10-K 1 taln20131231_10k.htm FORM 10-K taln20131231_10k.htm

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

[X]

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the fiscal year ended December 31, 2013

 

[_]

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission file number 1-13669

 

TALON INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

95-4654481

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

                                   

 

21900 Burbank Blvd., Suite 270

 

 

Woodland Hills, California

91367

 

(Address of Principal Executive Offices)

(Zip Code)

                

(818) 444-4100
(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Common Stock, $.001 par value

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes [_] No [X]

 

Indicate by check mark if the registration is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes

Yes[_] No [X]

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for past 90 days.

       Yes [X]        No [_]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [_]

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [_]

Accelerated filer [_]

Non-accelerated filer [_]

Smaller reporting company [X]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [_] No [X]

 

At June 30, 2013, the aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant was $1,143,166 

 

At March 21, 2014 the issuer had 91,990,747 shares of Common Stock, $.001 par value, issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 



 
 

 

 

TALON INTERNATIONAL, INC.


INDEX TO FORM 10-K

 

    Page

PART I

 

 

 

 

 

Item 1.

Business

2

 

 

 

Item 1A.

Risk Factors

8

 

 

 

Item 1B.

Unresolved Staff Comments

14

 

 

 

Item 2.

Properties

14

 

 

 

Item 3.

Legal Proceedings

14

 

 

 

Item 4.

Mine Safety Disclosures

14

 

 

 

 

 

 

PART II

 

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

15

 

 

 

Item 6.

Selected Financial Data

17

 

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

28

 

 

 

Item 8.

Financial Statements and Supplementary Data

29

 

 

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

66

 

 

 

Item 9A.

Controls and Procedures

66
     
Item 9B.

Other Information

66
     
     
PART III    
     
Item 10.

Directors, Executive Officers and Corporate Governance

67
     
Item 11. Executive Compensation 71
     
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 85
     
Item 13. Certain Relationships and Related Transactions and Director Independence 88
     
Item 14. Principal Accounting Fees and Services 89
     
     

PART IV

   
     
Item 15.

Exhibits and Financial Statement Schedule

90

                  

 
1

 

 

Forward Looking Statements

 

This report and other documents we file with the SEC contain forward looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, our business or others on our behalf, our beliefs and our management’s assumptions. In addition, we, or others on our behalf, may make forward looking statements in press releases or written statements, or in our communications and discussions with investors and analysts in the normal course of business through meetings, webcasts, phone calls and conference calls. Words such as “expect,” “anticipate,” “outlook,” “could,” “target,” “project,” “intend,” “plan,” “believe,” “seek,” “estimate,” “should,” “may,” “assume,” “continue,” variations of such words and similar expressions are intended to identify such forward looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. We describe our respective risks, uncertainties and assumptions that could affect the outcome or results of operations in “Item 1A. Risk Factors.” We have based our forward looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that actual outcomes and results may differ materially from what is expressed, implied, or forecast by our forward looking statements. Reference is made in particular to forward looking statements regarding projections or estimates concerning our business, including demand for our products and services, customer acceptance of new products, mix of revenue streams, ability to control or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, international businesses, competitive position, adequate liquidity to fund our operations and meet our other cash requirements, and the global economic environment in general and consumer demand for apparel. Except as required under the federal securities laws and the rules and regulations of the SEC, we do not have any intention or obligation to update publicly any forward looking statements after the distribution of this report, whether as a result of new information, future events, changes in assumptions, or otherwise.

 

 

PART I

 

ITEM 1.     BUSINESS

 

General

 

Talon International, Inc. specializes in the manufacturing and distribution of a full range of apparel accessories including zippers and trim items to manufacturers of fashion apparel, specialty retailers and mass merchandisers. We manufacture and distribute zippers under our Talon® brand name to manufacturers for apparel brands and retailers such as Abercrombie & Fitch, Fat Face, Wal-Mart, Kohl’s, JC Penney, Polo Ralph Lauren, Guess and Express, among others. We also provide full service outsourced trim design, sourcing and management services and supply specified trim items for manufacturers of fashion apparel such as V. F. Corporation, Victoria’s Secret, Tom Tailor, Fat Face, Abercrombie & Fitch, American Eagle, Polo Ralph Lauren, Express, and others. Under our Tekfit® brand, we develop and sell a stretch waistband that utilizes a patented technology to manufacturers for apparel brands and retailers such as Saks Fifth Avenue, HMX and Superior Uniforms.

 

We were incorporated in the State of Delaware in 1997. We were formed to serve as the parent holding company of our consolidated subsidiaries, which became our wholly owned subsidiaries immediately prior to the effective date of our initial public offering in January 1998. Our website is www.talonzippers.com

 

Our website address provided in this Annual Report on Form 10-K is not intended to function as a hyperlink and the information on our website is not and should not be considered part of this report and is not incorporated by reference in this document.

 

 
2

 

 

Business Summary

 

We operate our business within three product groups, Talon, Trim and Tekfit. In our Talon group, we design, engineer, test and distribute zippers under our Talon trademark to apparel brands and manufacturers on a global basis. Talon enjoys brand recognition in the apparel industry worldwide. Talon is a 100-year-old brand, which is known for its quality and product innovation and was the original pioneer of the formed wire metal zipper for the jeans industry, and is a specified and preferred zipper brand for manufacturers in the designer, sportswear and outerwear markets worldwide. We provide multiple lines of high quality custom zippers, including metal, coil and plastic zippers, vintage zippers, and specialty zippers for kids clothing and other fit for purpose applications, all for distribution to apparel manufacturers worldwide, including, China, Taiwan, India, Indonesia, Bangladesh, the Middle East, the European markets, Mexico and Central America. We have sales and marketing teams in most of these areas. We have joint manufacturing arrangements in strategic international local markets to manufacture, finish and distribute our products locally under the Talon brand name. Our manufacturing partners operate under our direct manufacturing and quality assurance oversight, to our manufacturing specifications and quality standards, using only Talon approved and authorized raw materials, resulting in the highest quality finished zippers for our customers in their local markets. Our operating structure allows us to significantly improve the speed at which we serve the market, the service we can provide to our customers, and to effectively expand the geographic footprint of our Talon products.

 

Our Trim products group acts as a fully-integrated single-source designer, product developer and exclusive supplier for a full range of trim items for manufacturers of fashion apparel. Our business focuses on servicing all of the trim requirements of our customers at the manufacturing and retail brand level of the fashion apparel industry. Our Trim products include essentially all components required to manufacture a garment with the exception of the fabric and the thread. Trim items include labels, buttons, rivets, leather patches, woven labels, heat transfer seals, tapes, ribbons, printed marketing material, polybasic, packing cartons, hangers, et al. Trim items comprise a relatively small part of the cost of most apparel products but comprise the vast majority of components necessary to fabricate and finish a typical apparel product. We offer customers a one-stop outsource service for all zipper and trim related matters. Our teams work with industry merchants, product developers and designers and function as an extension of their staff.

 

Under our Tekfit brand we supply apparel manufacturers with an advanced, patented fabric technology that creates a stretchable fabric from non-stretchable material. This innovative technology allows the fabric to be altered through the addition of stretch characteristics resulting in greatly improved fit and comfort. Pant manufacturers use this technology to build-in stretch into standard waistbands that does not alter the appearance of the garment, but will allow the waist to stretch out and back by as much as two waist sizes. Use of the stretchable fabric also has applications in shirt collars, hats and virtually any garment where added flexibility and comfort is desired.

 

Our Talon, Trim and Tekfit product teams collaborate with customers on their design vision and present examples of their vision in graphic form for all apparel accessory components. We design the buttons, snaps, hang tags, labels, zippers, zipper pulls and other items to meet the customers’ needs. Once our customer selects the designs they prefer, our sourcing and production teams coordinate with our manufacturing partners worldwide to ensure the best manufacturing solution for the items being produced. The proper manufacturing solution is a critical part of the expertise and service we provide to customers. Selecting the best facility to ensure timely production, the proper finishes, or other material needs or manufacturing techniques to be used is critical. We offer customers a depth and breadth of knowledge in the manufacturing of these products that our customers cannot otherwise achieve. We are consistently innovating new items, manufacturing techniques and finishes; introducing many new, fresh and unique ideas to our customers. Once our customers make a final decision on the accessories that will be used on their garments, we are typically identified as the sole or preferred source supplier for the project, and our customer’s factories are then directed to purchase the products directly from us. Throughout the garment manufacturing process, we consistently monitor the timing and accuracy of the production items until finally delivered to our customers' apparel factories.

 

 
3

 

 

We serve as a specified supplier in our zipper, trim and waistband products for a variety of major retail brand and private-label oriented companies. A specified supplier is a supplier that has been approved for its quality and service by a major retail brand or private-label company. Apparel contractors manufacturing for the retail brand or private-label company must purchase their zipper and trim components from a supplier that has been specified. We seek to expand our services as a supplier of select items for such customers, to being a preferred or single-source provider of the entire customer’s authorized trim and zipper requirements. Our ability to offer a full range of trim and zipper products is attractive to brand name and private-label oriented customers because it enables the customer to address their quality and supply needs for all of their trim requirements from a single source, avoiding the time and expense necessary to monitor quality and supply from multiple vendors and manufacturer sources. Becoming a specified supplier to brand customers gives us an advantage to become the preferred or sole vendor of trim and zipper items for all apparel manufacturers contracted for production for that brand name.

 

Our teams of sales employees, representatives, program managers, creative design personnel and global production and distribution coordinators at our facilities located in the United States, Europe, and throughout Southeast Asia enable us to take advantage of and address the increasingly complicated requirements of the large and expanding demand for complete apparel accessory solutions. We plan to continue to expand operations in Asia, Europe, and Central America to take advantage of the large apparel manufacturing markets in these regions.

 

Products

 

Talon Zippers - We offer a full line of custom metal, coil and plastic zippers bearing the Talon brand name or logo. Talon zippers are used primarily by manufacturers in the apparel industry and are distributed through our distribution facilities in the United States, Europe, Hong Kong, China, Taiwan, India, Indonesia and Bangladesh and through these designated offices to other international markets.

 

We expand our distribution of Talon zippers through the establishment of a combination of Talon owned sales and distribution locations, and strategic manufacturing and distribution relationships. These distribution and manufacturing relationships, in combination with Talon owned and affiliated facilities under the Talon brand, improve our time-to-market by allowing us to source, finish and distribute to apparel manufacturers within their local markets. The branded apparel zipper market is dominated by one company and we have positioned Talon to be a viable global alternative to this competitor and capture an increased market share position. We leverage the brand awareness of the Talon name by branding other products in our line with the Talon name.

 

Trim - We consider our high level of customer service as a fully integrated single-source supplier essential to our success. We combine our high level of customer service within our Trim solutions with a history of design and manufacturing expertise to offer our customers a complete trim solution product. We believe this full-service product gives us a competitive edge over companies that only offer selected trim components because our full service solutions save our customers substantial time in ordering, designing, sampling and managing trim orders from several different suppliers. Our tracking and order management systems allow us to seamlessly supply trim solutions and products to apparel brands, retailers and manufacturers around the world. We produce customized woven, leather, synthetic, embroidered and novelty labels and tapes, which can be printed on or woven into a wide range of fabrics and other materials using various types of high-speed equipment.

