Price
----------------------------------
102,564 $0.39
290,000 $1.00
480,768 $1.25 - $1.30
280,000 $2.40 - $2.60
1,000,000 $2.86
200,000 $4.75
------------
2,353,332
============
F-23
Earnings (Loss) Per Share
Earnings (loss) per share are computed using weighted average common shares and
dilutive common equivalent shares outstanding. Potentially dilutive securities
consist of outstanding options and warrants. A reconciliation of the numerator
and denominator of basic earnings per share and diluted earnings per share is as
follows:
Year Ended
(in thousands, except per share data)
-------------------------------------
2003 2002 2001
-------- -------- --------
Basic EPS Computation:
Numerator $(8,317) $572 $(618)
Denominator:
Weighted average common shares
outstanding 17,009 14,856 14,315
-------- -------- --------
Total shares 17,009 14,856 14,315
-------- -------- --------
Basic EPS $(0.49) $0.04 $(0.04)
======== ======== ========
Diluted EPS Calculation:
Numerator $(8,317) $572 $(618)
Denominator:
Weighted average common shares
outstanding 17,009 14,856 14,315
Incremental shares outstanding
from assumed exercise of options and
warrants -- 1,253 --
-------- -------- --------
Total shares 17,009 16,109 14,315
-------- -------- --------
Diluted EPS $(0.49) $0.04 $(0.04)
======== ======== ========
Potentially dilutive options and warrants in the aggregate of 4,090,000 and
8,397,000 in fiscal 2003 and fiscal 2001, respectively, have been excluded from
the calculation of the diluted loss per share as their effect would have been
anti-dilutive.
12. Commitments and Contingencies
Leases
Innovo Group leases certain properties, buildings, office spaces, showrooms and
equipment. Certain leases contain provisions for renewals and escalations.
Rental expense for the years ended November 29, 2003, November 30, 2002, and
December 1, 2001 was approximately $367,000, $136,000, and $107,000,
respectively. During September 2000, Innovo Group entered into a lease agreement
with a related party, which is owned by Innovo Group's Chairman, Sam Furrow, to
lease office space in Knoxville, Tennessee. The lease rate is $3,500 per month
for approximately 5,000 square feet of office space, has a ten-year term and is
cancelable with six months written notice.
Innovo Group also utilizes office space and office equipment under a cost
sharing arrangement with Commerce and its affiliates. Under the terms of the
verbal arrangement, Innovo Group is allocated a portion of costs incurred by
Commerce and its affiliates for rent, insurance, office supplies, certain
employees' wages and benefits, security and utilities.
F-24
Expenses for the years ended 2003, 2002 and 2001 under this arrangement were
$343,000, $25,000, and $25,000, respectively.
12. Commitments and Contingencies (continued)
The future minimum rental commitments under operating leases as of November 29,
2003 are as follows (in thousands):
2004 $ 616
2005 568
2006 500
2007 411
2008 401
Thereafter 316
-------
Total future minimum lease payments $ 2,812
=======
License Agreements
Joe's Jeans
On February 7, 2001, in connection with the acquisition of the Joe's Jeans
license rights, Innovo Group entered into a ten- year license agreement that
requires the payment of a royalty based upon 3% of net sales, subject to
additional royalty amounts in the event certain sales and gross profit
thresholds are met on an annual basis.
Bongo(R).
On March 26, 2001, Innovo Group entered into a license agreement with IP
Holdings LLC, the licensor of the Bongo(R) mark, pursuant to which Innovo Group
obtained the right to design, manufacture and distribute bags, belts and small
leather/pvc goods bearing the Bongo(R) trademark. The agreement was amended on
July 26, 2002 that extended the term of the license agreement commencing as of
April 1, 2003 and continuing through March 31, 2007, unless the Bongo(R) brand
is sold in its entirety, in which case the license agreement would terminate
immediately. Innovo Group pays a 5% royalty and a 2% advertising fee on the net
sales of Innovo Group's goods bearing the Bongo(R) trademark.
Mattel, Inc.
In fiscal 2002, IAA entered into a five-year license agreement with Mattel, Inc.
to produce Hot Wheels(R)branded adult apparel and accessories in the United
States, Canada and Puerto Rico. Under the terms of the license agreement, IAA
may produce apparel and accessory products targeted to men and women in the
junior and contemporary markets. The products lines may include active wear,
sweatshirts and pants, outerwear, t-shirts, "baby tees" for women, headwear,
bags, backpacks and totes, which will be emblazoned with the Hot Wheels(R) flame
logo.
IAA may terminate the agreement in any year by paying the remaining balance of
that years minimum royalty guarantees plus the subsequent years minimum royalty
guarantees. Royalties paid by IAA earned in excess of the minimum royalty
requirements for any one given year, may be credited towards the shortfall
amount of the minimum required royalties in any subsequent period during the
term of the license agreement.
According to the terms of the agreement, IAA has the right to sublicense the
accessory product's category to Innovo. The agreement calls for a royalty rate
of seven percent and a two percent advertising fee on the net sales of goods
bearing the Hot Wheels(R) trademark. In the event IAA defaults upon any material
terms of the agreement, the licensor shall have the right to terminate the
agreement. As of November 29, 2003, Innovo Group had not yet commenced sales of
the Hot Wheels(R) apparel and accessory products. Innovo Group has accrued for
the minimum royalties under the terms of the agreement.
F-25
Bow Wow
On August 1, 2002, IAA entered into an exclusive 42-month worldwide agreement
for the Bow Wow license, granting IAA the right to produce and market products
bearing the mark and likeness of the popular stage and screen performer. The IAA
division has created and market a wide range of apparel and coordinating
accessories for boys and plans on creating and marketing a wide range of apparel
and coordinating accessories for girls. The license agreement between IAA,
Bravado International Group, the agency with the master license rights to Bow
Wow, and LBW Entertainment, Inc. calls for the performer to make at least one
public appearance every six months during the term of the agreement to promote
the Bow Wow products, as well as use his best efforts to promote and market
these products on a daily basis.
Additional terms of the license agreement allows IAA to market boys and girls
products bearing the Bow Wow brand to all distribution channels, the right of
first refusal on all other Bow Wow related product categories during the term of
the license agreement, and the right of first of refusal on proposed
transactions by the licensor with third parties upon the expiration of the
agreement. The agreement calls for IAA to pay an eight percent royalty on the
nets sales of goods bearing Bow Wow related marks. In the event IAA defaults
upon any material terms of the agreement, the licensor shall have the right to
terminate the agreement. Furthermore, IAA has the right to sublicense the
accessory product's category to Innovo.
