UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended February 28, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-18926
INNOVO GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2928178
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5804 East Slauson Ave., Commerce, California 90040
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (323) 725-5516
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.10
par value per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months or (for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of April 11, 2004, there were 29,082,593 shares of the issuer's only
class of common stock outstanding.
INNOVO GROUP INC.
QUARTERLY REPORT ON FORM 10-Q
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets 1
February 28, 2004 (unaudited) and November 29, 2003
Consolidated Condensed Statements of Operations 2
For the three months ended February 28, 2004 and March 1, 2003,
respectively (unaudited)
Consolidated Condensed Statements of Cash Flows 3
For the three months ended February 28, 2004 and
March 1, 2003, respectively (unaudited)
Notes to Consolidated Condensed Financial Statements (unaudited) 4
Item 2. Management's Discussion and Analysis of Financial 12
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 34
Item 4. Controls and Procedures 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 2. Changes in Securities and Use of Proceeds 37
Item 3. Defaults Upon Senior Securities 37
Item 4. Submission of Matters to a Vote of Security Holders 37
Item 5. Other Information 38
Item 6. Exhibit and Reports on Form 8-K 39
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands, except per share data)
As of As of
02/28/04 11/29/03
----------- ---------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,261 $ 7,248
Accounts receivable, and due from factor net of allowance for
customer credits and allowances of $2,261 (2004) and $2,158 (2003) 832 1,683
Inventories 6,489 7,524
Due from related parties 2,227 --
Prepaid expenses and other current assets 1,538 2,115
-------- --------
TOTAL CURRENT ASSETS 12,347 18,570
-------- --------
PROPERTY, PLANT and EQUIPMENT, net 1,986 2,067
GOODWILL 12,592 12,592
INTANGIBLE ASSETS, NET 12,716 13,058
OTHER ASSETS 58 78
-------- --------
TOTAL ASSETS $ 39,699 $ 46,365
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 5,260 $ 6,128
Due to factor 42 332
Due to related parties 110 579
Note payable to officer 500 500
Current maturities of long-term debt (including related parties) 92 168
-------- --------
TOTAL CURRENT LIABILITIES 6,004 7,707
LONG-TERM DEBT, less current maturities (including related parties) 22,155 22,176
Commitments and Contingencies
8% Redeemable preferred stock, $0.10 par value: Authorized shares -- --
5,000, 194 shares (2004) and (2003)
STOCKHOLDERS' EQUITY
Common stock, $0.10 par - shares, Authorized 40,000
Issued and outstanding 25,794 (2004), and 25,785 (2003) 2,580 2,579
Additional paid-in capital 59,044 59,077
Accumulated deficit (46,793) (41,824)
Promissory note-officer (703) (703)
Treasury stock, 71 shares (2004) and (2003) (2,588) (2,588)
Accumulated other comprehensive loss -- (59)
-------- --------
TOTAL STOCKHOLDERS' EQUITY 11,540 16,482
-------- --------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 39,699 $ 46,365
======== ========
See accompanying notes
1
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended
--------------------------
02/28/04 03/01/03
----------- -----------
(unaudited) (unaudited)
NET SALES $ 16,604 $ 11,915
COST OF GOODS SOLD 13,734 8,656
----------- -----------
Gross profit 2,870 3,259
OPERATING EXPENSES
Selling, general and administrative 6,882 2,787
Depreciation and amortization 455 79
----------- -----------
7,337 2,866
INCOME (LOSS) FROM OPERATIONS (4,467) 393
INTEREST EXPENSE (419) (150)
OTHER INCOME 20 125
OTHER EXPENSE (62) (23)
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (4,928) 345
INCOME TAXES 41 63
----------- -----------
NET INCOME (LOSS) $ (4,969) $ 282
=========== ===========
NET INCOME (LOSS) PER SHARE:
Basic $ (0.19) $ 0.02
Diluted $ (0.19) $ 0.02
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 25,717 14,841
Diluted 25,717 17,241
See accompanying notes
2
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended
--------------------------
02/28/04 03/01/03
----------- -----------
(unaudited) (unaudited)
CASH USED IN OPERATING ACTIVITIES $ (5,548) $ (777)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from investment in real estate 28 773
Redemption of preferred shares -- (368)
Purchases of fixed assets (32) (39)
----------- -----------
Cash (used in) provided by investing activities $ (4) $ 366
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of treasury stock $ -- $ (10)
Payments on notes payables and long term debt (97) (183)
Repayments of factor borrowings (290) --
Proceeds from note payable to officer -- 500
Proceeds from issuance of stock and
exercise of stock options, net of expense (48) --
----------- -----------
Cash provided by (used in) financing activities $ (435) $ 307
Effect of exchange rate on cash -- 19
NET CHANGE IN CASH AND CASH EQUIVALENTS $ (5,987) $ (85)
CASH AND CASH EQUIVALENTS, at beginning of period 7,248 222
----------- -----------
CASH AND CASH EQUIVALENTS, at end of period $ 1,261 $ 137
=========== ===========
See accompanying notes
3
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1-BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of only
normal recurring and consolidating adjustments) considered necessary to present
fairly the balance sheets, the results of operations and cash flows for the
period reported. The accompanying unaudited condensed consolidated financial
statements include the financial results of Innovo Group Inc. (Innovo Group) and
all its wholly-owned subsidiaries (collectively, Innovo Group or we). All
inter-company balances have been eliminated. As used in these accompanying notes
to unaudited condensed consolidated financial statements, Innovo Group's
subsidiaries include the following entities: Innovo, Inc., (Innovo), Joe's
Jeans, Inc. (Joe's), Innovo Azteca Apparel, Inc. (IAA), Leaseall Management,
Inc. (Leaseall) and Innovo Realty, Inc. (IRI).
These accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. The balance
sheet at November 29, 2003 has been derived from the audited financial
statements at that date, but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements.
While management believes that the disclosures presented are adequate to
make the information not misleading, it is recommended that the condensed
consolidated financial statements and footnotes be read in conjunction with the
consolidated financial statements included in our Annual Report on Form 10-K for
the year ended November 29, 2003. Operating results for the three-month period
ended February 28, 2004, or first quarter of fiscal 2004, are not necessarily
indicative of the results that may be expected for the year ended November 27,
2004.
NOTE 2 - INVENTORY
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):
02/28/04 11/29/03
----------- -----------
Finished goods $ 6,988 $ 10,189
Work in progress 706 199
Raw materials 1,014 1,329
----------- -----------
$ 8,708 $ 11,717
Less allowance for obsolescence and
slow moving items (2,219) (4,193)
----------- -----------
$ 6,489 $ 7,524
=========== ===========
4
NOTE 3 - LONG-TERM DEBT
A summary of our long-term debt follows (in thousands):
02/28/04 11/29/03
----------- -----------
First mortgage loan on Springfield property $ 447 $ 476
Promissory note to Azteca (Blue Concepts) 21,800 21,800
Promissory note to Azteca (Knit Div. Note 1) -- 68
----------- -----------
Total long-term debt $ 22,247 $ 22,344
Less current maturities 92 168
----------- -----------
Total long-term debt $ 22,155 $ 22,176
=========== ===========
As used herein, Azteca means Azteca Production International, Inc., an
entity which two of our substantial stockholders, Hubert Guez and Paul Guez,
have a controlling interest.
NOTE 4-- DUE FROM FACTOR AND SHORT TERM DEBT
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 continues 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
each of Innovo and Joe's 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
5
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 February 28, 2004, Innovo Group's loan balance with CIT
was $42,000 and an aggregate amount of $1,863,000 of unused letters of credit
were outstanding. Cross guarantees were executed by and among 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.
NOTE 5 --EARNINGS PER SHARE
A reconciliation of the numerator and denominator of basic earnings (loss)
per share and diluted earnings (loss) per share is as follows (in thousands,
except per share data):
Three Months Ended
(in thousands, except per share data)
-------------------------------------
02/28/04 03/01/03
------------ -----------
Basic EPS Computation:
Numerator $ (4,969) $ 282
Denominator:
Weighted average common shares
outstanding 25,717 14,841
--------- ---------
Total shares 25,717 14,841
--------- ---------
Basic EPS $ (0.19) $ 0.02
========= =========
Diluted EPS Calculation:
Numerator $ (4,969) $ 282
Denominator:
Weighted average common shares
outstanding 25,717 14,841
Incremental shares outstanding from
assumed exercise of options and
warrants -- 2,400
--------- ---------
Total shares 25,717 17,241
--------- ---------
Diluted EPS $ (0.19) $ 0.02
========= =========
3,379,994 options and warrants at February 28, 2004 were excluded from the
calculation of diluted EPS as their effect would have been anti-dilutive.