 

 
4

 

 

Tekfit - We market and supply a proprietary stretch waistband and other products using our patented technology. We provide apparel manufacturers with proprietary equipment, custom materials and an advanced, patented fabric technology that allow for the manufacture of stretch characteristics into their standard waistbands resulting in greatly improved fit and comfort. This technology is used to build-in a stretch factor into standard waistbands that does not alter the appearance of the garment, but will allow the fabric to stretch out and back by as much as two waist sizes. Our supply of this product to customers was limited prior to 2013 by a licensing dispute with the technology inventor. In March 2012 we ended the licensing dispute, acquired all U.S. licenses and patents for this product technology, and settled all matters of litigation with the original owner. Following the end of this dispute we proceeded to actively expand our marketing and selling efforts of this unique product and brand within the industry. Consequently, the revenues we derived from the sales of products incorporating the stretch waistband technology were substantially limited for the periods prior to this litigation, and are now just beginning to be reestablished as we advance our marketing and product introductions to major retailers.

 

 The percentages of total revenue contributed by each of our three primary product groups for the last three fiscal years are as follows:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Product Group Net Sales:

                       

Talon zipper

    54.8

%

    49.4

%

    54.3

%

Trim

    45.0

%

    50.5

%

    45.7

%

Tekfit

    0.2

%

    0.1

%

    0.0

%

 

Design and Development

 

Our in-house creative teams produce products with innovative technology and designs that we believe distinguish our products from those of our competitors. We support our skills and expertise in material procurement and product manufacturing coordination with product technology and designs intended to meet fashion demands, as well as cost and functional parameters. An example of this is the Talon KidZip® which is a specialty zipper for children’s apparel engineered to surpass industry established strength and safety standards, while maintaining the fashion image and requirements of today’s apparel demands.

 

Many specialty design companies with which we compete have limited engineering, sourcing or manufacturing experience, and consequently they create products or designs that often cannot be implemented due to limitations in the manufacturing process, the high expense of required materials, or a lack of functionality in the resulting product. We design products to function within the limitations imposed by the applicable materials and manufacturing framework, while meeting our customers' specialty needs. Using our manufacturing experience, we ensure delivery of quality products and minimize the time-consuming delays that often arise in coordinating the efforts of independent design houses and manufacturing facilities. By supporting our material procurement and product manufacturing services with design services, we reduce development and production costs and deliver products to our customers sooner than many of our competitors. Our development costs are low, many of which are borne by our customers. Our design teams are based in our U.S. and Asian facilities.

 

Customers

 

We have more than 1,000 active customers representing 220 of the world’s best known brands. Our customers include the designated suppliers of well-known apparel retailers and brands, such as, VF Corporation, Victoria’s Secret, Tom Tailor, Fat Face, Abercrombie and Fitch, American Eagle, Polo Ralph Lauren, Phillips-Van Heusen, Super Dry, Eddie Bauer, Babies-R-Us, and Guess among others. Our customers also include contractors for specialty retailers such as Express and mass merchant retailers such as Wal-Mart, Kohl’s, J.C. Penney, and Costco.

 

 
5

 

 

For the years ended December 31, 2013, 2012 and 2011, our three largest customers combined represented approximately 5%, 6% and 8%, respectively, of consolidated net sales.

 

Sales and Marketing

 

We sell our products through our own sales force based in the United States, Hong Kong, China, India, Indonesia, Taiwan, and Bangladesh. We contract with outside sales representatives in the U.S. and Europe, and we develop Central America opportunities through our U.S. sales force and outside sales representatives. We also employ customer service representatives who are assigned to key customers and provide local customer support. We have developed relationships with our major customers at senior levels and our sales teams actively participate with these customers in their marketing and sales programs and sales strategies. When we become the outsourcing vendor for a customer’s packaging or trim requirements, we position ourselves as if we are an in-house department of the customer’s trim components procurement operation.

 

Sourcing and Assembly

 

We have developed expertise in identifying high quality materials, competitive prices and approved manufacturers for particular products and materials and ensuring strict adherence to quality manufacturing processes and materials. Our expertise enables us to produce a broad range of apparel accessories and trim products at competitive prices. The majority of products that we procure and distribute are secured on a finished-good basis, manufactured by our partners and under our direct oversight and scrutiny. Raw materials used to manufacture or assemble all of our products are obtained only from sources we authorize and specify and are in adequate supply. We purchase products only from qualified material suppliers, and guarantee our customers that all materials used in the manufacture of our products are fully compliant with all government regulations and controls over restricted substances.

 

We develop product artwork and any necessary dies and molds used to design and manufacture our products. Products that we design and sell are produced by manufacturing partners under our direct supervision or through joint manufacturing arrangements. We are confident in our ability to identify, secure and maintain high quality manufacturing sources. We will continue to build upon our production through qualified suppliers, particularly with respect to manufacturing activities that require substantial investments in time and capital equipment.

 

Principally through our Asian facilities, we distribute Talon zippers, trim items and apparel accessories and oversee the manufacture and distribution of the full range of our products. Through our Asian facilities we supply customers numerous significant zipper and trim programs, and serve these customers worldwide.

 

Intellectual Property Rights and Licenses

 

We have trademarks as well as patent rights, copyrights, software copyrights and trade names for which we rely on common law protection, including the Talon trademark. Several of our other trademarks are the subject of applications for federal trademark protection through registration with the United States Patent and Trademark Office, including “Talon”, “Tag-It”, “Kidzip” and “Tekfit”. We hold patent rights for several key processes and products including the Tekfit stretchable fabric products, and garment fasteners.

 

 
6

 

 

Seasonality

 

We typically experience seasonal fluctuations in sales volume consistent with the purchase demands of the apparel industry. In most years, these seasonal fluctuations result in lower sales volumes for our business in the first and fourth quarters of each year due to the seasonal buying patterns by the majority of our customers. Sales of our products typically precede the retail sales patterns by 90 to 150 days. The apparel retailers typically experience their highest sales volumes during the fourth quarter in association with year-end holiday purchases. Backlogs of sales orders are not considered material in the industries in which we compete, which reduces the predictability of our sales and reinforces the volatility of these cyclical buying patterns on our sales volume.

 

Inventories

 

In order to meet the rapid delivery requirements of our customers, we may be required to purchase inventories of raw materials based upon projections made by our customers. In these cases we may carry a substantial amount of inventory on their behalf. We manage this risk by obtaining customer commitments to purchase any excess materials or inventories. These commitments provide that in the event that inventories remain with us in excess of the apparel program life or the termination of production of a customer’s product line related to the inventories, the customer is required to purchase the inventories from us under normal invoice and selling terms. While these agreements provide us some advantage in the negotiated disposition of these inventories, we cannot be assured that our customers will complete these agreements or that we can enforce these agreements without adversely affecting our business operations.

 

Competition

 

We operate in highly competitive and fragmented segments of the apparel industry that include numerous local and regional companies that provide some or all of the products we offer. We also compete with United States and international design companies, distributors and manufacturers of tags, trim, packaging products and zippers. Some of our competitors are significantly larger in size and resources than us and have greater name recognition, longer operating histories and more financial and other resources.

 

Because of our integrated materials, manufacturing and assembly capabilities and our full-service zipper and trim solutions, we believe that we are able to effectively compete for our customers’ business, particularly where our customers require a high level of confidence regarding compliance with restricted substance regulations, and with the effective coordination of separately sourced production functions. We believe that we successfully compete in our industry by offering superior product pricing, quality, customer service, design capabilities, delivery lead times and complete supply-chain management. We also believe the Talon brand name and the quality of our Talon brand zippers allows us to gain market share in the apparel accessory industry. The unique stretch quality of our Tekfit waistbands will also allow us to compete effectively in the market for waistband components.

 

Segment Information

 

We operate in one industry segment, the distribution of a full range of apparel zipper and trim products to manufacturers of fashion apparel, specialty retailers and mass merchandisers. We separately report our revenues and gross margins by our selling groups in this segment to the extent these are distinguished and separate.

 

Financial Information about Geographic Areas

 

The majority of our products sold are for use by U.S. and European based brands, retailers and manufacturers. The majority of these customers produce their products or outsource the production of their products in manufacturing facilities located outside of the U.S. or Europe, primarily in China, Taiwan, India, Indonesia, Bangladesh and Central America.

 

 
7

 

 

A summary of our domestic and international net sales and long-lived assets is set forth in Item 8 of Part II of this Annual Report on Form 10-K, Note 10 in the accompanying Notes to Consolidated Financial Statements.

 

We are subject to certain risks referred to in Item 1A, “Risk Factors” and Item 3, “Legal Proceedings”, including those normally attending international and domestic operations, such as changes in economic or political conditions, currency fluctuations, foreign taxes, exchange control regulations and the effect of international relations and domestic affairs of foreign countries on the conduct of business, legal proceedings and the availability and pricing of raw materials.

 

Employees

 

As of December 31, 2013, we had approximately 215 full-time employees including 25 in the United States and 190 employees in Asia. Our labor forces are non-union. We believe that we have satisfactory employee and labor relations.

 

Corporate Governance and Information Related to SEC Filings

 

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed with, or furnished to, the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website, www.talonzippers.com (in the “Investor” section, as soon as reasonably practical after electronic filing with or furnishing of such material to the SEC). We make available on our website our (i) stockholder communications policies, (ii) Code of Ethical Conduct and (iii) Employee Complaint Procedures for Accounting and Auditing Matters. These materials are also available free of charge in print to stockholders who request them by writing to: Investor Relations, Talon International, Inc., 21900 Burbank Boulevard, Suite 270, Woodland Hills, CA 91367. Our website address provided in this Annual Report on Form 10-K is not intended to function as a hyperlink and the information on our website is not and should not be considered part of this report and is not incorporated by reference in this document.

 

 

 

ITEM 1A.     RISK FACTORS

 

Several of the matters discussed in this document contain forward-looking statements that involve risks and uncertainties. Factors associated with the forward-looking statements that could cause actual results to differ from those projected or forecast are included in the statements below. In addition to other information contained in this report, readers should carefully consider the following cautionary statements and risk factors.

 

If we lose our larger brand and retail nominations or customers or the customers fail to purchase at anticipated levels, our sales and operating results will be adversely affected.

 

Our results of operations depend to a significant extent upon the commercial success of our larger brand nominations and customers. If we lose our significant brand nominations, or these customers fail to purchase our products at anticipated levels, or our relationship with these customers or the brands and retailers they serve diminishes, it may have an adverse effect on our results because we may lose a primary source of revenue if these customers choose not to purchase our products or services; we may lose the nomination of the retailer or brand; we may not be able to recoup development and inventory costs associated with this customer; and we may not be able to collect our receivables from them.

 

 
8

 

  

U.S. and global financial and economic uncertainties could negatively affect our business, results of operations and financial condition.