Fetish(TM)
On February 13, 2003, IAA entered into a 44 month exclusive license agreement
for the United States, its territories and possessions with the recording artist
and entertainer Eve for the license of the Fetish(TM) trademark for use with the
production and distribution of apparel and accessory products. IAA has
guaranteed minimum net sales obligations of $8,000,000 in the first 18 months of
the agreement, $10,000,000 in the following 12 month period and $12,000,000 in
the 12 month period following thereafter. According to the terms of the
agreement, IAA is required to pay an 8% royalty and a 2% advertising fee on the
net sales of products bearing the Fetish(TM) logo. In the event IAA does not
meet the minimum guaranteed sales, IAA will be obligated to make royalty and
advertising payments equal to the minimum guaranteed sales multiplied by the
royalty rate of 8% and the advertising fee of 2%. IAA also has the right of
first refusal with respect to the license rights for the Fetish(TM) trademark in
the apparel and accessories category upon the expiration of the agreement,
subject to meeting certain sales performance targets during the term of the
agreement. Additionally, IAA has the right of first refusal for the apparel and
accessory categories in territories in which it does not currently have the
license rights for the Fetish(TM) trademark.
In connection with the launch and subsequent promotion of the Fetish(TM) brand,
IAA incurrent certain advertising and promotion expenses in excess of the
required 2% advertising royalty, which the licensor has agreed represent a
prepayment against future advertising royalties under the license. Accordingly,
Innovo Group has recorded approximately $985,000 of advertising expenses as
prepaid royalties in the accompanying balance sheet.
Innovo Group displays names and logos on its products under license agreements
that require royalties ranging from 3% to 8% of sales and required annual
advance payments (included in prepaid expenses) and certain annual minimum
payments. Royalty expense was $1,338,000, $463,000, and $132,000 for the years
ending 2003, 2002, and 2001, respectively. The future minimum royalty
commitments under royalty agreements as of November 29, 2003 are as follows (in
thousands):
2004 $ 832
2005 1,188
2006 885
2007 417
-------
Total future minimum royalty payments $ 3,322
=======
F-26
Litigation
Innovo Group is involved from time to time in routine legal matters incidental
to its business. In the opinion of Innovo Group's management, resolution of such
matters will not have a material effect on its financial position or results of
operations.
13. Segment Disclosures
Current Operating Segments
During fiscal 2003, Innovo Group operated in two segments, accessories and
apparel. The Accessories segment represents Innovo Group's historical line of
business as conducted by Innovo Group. The apparel segment is comprised of the
operations of Joe's and IAA, both of which began in fiscal 2001, as a result of
acquisitions. Innovo Group's real estate operations and real estate transactions
of Innovo Group's Leasall and IRI subsidiaries do not require substantial
management oversight and have therefore been treated as "other" for purposes of
segment reporting. The operating segments have been classified based upon the
nature of their respective operations, customer base and the nature of the
products sold.
Innovo Group evaluates performance and allocates resources based on gross
profits, and profit or loss from operations before interest and income taxes.
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies.
F-27
Information for each reportable segment during the three years ended November
29, 2003, is as follows (in thousands):
November 29, 2003 Accessories Apparel Other (A) Total
------------------------------------------------
(in thousands)
Net Sales $ 14,026 $ 69,103 $ -- $ 83,129
Gross Profit 3,095 9,881 -- 12,976
Depreciation & Amortization 39 1,087 101 1,227
Interest Expense 214 946 56 1,216
Segment Assets 4,218 33,571 8,576 46,365
Expenditures for Segment Assets 186 563 146 895
(A) Other includes corporate expenses and assets and expenses related to real
estate transactions.
November 30, 2002 Accessories Apparel Other (A) Total
------------------------------------------------
(in thousands)
Net Sales $ 12,072 $ 17,537 $ -- $ 29,609
Gross Profit 3,393 6,144 -- 9,537
Depreciation & Amortization 21 183 52 256
Interest Expense 140 339 59 538
Segment Assets 3,820 9,343 1,980 15,143
Expenditures for Segment Assets 70 97 455 622
(A) Other includes corporate expenses and assets and expenses related to real
estate transactions.
December 1, 2001 Accessories Apparel Other (A) Total
------------------------------------------------
(in thousands)
Net Sales $ 5,642 $ 3,650 $ -- $ 9,292
Gross Profit 1,749 1,208 -- 2,957
Depreciation & Amortization 45 35 87 167
Interest Expense 32 79 100 211
Segment Assets 2,705 6,658 884 10,247
Expenditures for Segment Assets 32 -- 29 61
(A) Other includes corporate expenses and assets and expenses related to real
estate transactions.
F-28
Operations by Geographic Areas
Information about Innovo Group's operations in the United States and Asia is
presented below (in thousands). Inter- company revenues and assets have been
eliminated to arrive at the consolidated amounts.
Adjustments &
United States Asia Eliminations Total
------------- ---------- ------------- ----------
(in thousands)
Novmeber 29, 2003
Sales $ 80,111 $ 3,018 $ -- $ 83,129
Intercompany sales 959 -- (959) --
---------- ---------- ---------- ----------
Total sales $ 81,070 $ 3,018 $ (959) $ 83,129
========== ========== ========== ==========
Income from operations $ (6,964) $ (1,093) $ 541 $ (7,516)
========== ========== ========== ==========
Total assets $ 48,386 $ (743) $ (1,278) $ 46,365
========== ========== ========== ==========
Novmeber 30, 2002
Sales $ 27,707 $ 1,902 $ -- $ 29,609
Intercompany sales 2,228 -- (2,228) --
---------- ---------- ---------- ----------
Total sales $ 29,935 $ 1,902 $ (2,228) $ 29,609
========== ========== ========== ==========
Income from operations $ 1,558 $ 115 $ (484) $ 1,189
========== ========== ========== ==========
Total assets $ 13,693 $ 1,974 $ (524) $ 15,143
========== ========== ========== ==========
December 1, 2001
Sales $ 9,292 $ -- $ -- $ 9,292
Intercompany sales -- -- -- --
---------- ---------- ---------- ----------
Total sales $ 9,292 -- -- $ 9,292
========== ========== ========== ==========
Income from operations $ (399) -- -- $ (399)
========== ========== ========== ==========
Total assets $ 10,247 $ -- $ -- $ 10,247
========== ========== ========== ==========
14. Related Party Transactions
Innovo Group has adopted a policy requiring that any material transaction
between Innovo Group and persons or entities affiliated with officers, directors
or principal stockholders of Innovo Group be on terms no less favorable to
Innovo Group than reasonably could have been obtained in arms' length
transactions with independent third parties.
Anderson Stock Purchase Agreement
Pursuant to a Stock Purchase Right Award granted in February 1997, Innovo
Group's president purchased 250,000 shares of common stock (the Award Shares)
with payment made by the execution of a non-recourse note (the Note) for the
exercise price of $2.81 per share ($703,125 in the aggregate). The Note was due,
without interest, on April 30, 2002, and was collateralized by the 1997 Award
Shares. The Note may be paid or prepaid (without penalty) by (i) cash, or (ii)
the delivery of Innovo Group's common stock (other than the Award Shares) held
for a period of at least six months, which shares would be credited against the
Note on the basis of the closing bid price for the common stock on the date of
delivery.