1,435,417 options and warrants were excluded from calculation of diluted EPS at
March 1, 2003, as they had an exercise price in excess of the average market
price of Innovo Group's common stock during the quarter.
6
NOTE 6 - OTHER INCOME AND EXPENSE
Other Income and Expense consists of the following (in thousands):
Three Months Ended
(in thousands)
-------------------
02/28/04 03/01/03
-------- --------
Rental, real estate, and management fee income $ 14 $ 94
Unrealized gain on foreign currency -- 27
Other items 6 4
-------- --------
Total other income $ 20 $ 125
======== ========
Rental expense $ 7 $ 23
Loss on foreign currency 55 --
-------- --------
Total other expense $ 62 $ 23
======== ========
In connection with the termination of Joe's Jeans Japan's operations
during the quarter ended February 28, 2004, the accumulated other comprehensive
loss resulting from the translation of the subsidiary's financial statements
from yen to dollars was reclassified to the statement of operations, resulting
in a $55,000 loss during the period.
NOTE 7 - EQUITY ISSUANCES
Subsequent to the end of the first quarter of fiscal 2004, on March 5,
2004, in connection with an asset purchase agreement with Azteca, Hubert Guez
and Paul Guez for the acquisition of the division known as the Blue Concept
Division from Azteca and pursuant to Nasdaq rules, Innovo Group conducted a
special meeting of its 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 common
stock. The conversion was approved by stockholders and as a result, Azteca has
initially been issued 3,125,000 shares of Innovo Group's common stock at a
conversion price of $4.00 per share 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. As
discussed in this Quarterly Report on Form 10-Q for the first quarter of fiscal
2004, Hubert Guez and Paul Guez are two of our substantial stockholders and
parties to the asset purchase agreement who 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.
NOTE 8 - INCOME TAXES
Innovo Group income tax expense for the three months ended February 28,
2004 and March 1, 2003, respectively, represents estimated state and foreign
income and franchise tax expense. For the 2004 period, Innovo Group recorded
$41,000 of income tax. For the 2004 and 2003 periods, the effective tax rate
differs from the statutory rate primarily as a result of the accrual for state
and foreign taxes and the recording of a valuation allowance which fully offset
the benefit of the losses for the period.
7
NOTE 9 - STOCK 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 three months ended February 28, 2004 and March 1, 2003
(in thousands, except per share data):
Three Months Ended
(in thousands, except per share data)
-------------------------------------
02/28/04 03/01/03
-----------------------------
Net (loss) income as reported $ (4,969) $ 282
Add:
Stock based employee compensation
expense included in reported net income,
net of related tax effects -- 25
Deduct:
Total stock based employee compensation
expense determined under fair market value
based method fo1 all awards, net of related
tax effects 93 184
-----------------------------
Pro forma net (loss) income $ (5,062) $ 123
=============================
Net (loss) income per share
As reported - basic $ (0.19) $ 0.02
As reported - diluted $ (0.19) $ 0.02
Pro forma - basic $ (0.20) $ 0.01
Pro forma - diluted $ (0.20) $ 0.01
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:
2003
----
Estimated dividend yield........................................... 0.0%
Expected stock price volatility.................................... 48%
Risk-free interest rate............................................ 5.0%
Expected life of options........................................... 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.
8
NOTE 10 - BLUE CONCEPT ACQUISITION
On July 17, 2003, our IAA subsidiary entered into an asset purchase
agreement (APA) with Azteca, Hubert Guez and Paul Guez, whereby IAA acquired the
Blue Concept Division of Azteca. The Blue Concept Division sells primarily denim
jeans to American Eagle Outfitters, Inc. (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 30 of the existing employees of the Blue Concept 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, partially
convertible promissory note (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 allowed Innovo Group, upon stockholder
approval, to convert a portion of the Blue Concept Note into 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 at the date stockholder approval is obtained. On
March 5, 2004 in accordance with the APA and Nasdaq rules, we conducted a
special meeting of our stockholders to convert up to $12.5 million of the debt
into up to 4,166,667 shares of our common stock. The conversion was approved by
our stockholders and as a result, Azteca has initially been issued 3,125,000
shares of our common stock at a conversion price of $4.00 per share 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. As a
result of this conversion, the Blue Concept Note was reduced from $21.8 million
to $9.3 million and the shares issued pursuant to the conversion are subject to
certain lock-up periods. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Debt Conversions" for a further discussion
of the conversion of the Blue Concept Note.
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 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 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 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 Innovo Group. In addition, IAA will pay to Sweet
Sportswear, LLC, an Azteca affiliate, an amount equal to 2.5% of IAA's revenues
generated as a result of sales to AEO.
As part of the transaction, IAA and AZT International SA de CV, a Mexico
corporation and wholly-owned subsidiary of Azteca (AZT), entered into a
two-year, renewable, non-exclusive supply agreement (Supply Agreement) for
products to be sold by Blue Concept Division. Under the terms of the Supply
Agreement, Innovo Group has agreed to market and sell the products to be
purchased from AZT Innovo Group's customers, more particularly the customers of
the Blue Concept Division. In addition to the customary obligations, the Supply
Agreement requires that: (i) Innovo Group shall 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) Innovo
9
Group shall give AZT reasonable time allowances upon placing its purchase orders
with AZT prior to delivery of the products by AZT; (iii) AZT shall receive
payment immediately upon receipt by Innovo Group of invoices for its purchase
orders; (iv) Innovo Group shall have a guaranteed profit margin of 15% on a "per
unit" basis; and (v) the products to be supplied shall be subject to quality
control measures by Innovo Group and by the customer of the Blue Concept
Division.
The results of operations of the Blue Concept Division have been included
in Innovo Group's statement of operations from July 17, 2003.
The following table shows Innovo Group's unaudited pro forma consolidated
results of operations for the three months ended February 28, 2004 and March 1,
2003 assuming the Blue Concept Division acquisition had occurred at the
beginning of the respective fiscal years (in thousands):
Three Months Ended
(in thousands, except per share data)
-------------------------------------
02/28/04 03/01/03
-------- --------
Net sales $ 16,604 $ 31,126
Net income (loss) (4,969) 1,383
Earnings (loss) per share:
Basic $ (0.19) $ 0.08
Diluted $ (0.19) $ 0.07
Management and the board of directors entered into the Blue Concept
acquisition for the following reasons: (i) Innovo Group was able to enter into
an acquisition with a seller with which Innovo Group has a long-standing
relationship; (ii) Innovo Group was able to acquire a profitable business that
has (x) a financial history of producing conservative profit margins with
significant revenues; (iii) Blue Concept had a strong customer relationship with
AEO, (iv) the manufacturing relationships with Azteca to produce effectively and
efficiently; and (v) was able 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 Innovo Group's revenue growth and is
expected to maintain positive cash flows. In the first quarter of fiscal 2004,
the Blue Concept Division accounted for $5,885,000 or 35% of our net revenue.
Furthermore, the APA protects Innovo Group 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.
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.
10
NOTE 11 - REPORTABLE SEGMENTS
Current Operating Segments
During the three-months ended February 28, 2004, Innovo Group continued to
operate in two segments, accessories and apparel. The accessories segment
represents Innovo Group's historical line of business as conducted by Innovo.
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 its 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.
Information for each reportable segment during each of the periods ending
February 28, 2004 is as follows:
Three Months Ended
2/28/04 Accessories Apparel Other (A) Total
---------------------------------------------------
(in thousands)
Net Sales from External Customers (1) $ 3,615 $ 12,989 $ -- $ 16,604
Gross Profit 873 1,997 -- 2,870
Depreciation & Amortization (19) (410) (26) (455)
Operating Income (Loss) (34) (3,249) (1,184) (4,467)
Total Assets 3,295 32,315 3,539 39,149
Three Months Ended
3/1/03 Accessories Apparel Other (A) Total
---------------------------------------------------
(in thousands)
Net Sales from External Customers (2) $ 2,743 $ 9,172 $ -- $ 11,915
Gross Profit 765 2,494 -- 3,259
Depreciation & Amortization (7) (52) (20) (79)
Operating Income (Loss) 57 822 (486) 393
Total Assets 3,632 10,486 1,872 15,990
1. There were no intercompany sales in 2004
2. Excludes intercompany sales of $374,000
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
When used in this Quarterly Report on Form 10-Q, the words "may," "will,"
"except," "anticipate," "intend," "estimate," "continue," "believe" and similar
expressions are intended to identify forward-looking statements. Similarly,
statements that describe our future expectations, objectives and goals or
contain projections of our future results of operations or financial condition
are also forward-looking statements. Statements looking forward in time are
included in this Quarterly Report on Form 10-Q pursuant to the "safe harbor"
provision of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties, which could cause
actual results to differ materially, including, without limitation, continued
acceptance of our product, product demand, competition, capital adequacy and the
potential inability to raise additional capital if required, and the risk
factors contained in our reports filed with the Securities and Exchange
Commission pursuant to the Securities Exchange Act of 1934, as amended,
including its Annual Report on Form 10-K for the year ended November 29, 2003.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. Our future results,
performance or achievements could differ materially from those expressed or
implied in these forward-looking statements. We do not undertake and
specifically decline any obligation to publicly revise these forward-looking
statements to reflect events or circumstances occurring after the date hereof or
to reflect the occurrence of unanticipated events.