 

Our performance is subject to worldwide economic conditions and their impact on levels of consumer spending that affect not only the ultimate consumer, but also retailers, which are served by many of our largest customers. The worldwide apparel industry is heavily influenced by general economic cycles. Purchases of fashion apparel and accessories tend to decline in periods of recession or uncertainty regarding future economic prospects, as disposable income declines. Many factors affect the level of consumer spending in the apparel industries, including, among others: prevailing economic conditions, levels of employment, salaries and wage rates, energy costs, interest rates, the availability of consumer credit, taxation and consumer confidence in future economic conditions. During periods of recession or economic uncertainty, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, or maintain our earnings from operations as a percentage of net sales. As a result, our operating results may be adversely and materially affected by weak or downward trends in the United States or global economy.

 

The loss of key management and sales personnel could adversely affect our business, including our ability to obtain and secure accounts and generate sales.

 

Our success has and will continue to depend upon key management and sales personnel, many of whom would be difficult to replace. The loss of the services of key employees could have a material adverse effect on our business, including our ability to establish and maintain client relationships. Our future success will depend in large part upon our ability to attract and retain personnel with a variety of sales, operating and managerial skills.

 

We may not be able to satisfy the financial covenants in our Credit Agreement and if we cannot, then our lender could declare the debt obligations in default

 

Our Credit Agreement requires certain covenants, including a minimum level of Adjusted EBITDA (as defined in the Credit Agreement) as discussed in Note 4 of the Notes to Consolidated Financial Statements. If we fail to satisfy the Credit Agreement covenants, the credit agreement could be in default and the outstanding balance could be declared immediately due and payable by the lender.

 

In the event we anticipate not being able to meet the required covenants, we will either negotiate for changes in the relative covenants or negotiate a waiver with the lender. However, our expectations of future operating results and continued compliance with all debt covenants cannot be assured and our lender’s actions are not controllable by us. If we default under the loan agreement, all amounts due under the loan agreement could be declared immediately due and payable and, unless we are able to secure alternative financing to repay the lender, the lender would have the right to exercise its remedies including enforcement of its lien on substantially all of our assets. Further, if the debt is placed in default, we could be required to reduce our expenses, curtail operations and/or raise capital through the sale of assets, issuance of equity or otherwise.

 

Global credit conditions may increase our credit risks.

 

Most of our customers are extended credit terms which are approved by us internally. While we attempt to cover as much of our credit risks as possible, not all of our risks can be fully covered due to the countries we operate in or the current credit conditions. Such exposure may translate into losses should there be any adverse changes to the financial condition of customers.

 

 
9

 

 

 We operate in an industry that is subject to significant fluctuations in operating results that may result in unexpected reductions in revenue and stock price volatility. 

 

We operate in an industry that is subject to seasonal and operational fluctuations that can significantly impact our results from quarter to quarter. Factors that may influence our quarterly operating results include:

 

 

The volume and timing of customer orders received during the quarter;

 

 

The timing and magnitude of customers’ marketing campaigns;

 

 

The loss or addition of a major customer or of a major retailer nomination;

 

 

The availability and pricing of materials for our products;

 

 

The increased expenses incurred in connection with the introduction of new products;

 

 

Currency fluctuations;

 

 

Political factors that may affect the expected flow of commerce;

 

 

Delays caused by third parties; and

 

 

Changes in our product mix or in the relative contribution to sales of our subsidiaries.

 

Due to these factors, it is possible that in some quarters our operating results may be below our stockholders’ expectations and those of public market analysts. If this occurs, the price of our common stock could be adversely affected.

 

Our products may not comply with various industry and governmental regulations and our customers may incur losses in their products or operations as a consequence of our non-compliance.

 

Our products are produced under strict supervision and controls to ensure that all materials and manufacturing processes comply with the industry and governmental regulations governing the markets in which these products are sold. However, if these controls fail to detect or prevent non-compliant materials from entering the manufacturing process, our products could cause damages to our customers' products or processes and could also result in fines being incurred. The possible damages, replacement costs and fines could significantly exceed the value of our products and these risks may not be covered by our insurance policies.

 

If customers default on inventory purchase commitments with us, we may be left holding non-salable inventory.

 

We hold inventories for specific customer programs, which the customers have committed to purchase. If any customer defaults on these commitments, or insists on markdowns, we may incur a charge in connection with our holding non-salable inventory and this would have a negative impact on our operations and cash flow.

 

Because we depend on a limited number of suppliers, we may not be able to always obtain materials when we need them and we may lose sales and customers.

 

Lead times for materials we order can vary significantly and depend on many factors, including the specific supplier, the contract terms and the demand for particular materials at a given time. From time to time, we may experience fluctuations in the prices and disruptions in the supply of materials. Shortages or disruptions in the supply of materials, or our inability to procure materials from alternate sources at acceptable prices in a timely manner, could lead us to miss deadlines for orders and lose sales and customers.

 

 
10

 

 

Our customers have cyclical buying patterns which may cause us to have periods of low sales volume.

 

Most of our customers are in the apparel industry. The apparel industry historically has been subject to substantial cyclical variations. Our business has experienced significant cyclical fluctuations due, in part, to customer buying patterns, which may result in periods of low sales usually in the first and fourth quarters of our financial year. Backlogs of sales orders are not considered material in the industries in which we compete, which reduces the predictability of revenues and reinforces the volatility of these cyclical buying patterns on our sales volume.

 

If we experience disruptions at any of our foreign facilities, we will not be able to meet our obligations and may lose sales and customers.

 

Currently, we do not operate duplicate facilities in different geographic areas. Therefore, in the event of a regional disruption where we maintain one or more of our facilities, it is unlikely that we could shift our operations to a different geographic region and we may have to cease or curtail our operations in a selected area. This may cause us to lose sales and customers. The types of disruptions that may occur include:

 

 

Foreign trade disruptions;

 

 

Import restrictions;

 

 

Labor disruptions;

 

 

Embargoes;

 

 

Government intervention;

 

 

Natural disasters; or

 

 

Regional pandemics.

 

Counterfeit products are not uncommon in the apparel industry and our customers may make claims against us for products we have not produced, adversely impacting us by these false claims.

 

Counterfeiting of valuable trade names is commonplace in the apparel industry and while there are industry organizations and federal laws designed to protect the brand owner, these counterfeit products are not always detected and it can be difficult to prove the manufacturing source of these products. Accordingly, we may be adversely affected if counterfeit products damage our relationships with customers, and we incur costs to prove these products are counterfeit, to defend ourselves against false claims and to pay for false claims.

 

On occasion, we have discovered that certain Asian factories have counterfeited Talon zippers. We undertake efforts to eliminate and prosecute all offenders. Counterfeiting of known quality brand products is commonplace within Asia and in particular where retailers limit their sources to recognized brands such as Talon. The full extent of counterfeiting of Talon products, its effect on our business operations and the costs to investigate and eliminate this activity are ongoing and are generally undeterminable. However, based upon evidence available, we believe the impact is not significant to our current overall operations. We continue to work closely with major retailers to identify these activities within the marketplace and will aggressively combat these efforts worldwide to protect the Talon brand.

 

Our business model is dependent on integration of information systems on a global basis and, to the extent that we fail to maintain and support our information systems, it can result in lost revenues.

 

We must consolidate and centralize the management of our subsidiaries and significantly expand and improve our financial and operating controls. Additionally, we must effectively integrate the information systems of our worldwide operations with the information systems of our principal offices in California. Our failure to do so could result in lost revenues, delay financial reporting or have adverse effects on the information reported.

 

 
11

 

 

Internet-based systems that we rely upon for our order tracking and management systems may experience disruptions and as a result we may lose revenues and customers.

 

To the extent that we fail to adequately update and maintain the hardware and software implementing our integrated systems, our customers may be delayed or interrupted due to defects in our hardware or our source code. In addition, since our software is Internet-based, interruptions in Internet service generally can negatively impact our ability to use our systems to monitor and manage various aspects of our customers' needs. Such defects or interruptions could result in lost revenues and lost customers.

 

The outcome of any dispute or litigation in which we have been named as a defendant is unpredictable and an adverse decision in any such matter could have a material adverse effect on our financial position and results of operations.

 

From time to time we are party to various disputes or litigation matters. These claims may divert financial and management resources that would otherwise be used to benefit our operations. Although we believe that we have meritorious defenses and arguments to the claims made in each and all of the matters to which we have been named a party and we intend to contest each vigorously, no assurances can be given that the results of these matters will be favorable to us. We maintain product liability, errors and omissions, product recall and director and officer insurance that we regard as reasonably adequate to protect us from potential claims; however, we cannot assure adequacy to cover any loss, or that we will be able to maintain our current levels of insurance at a reasonable cost or at all.

 

Unauthorized use of our proprietary technology may increase our litigation costs and adversely affect our sales.

 

We rely on trademark, patent, trade secret and copyright laws to protect our designs and other proprietary property worldwide. We cannot be certain that these laws will be sufficient to protect our property. In particular, the laws of some countries in which our products are distributed or may be distributed in the future may not protect our products and intellectual rights to the same extent as the laws of the United States. If litigation is necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others, such litigation could result in substantial costs and diversion of resources. This could have a material adverse effect on our operating results and financial condition. Ultimately, we may be unable, for financial or other reasons, to enforce our rights under intellectual property laws, which could result in lost sales.

 

If our products infringe any other person’s proprietary rights, we may be sued and have to pay legal expenses and judgments and redesign or discontinue selling our products.

 

From time to time in our industry, third parties allege infringement of their proprietary rights. Any infringement claims, whether or not meritorious, could result in costly litigation or require us to enter into royalty or licensing agreements as a means of settlement. If we are found to have infringed the proprietary rights of others, we could be required to pay damages, cease sales of the infringing products and redesign the products or discontinue their sale. Any of these outcomes, individually or collectively, could have a material adverse effect on our operating results and financial condition.

 

We may not be able to realize the anticipated benefits of acquisitions.

 

We may consider strategic acquisitions as opportunities arise. Acquisitions involve numerous risks, including diversion of our management’s attention away from our operating activities. We cannot assure you that we will not encounter unanticipated problems or liabilities relating to the integration of an acquired company’s operations, nor can we assure you that we will realize the anticipated benefits of any future acquisitions.

 

 
12

 

 

Our actual tax liabilities may differ from estimated tax resulting in unfavorable adjustments to our future results.

 

The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities. Our estimate of the potential outcome of uncertain tax issues is subject to our assessment of relevant risks, facts and circumstances existing at that time. Our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, which may impact our effective tax rate and our financial results.

 

We have experienced and may continue to experience major fluctuations in the market price for our common stock.

 

The following factors could cause the market price of our common stock to decrease, perhaps substantially:

 

 

The failure of our quarterly operating results to meet expectations of investors or securities analysts;

 

 

Adverse developments in the financial markets, the apparel industry and the worldwide or regional economies;

 

 

Interest rates;

 

 

Changes in accounting principles;

 

 

Intellectual property and legal matters;

 

 

Sales of common stock by existing stockholders or holders of options;

 

 

Announcements of key developments by our competitors; and

 

 

The reaction of markets and securities analysts to announcements and developments involving our company.

 

If we need to sell or issue additional shares of common stock or assume additional debt to finance future growth, our stockholders’ ownership could be diluted or our earnings could be adversely impacted.