On July 18, 2002, the Board of Directors voted in favor of extending the term of
Note until April 30, 2005. The remaining provisions of the Note remained the
same. As of November 29, 2003, $703,125 remains outstanding under this
promissory note.
F-29
Crossman Loan
On February 7, 2003 and on February 13, 2003, Innovo Group entered into a loan
agreement with Marc Crossman, then a member of our Board of Directors and now
also our Chief Financial Officer. The loan was funded in two phases of $250,000
each on February 7, 2003 and February 13, 2003 for an aggregate loan value of
$500,000. In the event of default, each loan is collateralized by 125,000 shares
of Innovo Group common stock as well as a general unsecured claim on the assets
of Innovo Group, subordinate to existing lenders. Each loan matures six months
and one day from the date of its respective funding, at which point the
principal amount loaned and any unpaid accrued interest is due and payable in
full without demand. The loan carries an 8% annualized interest rate with
interest payable in equal monthly installments. The loan may be repaid by us at
any time during the term of the loan without penalty. Further, prior to the
maturity of the loan and the original due dates, Innovo Group elected, at its
sole option, to extend the term of the loan for an additional period of six
months and one day. Innovo Group's disinterested directors approved the loan
from Mr. Crossman. Subsequent to the year ended November 29, 2003 and prior to
the maturity of the loans in February 2004, the parties agreed to extend the
term of the loan for an additional period of ninety days. Further, pursuant to
the extension of the loan, the loan was amended to provide Mr. Crossman with the
sole and exclusive option to continue to extend the term of the loan for three
additional ninety day periods by giving notice of such extension on or before
the due date of the loan.
Purchases of Goods and Services
As required under the terms of the Commerce investment, Innovo Group's Innovo,
Joe's and IAA subsidiaries each purchased its craft goods and distribution and
operational services from Commerce in fiscal 2003, fiscal 2002 and fiscal 2001.
The services purchased included but were not limited to accounts receivable
collections, certain general accounting functions, inventory management and
distribution logistics. The following schedule represents Innovo's, Joe's and
IAA's purchases from Commerce during fiscal 2003, fiscal 2002 and fiscal 2001
(in thousands):
Innovo
----------------------------------
Year Ended
(in thousands)
----------------------------------
2003 2002 2001
----------------------------------
Goods $ 2,898 $ 3,317 $ 2,320
Distribution Services 615 644 362
Operational Services 228 203 112
----------------------------------
Total $ 3,741 $ 4,164 $ 2,794
==================================
Joe's IAA
-------------------------------- --------------------------------
Year Ended Year Ended
(in thousands) (in thousands)
-------------------------------- --------------------------------
2003 2002 2001 2003 2002 2001
-------------------------------- --------------------------------
Goods $ 2,195 $ 6,102 $ 1,102 $ 41,798 $ 6,171 $ 1,794
Distribution Services 127 107 20 -- -- --
-------------------------------- --------------------------------
Total $ 2,322 $ 6,209 $ 1,122 $ 41,798 $ 6,171 $ 1,794
================================ ================================
Additionally, Innovo Group is charged an allocation expense from Commerce for
expenses associated with Innovo Group occupying space in Commerce's Commerce,
California facility and the use of general business machines and communication
services. These expenses totaled approximately $343,000 for fiscal 2003 and
$25,000 for fiscal 2002 and fiscal 2001. Innovo Group also utilizes office space
and office equipment under a cost sharing arrangement with Commerce and its
affiliates.
Innovo Group believes that all the transactions conducted between Innovo Group
and Commerce were completed on terms that were competitive and at market rates.
Included in due to related parties is $390,000 and $4,159,000 at November 29,
2003 and November 30, 2002, respectively, relating to amounts due to Commerce
and affiliated entities for goods and services described above.
F-30
Azteca Production International, Inc.
In the third quarter of fiscal 2001, Innovo Group acquired Azteca Productions
International, Inc.'s Knit Division and formed the subsidiary Innovo Azteca
Apparel, Inc. Pursuant to equity transactions completed in fiscal 2000, the
principals of Azteca Production International, Inc. became affiliates of Innovo
Group. Innovo Group purchased the Division's customer list, the right to
manufacture and market all of the Knit Division's current products and entered
into certain non-compete and non- solicitation agreements and other intangible
assets associated with the Knit Division. As consideration, Innovo Group issued
to Azteca, 700,000 shares of Company's common stock valued at $1.27 per share
based upon the closing price of the common stock on August 24, 2001, and
promissory notes in the amount of $3.6 million.
As part of the acquisition of the Blue Concept Division from Azteca in July
2003, IAA and AZT entered into a two-year, renewable, non-exclusive Supply
Agreement for products to be sold by the Blue Concept Division. In addition to
the customary obligations, the Supply Agreement requires that AZT will receive
payment immediately upon receipt of invoices for our purchase orders and that
AZT will charge a per unit price such that IAA will have a guaranteed profit
margin of 15 percent on a "per unit" basis. In addition, AZT is responsible for
all quality defects in merchandise manufactured.
IAA also utilizes AZT to distribute goods manufactured under the Supply
Agreement, and temporarily has AZT invoice and collect payments from AEO, for
goods manufactured in Mexico, until such time that we can establish a Mexican
subsidiary to invoice and collect payments from AEO.
JD Design, LLC
Pursuant to the license agreement entered into with JD Design, LLC under which
Innovo Group obtained the license rights to Joe's Jeans, Joe's is obligated to
pay a 3% royalty on the net sales of all products bearing the Joe's Jeans or JD
trademark or logo. For fiscal 2003, fiscal 2002 and fiscal 2001, this amount
totaled $339,000, $277,000 and $46,000, respectively. Included in due to related
parties on our balance sheet are accrued royalties of $189,000 and $91,000 for
fiscal 2003 and fiscal 2002, respectively.
F-31
15. Quarterly Results of Operations (Unaudited)
The following is a summary of the quarterly results of operations for the three
years ended November 29, 2003, November 30, 2002 and December 1, 2001,
respectively: (in thousands, except per share amounts)
2003 Quarter Ended
(in thousands, except per share data)
-------------------------------------------------
March 1 May 31 August 30 November 29
-------- -------- --------- -----------
Net Sales $ 11,915 $ 12,013 $ 21,906 $ 37,295
Gross Profit 3,310 3,456 3,893 2,317
Income (Loss) before Income Taxes 345 (503) (2,288) (5,827)
Net Income (Loss) 282 (493) (2,312) (5,794)
Net Income (Loss) per Share:
Basic $ 0.02 $ (0.03) $ (0.14) $ (0.27)
Diluted $ 0.02 $ (0.03) $ (0.14) $ (0.27)
2002 Quarter Ended
(in thousands, except per share data)
-------------------------------------------------
March 2 June 1 August 31 November 30
-------- -------- --------- -----------
Net Sales $ 3,201 $ 6,802 $ 10,148 $ 9,458
Gross Profit 912 2,345 3,357 3,156
Income (Loss) before Income Taxes (475) 223 932 32
Net Income (Loss) (496) 207 820 41
Net Income (Loss) per Share:
Basic $ (0.03) $ 0.01 $ 0.06 $ 0.00
Diluted $ (0.03) $ 0.01 $ 0.05 $ 0.00
16. Employee Benefit Plans
On December 1, 2002, Innovo Group established a tax qualified defined
contribution 401(k) Profit Sharing Plan (the "Plan"). All employees who have
worked for Innovo Group for 30 consecutive days may participate in the Plan and
may contribute up to 100% of their salary to the plan. Innovo Group's
contributions may be made on a discretionary basis. All employees who have
worked 500 hours qualify for profit sharing in the event at the end of each year
Innovo Group decides to do so. Costs of the plan charged to operations were
$20,000 for the year ended November 29, 2003.