The following discussion provides information and analysis of our results
of operations for the three month periods ended February 28, 2004 and the three
month period ended March 1, 2003, and our liquidity and capital resources. The
following discussion and analysis should be read in conjunction with our Notes
to Consolidated Condensed Financial Statements included elsewhere herein.
We completed our acquisition of the Blue Concept Division from Azteca
Production International, Inc., or 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.
Introduction
This discussion and analysis summarizes the significant factors affecting
our results of operations and financial conditions during the three-month period
ended February 28, 2004 and March 1, 2003. This discussion should be read in
conjunction with our Consolidated Condensed Financial Statements, Notes to
Consolidated Condensed Financial Statements and supplemental information in Item
1 of this Quarterly Report on Form 10-Q for the period ended February 28, 2004.
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 Quarterly
Report on Form 10-Q for the period ended February 28, 2004 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
12
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 periods ended February 28, 2004 and March 1, 2003, we operated in
two segments: apparel and accessories. The apparel segment is conducted by our
Joe's Jeans, Inc., or Joe's, and Innovo Azteca Apparel, Inc., or IAA,
subsidiaries, 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, Inc., or 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., or IGI, the parent company, and our two-wholly owned subsidiaries, Leasall
Management Inc., or Leasall, and Innovo Realty Inc., or 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.
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.
IAA
Under our IAA subsidiary, we design and market private and branded apparel
products under various license agreements. The private label business represents
our largest source of sales, both under IAA and in the aggregate of all our
subsidiaries, primarily because of our knowledge and experience within the denim
apparel business. Through private label arrangements, we sell denim products
primarily to American Eagle Outfitters, Inc., or AEO, and Target Corporation. 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.
We currently license and market the Fetish(TM) and Shago(R) branded
apparel lines, which are sold to better departments stores, such as Macy's and
the other subsidiaries within 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 world-renowned recording
artists and actors, provide marketing and exposure for their respective
Fetish(TM) and Shago(R) brands through their talents and celebrity status,
As of the date of this Quarterly Report on Form 10-Q for the first quarter
of fiscal 2004, we have begun to re-evaluate the license agreements associated
with our branded label apparel operating segments. As we discussed in our Annual
Report on Form 10-K for the fiscal year ended November 29, 2003, we entered into
a license agreement with Mattel, Inc. for Hot Wheels(R) branded adult apparel
and accessories. Because we did not have any sales in fiscal 2003 under this
license agreement due to lack of interest in the consumer marketplace, we have
been in discussions with Mattel regarding these and other concerns in connection
with our contractual obligations under the license agreement. Presently, we are
still in discussions with Mattel regarding the potential termination of the
license agreement. We believe that we will be able to terminate the license
agreement for Hot Wheels(R) branded apparel and accessory products amicably and
under terms favorable to us, however, there can be no assurance that such a
termination will take place.
13
Secondly, with respect to the license agreement for Shago(R) branded
apparel and accessories, we have also been in discussions with the licensor
regarding the future of the Shago(R) brand due to a lack of significant sales of
Shago(R) branded apparel in the latter part of fiscal 2003 and the first quarter
of fiscal 2004. As of April 13, 2004, we have had discussions with
representatives with the Shago(R) brand regarding the future of the Shago(R)
brand.
Finally, on or about March 30, 2004, we received a notice of termination
for our license agreement for the Fetish(TM) mark due to an alleged breach of
certain provisions related primarily to production and distribution in agreed
upon channels of distribution. Upon receipt of the notice, we contacted the
licensor and representatives to discuss this notice. We dispute the claims made
by the licensor because, in our opinion, we believe that we have fulfilled all
of our obligations under the license agreement.
Since that time, the licensor has rescinded its termination notice in
writing while reserving its rights to re-assert and/or revive its alleged claims
contained within the notice including the right to send a new termination
notice. Consequently, the two parties have agreed to continue to perform under
the terms and conditions of the license agreement. We are working to resolve
this matter amicably between the parties. However, we cannot assure you that
this matter will be resolved amicably to the satisfaction of the parties without
resulting in further discussions the transmission of a new termination notice,
actual termination, and/or potential litigation.
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 first
quarter of 2004, respectively, we generated significant losses for these
periods. Management believes that certain activities conducted during fiscal
2003, such as the launch of the Fetish(TM) brand and the Blue Concept Division
acquisition, have created a foundation which will benefit us on a going-forward
basis and further establish us as a quality apparel and accessory marketer.
Innovo experienced production and delivery inefficiencies during the fourth
quarter of fiscal 2003 that resulted in our disappointing financial results.
However, we believe that such issues have been identified, corrected and should
be mitigated in future periods.
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 Production International, Inc., or 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 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.
14
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.
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 three-month periods as indicated (in thousands):
Three Months Ended
(in thousands)
--------------------------------------------------------------
02/28/04 03/01/03 $ Change % Change
----------- ----------- ----------- -----------
Net Sales $ 16,604 $ 11,915 $ 4,689 39%
Cost of Goods Sold 13,734 8,656 5,078 59
----------- ----------- ----------- -----------
Gross Profit 2,870 3,259 (389) (12)
Selling, General & Administrative 6,882 2,787 4,095 147
Depreciation & Amortization 455 79 376 476
----------- ----------- ----------- -----------
Income (Loss) from Operations (4,467) 393 (4,860) (1,237)
Interest Expense (419) (150) (269) 179
Other Income 20 125 (105) (84)
Other Expense (62) (23) (39) 170
----------- ----------- ----------- -----------
Income (Loss) before Income Taxes (4,928) 345 (5,273) (A)
Income Taxes 41 63 (22) (35)
Net Income (Loss) $ (4,969) $ 282 $ (5,251) (A)
(A) Not Meaningful
15
Comparison of Three Months Ended February 28, 2004 to Three Months Ended March
1, 2003
Three Months Ended February 28, 2004 Overview
For the three months ended February 28, 2004, or the first quarter of
fiscal 2004, our net sales increased to $16,604,000 from $11,915,000 for the
three months ended March 1, 2003, or the first quarter of fiscal 2003, or a 39%
increase. However, we generated a net loss of $4,969,000 for the first quarter
of fiscal 2004 compared to a net profit of $282,000 for the first quarter of
fiscal 2003. As further discussed below, we have identified the issues
associated with our losses in the first quarter of fiscal 2004 and we are taking
steps to address these issues.
The primary reasons for our net loss in the first quarter of fiscal 2004
were the following:
o Lower gross margins as a result of sales of slow moving and out-of-season
Fetish(TM) and Shago(R) branded apparel and accessories and lower gross
margins for Joe's Jeans as a result of a change in inventory strategy
regarding purchasing of raw materials for finishing as opposed to
purchasing finished goods;
o Increased employee wages of $1,743,000 primarily as a result of hiring 31
employees related to the Blue Concept Division acquisition and the hiring
of 40 employees to support or facilitate the establishment of and increase
sales for Fetish(TM), Shago(R) and Joe's(R) branded products;
o Increased advertising, marketing, tradeshow and related costs of $547,000
incurred in order to market the Joe's(R), Shago(R) and Fetish(TM)brands;
o Increased royalties and commissions associated with our Fetish(TM) and
Shago(R) branded apparel products and the earnout associated with the Blue
Concept Division purchase of $614,000;
o Increases in legal, accounting, and other professional fees and insurance
of $290,000; and
o Increase in interest expense of $269,000 and depreciation and amortization
costs of $376,000 primarily associated with the acquisition of the Blue
Concept Division from Azteca in fiscal 2003.