 

Our business strategy may include expansion through internal growth, by acquiring complementary businesses or by establishing strategic relationships with targeted customers and suppliers. In order to do so, or to fund our other activities, we may issue additional equity securities that could dilute our stockholders’ value. We may also assume additional debt and incur impairment losses to our intangible assets if we acquire another company.

 

We have adopted a number of anti-takeover measures that may depress the price of our common stock. 

 

Our stockholders’ rights plan, our ability to issue additional shares of preferred stock and some provisions of our certificate of incorporation and bylaws and of Delaware law could make it more difficult for a third party to make an unsolicited takeover attempt of us. These anti-takeover measures may depress the price of our common stock by making it more difficult for third parties to acquire us by offering to purchase shares of our stock at a premium to its market price.

 

 
13

 

 

We may face interruption of production and services due to increased security measures in response to terrorism.

 

Our business depends on the free flow of products and services through the channels of commerce. In response to terrorists’ activities and threats aimed at the United States, transportation, mail, financial and other services may be slowed or stopped altogether. Extensive delays or stoppages in transportation, mail, financial or other services could have a material adverse effect on our business, results of operations and financial condition. Furthermore, we may experience an increase in operating costs, such as costs for transportation, insurance and security as a result of the activities and potential delays. We may also experience delays in receiving payments from payers that have been affected by the terrorist activities. The United States economy in general may be adversely affected by the terrorist activities and any economic downturn could adversely impact our results of operations, impair our ability to raise capital or otherwise adversely affect our ability to grow our business.

 

 

 

ITEM 1B.     UNRESOLVED STAFF COMMENTS

 

None.

 

 

 

ITEM 2.     PROPERTIES

 

Our headquarters are located in the greater Los Angeles area, in Woodland Hills, California. We lease approximately 13,785 square feet of office, warehouse and product development spaces in the U.S. and 38,982 square feet of office, warehouse, product development and showroom spaces within Asia. The lease agreements related to these properties expire at various dates through March 2016. We believe our existing facilities are adequate to meet our needs for the foreseeable future.

 

 

ITEM 3.     LEGAL PROCEEDINGS

 

We currently have pending various claims and complaints that arise in the ordinary course of our business. We believe that we have meritorious defenses to these claims and that the claims are either covered by insurance or would not have a material effect on our consolidated financial condition if adversely determined against us.

 

 

 

ITEM 4.     MINE SAFETY DISCLOSURES

 

Not applicable.

 

 
14

 

  

PART II

 

ITEM 5.     MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Common Stock

 

Our common stock is currently listed on the OTCQB under the trading symbol “TALN”. The following table sets forth the high and low sales prices for the Common Stock as reported by the OTCQB during the periods indicated. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.

 

   

High

   

Low

 

Year ended December 31, 2013

               

1st Quarter

  $ 0.08     $ 0.03  

2nd Quarter

    0.12       0.05  

3rd Quarter

    0.40       0.06  

4th Quarter

    0.46       0.25  
                 

Year ended December 31, 2012

               

1st Quarter

  $ 0.11     $ 0.05  

2nd Quarter

    0.09       0.04  

3rd Quarter

    0.05       0.03  

4th Quarter

    0.14       0.03  

 

 

On March 21, 2014 the closing sales price of our common stock as reported on the OTCQB was $0.25 per share. As of March 21, 2014, there were 27 recorded holders of our common stock and approximately 31.3% of our outstanding shares were held by brokers and dealers.

 

We intend to apply for listing on the NASDAQ Capital Market promptly following our compliance with the applicable initial listing requirements. 

 

Dividends

 

We have never paid dividends on our common stock. In addition, our credit agreement with Union Bank, N.A. (“Union Bank”) prohibits us from paying dividends without prior approval by the Bank. It is our intention to retain future earnings for use in our business.

 

 
15

 

 

Issuer Purchases of Equity Securities

 

Period

 

Total

Number of

Shares

Purchased

   

Average

Price

Paid per

Share

   

Total Number

of Shares

Purchased as

Part of

Publicly

Announced

Plans or

Programs

   

Maximum

Number of

Shares that

May Yet Be Purchased

Under the

Plans or

Programs

 
                                 

October 1, 2013 through October 31, 2013

    -       -       -       -  

November 1, 2013 through November. 30, 2013 (1)

    576,000     $ 0.38       -       -  

December 1, 2013 through December 31, 2013

    -       -       -       -  

Total

    576,000     $ 0.38       -       -  

 

 

 

(1)

On November 7, 2013, we redeemed 288,000 shares of common stock from each of Lonnie D. Schnell (our Chief Executive Officer, Chief Financial Officer and member of our Board of Directors) and Larry Dyne (our President) at a price of $0.38 per share. These redemptions were made in payment of tax obligations of these executives associated with the settlement in July 2013 of previously granted restricted stock units.

 

 
16

 

 

ITEM 6.     SELECTED FINANCIAL DATA

 

The following selected financial data is not necessarily indicative of our future financial position or results of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto included in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

 

   

(In thousands except per share data)

 
   

2013

   

2012

   

2011

   

2010

   

2009

 

Consolidated Statements of Operations Data:

                                       

Talon zippers net sales

  $ 28,756     $ 22,062     $ 22,613     $ 24,517     $ 21,341  

Trim net sales

    23,612       22,519       19,048       16,936       17,274  

Tekfit net sales

    79       20       8       7       61  

Total net sales

  $ 52,447     $ 44,601     $ 41,669     $ 41,460     $ 38,676  

Income from operations (1)

  $ 2,757     $ 995     $ 1,339     $ 1,471     $ 289  

Net income (loss) (2)(3)

  $ 9,731     $ 679     $ 729     $ (1,467

)

  $ (2,693

)

Net income (loss) per share

  $ 0.17     $ 0.03     $ 0.04     $ (0.07

)

  $ (0.13

)

Basic net income (loss) per share

  $ 0.26     $ (0.12

)

  $ (0.10

)

  $ (0.17

)

  $ (0.13

)

Diluted net income (loss) per share

  $ 0.24     $ (0.12

)

  $ (0.10

)

  $ (0.17

)

  $ (0.13

)

Weighted average shares outstanding – basic

    56,213       22,458       20,568       20,291       20,291  

Weighted average shares outstanding – diluted

    60,555       22,458       20,568       20,291       20,291  

Total comprehensive income (loss)(2)(3)

  $ 9,778     $ 685     $ 761     $ (1,510

)

  $ (2,718

)

                                         

Consolidated Balance Sheets Data:

                                       

Cash and cash equivalents

  $ 3,780     $ 8,927     $ 5,749     $ 2,795     $ 2,265  

Total assets

  $ 20,523     $ 18,976     $ 16,358     $ 13,828     $ 13,834  

Notes payable and capital lease obligations

  $ 5,000     $ 3     $ 324     $ 362     $ 15,270  

Series B Convertible Preferred Stock

  $ -     $ 23,979     $ 20,672     $ 17,820     $ -  

Stockholders’ equity (Deficit)

  $ 4,431     $ (16,028

)

  $ (13,919

)

  $ (12,801

)

  $ (11,179

)

                                         

Per Share Data:

                                       

Net book value per common share

  $ 0.05     $ (0.68

)

  $ (0.66

)

  $ (0.63

)

  $ (0.55

)

Common shares outstanding

    91,342       23,401       21,001       20,291       20,291  

 

 

 

(1)

Income from operations for each fiscal year includes the following items:

 

   

(In thousands)

 
   

2013

   

2012

   

2011

   

2010

   

2009

 

Trademark infringement litigation recovery (costs)

  $ 330     $ (574

)

  $ -     $ -     $ -  

Related party note receivable recovery (impairment)

    -       -       -       275       (200

)

Prior years consulting fees

    -       -       -       -       (201

)

Combined

  $ 330     $ (574

)

  $ -     $ 275     $ (401

)

 

 

(2)

Loss on extinguishment of debt was included in the net loss for the year ended December 31, 2010 in amount of approximately $571,000, see Note 5 in the accompanying Notes to Consolidated Financial Statements.

 

(3)

Benefit from income taxes, net in the amount of $7,492,000 was recorded on December 31, 2013, arising from the recognition of our net deferred tax assets principally associated with our U.S. operating loss carryforwards.

 

 
17

 

 

ITEM 7.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following management’s discussion and analysis is intended to assist the reader in understanding our consolidated financial statements. This management’s discussion and analysis is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and accompanying notes. Amounts presented in this report, with the exception of the Consolidated Financial Statements and accompanying Notes to the Financial Statements, are rounded to the nearest thousand dollars, except per share amounts.

 

Overview

 

Talon International, Inc. designs, manufactures, sells and distributes apparel zippers, specialty waistbands and various apparel trim products to manufacturers of fashion apparel, specialty retailers and mass merchandisers. We sell and market these products under various branded names including Talon and Tekfit. We operate the business globally under three product groups.

 

We pursue the global expansion of our business through the establishment of Talon owned sales and distribution locations, and strategic manufacturing relationships. The manufacturing arrangements, in combination with Talon owned and affiliated facilities under the Talon brand, improve our time-to-market throughout the world by sourcing, finishing and distributing to apparel manufacturers in their local markets.

 

Our primary business focus is on serving as an outsourced apparel zipper and trims supplier, product design and development, sampling and sourcing department for the most demanding brands and retailers. We believe that design differentiation among brands and retailers is a critical marketing tool for our customers. By assisting our customers in the design, development, sampling and sourcing of all trim components, we generally achieve higher margins for our products, create long-term relationships with our customers, grow our sales to a particular customer by serving a larger proportion of their brands and better differentiate our sales and services from those of our competitors. We are expanding our business globally, to better serve our apparel customers in the field, in addition to our brand and retail customer. We believe we can lead the industry in apparel accessories by having strong relationships with our brand and retail customers and having a distributed service organization to serve our factory customers globally.

 

Our Tekfit business provides manufacturers with the patented technology, manufacturing know-how, equipment and materials required to produce an expandable waistband. Our supply of this product to customers was limited prior to 2013 by a licensing dispute with the technology inventor. In March 2012 we ended the licensing dispute, and acquired all U.S. licenses and patents for this product technology, and settled all matters of litigation with the original owner. Following the end of this dispute we proceeded to actively expand our marketing and selling efforts of this unique product and brand within the industry. Consequently, the revenues we derived from the sales of products incorporating the stretch waistband technology were substantially limited for the periods prior to this litigation, and are now just beginning to be reestablished as we advance our marketing and product introductions to major retailers.

 

 
18

 

 

Recent developments

 

On July 12, 2013 we entered into a Redemption Agreement with CVC California LLC (“CVC”) and repurchased from CVC all of the 407,160 outstanding shares of Series B Preferred Stock for an aggregate purchase price of $18,800,000. The purchase price was paid by delivery to CVC of $13,000,000 in cash and an unsecured promissory note (“Promissory Note”) in the principal amount of $5,800,000. The Promissory Note accrued interest in the amount of 1% per annum, and was due and payable in full on January 12, 2014. On December 31, 2013, we entered into a Credit Agreement with Union Bank and we used all of the proceeds of $5,000,000 from the Term Note and $800,000 of the proceeds of a Revolving Credit Loan as part of this Credit Agreement to repay the $5,800,000 Promissory Note to CVC.