F-32
17. Other Income and Expense.
Other income and expense consist of the following:
Year Ended
(in thousands)
--------------------------
2003 2002 2001
------ ------ ------
Rental, real estate, and management fee income $ 366 $ 217 $ 71
Unrealized gain on foreign currency 154 -- --
Other items 6 18 13
------ ------ ------
Total other income $ 526 $ 235 $ 84
====== ====== ======
Rental expense $ 58 $ 43 $ --
Unrealized loss on foreign currency -- 41 --
Other items 10 90 3
------ ------ ------
Total other expense $ 68 $ 174 $ 3
====== ====== ======
F-33
You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information contained in this document is current
only as of its date.
298,590 SHARES
INNOVO GROUP INC.
COMMON STOCK
------------
PROSPECTUS
------------
March 10, 2004
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the costs and expenses to be paid by
the Registrant in connection with the sale of the shares of common stock being
registered hereby. All amounts are estimates except for the Securities and
Exchange Commission registration fee.
Securities and Exchange Commission registration fee ........... $ 100.44
Accounting fees and expenses .................................. $15,000.00
Legal fees and expenses ....................................... $ 7,500.00
Transfer agent and registrar fees and expenses ................ $ 1,000.00
Miscellaneous expenses ........................................ $ 1,000.00
Total ................................................ $24,600.44
Item 14. Indemnification of Directors and Officers.
Under Section 145 of the Delaware General Corporation Law, a
corporation may indemnify any of its directors and officers against expenses
(including attorney's fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by such person in connection with such action,
suit or proceeding (i) if any such person acted in good faith and in a manner
reasonably believed to be in or not opposed to be the best interests of the
corporation, and (ii) in connection with any criminal action or proceeding if
such person had no reasonable cause to believe such conduct was unlawful. In
actions brought by or in the right of the corporation, however, Section 145
provides that no indemnification may be made in respect of any claim, issue or
matter as to which such person shall have been adjudged to be liable for
negligence or misconduct in the performance of such person's duty to the
corporation unless, and only to the extent that, the Court of Chancery of the
State of Delaware or the court in which such action or suit was brought shall
determine upon application that, despite the adjudication of liability but in
review of all the circumstances of the case, such person is fairly and
reasonably entitled to indemnity for such expenses which the Court of Chancery
or such other court shall deem proper. Article Nine of the registrant's Amended
and Restated Certificate of Incorporation requires that the registrant indemnify
its directors and officers for certain liabilities incurred in the performance
of their duties on behalf of the registrant to the fullest extent allowed by
Delaware law.
The registrant's Amended and Restated Certificate of Incorporation
relieves the directors from personal liability to the registrant or to
stockholders for breach of any such director's fiduciary duty as a director to
the fullest extent permitted by the Delaware General Corporation Law. Under
Section 102(b)(7) of the Delaware General Corporation Law, a corporation may
relieve its directors from personal liability to such corporation or its
stockholders for monetary damages for any breach of their fiduciary duty as
directors except (i) for a breach of the duty of loyalty, (ii) for failure to
act in good faith, (iii) for intentional misconduct or knowing violation of law,
(iv) for willful or negligent violations of certain provisions of the Delaware
General Corporation Law imposing certain requirements with respect to stock
repurchases, redemptions and dividends, or (v) for any transaction from which
the director derived an improper personal benefit.
Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers or controlling persons of
the registrant pursuant to the foregoing provisions, the registrant has been
informed that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act and
is therefore unenforceable.
Item 15. Recent Sales of Unregistered Securities
For the year ended November 29, 2003, we consummated five private
placements of our common stock to a limited number of "accredited investors"
pursuant to Rule 506 of Regulation D under the Securities Act of 1933,
II-1
as amended, or the Securities Act, resulting in net proceeds of approximately
$17,540,000 after all commissions and expenses (including legal and accounting)
to us. Our first private placement, completed on March 19, 2003 to 17 accredited
investors, raised net proceeds of approximately $407,000 at $2.65 per share. Our
second private placement, completed on March 26, 2003 to 5 accredited investors,
raised net proceeds of approximately $156,000 at $2.65 per share. Our third
private placement, completed on July 1, 2003 to 34 accredited investors, raised
net proceeds of approximately $8,751,000 at $3.33 per share. Our fourth private
placement was completed on August 29, 2003 to 5 accredited investors, and raised
net proceeds of approximately $592,000 at $3.62 per share. Our fifth private
placement was completely funded on or before November 29, 2003, but not
completed until December 1, 2003, to 14 accredited investors, and raised net
proceeds of approximately $10,704,000 at $3.00 per share and warrants at $4.00
per share. We issued 165,000 shares, or the I Shares, as a result of the first
private placement. Capital Wealth Management, LLC or Capital Wealth, acted as
the placement agent on a best efforts basis for the first private placement. In
consideration of the services rendered by Capital Wealth, they were paid 7% of
the gross proceeds, plus expenses, for a total of approximately $31,000. We
issued 63,500 shares, or the II Shares, as a result of the second private
placement. Capital Wealth acted as the placement agent on a best efforts basis
for the second private placement. In consideration of the services rendered,
Capital Wealth was paid 7% of the gross proceeds, plus expenses, for a total of
approximately $12,000. We issued 2,835,481 shares, or the III Shares, as a
result of the third private placement. Sanders Morris Harris, Inc., or SMH,
acted as the placement agent on a best efforts basis for the third private
placement. In consideration of the services rendered by SMH, SMH was paid 7% of
the gross proceeds, plus expenses, for a total of approximately $691,000, and
also received a five year warrant entitling SMH to purchase 300,000 shares of
common stock at $4.50 per share which is exercisable on January 1, 2004. We
issued 175,000 shares, or the IV Shares, as a result of the fourth private
placement. Pacific Summit Securities, Inc., or PSS, acted as the placement agent
on a best efforts basis for the fourth private placement. In consideration of
the services rendered by PSS, PSS was paid 6% of gross proceeds, plus expenses,
for a total of approximately $42,000, and also received a warrant entitling PSS
to purchase 17,500 shares of our common stock at $3.62 per share which is
exercisable on January 1, 2004. We issued 2,996,667 shares and warrants to
purchase an additional 599,333 shares of common stock to these certain investors
at $4.00 per share, or the V Shares, and together with the I Shares, the II
Shares, the III Shares and the IV Shares, we will refer to them as the 2003
Placement Shares, as a result of the fifth private placement. SunTrust Robinson
Humphrey Capital Markets Division, or SunTrust, acted as the placement agent on
a best efforts basis for the fifth private placement. In consideration of the
services rendered by SunTrust, SunTrust was paid 6% of gross proceeds, plus
expenses, for a total of approximately $683,000. Each of the warrants issued to
SMH and PSS includes a cashless exercise option, pursuant to which the holder
thereof can exercise the warrant without paying the exercise price in cash. If
the holder elects to use this cashless exercise option, it will receive a fewer
number our shares than it would have received if the exercise price were paid in
cash. The number of shares of common stock a holder of the warrant would receive
in connection with a cashless exercise is determined in accordance with a
formula set forth in the applicable warrant. We intend to use the proceeds from
the transactions for general corporate purposes.