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:
Three Months Ended
2/28/04 Accessories Apparel Other (A) Total
------------------------------------------------
(in thousands)
Net Sales $ 3,615 $ 12,989 $ -- $ 16,604
Gross Profit 873 1,997 -- 2,870
Depreciation & Amortization (19) (410) (26) (455)
Interest Expense (18) (380) (21) (419)
Three Months Ended
3/1/03 Accessories Apparel Other (A) Total
------------------------------------------------
(in thousands)
Net Sales $ 2,743 $ 9,172 $ -- $ 11,915
Gross Profit 765 2,494 -- 3,259
Depreciation & Amortization (7) (52) (20) (79)
Interest Expense (38) (103) (9) (150)
Three Months Ended
2/28/04 to 3/1/03 Accessories Apparel Other(A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
--------------------------------------------------------------------------------------
(in thousands)
Net Sales $ 872 32% $ 3,817 42% $ -- N/A $ 4,689 39%
Gross Profit 108 14 (497) (20) -- N/A (389) (12)
Depreciation & Amortization (12) 171 (358) N/A (6) 30 (376) 476
Interest Expense 20 (53) (277) 269 (12) 133 (269) 179
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
16
Net Sales
Our net sales increased to $16,604,000 in the first quarter of fiscal 2004
from $11,915,000 in the first quarter of fiscal 2003, or a 39% increase. The
primary reasons for the increase in our net sales were due: (i) to 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 sales of Joe's
Jeans in various international markets; and (iii) sales from our Fetish(TM) and
Shago(R) branded apparel and accessory products.
Accessory
Innovo
Sales for our accessory segment increased to $3,615,000 in the first
quarter of fiscal 2004 from $2,743,000 in the first quarter of fiscal 2003, or a
32% increase. The increase is primarily a result of higher sales of Innovo's
private label and branded accessories products.
Net Sales
($ in thousands) % of Total Net Sales
-------------------- ---------------------
Three Months Ended Three Months Ended
-------------------- ---------------------
2/28/04 3/1/03 % Chg. 2/28/04 3/1/03
-------------------- -------- ---------------------
Craft $ 1,025 $ 1,342 -24% 28% 49%
Private Label 1,694 947 79% 47% 35%
Branded 896 455 97% 25% 17%
--------------------
Total Net Sales $ 3,615 $ 2,743 32% 100% 100%
====================
Craft Accessories
Innovo's net sales from its craft accessories business decreased to
$1,025,000 in the first quarter of fiscal 2004 from $1,342,000 in the first
quarter of fiscal 2003, or a 24% decrease. Craft accessories sales accounted for
28% of Innovo's sales in the first quarter of fiscal 2004. Sales of craft
accessories decreased because certain orders that were scheduled to ship in
February of our first quarter of fiscal 2004 were delayed and subsequently
shipped in March of our second quarter of fiscal 2004. As a result, we expect
craft sales to increase in the second quarter of fiscal 2004. Further, in fiscal
2004, we expect craft sales to continue to increase as our customers continue to
aggressively expand their store bases and we take on new customers. However, we
anticipate sales of craft products to 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 $1,694,000
in the first quarter of fiscal 2004 from $947,000 in the first quarter of fiscal
2003, or a 79% increase. Private label accessories sales accounted for 47% of
Innovo's sales in the first quarter of fiscal 2004. This increase was due to
sales to a private label customer with which we did minimal business in the
first quarter of fiscal 2003 and increased sales volume with one of our largest
existing customers. 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 increased to
$896,000 in the first quarter of fiscal 2004 from $455,000 in the first quarter
of fiscal 2003, or a 97% increase. Branded accessories sales accounted for 25%
of Innovo's net sales in the first quarter of fiscal 2004. Innovo's branded
accessories carry the following brand names: Bongo(R), Fetish(TM),
Friendship(TM) and Clear Gear(TM). Sales of branded accessories increased
primarily as a result of the addition of sales of Fetish(TM) branded accessories
products in the last month of fiscal 2003. In addition,
17
sales of our Bongo(R) branded line of bags did not increase as significantly, as
sales in the first quarter of fiscal 2004 were $418,000 compared to $415,000 in
the first quarter of fiscal 2003, or a 1% increase. In prior quarters, sales of
our Bongo(R) branded line of bags have usually decreased. In the second quarter
of fiscal 2004, we expect sales of our Bongo(R) branded line of bags to grow
based on recent sales trends. 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
may be offset by the growth in other branded accessories, such as our Bongo(R)
accessories, and increased sales of Bongo(R) bags based on our initial
projections for the back-to-school season.
Apparel
Joe's
Joe's net sales decreased to $1,670,000 in the first quarter of fiscal
2004 from $2,128,000 in the first quarter of fiscal 2003, or a 22% decrease,
primarily as a reduction in units sold domestically and a lack of sales under
the Joe's Jeans Japan subsidiary, as discussed below.
Net Sales % of Total
($ in thousands) Net Sales
-------------------- ---------------------
Three Months Ended Three Months Ended
-------------------- ---------------------
2/28/04 3/1/03 % Chg. 2/28/04 3/1/03
-------------------- -------- ---------------------
Domestic $ 1,261 $ 1,516 -17% 76% 71%
Joe's Jeans Japan -- 460 -100% 0% 22%
International Distributors 408 152 168% 24% 7%
--------------------
Total International Markets 408 612 -33% 24% 29%
--------------------
Total Net Sales $ 1,670 $ 2,128 -22% 100% 100%
====================
Domestic
Joe's domestic net sales decreased to $1,261,000 in the first quarter of
fiscal 2004 from $1,516,000 in the first quarter of fiscal 2003, or a 17%
decrease. The decrease in domestic net sales is attributable to a reduction of
the number of units Joe's sold in the domestic market. While we had a
substantially higher backlog of orders for new product during the quarter, we
were not able to fulfill the backlog in the first quarter of fiscal 2004 due to
production delays. In order to address these production delays, we are
consolidating Joe's production under the existing production department we use
for our other branded and private label apparel products. In fiscal 2004, we are
taking the following steps to increase Joe's net sales in the domestic market:
(i) expanding our collection of products to include pants in materials other
than denim, and tops, such as shirts and jackets; (ii) expanding our denim pants
line to include four fits that are tailored to different body types; and (iii)
increasing advertising spending to include billboards as well as print ads due
to Joe's receiving positive reception from recent billboard advertising.
Joe's Jeans Japan
Joe's Jeans Japan had no sales in the first quarter of fiscal 2004
compared to net sales of $460,000 in the first quarter of fiscal 2003. During
the third quarter of fiscal 2003, Joe's decided to terminate its direct sales
operations in Japan and entered into a licensing and distribution agreement with
Itochu Corporation, or Itochu, for the licensing and distribution of Joe's and
the Joe's Jeans brands in Japan. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation - Recent Acquisitions and Licenses"
for a further discussion regarding the Joe's Jeans licensing and distribution
agreement with Itochu.
18
International Distributors
Joe's net sales to international distributors increased to $408,000 in the
first quarter of fiscal 2004 from $152,000 in the first quarter of fiscal 2003,
or a 168% increase. Currently, Joe's products are sold internationally primarily
in Japan, France, England, Canada, Australia, Norway and Korea. The increase in
international sales is attributable to an increase in the number of
international markets into which Joe's is selling product. Sales to France,
which represents our second largest international market behind Japan, increased
to $104,000 in the first quarter of fiscal 2004 from $65,000 in the first
quarter of fiscal 2003, or a 60% increase. Offsetting a portion of the growth in
the international markets was a decline in sales to Canada. In fiscal 2004, we
expect sales to international distributors to increase as a result of partnering
with Beyond Blue to 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. See "Management's Discussion and Analysis of Financial Condition and
Results of Operation - Recent Acquisitions and Licenses" for a further
discussion regarding the international distribution agreement with Beyond Blue.
IAA
IAA's net sales increased to $11,319,000 in the first quarter of fiscal
2004 from $7,044,000 in the first quarter of fiscal 2003, or a 61% 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 within the Blue
Concept Division, which we acquired from Azteca Production International, Inc.,
or Azteca, Hubert Guez and Paul Guez in July 2003. See "Management's Discussion
and Analysis of Financial Condition and results of Operation - Recent
Acquisitions and Licenses" for a further discussion regarding the acquisition of
the Blue Concept Division from Azteca. As a result of the license agreements for
Fetish(TM) and Shago(R) entered into during fiscal 2002 and 2003, IAA generated
approximately 26% of its net sales from its branded business in the first
quarter of fiscal 2004. For the first quarter of fiscal 2004, net sales of
Shago(R) and Fetish(TM) branded apparel were $1,039,000 and $1,957,000,
respectively.
Net Sales % of Total
($ in thousands) Net Sales
-------------------- ---------------------
Three Months Ended Three Months Ended
-------------------- ---------------------
2/28/04 3/1/03 % Chg. 2/28/04 3/1/03
-------------------- -------- ---------------------
Branded $ 2,995 $ -- (A) 26% 0%
Private Label 8,324 7,044 18% 74% 100%
--------------------
Total Net Sales $ 11,319 $ 7,044 61% 100% 100%
====================
(A) Not Meaningful
19
Private Label
IAA's net sales from its private label business increased to $8,324,000 in
the first quarter of fiscal 2004 from $7,044,000 in the first quarter of fiscal
2003, or an 18% increase. The increase in sales is attributable to sales
generated in connection with the Blue Concept Division acquisition in July 2003.