 

In order to provide additional funds necessary for the redemption of the Series B Preferred Stock, on July 12, 2013 we raised $5,500,000 of new equity capital through the offer and sale, in a private placement transaction, of 61,111,109 shares of our common stock at a price of $0.09 per share. The closing of the private placement was expressly conditioned upon the contemporaneous closing of the transactions under the Redemption Agreement.

 

The redemption of the preferred shares removed our liquidation preference obligation of $25,894,000, which entitled the preferred stockholders to payment of the preference amount before any payment to the common stockholders. The liquidation preference was scheduled to increase to approximately $40,700,000 at the time the preferred shares became mandatorily redeemable in 2016. The removal of this obligation resulted in an immediate benefit to common stockholders of approximately $6,939,000 net of related costs of the transaction, and also eliminated the obligation to redeem the Series B Preferred Stock in the future. We now have only common shares outstanding.

 

On December 31, 2013, we entered into a credit agreement with Union Bank and we used proceeds of the borrowings from Union Bank to repay the $5,800,000 Promissory Note to CVC. The credit agreement we entered into with Union Bank on December 31, 2013 provides for a revolving loan commitment in the amount of up to $3,500,000 (the “Revolving Credit Loan”) and a term loan in the amount of $5,000,000 (the “Term Loan” and together with the Revolving Credit Loan, the “Credit Facilities”). The Revolving Credit Loan consists of revolving loans up to $3,500,000 and a sublimit of letters of credit not to exceed a maximum aggregate principal amount of $1,000,000. Borrowings under the Revolving Credit Loan bear interest at two and one-half percent (2.50%) in excess of Union Bank’s Reference Rate, which is an index rate determined by Union Bank from time to time as a means of pricing certain extensions of credit. The Term Loan bears interest at two and three-quarters percent (2.75%) in excess of the Reference Rate.

 

For further details on the Redemption and the Credit Facilities, see Notes 4 and 5 in the accompanying Notes to Consolidated Financial Statements.

 

 
19

 

 

Results of Operations

 

Net Sales

 

For the years ended December 31, 2013, 2012 and 2011, total sales by geographic region based on customer delivery locations were as follows:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Sales:

                       

United States

  $ 4,145,000     $ 4,495,000     $ 3,519,000  

Hong Kong

    14,682,000       14,595,000       14,696,000  

China

    15,078,000       10,760,000       9,558,000  

Bangladesh

    2,618,000       2,242,000       2,093,000  

Other

    15,924,000       12,509,000       11,803,000  

Total

  $ 52,447,000     $ 44,601,000     $ 41,669,000  

 


 The net sales for the three primary product groups are as follows:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Product Group Net Sales:

                       

Talon zipper

  $ 28,756,000     $ 22,062,000     $ 22,613,000  

Trim

    23,612,000       22,519,000       19,048,000  

Tekfit

    79,000       20,000       8,000  

Total

  $ 52,447,000     $ 44,601,000     $ 41,669,000  

 

Net sales are influenced by a number of factors, including demand, pricing strategies, new product launches, competitive products, product supply and foreign exchange rates. See Item 1 “Business” for a discussion of our principal products.

 

Net sales for the year ended December 31, 2013 were $52,447,000, an increase of $7,847,000 over the net sales for the same period in 2012. The increases reflected higher sales to our specialty retail branded customers in the Zipper and Trim segments, and sales to new brands in all three business segments, as we continue to win approval nominations from retailers and brands for the use of all of our products in their garments. Our Zipper, Trim and Tekfit Products segments increased sales by $6,695,000, $1,093,000 and $59,000, respectively compared to the same periods in 2012.

 

Net sales for the year ended December 31, 2012 were $44,601,000, an increase of $2,932,000 over the net sales for the same period in 2011. The increases reflected sales to new specialty apparel customers and new programs within key customer accounts, partially offset by a decline in the sales of generic zippers to price sensitive mass merchandise and licensing customers. Over the past year we have focused our sales efforts on increasing sales to specialty apparel customers rather than mass merchandise customers. Our sales strategy is to continue to focus on customers who precede quality, brand image and product value before low-cost selections.

 

 
20

 

 

Cost of goods sold and selected operating expenses

 

The following table summarizes cost of goods sold and selected operating expenses for the years ended December 31, 2013, 2012 and 2011 (amounts in thousands) and the percentage change in such operating expenses as compared to the previous year:

 

   

2013

   

Change

   

2012

   

Change

   

2011

 
                                         

Sales

  $ 52,447       18

%

  $ 44,601       7

%

  $ 41,669  

Cost of goods sold

    35,475       18

%

    30,140       6

%

    28,465  

% of sales

    68

%

            68

%

            68

%

Sales and marketing expenses

    5,889       18

%

    4,974       17

%

    4,261  

% of sales

    11

%

            11

%

            10

%

General and administrative expense

  $ 8,327       -2

%

  $ 8,492       12

%

  $ 7,604  

% of sales

    16

%

            19

%

            18

%

 

Cost of goods sold

 

Cost of goods sold for the year ended December 31, 2013 increased $5,334,000 as compared to the same period in 2012, and represented 68% of sales in each of the years ended December 31, 2013 and 2012.  The increase in the cost of goods sold was the result of higher overall sales volumes of $4,603,000, higher manufacturing overhead costs, inventory obsolescence costs and freight expenses of $906,000, offset by lower direct purchase costs associated with a greater mix of higher-margin products in the Talon and the Trim divisions of $175,000.

 

Cost of goods sold for the year ended December 31, 2012 increased $1,676,000 as compared to the same period in 2011, and represented 68% of sales in each of the years ended December 31, 2012 and 2011.  The increase in the cost of goods sold was the result of higher overall sales volumes of $1,764,000, higher manufacturing overheads, inventory obsolescence costs and freight expenses of $579,000, offset by lower direct purchase costs associated with a greater mix of higher-margin products in the Talon and the Trim divisions of $667,000.

 

Sales and marketing expenses

 

Sales and marketing expenses for the year ended December 31, 2013 totaled $5,889,000, an increase of $915,000 as compared to the same period in 2012. Sales and marketing expenses increased mainly due to higher sales commissions associated with the higher sales volumes in the amount of $408,000, and due to increased new product development costs in the amount of $223,000.

 

Sales and marketing expenses for the year ended December 31, 2012 totaled $4,974,000, an increase of $713,000 as compared to same period in 2011. Sales expenses increased mainly due to the continued investment in strengthening and expanding our internal sales force within the U.S., Europe and Asia during 2011 and the first half of 2012; and increased commissions to our sales representative network. Increased sales and marketing efforts are designed to expand our presence in select product markets within the U.S., Europe and Asia where we see significant growth potential.

 

 
21

 

 

General and administrative expenses

 

General and administrative expenses for the year ended December 31, 2013 were $8,327,000 or 16% of sales, a reduction of $165,000 as compared to the same period in 2012. The decline resulted mainly from receipt of a settlement of $350,000 for a previous legal dispute regarding intellectual property rights, lower legal fees of $398,000 mainly associated with our efforts to protect worldwide trademark filings, reduced professional services, recruiting expenses and other cost reductions of $35,000, offset by higher net compensation costs of $618,000.

 

General and administrative expenses for the year ended December 31, 2012 were $8,492,000 or 19% of sales, an increase of $888,000 as compared to the same period in 2011. Legal fees amounted to $574,000 for a legal dispute regarding intellectual property rights included in our general and administrative expenses for the year ended December 31, 2012. The increase mainly reflects the absence of a non-recurring benefit recorded in 2011 for the expiration and settlement of claims by former suppliers to our discontinued Mexico operations totaling $381,000; increased legal fees of $344,000 to maintain and defend our patent and trademark filings worldwide; and higher professional expenses consisting of fees to third party advisors and board members of $201,000 related to an ad hoc committee of our Board of Directors; offset by cost reductions of $38,000.

 

Interest expense and interest income

 

Interest expense for the year ended December 31, 2013 was $30,000, as compared to interest expense of $51,000 for the same period in 2012. Interest income for the year ended December 31, 2013 and 2012 was $4,000.

 

Interest expense for the year ended December 31, 2012 was $51,000, as compared to interest expense of $128,000 for the same period in 2011. Interest income for the year ended December 31, 2012 and 2011 was $4,000.

 

Income taxes

 

Benefit from income taxes, net for the year ended December 31, 2013 was $7,000,000, as compared to a provision for income taxes, net for the year ended December 31, 2012 of $268,000. The benefit from income taxes, net for the year ended December 31, 2013 includes the recognition of our deferred tax assets, net in the amount of $7,492,000 principally associated with our U.S. operating loss carryforwards. Previously these assets were fully offset with a valuation reserve based upon an evaluation of the likelihood of the recovery of these assets. As of December 31, 2013 we concluded that there is now sufficient evidence to ensure that it is more likely than not that we will be able to utilize substantially all of our U.S. operating loss carryforwards. (See Note 8 in the accompanying Notes to Consolidated Financial Statements.) The provision for income taxes for the year ended December 31, 2013 and 2012 also includes the elimination of a tax liability of $135,000 and $196,000, respectively, that was originally established in 2007 in connection with foreign tax positions that could have been subject to reversal upon a regulatory review. The time limit for a regulatory assessment of the tax position expired and the liabilities were removed.

 

Provision for income taxes for the year ended December 31, 2012 was $268,000, as compared to $486,000 for the year ended December 31, 2011. The provision for income taxes for the year ended December 31, 2012 includes the elimination of a tax liability of $196,000 that was originally established in 2007 in connection with foreign tax positions that could have been subject to reversal upon a regulatory review. At March 31, 2012 the time limit for a regulatory assessment of the tax position expired and the liability was removed. (See Note 8 in the accompanying Notes to Consolidated Financial Statements). During the year ended December 31, 2012, funds transfers from our foreign subsidiaries were lower than in the same period in 2011. Consequently, the provision for income taxes compared to the same period in 2011 reflected lower withholding tax from our Asian operations offset by higher income tax expense due to higher profitability in the foreign subsidiaries.

 

 
22

 

 

Provision for income taxes for the year ended December 31, 2011 was $486,000, which included a U.S. charge for foreign taxes arising from intellectual property charges to our foreign operations, a charge for foreign taxes in China arising from collected service fees, a tax provision for Hong Kong operations offset by lower deferred tax assets in Hong Kong, and a U.S. tax basis difference related to our indefinite lived intangible asset. There was not sufficient evidence at that time to determine that it was more likely than not that we would be able to utilize our net operating loss carryforwards to offset future taxable income and as a result, these deferred tax assets have a full valuation reserve applied against them.