The buyers of the 2003 Placement Shares have represented to us that they
purchased the 2003 Placement Shares for their own account, with the intention of
holding the 2003 Placement Shares for investment and not with the intention of
participating, directly or indirectly, in any resale or distribution of the 2003
Placement Shares. The 2003 Placement Shares were offered and sold to the buyers
in reliance upon Regulation D, which provides an exemption from registration
under Section 4(2) of the 1933 Act. Each buyer has represented to us that he or
she is an "Accredited Investor," as that term is defined in Rule 501(a) of
Regulation D under said Act.
On March 5, 2004, in connection with an asset purchase agreement with
Azteca and the Guez brothers for the acquisition of the Blue Concept Division
from Azteca and pursuant to Nasdaq rules, we conducted a special meeting of our
stockholders to approve the conversion of approximately $12.5 million of the
$21.8 million seven-year convertible promissory note issued in connection with
the acquisition into a maximum of 4,166,667 shares of our common stock. The
conversion was approved by our stockholders and as a result, Azteca and the Guez
brothers have initially been issued 3,125,000 shares of our common stock at a
conversion price of $4.00 per share, or the Azteca Conversion Shares, with the
possible issuance of up to 1,041,667 additional shares of common stock upon the
occurrence of certain contingencies described in the Blue Concept asset purchase
agreement. The Azteca Conversion Shares were initially issued in reliance upon
Section 4(2) of the 1933 Act, which provides an exemption from registration for
shares not issued in a public offering to a single entity.
II-2
Engagement of Research Firm
In or around February 2002, we engaged Barrow Street Research, Inc., or
Barrow, an independent New York City-based research firm to prepare and issue a
basic research report on us to better inform the investing public of our long
term prospects. We paid Barrow $6,000 for writing and disseminating its report,
inclusion of the report on Barrow's website for the remainder of fiscal 2002, as
well as continued coverage of us by Barrow in fiscal 2002, which included a
mid-year update of our prospects. We also engaged Barrow to prepare a business
plan for us. We paid Barrow $13,209 for (i) the preparation of the business plan
and (ii) reimbursement of expenses. We did not, at any time, issue our
securities to Barrow as compensation for its services and is not aware of any
holdings of our securities by Barrow or its affiliates. We currently do not have
any relationships, financial or otherwise, with any research firms that publish
reports about us.
Item 16. Exhibits and Financial Statement Schedules.
(a) The following exhibits are filed herewith:
Exhibit
Number Description Document if Incorporated by Reference
------ ----------- -------------------------------------
2.1 Asset Purchase Agreement dated July 17, 2003 by and among Innovo Exhibit 2.1 to Current Report on Form 8-K
Azteca Apparel, Inc., Azteca Production International, Inc., dated July 18, 2003 filed on August 1, 2003
Hubert Guez and Paul Guez
2.2 Asset Purchase Agreement dated August 16, 2001 by and among Innovo Exhibit 2.1 to Current Report on Form 8-K
Group Inc., Innovo Apparel, Inc. and Azteca Production dated September 10, 2001
International, Inc.
3.1 Fifth Amended and Restated Certificate of Incorporation of the Exhibit 10.73 to Annual Report on Form 10-K
Registrant for the year ended November 30, 2000 filed on
March 15, 2001
3.2 Amended and Restated Bylaws of Registrant Exhibit 4.2 to Registration Statement on Form
S-8 (file no. 33-71576) filed on November 12,
1993
4.1 Article Four of the Registrant's Amended and Restated Certificate Exhibit 10.73 to Annual Report on Form 10-K
of Incorporation (included in Exhibit 3.1 filed herewith) for the year ended November 30, 2000 filed on
March 15, 2001
4.2 Certificate of Resolution of Designation, Preferences and Other Exhibit 4.2 to Quarterly Report on Form 10-Q/A
Rights, $100 Redeemable 8% Cumulative Preferred Stock, Series A for the period ended June 1, 2002 filed on
dated April 4, 2002 July 25, 2002
4.3 Amendment to Certificate of Resolution of Designation, Preferences Exhibit 4.3 to Quarterly Report on Form 10-Q/A
and Other Rights, $100 Redeemable 8% Cumulative Preferred Stock, for the period ended June 1, 2002 filed on
Series A, dated April 14, 2002. July 25, 2002
4.4 Form of Stock Purchase and Subscription Agreement between Innovo Exhibit 4.1 to Quarterly Report on Form 10-Q
Group Inc. and purchasers dated as of March 19, 2003 and March 26, for the period ended May 31, 2003 filed on
2003 July 15, 2003
II-3
4.5 Placement Agent Agreement between Innovo Group Inc. and Sanders Exhibit 4.2 to Quarterly Report on Form 10-Q
Morris Harris, Inc. dated June 23, 2003 for the period ended May 31, 2003 filed on
July 15, 2003
4.6 Common Stock Purchase Warrant Agreement between Innovo Group Inc. Exhibit 4.3 to Quarterly Report on Form 10-Q
and Sanders Morris Harris, Inc. dated June 30, 2003 for the period ended May 31, 2003 filed on
July 15, 2003
4.7 Registration Rights Agreement between Innovo Group Inc and certain Exhibit 4.4 to Quarterly Report on Form 10-Q
purchasers dated June 30, 2003 for the period ended May 31, 2003 filed on
July 15, 2003
4.8 Placement Agent Agreement between Innovo Group Inc. and Pacific Exhibit 4.4 to Quarterly report on Form 10-Q/A
Summit Securities dated July 30, 2003, as amended on August 6, 2003 for the period ended August 30, 2003 filed on
October 17, 2003
4.9 Common Stock Purchase Warrant Agreement between Innovo Group Inc. Exhibit 4.5 to Quarterly Report on Form 10-Q/A
and certain purchasers dated August 29, 2003 for the period ended August 30, 2003 filed on
October 17, 2003
4.10 Registration Rights Agreement between Innovo Group Inc and certain Exhibit 4.6 to Quarterly Report on Form 10-Q/A
purchasers dated August 29, 2003 for the period ended August 30, 2003 filed on
October 17, 2003
4.11 Form of Securities Purchase Agreement dated December 1, 2003 Exhibit 4 to Current Report on Form 8-K dated
December 1, 2003 filed on December 2, 2003