In fiscal 2004, we expect sales from IAA's private label division to increase as
a result of the benefit of a full year's contribution of sales from the Blue
Concept Division versus only four months in fiscal 2003.
Branded
IAA's net sales from its branded apparel business was $2,995,000 in the
first quarter of fiscal 2004. IAA did not have branded apparel sales in the
first quarter of fiscal 2003. Branded apparel sales accounted for 26% of IAA's
net sales in the first quarter of fiscal 2004. In the first quarter of fiscal
2004, IAA's branded apparel carried the Shago(R) and Fetish(TM) brand names and
generated net sales of $1,039,000 and $1,957,000 respectively. 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 and discounters. For a further discussion of the Hot
Wheels(R), Shago(R) and Fetish(TM) license agreements and their status, as well
as reasons for high net sales, but overall net losses from our branded apparel,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Executive Overview." In the first quarter of fiscal 2004, we
entered into a license agreement with Betsey Johnson 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. As a result, we
expect to generate sales under this license agreement in the fourth quarter in
fiscal 2004. Production of the apparel under the Betsey Johnson(R) brand name is
currently underway and we anticipate introducing the Betsey Johnson(R) products
in the third quarter of fiscal 2004. See "Management's Discussion and Analysis
of Financial Condition and Results of Operation - Recent Acquisitions and
Licenses" for a further discussion of the Betsey Johnson(R) license.
Gross Margin
Our gross profit decreased to $2,870,000 in the first quarter of fiscal
2004 from $3,259,000 in the first quarter of fiscal 2003, or a 12% decrease.
Overall, gross margin, as a percentage of net sales, decreased to 17% in the
first quarter of fiscal 2004 from 27% in the first quarter of fiscal 2003. The
decline was attributable to sales of slow moving and out-of-season Fetish(TM)
and Shago(R) branded apparel and accessories at cost and lower gross margins due
to an increased percentage of our sales coming from international distributors
and increased sales to domestic discounters.
Accessory
Innovo
Innovo's gross profit increased to $873,000 in the first quarter of fiscal
2004 from $712,000 in the first quarter of fiscal 2003, or a 23% increase.
Innovo's gross margin is a function of its product mix, such as private label,
craft and branded accessory products, for a given period. Our craft and private
label accessory products have traditionally experienced lower gross margins than
our branded accessory products. Innovo's gross margin decreased to 24% in the
first quarter of fiscal 2004 from 26% in the first quarter of fiscal 2003. The
decrease in gross margin is a result of: (i) approximately $100,000 of our
Fetish(TM) and Shago(R) branded accessory products were sold at cost, which
reduced gross margin by approximately 3 percentage points; and (ii) lower gross
margins on our craft products in the first quarter of fiscal 2004 compared to
the first quarter of fiscal 2003. The gross margins on our craft products were
lower in the first quarter of fiscal 2004 compared to the first quarter of
fiscal 2003 due to higher distribution costs. The higher distribution costs
associated with our craft accessory sales were a result of a higher percentage
of Innovo's craft accessory sales coming from craft accessory products with
lower unit selling prices but with the same fixed per unit distribution cost as
our craft accessory products with a higher unit selling price. In fiscal 2004,
we anticipate that Innovo's gross margins will approach those of fiscal 2003
since we expect that branded accessory products will grow faster and result in a
greater portion of Innovo's net sales to be attributed to branded accessories,
which are products with higher gross margins, in fiscal 2004 than in fiscal
2003.
20
Apparel
Joe's
Joe's gross profit decreased to $277,000 in the first quarter of
fiscal 2004 from $1,277,000 in the first quarter of fiscal 2003, or a 79%
decrease. Joe's gross margin decreased to 17% in the first quarter of fiscal
2004 from 60% in the first quarter of fiscal 2003 for the following two reasons:
(i) an increased percentage of our sales coming from international distributors;
and (ii) increased sales to domestic discounters. We shipped a higher percentage
of our goods to international distributors in the first quarter of fiscal 2004
compared to the first quarter of fiscal 2003. In the first quarter of fiscal
2004, 24% of our sales were to international distributors compared to just 7% in
the first quarter of fiscal 2003. Furthermore, sales to international
distributors carry lower gross margins than domestic sales because we sell to
our international distributors at a lower selling price than our domestic
selling price. We had a higher level of sales to domestic discounters during the
first quarter of fiscal 2004 than in the first quarter of fiscal 2003 because we
chose to sell slow moving inventory at cost to domestic discounters in order to
reduce our slow moving inventory balance. More specifically, 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.
IAA
IAA's gross profit increased to $1,720,000 in the first quarter of fiscal
2004 from $1,217,000 in the first quarter of fiscal 2003, or a 41% increase.
However, gross margin decreased to 15% in the first quarter of fiscal 2004 from
17% in the first quarter of fiscal 2003. The decrease in gross margin is
primarily attributable to lower gross margins associated with sales of private
label apparel products, primarily sales to AEO and lower gross margins
associated with sales of our out-of-season Shago(R) and Fetish(TM) inventory.
Selling, General and Administrative Expense
Selling, general and administrative, or SG&A, expenses increased to
$6,882,000 in the first quarter of fiscal 2004 from $2,838,000 in the first
quarter of fiscal 2003, or a 142% 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 40 employees to support or facilitate the
establishment of and increase sales for Fetish(TM), Shago(R) and Joe's(R)
branded products; (iv) increased royalty and commission expense associated with
our existing and new branded accessory and apparel lines; (v) increased outside
legal, accounting and other professional fees as a result of continued growth of
the business in fiscal 2003; and (vi) increased insurance costs primarily as a
result of increase in our general liability and directors and officers
insurance.
As discussed in greater detail below, we incurred the following SG&A
expenses in the first quarter of fiscal 2004: (i) $727,000 of expense in the
first quarter of fiscal 2004 from $328,000 of expense in the first quarter of
fiscal 2003, or a 122% increase, to establish and market our branded products
through advertising and tradeshows; (ii) $2,781,000 of expense in the first
quarter of fiscal 2004 from $1,038,000 of expense in the first quarter of fiscal
2003, or a 168% increase, for hiring additional employees and wage increases;
(iii) $698,000 of expense in the first quarter of fiscal 2004 from $300,000 of
expense in the first quarter of fiscal 2003, or a 133% increase, for royalties
and commissions associated with our existing and new branded accessory and
apparel lines; (iv) $566,000 of expense in the first quarter of fiscal 2004 from
$289,000 of expense in the first quarter of fiscal 2003, or a 96% increase, for
increased legal, accounting and other professional fees; and (v) $52,000 of
expense in the first quarter of fiscal 2004 from $39,000 in the first quarter of
fiscal 2003, or a 33% increase, for increased D & O and general liability
insurance.
21
Accessory
Innovo
Innovo's SG&A expenses increased to $889,000 in the first quarter of
fiscal 2004 from $658,000 in the first quarter of fiscal 2003, or a 35%
increase. This SG&A expense increase is primarily attributable to wage
increases. Innovo's employee wages increased to $416,000 in the first quarter of
fiscal 2004 from $337,000 in the first quarter of fiscal 2003, or a 23%
increase. Wage increases are a result of hiring of additional salespeople to
replace outsourced sales personnel working on a "commission-only" basis and the
hiring of additional employees in our sourcing office in Hong Kong.
Due to the expansion of the branded accessories product line, five other
SG&A expense categories increased, namely: (i) product sample expenses; (ii)
sales shows expense; (iii) travel expense; (iv) royalty expense; and (v) rent.
First, expenses to make samples of future products increased to $44,000 in the
first quarter of fiscal 2004 from $14,000 in the first quarter of fiscal 2003,
or a 214% increase. Sample expense increased due to additional development of
branded accessories such as Fetish(TM) accessories. Second, we incurred growth
in our sales show expense with the addition of Fetish(TM) accessories. As a
result, our sales shows expense increased to $19,000 in the first quarter of
fiscal 2004 from $8,000 in the first quarter of fiscal 2003, or a 138% increase.
Third, as a result of increase travel overseas to expand our Hong Kong sourcing
office and the travel associated with attending additional sales shows, our
travel expenses increased to $38,000 in the first quarter of fiscal 2004 from
$32,000 in the first quarter of fiscal 2003, or a 19% increase. Fourth, the
addition of sales of Fetish(TM) branded accessories resulted in an increase in
our royalty expense to $62,000 in the first quarter of fiscal 2004 from $27,000
in the first quarter of fiscal 2003, or a 130% increase. Finally, rental expense
increased to $64,000 in the first quarter of fiscal 2004 from $37,000 in the
first quarter of fiscal 2003, or a 73% 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 accessory lines.