 

Liquidity and Capital Resources

 

The following table summarizes selected financial data at the following year end dates:

 

   

December 31,

 
   

2013

   

2012

 
                 

Cash and cash equivalents

  $ 3,780,000     $ 8,927,000  

Total assets

  $ 20,523,000     $ 18,976,000  

Current liabilities

  $ 12,706,000     $ 9,893,000  

Long term liabilities

  $ 3,386,000     $ 1,132,000  

Preferred Stock

  $ -     $ 23,979,000  

Stockholders’ Equity (Deficit)

  $ 4,431,000     $ (16,028,000

)

Total Equity and Preferred Stock

  $ 4,431,000     $ 7,951,000  

 

 

We believe that our existing cash and cash equivalents, our anticipated cash flows from our operating activities, and available borrowings from our Credit Facilities, will be sufficient to fund our minimum working capital and capital expenditure needs for operating activities for at least the next twelve months.

 

Cash and cash equivalents

 

Most of our cash is held within various financial institutions globally and as of December 31, 2013 and 2012 there were no restricted cash balances.

 

Cash and cash equivalents of $3,780,000 at December 31, 2013 declined by $5,148,000 from balances at December 31, 2012, principally due to our redemption of the Series B Preferred Stock, net of the proceeds from the sale of common stock, our borrowings under our Credit Facilities, and the acquisition of property and equipment, offset by the cash provided by operating activities of $3,192,000.

 

Cash and cash equivalents of $8,927,000 increased by $3,178,000 at December 31, 2012 as compared to December 31, 2011, principally due to net cash provided by operating activities partially offset by the acquisition of property and equipment and intangibles and payments of notes payables.

 

 
23

 

 

Cash flows

 

The following table summarizes our cash flow activity for the years ended December 31, 2013, 2012 and 2011:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Net cash provided by operating activities

  $ 3,192,000     $ 3,853,000     $ 3,042,000  

Net cash (used in) investing activities

    (329,000

)

    (375,000

)

    (118,000

)

Net cash (used in) financing activities

    (8,091,000

)

    (312,000

)

    (39,000

)

Net effect of foreign currency translation on cash

    80,000       12,000       69,000  

Net (reduction) increase in cash and cash equivalents

  $ (5,148,000

)

  $ 3,178,000     $ 2,954,000  

 

 

Operating Activities

 

The net cash provided by operating activities is our primary recurring source of funds, and reflects net income from operations, excluding non cash charges and changes in operating capital. The net cash provided by operating activities during the years ended December 31, 2013, 2012 and 2011 resulted principally from:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Net income before non-cash charges

  $ 3,512,000     $ 1,894,000     $ 2,521,000  

Inventory reductions (increases)

    (135,000

)

    298,000       231,000  

Accounts receivable reductions (increases)

    36,000       246,000       (392,000

)

Accounts payable and accrued expense increases

    86,000       1,729,000       1,002,000  

Other reductions in operating capital

    (307,000

)

    (314,000

)

    (320,000

)

Cash provided by operating activities

  $ 3,192,000     $ 3,853,000     $ 3,042,000  

 

 

Investing Activities

 

Net cash used in investing activities for the year ended December 31, 2013 was $329,000, primarily due to the acquisition of property and equipment.

 

Net cash used in investing activities for the year ended December 31, 2012 was $375,000 for the acquisition of intangibles of $179,000 and the acquisition of property and equipment of $196,000.

 

Net cash used in investing activities for the year ended December 31, 2011 was $118,000, primarily representing the acquisition of property and equipment of $173,000, offset by proceeds from the sale of equipment in the amount of $55,000.

 

 

Financing Activities

 

Net cash used in financing activities for the year ended December 31, 2013 was $8,091,000, reflecting the redemption of Series B Preferred Stock of ($13,000,000) offset by the proceeds from the sale of stock of $5,500,000, the borrowings under our Credit Facilities of $6,000,000 and the payment of the Promissory Note of ($5,800,000), the associated issuance costs for the stock ($163,000) and redemption of the preferred shares ($154,000), the ($250,000) payment of financing costs, the redemption of common stock ($219,000), and the repayment of borrowings under capital leases and payments related to tax withholding on exercise of stock options ($5,000).

 

 
24

 

 

Net cash used in financing activities for the year ended December 31, 2012 was $312,000, reflecting the payment of notes payable to related parties in the amount of $241,000, payment of other notes payable in the amount of $67,000, and repayment of borrowings under capital leases of $4,000.

 

Net cash used in financing activities for the year ended December 31, 2011 was $39,000, reflecting payment of a note payable to related parties in the amount of $45,000 and repayment of borrowings under capital leases of $6,000, offset by proceeds from the exercise of stock options in the amount of $12,000.

 

On July 12, 2013 we entered into a Redemption Agreement with CVC California LLC and repurchased from CVC all of the 407,160 outstanding shares of Series B Preferred Stock for an aggregate purchase price of $18,800,000. The purchase price was paid by delivery to CVC of $13,000,000 in cash and an unsecured Promissory Note in the principal amount of $5,800,000. The Promissory Note accrued interest in the amount of 1% per annum, and was due and payable in full on January 12, 2014. On December 31, 2013, we entered into a credit agreement with Union Bank and we used all of the proceeds of $5,000,000 from the Term Note and $800,000 of the proceeds of a Revolving Credit Loan as part of this Credit Agreement to repay the $5,800,000 Promissory Note to CVC.

 

The credit agreement we entered into with Union Bank provides for a Revolving Credit Loan in the amount of up to $3,500,000 and a Term Loan in the amount of $5,000,000. The Revolving Credit Loan consists of revolving loans up to the $3,500,000 and a sublimit of letters of credit not to exceed a maximum aggregate principal amount of $1,000,000. Borrowings under the Revolving Credit Loan bear interest at two and one-half percent (2.50%) in excess of Union Bank’s Reference Rate, which is an index rate determined by Union Bank from time to time as a means of pricing certain extensions of credit. We paid $250,000 in financing costs associated with the credit agreement.

 

The credit agreement contains representations and warranties, affirmative, negative and financial covenants, and events of default, applicable to us and to our subsidiaries, which are customary for credit facilities of this type including maintaining a Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of not less than 1.25:1.00 as of the close of each fiscal quarter and an Adjusted EBITDA (as defined in the credit agreement) of at least $2,750,000 as of the close of each fiscal quarter, for the 12-month period ended as of the last day of the quarter.

 

The payment and performance of all indebtedness and other obligations under the Credit Facilities, are secured by liens on substantially all of our assets pursuant to the terms and conditions of one or more Security Agreements and guaranties duly executed by us and our principal operating subsidiaries including Tag-It, Inc., Talon Technologies, Inc., and Tag-It Pacific Limited.

 

As of December 31, 2013, we had outstanding borrowings of $6,000,000 under our Credit Facilities and $1,074,000 in available borrowings.

 

We have satisfied our working capital requirements primarily through cash flows generated from operations and borrowings under our credit facilities. As we continue to expand globally with our apparel manufacturing in offshore locations, our customers are substantially all foreign-based and foreign-owned entities. We continue to evaluate both financing and equity options to provide capital if needed to fund our expansion and on-going operations. If we experience greater than anticipated reductions in sales, we may need to borrow or raise additional capital, or further reduce the scope of our business in order to fund our on-going operations or to satisfy our future short-term operating requirements. The extent of our future long-term capital requirements will depend on many factors, including our results of operations, future demand for our products, the size and timing of possible acquisitions, and our expansion into foreign markets. Our need for additional long-term financing may include the integration and expansion of our operations to exploit our rights under our Talon and Tekfit trade names, and the expansion of our operations in the Asian and European markets. If our cash from operations is less than anticipated or our working capital requirements and capital expenditures are greater than we expect, we may need to raise debt or equity financing in order to provide for our operations.

 

 
25

 

 

Contractual Obligations

 

The following summarizes our contractual obligations at December 31, 2013 and the effects such obligations are expected to have on liquidity and cash flow in future periods:

 

   

Payments Due by Period ($)

 

Contractual Obligations

 

Total

   

Less than

 1 Year

   

1-3

 Years

   

4-5

 Years

   

More than

 5 years

 

Revolving credit loan

  $ 1,000,000     $ 1,000,000     $ -     $ -     $ -  

Term loan payable

    5,468,000       1,924,000       3,544,000       -       -  

Operating leases

    1,162,000       732,000       425,000       5,000       -  

Total Obligations

  $ 7,630,000     $ 3,656,000     $ 3,969,000     $ 5,000     $ -  

 

 

Off-Balance Sheet Arrangements

 

At December 31, 2013 and 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

 

Related Party Transactions

 

For a description of certain transactions to which we were or will be a party, and in which any director, executive officer, or stockholder of more than 5% of our common stock or any member of their immediate family had or will have a direct or indirect material interest, see Item 13, “Certain Relationships and Related Transactions and Director Independence,” in Part III of this Report.

 

Application of Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions for the reporting period and as of the financial statement date. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenue and expense. Actual results could differ from those estimates.

 

Critical accounting policies are those that are important to the portrayal of our financial condition and results of operations, and which require us to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

 

 

Accounts receivable balances are evaluated on a continual basis and allowances are provided for potentially uncollectible accounts based on management’s estimate of the collectability of customer accounts. If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments, an additional allowance may be required. Allowance adjustments are charged to operations in the period in which the facts that give rise to the adjustments become known. The bad debt expenses, recoveries and allowances for the years ended December 31, 2013, 2012 and 2011 are as follows:

 

 
26

 

 

   

Years ended December 31,

 
   

2013

   

2012

   

2011

 

Bad debt expense (recovery), accounts receivable

  $ 42,000     $ (33,000

)

  $ 28,000  

Allowance for doubtful accounts, accounts receivable

  $ 42,000     $ 1,000     $ 53,000  

 

 

Inventories are stated at the lower of cost, determined using the first-in, first-out (“FIFO”) basis, or market value and are all substantially finished goods. The costs of inventory include the purchase price, inbound freight and duties, conversion costs and certain allocated production overhead costs. Inventory is evaluated on a continual basis and reserve adjustments are made based on management’s estimate of future sales value, if any, of specific inventory items. Inventory reserves are recorded for damaged, obsolete, excess, impaired and slow-moving inventory. We use estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory. Reserve adjustments are made for the difference between the cost of the inventory and the estimated market value, if lower, and charged to operations in the period in which the facts that give rise to these adjustments become known. Market value of inventory is estimated based on the impact of market trends, an evaluation of economic conditions and the value of current orders relating to the future sales of this type of inventory. Inventory reserve is reduced by the disposition of inventory and write-off of reserved inventory, and increased by additions to the reserve for slow moving inventory. The inventory valuations provisions and allowances for inventory valuation reserves for the years ended December 31, 2013, 2012 and 2011 are as follows. The net recovery in 2011 resulted mainly due to sale of legacy zippers held in inventory, which were previously reserved:

 

   

Years ended December 31,

 
   

2013

   

2012

   

2011

 

Inventory valuation provisions, net

  $ 65,000     $ 48,000     $ (36,000

)

Allowance for inventory valuation reserves

  $ 230,000     $ 261,000     $ 485,000  

 

 

We record deferred tax assets and liabilities arising from temporary timing differences between recorded net income and taxable net income when and if we believe that future earnings will be sufficient to realize the tax benefit. For those jurisdictions where the expiration date of tax benefit carry-forwards or the projected taxable earnings indicate that realization is not likely, a valuation allowance is provided. If we determine that we may not realize all of our deferred tax assets in the future, we will make an adjustment to the carrying value of the deferred tax asset, which would be reflected as an income tax expense. Conversely, if we determine that we will realize a deferred tax asset, which currently has a valuation allowance, we would be required to reverse the valuation allowance, which would be reflected as an income tax benefit. A deferred income tax liability related to indefinite lived intangibles should not be offset against deferred income tax assets. We believe that our estimate of deferred tax assets and liabilities and determination to record a valuation allowance against such assets are critical accounting estimates because they are subject to, among other things, an estimate of future taxable income, which is susceptible to change and dependent upon events that may or may not occur, and because the impact of recording a valuation allowance may be material to the assets reported on the balance sheet and results of operations. Benefit from income taxes, net in the amount of $7,492,000 was recorded on December 31, 2013, arising from the recognition of our net deferred tax assets principally associated with our U.S. operating loss carryforwards. See Note 8 in the accompanying Notes to Consolidated Financial Statements.