5.1 Opinion of Akin Gump Strauss Hauer & Feld, LLP. Filed Herewith
10.1 Note executed by NASCO, Inc. and payable to First Independent Filed with Amendment No. 2 to the Registration
Bank, Gallatin, Tennessee in the principal amount of $950,000 Statement on Form S-1(file no. 33-51724) filed
dated August 6, 1992 November 12, 1992
10.2 Authorization and Loan Agreement from the U.S. Small Business Filed with Amendment No. 2 to the Registration
Administration, Nashville, Tennessee dated July 21, 1992 Statement on Form S-1(file no. 33-51724) filed
November 12, 1992
10.3 Indemnity Agreement between NASCO, Inc. and First Independent Filed with Amendment No. 2 to the Registration
Bank, Gallatin, Tennessee Statement on Form S-1(file no. 33-51724) filed
November 12, 1992
10.4 Compliance Agreement between NASCO, Inc. and First Independent Filed with Amendment No. 2 to the Registration
Bank, Gallatin, Tennessee Statement on Form S-1(file no. 33-51724) filed
November 12, 1992
10.5 Assignment of Life Insurance Policy upon the life of Patricia Filed with Amendment No. 2 to the Registration
Anderson-Lasko to First Independent Bank, Gallatin, Tennessee Statement on Form S-1(file no. 33-51724) filed
dated July 31, 1992 November 12, 1992
10.6 Guaranty of Patricia Anderson on behalf of NASCO, Inc. in favor of Filed with Amendment No. 2 to the Registration
First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Statement on Form S-1(file no. 33-51724) filed
November 12, 1992
II-4
10.7 Guaranty of Innovo Group Inc. on behalf of NASCO, Inc. in favor of Filed with Amendment No. 2 to the Registration
First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Statement on Form S-1(file no. 33-51724) filed
November 12, 1992
10.8 Guaranty of Innovo Group, Inc. on behalf of NASCO, Inc. in favor Filed with Amendment No. 2 to the Registration
of First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Statement on Form S-1(file no. 33-51724) filed
November 12, 1992
10.9 Guaranty of NASCO Products, Inc. on behalf of NASCO, Inc. in favor Filed with Amendment No. 2 to the Registration
of First Independent Bank, Gallatin, Tennessee dated August 6, 1992 Statement on Form S-1(file no. 33-51724) filed
November 12, 1992
10.10 Merger Agreement between Innovo Group Inc and TS Acquisition, Inc. Exhibit 10.1 to Current Report on Form 8-K
and Thimble Square, Inc. and the stockholders of Thimble Square dated April 12, 1996 filed on April 29, 1996
Inc. dated April 12, 1996
10.11 Property Acquisition Agreement between Innovo Group Inc., TS Exhibit 10.2 to Current Report on Form 8-K
Acquisition, Inc., Philip Schwartz and Lee Schwartz dated April dated April 12, 1996 filed on April 29, 1996
12, 1996
10.12 Common Stock and Warrant Purchase Agreement between Innovo Group Exhibit 10.63 to Current Report on Form 8-K/A
Inc. and Commerce Investment Group LLC dated August 11, 2000 dated August 11, 2000 filed on September 15,
2000
10.13 Warrant Agreement between Innovo Group Inc. and Commerce Exhibit 10.64 to Current Report on Form 8-K/A
Investment Group LLC dated August 11, 2000 dated August 11, 2000 filed on September 15,
2000
10.14 Investor Rights Agreement between Innovo Group Inc., the Furrow Exhibit 10.65 to Current Report on Form 8-K/A
Group, the Board Members and Commerce Investment Group LLC dated dated August 11, 2000 filed on September 15,
August 11, 2000 2000
10.15 Investor Rights Agreement dated October 31, 2000between Innovo Exhibit 10.75 to Annual Report on Form 10-K for
Group Inc., the Furrow Group, the Board Members and Third the period ended November 30, 2000 filed on
Millennium Properties, Inc. JAML, LLC and Innovation, LLC [sic] March 15, 2001
10.16 Common Stock and Warrant Purchase Agreement between Innovo Group Exhibit 10.79 to Quarterly Report on Form 10-Q
Inc. and JD Design, LLC dated February 7, 2001 for the period ended March 3, 2001 filed on
April 17, 2001
10.17 Stock Purchase Warrant between Innovo Group Inc. and JD Design, Exhibit 10.80 to Quarterly Report on Form 10-Q
LLC dated February 7, 2001 for the period ended March 3, 2001 filed on
April 17, 2001
10.18 Employment Agreement between Innovo Group Inc. and Joe Dahan dated Exhibit 10.81 to Quarterly Report on Form 10-Q
February 7, 2001 for the period ended March 3, 2001 filed on
April 17, 2001
10.19 Stock Incentive Agreement between Innovo Group Inc. and Joe Dahan Exhibit 10.82 to Quarterly Report on Form 10-Q
dated February 7, 2001 for the period ended March 3, 2001 filed on
April 17, 2001
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10.20 License Agreement between Innovo Group Inc and JD Design, LLC Exhibit 10.83 to Quarterly Report on Form 10-Q
dated February 7, 2001 for the period ended March 3, 2001 filed on
April 17, 2001
10.21 Form of Investment Letter relating to purchase of $100 Redeemable Exhibit 10.85 to Quarterly Report on Form
8% Cumulative Preferred Stock, Series A, of Innovo Group Inc. 10-Q/A for the period ended June 1, 2002 filed
dated April 4, 2002 on July 25, 2002
10.22 Form of Limited Partnership Agreement relating to Metra Capital Exhibit 10.86 to Quarterly Report on Form
LLC and Innovo Realty, Inc. as limited partners 10-Q/A for the period ended June 1, 2002 filed
on July 25, 2002
10.23 Form of Sub-Asset Management Agreement between Metra Management, Exhibit 10.87 to Quarterly Report on Form
L.P., Innovo Realty Inc. and a Sub-Asset Manager 10-Q/A for the period ended June 1, 2002 filed
on July 25, 2002
10.24 Distribution of Cash Flow and Capital Events Proceeds Letter Exhibit 10.88 to Quarterly Report on Form
Agreement dated April 5, 2002, between Innovo Realty, Inc., Innovo 10-Q/A for the period ended June 1, 2002 filed
Group Inc., Income Opportunity Realty Investors, Inc., on July 25, 2002
Transcontinental Realty Investors, Inc., American Realty
Investors, Inc., and Metra Capital, LLC
10.25 Distribution of Capital Events Letter Agreement dated April 5, Exhibit 10.89 to Quarterly Report on Form
2002, between Metra Capital, LLC, Innovo Realty, Inc., Innovo 10-Q/A for the period ended June 1, 2002 filed
Group Inc., Income Opportunity Realty Investors, Inc., on July 25, 2002
Transcontinental Realty Investors, Inc., and American Realty
Investors, Inc.