Apparel
Joe's
Joe's SG&A expenses increased to $1,286,000 during the first quarter of
fiscal 2004 from $1,208,000 in the first quarter of fiscal 2003, or a 6%
increase. This increase is primarily attributable to the following factors: (i)
wage and related benefits increase in connection with the hiring of eight
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) an increase in advertising expenditures on marketing and
advertising the Joe's(R) and Joe's Jeans(R) brand; and (iii) an increase in
legal, accounting and professional fees associated with the dissolution of our
Joe's Jeans subsidiary in Japan. The above mentioned expenses were offset in
part by the payment of lower commissions due to a decrease in overall sales, as
well as a decrease in factoring expenses also attributable to lower sales.
More specifically, Joe's employee wages and related benefits expenses
increased to $503,000 in the first quarter of fiscal 2004 from $456,000 in the
first quarter of fiscal 2003, or a 10% increase. Advertising expenditures
increased to $212,000 in the first quarter of fiscal 2004 from $128,000 in the
first quarter of fiscal 2003, or a 66% increase. Legal, accounting and
professional fees increased to $135,000 in the first quarter of fiscal 2004 from
$94,000 in the first quarter of fiscal 2003, or a 44% increase A large portion
of this increase in legal, accounting and professional fees was due to increased
legal fees associated with protection of our existing trademarks and
applications of new trademarks in current and new international markets.
Offsetting a portion of these expenses, Joe's commissions and factoring expenses
decreased as a result of lower sales. Joe's factoring expense under its
factoring arrangement with CIT Commercial Services decreased to $14,000 in the
first quarter of fiscal 2004 from $31,000 in the first quarter of fiscal 2003,
or a 121% decrease. Commission expenses decreased to $65,000 in the first
quarter of fiscal 2004 from $144,000 in the first quarter of fiscal 2003, or a
55% decrease.
22
IAA
IAA's SG&A expenses increased to $3,529,000 in the first quarter of fiscal
2004 from $412,000 in the first quarter of fiscal 2003, or a 757% 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 from
Azteca.
IAA had higher employee costs associated with the expansion of its branded
apparel business and the acquisition of the Blue Concept Division. IAA increased
its employee count by adding 71 new employees after the first quarter of fiscal
2003 through the first quarter of fiscal 2004. In addition, we expanded our Hong
Kong sourcing office to include sourcing for apparel products, as discussed in
the Innovo section above. The expansion into the branded apparel business
required us to fill certain positions, including a designs 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 $1,519,000 in the first quarter of fiscal 2004 from $140,000 in the
first quarter of fiscal 2003, or a 985% increase.
During the first quarter of fiscal 2004, we incurred $496,000 of expense
to market and promote our branded apparel products compared to $102,000 incurred
in the first quarter of fiscal 2003, or a 386% increase. These expenses include:
(i) $68,000 spent on billboard advertising, photo shoots in connection with
Fetish(TM) and Shago(R) apparel and for advertising in national print
publications, such as Vibe, Honey and Women's Wear Daily, from $4,000 spent in
the first quarter of fiscal 2003, or a 1,600% increase; and (ii) $329,000
incurred in connection with the semi-annual trade show MAGIC held in Las Vegas,
Nevada to showcase the Fetish(TM) and Shago(R) lines compared to $85,000 in the
first quarter of fiscal 2003, or a 287% increase; and (iii) $99,000 for samples,
production and development of its apparel products in the first quarter of
fiscal 2004, compared to $13,000 of expenses for these sample and development
costs in the first quarter of fiscal 2003, or a 662% increase.
During the first quarter of fiscal 2004, we incurred $486,000 of royalties
and commissions for Shago(R) and Fetish(TM) branded apparel sales, which
commenced shipping in the second and fourth quarters of fiscal 2003,
respectively. With the exception of $32,000 spent in the first quarter of fiscal
2003 and allocated toward minimum royalty guarantees in connection with the Hot
Wheels(R) and Shago(R) apparel lines, no commissions were expensed during the
first quarter of fiscal 2003 since we generated no sales from branded apparel
during the first quarter of fiscal 2003. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation - Executive Overview"
for a discussion of these license agreements and their status.
Rental expense associated with the opening of our branded apparel showroom
in New York was $30,000 in the first quarter of fiscal 2004. IAA did not have a
New York showroom in the first quarter of fiscal 2003.
Travel, meals and entertainment expense increased to $150,000 in the first
quarter of fiscal 2004 from $27,000 in the first quarter of fiscal 2003, or a
456% increase, as a result of the larger employee and customer base.
Legal, accounting and other professional fees increased to $37,000 in the
first quarter of fiscal 2004 from $28,000 in the first quarter of fiscal 2003,
or a 32% increase, as a result of increased costs associated with the
development of the branded apparel business.
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. In the first quarter of fiscal 2004, IAA
recorded $318,000 for such expenses compared to no allocation in the first
quarter of fiscal 2003 since the business was not acquired until the third
quarter of fiscal 2003.
During fiscal 2003, we incurred $160,000 of expense to Sweet Sportswear
LLC, or Sweet Sportswear, pursuant to an earn-out agreement. In connection with
the Blue Concept Division acquisition, IAA pays to Sweet Sportswear, an entity
owned by Hubert Guez and Paul Guez who were parties to the Blue Concept asset
purchase agreement, an earn-out on a quarterly basis equal to 2.5% of the gross
sales to AEO. This earn-out agreement was additional consideration for the
acquisition of the Blue Concept Division. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Recent Acquisitions
and Licenses" for further
23
discussion regarding the acquisition of the Blue Concept Division. We expect
earn-out expenses to increase as we anticipate sales growth from the Blue
Concept Division for a full year of sales in fiscal 2004.
The balance of the approximate $333,000 of additional SG&A in the first
quarter of fiscal 2004 is attributable to the growth of our business from IAA
having net sales of $7,044,000 and 7 employees in the first quarter of fiscal
2003 to having net sales of $11,319,000 and 80 employees in the first quarter of
fiscal 2004.
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 $1,008,000 in the first quarter of fiscal 2004
from $456,000 in the first quarter of fiscal 2003, or a 117% increase. IGI's
management level wages and related benefits increased to $345,000 in the first
quarter of fiscal 2004 from $134,000 in the first quarter of fiscal 2003, or a
157% increase, primarily as a result of hiring seven additional management level
employees, including a Chief Financial Officer and a Chief Operating Officer, to
provide the infrastructure necessary to manage our growth. Insurance expense
increased to $52,000 in the first quarter of fiscal 2004 from $34,000 in the
first quarter of fiscal 2003, or a 53% increase. Travel, meals and entertainment
expense increased to $101,000 in the first quarter of fiscal 2004 compared to
$38,000 in the first quarter of fiscal 2003, or a 166% increase, as a result of
the increased size and international presence of our operations. Legal,
accounting and professional fees increased to $385,000 in the first quarter of
fiscal 2004 compared to $161,000 in the first quarter of fiscal 2003, or a 139%
increase, as a result of increased business activity.
Leaseall
Leasall's SG&A expense increased to $170,000 in the first quarter of
fiscal 2004 from $10,000 in the first quarter of fiscal 2003, or a 1,600%
increase, due to $160,000 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.
IRI
IRI had no SG&A expenses in either the first quarter of fiscal 2004 or the
first quarter of fiscal 2003.
Depreciation and Amortization Expenses
Our depreciation and amortization expenses increased to $455,000 in the
first quarter of fiscal 2004 from $79,000 in the first quarter of fiscal 2003,
or a 476% increase. The increase is primarily attributable to: (i) the
depreciation and amortization associated with the purchase of the Blue Concept
Division; and (ii) the purchase of a booth for the MAGIC tradeshow. More
specifically, in connection with the acquisition of the Blue Concept Division,
in the first quarter of fiscal 2004, we amortized $330,000 of the intangible
asset related to the 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 $75,000 is due
to: (i) deprecation of $20,000 in connection with the Springfield, Tennessee
facility and related leasehold improvements; (ii) amortization of $12,000 in
connection with the licensing rights to the Joe's(R) and Joe's Jeans(R) marks
acquired on February 7, 2001; and (iii) depreciation of $43,000 related to small
operational assets such as furniture, fixtures, machinery and software.