 

 
27

 

 

 

Sales are recognized when persuasive evidence of an arrangement exists, product title has passed, pricing is fixed or determinable and collection is reasonably assured. Sales resulting from customer buy-back agreements, or associated inventory storage arrangements are recognized upon delivery of the products to the customer, the customer’s designated manufacturer, or upon notice from the customer to destroy or dispose of the goods. Sales, provisions for estimated sales returns, and the cost of products sold are recorded at the time title transfers to customers. Actual product returns are charged against estimated sales return allowances, which returns have been insignificant.

 

 

We are currently involved in various lawsuits, claims and inquiries, most of which are routine to the nature of the business and in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No 450, “Contingencies”, we accrue estimates of the probable and estimable losses for the resolution of these claims. The ultimate resolution of these claims could affect our future results of operations for any particular quarterly or annual period should our exposure be materially different from our earlier estimates or should liabilities be incurred that were not previously accrued.

 

We believe that we have meritorious defenses to these claims and that the claims are either covered by insurance or would not have a material effect on our consolidated financial position or results of operations if adversely determined against us.

 

New Accounting Pronouncements 

 

In July 2013, the Financial Accounting Standards Board (“FASB”) issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"), which sets forth explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance is effective for fiscal years, and interim periods beginning after December 15, 2013, with early adoption permitted. We adopted ASU 2013-011 as of September 30, 2013 with no impact on the consolidated financial statements.

 

 

 

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

All of our sales are denominated in United States dollars or the currency of the country in which our products originate. We are exposed to market risk for fluctuations in the foreign currency exchange rates for certain product purchases that are denominated in Hong Kong dollars and Chinese Yuan. We do not intend to purchase contracts to hedge the exchange exposure for future product purchases. There were no hedging contracts outstanding as of December 31, 2013. Currency fluctuations can increase the price of our products to foreign customers which can adversely impact the level of our export sales from time to time. The majority of our cash equivalents are held in United States dollars in various bank accounts and we do not believe we have significant market risk exposure with regard to our investments.

 

 
28

 

 

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

TABLE OF CONTENTS

 

   

Page

     

Report of Independent Registered Public Accounting Firm

 

30

Consolidated Balance Sheets

 

31

Consolidated Statements of Operations and Comprehensive Income

 

32

Consolidated Statements of Stockholders’ Equity (Deficit)

 

33

Consolidated Statements of Cash Flows

 

34

Notes to Consolidated Financial Statements

 

36

 

 
29

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Talon International, Inc.
Woodland Hills, California

 

We have audited the accompanying consolidated balance sheets of Talon International, Inc. and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations and comprehensive income, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule of Talon International, Inc. and subsidiaries, listed in Item 15(a). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Talon International, Inc. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and comprehensive income and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

 

 

 /s/ SingerLewak LLP                                               

SingerLewak LLP

Los Angeles, California

March 24, 2014

 

 
30

 

 

TALON INTERNATIONAL, INC.

 

Consolidated balance sheets

 

   

December 31,

 
   

2013

   

2012

 
                 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 3,779,508     $ 8,927,333  

Accounts receivable, net

    3,576,925       3,635,136  

Inventories, net

    800,240       730,503  

Prepaid expenses and other current assets

    973,836       456,460  

Total current assets

    9,130,509       13,749,432  
                 

Property and equipment, net

    614,592       763,770  

Intangible assets, net

    4,267,110       4,279,943  

Deferred income tax assets, net

    6,050,402       -  

Other assets

    460,226       182,671  

Total assets

  $ 20,522,839     $ 18,975,816  
                 

Liabilities, Preferred Stock and Stockholders’ Equity (Deficit)

               

Current liabilities:

               

Accounts payable

  $ 7,158,938     $ 7,866,662  

Accrued incentive payments

    667,500       332,815  

Other accrued expenses

    2,213,264       1,690,720  

Revolving credit loan

    1,000,000       -  

Current portion of term loan payable

    1,666,667       -  

Current portion of capital lease obligations

    -       3,247  

Total current liabilities

    12,706,369       9,893,444  
                 

Term loan payable, net of current portion

    3,333,333       -  

Deferred income tax liabilities

    30,388       945,543  

Other liabilities

    22,169       186,051  

Total liabilities

    16,092,259       11,025,038  

Commitments and contingencies (Note 9)

               
                 

Series B Convertible Preferred Stock, $0.001 par value; no shares authorized, issued or outstanding at December 31, 2013; 407,160 shares authorized, issued and outstanding at December 31, 2012

    -       23,979,216  
                 

Stockholders’ Equity (Deficit):

               

Common Stock, $0.001 par value, 300,000,000 shares authorized; 91,342,215 and 23,400,808 shares issued and outstanding at December 31, 2013 and December 31, 2012, respectively

    91,342       23,401  

Additional paid-in capital

    64,046,631       58,458,731  

Accumulated deficit

    (59,822,178

)

    (74,578,052

)

Accumulated other comprehensive income

    114,785       67,482  

Total stockholders’ equity (deficit)

    4,430,580       (16,028,438

)

Total liabilities, preferred stock and stockholders’ equity (deficit)

  $ 20,522,839     $ 18,975,816  

 

 

See accompanying notes to consolidated financial statements.

 

 
31

 

 

TALON INTERNATIONAL, INC.

 

Consolidated statements of operations AND COMPREHENSIVE INCOME

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Net sales

  $ 52,447,387     $ 44,600,872     $ 41,668,507  

Cost of goods sold

    35,474,536       30,140,471       28,464,741  

Gross profit

    16,972,851       14,460,401       13,203,766  
                         

Sales and marketing expenses

    5,889,087       4,974,037       4,260,609  

General and administrative expenses

    8,326,540       8,491,596       7,603,909  

Total operating expenses

    14,215,627       13,465,633       11,864,518  
                         

Income from operations

    2,757,224       994,768       1,339,248  

Interest expense, net

    25,777       47,308       123,998  
                         

Income before provision for income taxes

    2,731,447       947,460       1,215,250  

Provision for (benefit from) income taxes, net

    (6,999,640

)

    268,113       486,117  

Net income

  $ 9,731,087     $ 679,347     $ 729,133  

Available to Preferred Stockholders:

                       

Series B Preferred Stock liquidation preference increase

    (1,914,470

)

    (3,307,478

)

    (2,851,274

)

Series B Preferred Stock redemption discount, net

    6,939,257       -       -  

Net income (loss) applicable to Common Stockholders

  $ 14,755,874     $ (2,628,131

)

  $ (2,122,141

)

                         

Per share amounts:

                       

Net income

  $ 0.17     $ 0.03     $ 0.04  

Net income (applicable to) redeemed from Preferred Stockholders

    0.09       (0.15

)

    (0.14

)

Basic net income (loss) applicable to Common Stockholders

  $ 0.26     $ (0.12

)

  $ (0.10

)

Diluted net income (loss) applicable to Common Stockholders

  $ 0.24     $ (0.12

)

  $ (0.10

)

Weighted average number of common shares outstanding - Basic

    56,213,272       22,458,185       20,567,640  

Weighted average number of common shares outstanding - Diluted

    60,554,721       22,458,185       20,567,640  
                         

Net income

  $ 9,731,087     $ 679,347     $ 729,133  

Other comprehensive income - Foreign currency translation

    47,303       5,253       31,474  

Total comprehensive income

  $ 9,778,390     $ 684,600     $ 760,607  

 

 

See accompanying notes to consolidated financial statements.

 

 
32

 

 

TALON INTERNATIONAL, INC.

 

Consolidated Statements of Stockholders’ equity (deficit)

Years Ended December 31, 2013, 2012 and 2011

 

   

Common Stock

   

Additional

Paid-In

   

Other

Comprehensive

   

Accumulated

         
   

Shares

   

Amount

   

Capital

   

Income

   

Deficit

   

Total

 

Balance, January 1, 2011

    20,291,433      $ 20,291     $ 56,975,314     $ 30,755     $ (69,827,780

)

  $ (12,801,420

)

Stock based compensation

                    961,477                       961,477  

Foreign currency translation

                            31,474               31,474  

Exercise of stock options

    109,375       110       11,920                       12,030  

RSU’s settlement in common stock

    600,000       600       (600

)

                    -  

Series B preferred stock liquidation preference increase

                                    (2,851,274

)

    (2,851,274

)

Net income

                                    729,133       729,133  

Balance, December 31, 2011

    21,000,808       21,001       57,948,111       62,229       (71,949,921

)

    (13,918,580

)

Stock based compensation

                    513,020                       513,020  

Foreign currency translation

                            5,253               5,253  

RSU’s settlement in common stock

    2,400,000       2,400       (2,400

)

                    -  

Series B preferred stock liquidation preference increase

                                    (3,307,478

)

    (3,307,478

)

Net income

                                    679,347       679,347  

Balance, December 31, 2012

    23,400,808       23,401       58,458,731       67,482       (74,578,052

)

    (16,028,438

)

Stock based compensation

                    538,781                       538,781  

Foreign currency translation

                            47,303               47,303  

Series B preferred stock liquidation preference increase

                                    (1,914,470

)

    (1,914,470

)

Series B preferred stock redemption discount

                                    6,939,257       6,939,257  

Common stock issued, net

    61,111,109       61,111       5,276,218                       5,337,329  

RSU’s settlement in common stock

    7,401,300       7,401       (7,401

)

                    -  

Common stock redemption

    (576,000     (576

)

    (218,304

)

                    (218,880

)

Exercise of stock options

    4,998       5       (1,394

)

                    (1,389

)

Net income

                                    9,731,087       9,731,087  

Balance, December 31, 2013

    91,342,215      $ 91,342       64,046,631     $ 114,785     $ (59,822,178

)

  $ 4,430,580  

 

Series A Preferred Stock of 250,000 shares were authorized at December 31, 2012 and 2011, with no shares ever issued or outstanding. In 2013 the Company amended the Corporation’s Certificate of Incorporation and eliminated all of the Series A Preferred Stock.

 

See accompanying notes to consolidated financial statements.

 

 
33

 

 

TALON INTERNATIONAL, INC.