10.26 Reimbursement of Legal Fees Letter dated April 5, 2002 between Exhibit 10.90 to Quarterly Report on Form
Innovo Realty, Inc., Innovo Group Inc., Income Opportunity Realty 10-Q/A for the period ended June 1, 2002 filed
Investors, Inc., Transcontinental Realty Investors, Inc., American on July 25, 2002
Realty Investors, Inc. and Third Millennium Partners, LLC
10.27 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.85 to Form S-8 filed on January 17,
Samuel J. Furrow dated June 5, 2001 2003
10.28 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.86 to Form S-8 filed on January 17,
Patricia Anderson-Lasko dated June 5, 2001 2003
10.29 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.87 to Form S-8 filed on January 17,
Samuel J. Furrow dated December 11, 2002 2003
10.30 Nonqualified Stock Option Agreement between Innovo Group Inc. and Exhibit 10.88 to Form S-8 filed on January 17,
Patricia Anderson-Lasko dated December 11, 2002 2003
10.31 Letter of Intent regarding License Agreement between Mattel, Inc. Exhibit 10.91 to the Annual Report on Form 10-K
and Innovo Group Inc. dated July 25, 2002 for the year ended November 30, 2003 filed on
March 17, 2003
10.32 License Agreement between Bravado International Group Inc. and Exhibit 10.93 to the Annual Report on Form 10-K
Innovo Azteca Apparel, Inc. dated October 15, 2002 for the year ended November 30, 2003 filed on
March 17, 2003
II-6
10.33 Trademark License Agreement between Blondie Rockwell, Inc. and Exhibit 10.96 to the Quarterly Report on Form
Innovo Azteca Apparel, Inc. dated as of February 13, 2003 10-Q for the period ending March 1, 2003 filed
on April 15, 2003
10.34 First Amendment to Trademark License Agreement between Blondie Exhibit 10.14 to Quarterly Report on Form
Rockwell, Inc. and Innovo Azteca Apparel, Inc. effective as of 10-Q/A for the period ended August 30, 2003
September 8, 2003 filed on October 17, 2003.
10.35 Second Amendment to Trademark License Agreement between Innovo Exhibit 10.35 to the Annual Report on Form 10-K
Group Inc. and Blondie Rockwell, Inc. dated effective as of for the year ended November 29, 2003 filed on
February 18, 2004 February 27, 2004
10.36 Promissory Note between Innovo Group Inc. and Marc Crossman dated Exhibit 10.97 to the Quarterly Report on Form
February 7, 2003 10-Q for the period ending March 1, 2003 filed
on April 15, 2003
10.37 Promissory Note between Innovo Group Inc. and Marc Crossman dated Exhibit 10.98 to the Quarterly Report on Form
February 13, 2003 10-Q for the period ending March 1, 2003 filed
on April 15, 2003
10.38 Second Amendment to Promissory Note between Innovo Group Inc. and Exhibit 10.38 to the Annual Report on Form 10-K
Marc Crossman dated February 9, 2003 for the year ended November 29, 2003 filed on
February 27, 2004
10.39 Second Amendment to Promissory Note between Innovo Group Inc. and Exhibit 10.39 to the Annual Report on Form 10-K
Marc Crossman dated February 9, 2003 for the year ended November 29, 2003 filed on
February 27, 2004
10.40 Supply Agreement between Innovo Group Inc. and Commerce Investment Exhibit 10.1 to Quarterly Report on Form 10-Q
Group, LLC dated August 11, 2000 for the period ended May 31, 2003 filed on July
15, 2003
10.41 Distribution Agreement between Innovo Group Inc. and Commerce Exhibit 10.2 to Quarterly Report on Form 10-Q
Investment Group, LLC dated August 11, 2000 for the period ended May 31, 2003 filed on July
15, 2003
10.42 License Agreement between Innovo, Inc. and Michael Caruso & Exhibit 10.3 to Quarterly Report on Form 10-Q
Company, Inc. dated March 26, 2001 and Amendment Letter dated July for the period ended May 31, 2003 filed on July
26, 2002 15, 2003
10.43 Amendment to License Agreement between Innovo Inc. and IP Holdings Exhibit 10.92 to the Annual Report on Form 10-K
LLC dated effective as of April 1, 2003 for the year ended November 30, 2003 filed on
March 17, 2003
10.44 Factoring Agreement dated June 1, 2001 between Joe's Jeans, Inc. Exhibit 10.4 to Quarterly Report on Form 10-Q/A
and CIT Commercial Services for the period ended August 30, 2003 filed on
October 17, 2003
10.45 Factoring Agreement dated June 1, 2001 between Innovo, Inc. and Exhibit 10.6 to Quarterly Report on Form 10-Q/A
CIT Commercial Services for the period ended August 30, 2003 filed on
October 17, 2003
10.46 Factoring Agreement dated September 10, 2001 between Innovo Azteca Exhibit 10.5 to Quarterly Report on Form 10-Q/A
Apparel, Inc. and CIT Commercial Services for the period ended August 30, 2003 filed on
October 17, 2003
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10.47 Inventory Security Agreement dated August 20, 2002 between Joe's Exhibit 10.7 to Quarterly Report on Form 10-Q/A
Jeans, Inc. and CIT Commercial Services for the period ended August 30, 2003 filed on
October 17, 2003
10.48 Inventory Security Agreement dated August 20, 2002 between Innovo Exhibit 10.8 to Quarterly Report on Form 10-Q/A
Azteca Apparel, Inc. and CIT Commercial Services for the period ended August 30, 2003 filed on
October 17, 2003
10.49 Inventory Security Agreement dated August 20, 2002 between Innovo, Exhibit 10.9 to Quarterly Report on Form 10-Q/A
Inc. and CIT Commercial Services for the period ended August 30, 2003 filed on
October 17, 2003
10.50 Amendment to Factoring Agreement originally dated June 1, 2001 Exhibit 10.6 to Quarterly Report on Form 10-Q
between Joe's Jeans, Inc. and CIT Commercial Services dated for the period ended May 31, 2003 filed on July
effective April 23, 2003 15, 2003
10.51 Amendment to Factoring Agreement originally dated June 1, 2001 Exhibit 10.8 to Quarterly Report on Form 10-Q
between Innovo Inc. and CIT Commercial Services dated effective for the period ended May 31, 2003 filed on July
April 23, 2003 15, 2003
10.52 Amendment to Factoring Agreement originally dated September 10, Exhibit 10.7 to Quarterly Report on Form 10-Q
2001 between Innovo Azteca Apparel, Inc. and CIT Commercial for the period ended May 31, 2003 filed on July
Services dated effective April 23, 2003 15, 2003
10.53 Supply Agreement between Innovo Azteca Apparel, Inc. and AZT Exhibit 10.1 to Current Report on Form 8-K
International SA de CV dated July 17, 2003 dated July 18, 2003 filed on August 1, 2003
10.54 Master Distribution and Licensing Agreement between Joe's Jeans, Exhibit 10.3 to Quarterly Report on Form 10-Q/A
Inc. and Itochu Corporation dated July 10, 2003 for the period ended August 30, 2003 filed on
October 17, 2003
10.55 2000 Employee Stock Incentive Plan, as amended Exhibit 99.1 to Current Report on Form 8-K
dated July 18, 2003 filed on August 1, 2003
10.56 2000 Director Option Plan Attachment E to Definitive Proxy Statement on
Schedule 14A filed on September 19, 2000