Interest Expense
Our combined interest expense increased to $419,000 in the first quarter
of fiscal 2004 from $150,000 in the first quarter of fiscal 2003, or a 179%
increase. Our interest expense is primarily associated with: (i) $76,000 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)
$321,000 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 in July of
2003 (which such interest expense has
24
been partially eliminated due to the partial conversion of the convertible note
at our March 5, 2004 special meeting of stockholders); (iii) $10,000 of interest
expense from two loans totaling $500,000 provided by Marc Crossman, our Chief
Financial Officer, to Innovo Group on February 7, 2003 and February 13, 2003;
and (iv) $11,000 of interest expense from a mortgage on our former manufacturing
facility and headquarters in Springfield, Tennessee.
Other Income
IRI
Other income in the first quarter of fiscal 2004 included no income from a
quarterly sub-asset management fee that IRI is entitled to receive pursuant to a
sub-asset management agreement entered into on April 5, 2002, in connection with
the 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. Because the outstanding balance due to Innovo
Group at the end of the first quarter of fiscal 2004 was $232,000, Innovo Group
has elected not to record the sub-asset management fee as income during the
quarter as collectibility of the balance was not deemed probable. Part of the
consideration accepted by the sellers in the Limited Partnership Real Estate
Acquisition was 195,000 shares of our $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 $85,000 of income from the
sub-asset management fee in the first quarter of fiscal 2003.
Joe's and Leaseall
Additionally, we had $50,000 of other expense from Joe's in the first
quarter of fiscal 2004 compared to $31,000 of other income in the first quarter
of fiscal 2003, which is principally attributable to foreign currency
translation expense. Other income also included net rental income of $7,000 from
tenants who are occupying our former manufacturing facility located in
Springfield, Tennessee.
Net Income
We generated a net loss of $4,969,000 in the first quarter of fiscal 2004
compared to net income of $282,000 in the first quarter of fiscal 2003.
The net loss in the first quarter of fiscal 2004 compared to net income in
the first quarter of fiscal 2003 is largely the result of the following factors:
(i) lower gross margins due to a greater percentage of our business coming from
private label apparel and accessory products as well as close-out inventory
sales; (ii) increased employee wages of $1,743,000, primarily due to the
acquisition of the Blue Concept Division and the development of our branded
apparel and accessory lines; (iii) increased advertising, marketing, tradeshow
and related costs of $444,000 incurred in order to market the Joe's(R), Shago(R)
and Fetish(TM) brands; (iv) increased royalties and commissions associated with
our Fetish(TM) and Shago(R) branded apparel products and the earnout associated
with the Blue Concept Division purchase of $614,000; (vi) increased legal,
accounting, and other professional fees and insurance of $290,000; (vii) an
increase in interest expense of $269,000 and depreciation and amortization costs
of $376,000 primarily associated with the acquisition of the Blue Concept
Division from Azteca in fiscal 2003 as discussed in greater detail above.
Liquidity and Capital Resources
Our primary sources of liquidity are: (i) cash flows from operations; (ii)
trade payables credit from vendors and related parties; (iii) equity financings
and borrowings from the factoring of accounts receivables and borrowing against
inventory. Cash used for operating activities was $5,548,000 in the first
quarter of fiscal 2004 compared to $777,000 in the first quarter of fiscal 2003.
During the period, we used cash to fund our operating expenses, reduce related
party payables and reduce trade credit extended to us by our suppliers. Cash
used in operating activities, combined with $4,000 of cash used in investing
activities and $387,000 used to repay debt and reduce our outstanding loan
balance with CIT, was funded by $7,248,000 of cash on hand at the beginning of
the first quarter of fiscal 2004. We ended the first quarter of fiscal 2004 with
$1,261,000 of cash.
25
We are dependent on credit arrangements with suppliers and factoring and
inventory based lines of credit agreements for working capital needs. From time
to time, we have conducted equity financing through private placements and
obtained short-term working capital loans from senior members of management and
from members of our Board of Directors.
Our primary capital needs are for our operating expenses and working
capital necessary to fund inventory purchases and extension of our trade credit
to our customers. During the remainder of fiscal 2004, we anticipate funding
operating expenses and working capital through the following: (i) existing cash;
(ii) utilizing our receivables and inventory based line of credit with CIT;
(iii) maximizing our trade payables with our domestic and international
suppliers; (iv) managing our inventory levels; and (v) reducing the trade credit
we extend to our customers.
In the first quarter of fiscal 2004, we relied on the following primary
sources to fund operations:
- A financing and inventory based line of credit agreements with
CIT;
- Cash balances;
- Reduction of credit we extend to our domestic and
international customers; and
- Reduction of inventory levels.
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
each of Innovo and Joe's 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, 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
26
balance as a liability on our balance sheet as "Due to Factor." Cross guarantees
were executed by and among 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. Our loan balance as of February 28, 2004 with
CIT was $42,000 and an aggregate amount of $1,863,107 of unused letter of credit
was outstanding.
In connection with the agreements with CIT, certain assets of Innovo,
Joe's and IAA are pledged to CIT. The pledged assets include inventory,
merchandise, and/or goods, including raw materials through finished goods.
Based on our projected results for the remainder of fiscal 2004 as well as
the availability on our CIT financing facilities and cash on-hand of $1.3
million, we believe that we have the working capital resources necessary to meet
the operational needs associated with our anticipated internal growth for the
remainder of fiscal 2004. During fiscal 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.
However, if we grow beyond our current anticipated expectations or
continue to have operating losses, 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.
Debt Conversion
Subsequent to the end of the first quarter of fiscal 2004, 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 has 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.
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, whereby Mr. Crossman loaned us an aggregate of
$500,000. The loan was funded in two phases of $250,000 each on February 7, 2003
and February 13, 2003. 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. 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.
27
CIT Commercial Services
At February 28, 2004, our loan balance with CIT was $42,000 and an
aggregate amount of $1,863,000 of unused letters of credit were 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.
Long-Term Debt
Long-term debt consists of the following (in thousands):
02/28/04 11/29/03
-------------------
First mortgage loan on Springfield property $ 447 $ 476
Promissory note to Azteca (Blue Concepts) 21,800 21,800
Promissory note to Azteca (Knit Div. Note 1) -- 68
-------------------
Total long-term debt $22,247 $22,344
Less current maturities 92 168
-------------------
Total long-term debt $22,155 $22,176
==================
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 as of February 28, 2004), 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.
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 allowed us, upon shareholder approval 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. On March 5, 2004, the Blue Concept Note was reduced by $12.5
million to $9.3 million. The reduction in the Blue Concept Note was determined
by the product of the Conversion Price and 3,125,000, and the shares issued
pursuant to the conversion are 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
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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 February 28, 2004 (in thousands):
Contractual Obligations Payments Due by Period
-----------------------------------------------------------------
Total Less than 1 1-3 years 4-5 years After 5 years
year*
- --------------------------------------------------------------------------------------------------------------------
Long Term Debt 22,247 68 9,675 9,206 3,298
Operating Leases 2,682 486 1,479 717 --
Other Long Term Obligations-Minimum Royalties 4,308 588 3,390 330 --
Open Purchase Orders 19,377 19,377 -- -- --
* Period from 2/29/04 through 11/30/04
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(TM) mark because we believed it was an
opportunity to expand and complimented our existing branded and accessory
business.
29
On or about March 30, 2004, we received a notice of termination for our
license agreement for the Fetish(TM) mark due to an alleged breach of certain
provisions related primarily to production and distribution in agreed upon
channels of distribution. Upon receipt of the notice, we contacted the licensor
and representatives to discuss this notice. We dispute the claims made by the
licensor because, in our opinion, we believe that we have fulfilled all of our
obligations under the license agreement.
Since that time, the licensor has rescinded its termination notice in
writing while reserving its rights to re-assert and/or revive its alleged claims
contained within the notice including the right to send a new termination
notice. Consequently, the two parties have agreed to continue to perform under
the terms and conditions of the license agreement. We are working to resolve
this matter amicably between the parties. However, we cannot assure you that
this matter will be resolved amicably to the satisfaction of the parties without
resulting in further discussions, the transmission of a new termination notice,
actual termination, and/or potential litigation.
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.
In the first quarter of fiscal 2004, Innovo Group ceased operations of
JJJ. Innovo Group anticipates completing the dissolution of JJJ in the second
quarter of fiscal 2004. We will continue to sell product in Japan through the
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.
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 and
Analysis of Financial Condition and Results of Operation --Long Term Debt" for
further discussion of the terms of the Blue Concept Note. On March 5, 2004 in
accordance with the APA and Nasdaq rules, we
30
conducted a special meeting of our stockholders to convert up to $12.5 million
of the debt into up to 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 APA. As a result of this
conversion, the Blue Concept Note was reduced from $21.8 million to $9.3
million. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Debt Conversions" for a further discussion of the
conversion 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 and Analysis of Financial
Condition and Results of Operations - 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.
Betsey Johnson(R) License
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.