10.57 Sublease Agreement between Innovo Group Inc. and WRC Media Inc. Exhibit 10.57 to the Annual Report on Form 10-K
dated July 28, 2003 for the year ended November 29, 2003 filed on
February 27, 2004
10.58 Agreement of Lease between 500-512 Seventh Avenue Limited Exhibit 10.58 to the Annual Report on Form 10-K
Partnership and WRC Media, Inc. dated as of March 2000 relating to for the year ended November 29, 2003 filed on
Sublease Agreement filed as Exhibit 10.57 hereto February 27, 2004
10.59 Assignment and Amendment of License Agreement, Amendment of Exhibit 10.59 to the Annual Report on Form 10-K
Guaranty and Consent Agreement among Innovo Azteca Apparel, Inc., for the year ended November 29, 2003 filed on
B.J. Vines, Inc., and Blue Concept, LLC dated February 3, 2004 February 27, 2004
10.60 Letter License Agreement between B.J. Vines, Inc. and Blue Concept Exhibit 10.60 to the Annual Report on Form 10-K
LLC executed on January 8, 2004 relating to Assignment and for the year ended November 29, 2003 filed on
Amendment of License Agreement, Amendment of Guaranty and Consent February 27, 2004
Agreement filed as Exhibit 10.59 hereto
II-8
10.61 Master Distribution Agreement between Joe's Jeans, Inc. and Beyond Exhibit 10.61 to the Annual Report on Form 10-K
Blue, Inc. dated effective as of January 1, 2004 for the year ended November 29, 2003 filed on
February 27, 2004
21 Subsidiaries of the Registrant Filed herewith
23.1 Consent of Akin Gump Strauss Hauer & Feld LLP (included in Filed herewith
Exhibit 5.1)
23.2 Consent of Ernst & Young LLP Filed herewith
24.1 Power of Attorney (included on page II-12 and II-13) Filed herewith
(b) The following financial statement schedule is filed herewith:
Schedule II "Valuation and Qualifying Accounts."
Other financial statement schedules are omitted because the information
called for is not required or is shown either in the Registrant's consolidated
financial statements or the notes thereto.
Item 17. Undertakings.
(a) The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of
the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or the
most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information in the registration statement; and
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in the
registration statement or any material change to such
information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain unsold
at the termination of the offering.
(b) Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the provisions described under Item
14 above, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is,
therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of
expenses incurred or paid by a director, officer of controlling person of
II-9
the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered hereunder, the Registrant
will, unless in the opinion of its counsel the matter has been settled by
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(c) The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as
part of this Registration Statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant pursuant
to Rule 424(b)(1) or (4), or 497(h) under the Securities Act shall
be deemed to be part of this Registration Statement as of the time
it was declared effective.
(2) For the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a form
of prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide
offering thereof.
II-10
ITEM 16(b)
Innovo Group Inc. and Subsidiaries
Schedule II
Valuation and Qualifying Accounts
Additions
Balance at Charged to Charged Balance at
Beginning Costs & to Other End of
Description of Period Expenses Accounts Deductions Period
---------------------------------------------------------------------------------------------------------------------------
Allowance for customer credits and allowances:
Year ended November 29, 2003 $ 383,000 $ 1,775,000 $ -- $ -- $ 2,158,000
Year ended November 30, 2002 164,000 56,000 163,000 (A) -- 383,000
Year ended December 1, 2001 36,000 128,000 -- -- 164,000
Allowances for inventories:
Year ended November 29, 2003 105,000 4,088,000 -- -- 4,193,000
Year ended November 30, 2002 125,000 19,000 -- (39,000) 105,000
Year ended December 1, 2001 78,000 47,000 -- -- 125,000
Allowance for deferred taxes:
Year ended November 29, 2003 13,918,000 (5,720,000) -- -- 8,198,000
Year ended November 30, 2002 7,316,000 6,602,000 -- -- 13,918,000
Year ended December 1, 2001 6,032,000 1,284,000 -- -- 7,316,000
(A) Uncollected receivables written off, net of recoveries
II-11
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registration has
duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Commerce, State of
California, on this 10th day of March, 2004.
INNOVO GROUP INC.
By:/s/ Samuel J. Furrow, Jr.
-------------------------
Samuel J. Furrow, Jr.
Chief Executive Officer
(Principal Executive Officer)
POWER OF ATTORNEY
KNOW ALL PERSON BY THESE PRESENTS that each individual whose signature
appears below constitute and appoints Samuel J. Furrow, Jr., and his or her true
and lawful attorneys-in-fact and agents with full power of substitution, for him
or her and in his or her name, place and stead, in any and all capacities, to
sign any and all amendments (including post-effective amendments) to this
Registration Statement, and to sign any registration statement for he same
offering covered by the Registration Statement that is to be effective upon
filing pursuant to Rule 462(b) promulgated under the Securities Act, and all
post-effective amendments thereto, and to file the same, with all exhibits
thereto and all documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he or she might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents or any of them, or
his, her or their substitute or substitutes, may lawfully do or cause to be done
or by virtue hereof.
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons in the capacities and on the
date indicated.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK.
SIGNATURE PAGE TO FOLLOW.]
II-12
Signature Capacity Date
--------- -------- ----
Chief Executive Officer (Principal
/s/ Samuel J. Furrow, Jr. Executive Officer) and Director March 8, 2004
Samuel J. Furrow, Jr.
Chief Financial Officer (Principal
/s/ Marc B. Crossman Financial Officer) and Director March 8, 2004
Marc B. Crossman
/s/ Patricia Anderson President and Director March 9, 2004
Patricia Anderson
/s/ Samuel J. Furrow Chairman of the Board of Directors March 9 2004
Samuel J. Furrow
/s/ John G. Looney Director March 8, 2004
John G. Looney, M.D.
/s/ Daniel A. Page Director March 9, 2004
Daniel A. Page
/s/ Suhail R. Rizvi Director March 8, 2004
Suhail R. Rizvi
/s/ Vincent Sanfilippo Director March 10, 2004
Vincent Sanfilippo
/s/ Kent A. Savage Director March 10, 2004
Kent A. Savage
II-13