Beyond Blue, Inc. Master Distribution Agreement
On February 16, 2004, our Joe's subsidiary 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
31
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.
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.
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 Notes to Consolidated
Financial Statements included in our Annual Report on Form 10-K 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. We record
estimated reductions to revenue for customer programs, including co-op
advertising, other advertising programs or allowances, based upon a percentage
of sales. We also allow 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 three-months ended February 28, 2004, the balance in the allowance
for returns, discounts and bad debts reserves was $2,261,000 compared to
$2,158,000 for the year ended November 29, 2003.
32
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.
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 February 28, 2004.
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.
33
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. The adoption did not 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. The adoption did not
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.
ITEM 3. 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 from Azteca.
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.
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.
34
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 quarter ended February 28, 2004, 27% 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 (13%) and
Mexico (60%). All of our products manufactured in Mexico are manufactured by an
affiliate of Commerce, Azteca or its affiliates.
ITEM 4. CONTROLS AND PROCEDURES
As of February 28, 2004, the end of the period covered by this Quarterly
Report on Form 10-Q, we carried out an evaluation, under the supervision and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Securities and Exchange Act
Rule 15d-15.
A control system, no matter how well conceived and operated, can provide
only reasonable assurance that the objectives of the control system are met. Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls and procedures will prevent all
error and fraud. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues within the company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
Our Chief Executive Officer and Chief Financial Officer have concluded,
based on our evaluation of our disclosure controls and procedures, that our
disclosure controls and procedures under Rule 13a-15(e) and Rule 15d-15(e) of
the Securities Exchange Act of 1934 are effective, except as discussed below.
Subsequent to our evaluation, there were no significant changes in internal
controls or other factors that could significantly affect these internal
controls, except as discussed below.
Our independent auditors, Ernst & Young LLP, or Ernst & Young, have
advised management and the audit committee of our board of directors of the
following matters that Ernst & Young considered to be material weaknesses in our
internal controls, which constitute reportable conditions under standards
established by the American Institute of Certified Public Accountants: (i) lack
of adequate preparation of account reconciliations and analysis necessary to
accurately prepare annual financial statements; and (ii) shared accounting
responsibilities for accounting functions between our company and Azteca
Production International, Inc., or Azteca, and its related entities.
The primary reasons for the lack of adequate preparation of account
reconciliations and analysis to accurately prepare our annual financial
statements include, but are not limited to: (i) our significant growth in fiscal
2003 in both size and complexity, which significantly increased the number of
accounting transactions from prior reporting periods; for example, our net sales
increased from $29,609,000 for fiscal 2002 to $83,129,000 in fiscal 2003, or a
181% increase; in fiscal 2003 we acquired the Blue Concept Division; and we
began shipping branded products under our license agreements for the Fetish(TM)
and Shago(R) marks for the first time; (ii) the introduction of
35
new operating software to track production, delivery and sales of our products
during the third quarter of 2003; (iii) the loss of key accounting personnel
during completion of account reconciliations and analysis after our fiscal year
end; and (iv) certain accounting personnel were not sufficiently competent to
adequately reconcile and analyze certain accounts.
Our second material weakness resulted from our hiring of former Azteca
accounting employees in connection with the Blue Concept Division acquisition.
During this integration, some of the newly acquired accounting personnel have,
in their transitional roles, been responsible for the shared recording of
transactions between our company and Azteca, and/or its affiliates. We hired the
Azteca accounting personnel because we believed that their historical knowledge
of the Blue Concept Division accounting process and systems would help
facilitate the transition of recording the new transactions into our books and
records. Despite their historical knowledge, we discovered during the completion
of account reconciliations and analysis after our fiscal year end that this was
not the case.
These material weaknesses have been discussed in detail among the audit
committee of our board of directors, the board of directors, management and
Ernst & Young. We have assigned the highest priority to the correction of these
material weaknesses, and management and our audit committee are committed to
addressing and resolving them fully. On February 22, 2004, the audit committee
of our board of directors instructed management to improve the overall level of
our disclosure and internal controls by increasing the number and competency of
accounting personnel, including the hiring of a controller and/or chief
accounting officer at IGI, who would report directly to our Chief Financial
Officer. The audit committee instructed management to hire, subject to audit
committee approval, a controller with sufficient experience to function as the
chief accounting officer of a public company with appropriate public accounting
experience. Management has taken certain steps to improve its controls and
procedures since the end of fiscal 2003, including, but not limited to: (i)
hiring of additional qualified accounting personnel in positions that are
responsible for cost accounting and accounts receivable; and (ii) engaging an
executive search firm to assist it in the search process for a controller with
sufficient experience to function as the chief accounting officer. Management
will use its best efforts to find a suitable person for this position prior to
the end of our second quarter of fiscal 2004.
In addition, prior to the report of our independent accountants we had
already taken the following actions to improve our disclosure controls and
procedures and internal controls: (i) hired a seasoned manager for our apparel
division, who will be able to supervise our continued growth and complexity and
coordinate information between operations and accounting; (ii) hired two new
staff accountants; and (iii) increased training of staff on our new operating
software. Also, we are currently transferring responsibility for recording
transactions between our company and Azteca and its affiliates to non-Azteca
related staff accountants and implementing internal controls to reconcile and
verify account balances and transactions between our company and Azteca and/or
its affiliates. In addition we are reviewing and revising our procedures for the
timely reconciliation of all accounts and for the appropriate review of account
reconciliation.
We are confident that our financial statements for the fiscal year ended
November 29, 2003 and for the three-months ended February 28, 2004 fairly
present, in all material respects, our financial condition, results of
operations and cash flows.
36
PART II: OTHER INFORMATION
ITEM 1. 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.
ITEM 2. CHANGES IN SECURITIES
Subsequent to end of the first quarter of fiscal 2004, 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 has 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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On February 5, 2004, we filed a Definitive Proxy Statement on Schedule 14A
with the Securities and Exchange Commission relating to a special meeting of our
stockholders to be held on March 5, 2004. The purpose of the special meeting was
to vote on a proposal to approve the conversion of $12.5 million in outstanding
principal amount of our indebtedness into a maximum of 4,166,667 shares of our
common stock. The special meeting was required to be conducted in connection
with the convertible promissory note issued in connection with the asset
purchase agreement with Azteca and the Guez brothers for the acquisition of the
Blue Concept Division from Azteca and pursuant to Nasdaq rules. Our Board of
Directors fixed the close of business on February 4, 2004 as the record date for
identifying those stockholders entitled to notice of, and to vote, at the
special meeting. On February 6, 2004, the notice of special meeting, proxy
statement and proxy cards were first mailed to stockholders. On March 5, 2004,
after the end of the quarter covered in this Quarterly Report on Form 10-Q, we
conducted the special meeting of our stockholders The conversion was approved by
our stockholders and as a result, Azteca has 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.
37
On March 5, 2004, a total of 16,698,574 shares were represented at the
meeting, which reflected approximately 65% of the total shares outstanding,
which was 25,784,850 as of February 4, 2004, the record date of the special
meeting. The vote totals on the one proposal were as follows:
% Shares
- ------
For 99% 16,513,716
Against *% 183,510
Abstain *% 1,348
* Represents less than 1%.
ITEM 5. OTHER INFORMATION
NONE.
38
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits (listed according to the number assigned in the table in
item 601 of Regulation S-K):
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
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
39
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
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
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
40
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, 2000 between 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
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
41
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
10.33 Trademark License Agreement between Blondie Rockwell, Inc. and Exhibit 10.13 to the Quarterly Report on Form
Innovo Azteca Apparel, Inc. dated as of February 13, 2003 10-Q/A for the period ended August 30, 2003
filed on October 17, 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
42
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
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
43
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 Report on Form S-8 filed on
September 26, 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
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
10.62 2004 Stock Incentive Plan Attachment B to Definitive Proxy Statement on
Schedule 14A filed on April 13, 2004
21 Subsidiaries of the Registrant Filed herewith
31.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Filed herewith
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Filed herewith
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certification of the Chief Executive Officer and Chief Financial Filed herewith
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
44
(b) Reports on Form 8-K
Date Purpose
---- -------
December 2, 2003 To report a press release dated December 2, 2003
announcing the completion of a private placement
to institutional and accredited investors of (i)
2,996,667 shares at a purchase price of $3.00
per share and (ii) warrants to purchase an
additional 599,333 shares of our common stock at
an exercise price of $4.00 per share.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
INNOVO GROUP INC.
April 13, 2004
By: /s/ Samuel J. Furrow, Jr.
-------------------------
Samuel J. Furrow, Jr.
Chief Executive Officer
(Principal Executive Officer)
By: /s/Marc B. Crossman
--------------------
Marc. B. Crossman
Chief Financial Officer
(Principal Financial Officer)
45