 

Consolidated Statements of Cash Flows

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Cash flows from operating activities:

                       

Net income

  $ 9,731,087     $ 679,347     $ 729,133  

Adjustments to reconcile net income to net cash provided by operating activities:

                       

Depreciation and amortization

    493,981       525,439       605,987  

Gain on disposal of equipment

    (408

)

    (67,576

)

    (38,976

)

Amortization of deferred financing cost and debt discounts

    -       17,500       30,000  

Stock based compensation

    538,781       513,020       961,477  

Deferred income taxes (benefits), net

    (7,358,541

)

    210,721       240,686  

Bad debt expense (recovery)

    42,204       (32,718

)

    28,350  

Inventory valuation provisions, net

    65,241       48,094       (35,824

)

Changes in operating assets and liabilities:

                       

Accounts receivable

    36,185       246,483       (391,920

)

Inventories

    (134,870

)

    297,928       231,293  

Prepaid expenses and other current assets

    (117,803

)

    (140,968

)

    19,079  

Other assets

    (26,322

)

    20,196       21,415  

Accounts payable and accrued expenses

    86,179       1,728,957       1,001,978  

Other liabilities

    (163,882

)

    (193,752

)

    (361,074

)

Net cash provided by operating activities

    3,191,832       3,852,671       3,041,604  
                         

Cash flows from investing activities:

                       

Proceeds from the sale of equipment

    2,325       168       55,000  

Capital expenditures

    (330,948

)

    (196,074

)

    (173,401

)

Acquisitions of intangibles

    -       (178,722

)

    -  

Net cash used in investing activities

    (328,623

)

    (374,628

)

    (118,401

)

                         

Cash flows from financing activities:

                       

Proceeds from exercise of stock options

    -

 

    -       12,030  
Payments related to tax withholding on exercise of stock options     (1,389 )     -       -  

Common stock issued

    5,500,000       -       -  

Common stock issuance costs

    (162,671

)

    -       -  

Series B preferred stock redemption costs

    (154,429

)

    -       -  

Series B preferred stock redemption

    (13,000,000

)

    -       -  

Common stock redemptions

    (218,880

)

    -       -  

Revolving credit loan borrowing

    1,000,000       -       -  

Term loan payable borrowing

    5,000,000       -       -  

Financing costs associated with credit facilities

    (250,000

)

    -       -  

Payment of promissory note

    (5,800,000

)

    -       -  

Payment of capital leases

    (3,247

)

    (4,410

)

    (6,011

)

Payment of notes payable to related parties

    -       (240,957

)

    (44,340

)

Payment of other notes payable

    -       (66,675

)

    -  

Net cash used in financing activities

    (8,090,616

)

    (312,042

)

    (38,321

)

Net effect of foreign currency exchange translation on cash

    79,582       11,991       69,175  

Net increase (decrease) in cash and cash equivalents

    (5,147,825

)

    3,177,992       2,954,057  

Cash and cash equivalents at beginning of period

    8,927,333       5,749,341       2,795,284  

Cash and cash equivalents at end of period

  $ 3,779,508     $ 8,927,333     $ 5,749,341  

 

See accompanying notes to consolidated financial statements.

 

 
34

 

 

TALON INTERNATIONAL, INC.

 

Consolidated Statements of Cash Flows

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Supplemental disclosures of cash flow information:

                       
                         

Cash received (paid) during the period for:

                       

Interest paid

  $ (29,199

)

  $ (2,910

)

  $ (119,951

)

Interest received

  $ 4,415     $ 3,809     $ 4,190  

Income tax paid, net (principally foreign)

  $ (428,286

)

  $ (331,139

)

  $ (140,148

)

Non-cash financing activities:

                       

Series B preferred stock liquidation preference increase

  $ (1,914,470

)

  $ (3,307,478

)

  $ (2,851,274

)

Series B preferred stock redemption discount

  $ 7,093,686     $ -     $ -  

Series B preferred stock redemption through issuance of promissory note

  $ 5,800,000     $ -     $ -  

Restricted stock units settled in common stock

  $ 7,401     $ 2,400     $ 600  

Interest accrued on notes payable

  $ -     $ 1,540     $ 11,587  

Capital lease terminations

  $ -     $ 9,802     $ -  

Effect of foreign currency translation on net assets

  $ 47,303     $ 5,253     $ (31,474

)

Non-cash investing activity:

                       

Equipment exchanged for manufacturing services

  $ -     $ 67,632     $ 46,368  

 

 

See accompanying notes to consolidated financial statements.

 

 
35

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Business

 

Talon International, Inc. (together with its subsidiaries, the “Company”) is an apparel company that specializes in the distribution of trim items to manufacturers of fashion apparel, specialty retailers and mass merchandisers. The Company acts as a full service outsourced trim management department for manufacturers, a specified supplier of trim items to owners of specific brands, brand licensees and retailers, a manufacturer and distributor of zippers under the Talon brand name and a distributor of stretch waistbands that utilize licensed patented technology under the Tekfit brand name.

 

Organization and Basis of Presentation

 

Talon International, Inc. is the parent holding company of Tag-It, Inc., a California corporation (“Tag-It”), Talon Technologies, Inc., a California corporation (“Talon Tech”), formerly A.G.S. Stationery, Inc., Tag-It Pacific Limited, a Hong Kong corporation (“Tag-It HK”), Talon Zipper (Shenzhen) Co. Ltd., a China corporation and Talon International Private Limited, an India corporation (collectively, the “Subsidiaries”), all of which are wholly-owned operating subsidiaries of the Company.

 

All significant intercompany accounts and transactions have been eliminated in consolidation. Assets and liabilities of foreign subsidiaries are translated at rates of exchange in effect at the close of the period. Revenues and expenses are translated at the weighted average of exchange rates in effect during the year. The resulting translation gains and losses are deferred and are shown as a separate component of stockholders’ deficit, if material, and transaction gains and losses, if any, are recorded in the consolidated statement of operations in the period incurred. During 2013, 2012 and 2011, foreign currency translation and transaction gains and losses were not material. The Company does not engage in hedging activities with respect to exchange rate risk.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year. The accounting estimates that require the Company’s most significant, difficult and subjective judgments include the valuation of allowances for accounts receivable and inventory, the assessment of recoverability of long-lived assets and intangible assets, stock-based compensation and the recognition and measurement of current and deferred income taxes (including the measurement of uncertain tax positions). Actual results could differ materially from the Company’s estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments purchased with an initial maturity of three months or less to be cash equivalents. The Company had approximately $3.4 million and $3.1 million at financial institutions in excess of governmentally insured limits at December 31, 2013 and 2012.

 

 
36

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Allowance for Accounts Receivable Doubtful Accounts

 

The Company is required to make judgments as to the collectability of accounts receivable based on established aging policy, historical experience and future expectations. The allowances for doubtful accounts represent allowances for customer trade accounts that are estimated to be partially or entirely uncollectible. These allowances are used to reduce gross trade receivables or notes receivable to their net realizable value. The Company records these allowances based on estimates related to the following factors: (i) customer specific allowances; (ii) amounts based upon an aging schedule; and (iii) an estimated amount, based on the Company’s historical experience, for issues not yet identified. The Company writes off an account when it is considered to be uncollectible. The total allowance for accounts receivable doubtful accounts at December 31, 2013 and 2012 was $41,596 and $1,093, respectively.

 

Inventories

 

Inventories are stated at the lower of cost, determined using the first-in, first-out basis, or market value and are all substantially finished goods. The costs of inventory include the purchase price, inbound freight and duties, conversion costs and certain allocated production overhead costs. Inventory reserves are recorded for damaged, obsolete, excess and slow-moving inventory. The Company uses estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory. Reserve adjustments are made for the difference between the cost of the inventory and the estimated market value, if lower, and charged to operations in the period in which the facts that give rise to these adjustments become known. Market value of inventory is estimated based on the impact of market trends, an evaluation of economic conditions and the value of current orders relating to the future sales of this type of inventory.

 

Inventories consist of the following:

   

December 31,

 
   

2013

   

2012

 

Finished goods

  $ 1,029,759     $ 991,635  

Less inventory valuation reserves

    (229,519

)

    (261,132

)

Total inventories

  $ 800,240     $ 730,503  

 

Impairment of Long-Lived Assets

 

The Company records impairment charges when the carrying amounts of long-lived assets are determined not to be recoverable. Impairment is measured by assessing the usefulness of an asset or by comparing the carrying value of an asset to its fair value. Fair value is typically determined using quoted market prices, if available, or an estimate of undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. The amount of impairment loss is calculated as the excess of the carrying value over the fair value. Changes in market conditions and management strategy have historically caused us to reassess the carrying amount of the Company’s long-lived assets. The Company completed the required assessment as at the end of 2013, 2012 and 2011, and noted no impairment.

 

 

Property and Equipment

 

Property and equipment are recorded at historical cost. Maintenance and repairs are expensed as incurred. Upon retirement or other disposition of property and equipment, the related cost and accumulated depreciation or amortization are removed from the accounts and any gains or losses are included in results of operations.

 

 
37

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Property and equipment consist of the following:

 

   

December 31,

   

Depreciable Life

 
   

2013

   

2012

   

In Years (1)

 
                           

Furniture and fixtures

  $ 298,956     $ 295,298       5    

Machinery and equipment

    819,398       791,354     5 - 10  

Software and computer equipment

    4,078,347       3,909,233      3 - 5  

Leasehold improvements (2)

    454,664       436,311            

Automobile

    -       15,711       4    
                           

Cost, total

    5,651,365       5,447,907            

Less: Accumulated depreciation and amortization

    (5,036,773

)

    (4,684,137

)

         
                           

Property and equipment, net

  $ 614,592     $ 763,770            

 

 

(1)

Depreciation of property and equipment is computed using the straight-line method based on estimated useful lives as shown above.

 

 

(2)

Depreciated life for leasehold improvements represents the term of the lease or the estimated life of the related improvements, whichever is shorter.

  

Intangible Assets, net

 

Intangible assets consist of the Talon trade name acquired in a purchase business combination, patents, licenses, intellectual property rights and technology. Intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment at least annually in accordance with the provisions of FASB Accounting Standards Codification (“ASC”) 350, “Intangibles - Goodwill and Other”. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives using the straight-line method, and are reviewed for impairment in accordance with the provisions of ASC 360, “Property, Plant and Equipment”. Costs incurred to renew or extend the term of recognized intangible assets are capitalized and amortized over the useful life of the asset.

 

In July 2012, the FASB issued Accounting Standards Update (“ASU”) 2012-02, “Intangibles – Goodwill and Other - Testing Indefinite-lived Intangible Assets for Impairment.”  The updated guidance gives companies the option to first perform a qualitative assessment to determine whether it is more likely than not, defined as a likelihood of more than 50%, that an indefinite-lived intangible asset is impaired.  If it is determined that it is more likely than not that an impairment exists, then the company is required to estimate the fair value of the indefinite-lived intangible assets and perform a quantitative impairment test in accordance with ASU 350-30. The updated guidance was effective for annual and interim indefinite lived intangibles asset impairment tests performed for fiscal years, and interim periods within those years, beginning after September 15, 2012.  Early adoption was permitted as of a date before July 27, 2012. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements. The Company completed the required assessment as at the end of 2013, 2012 and 2011, and noted no impairment.

 

 
38

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

On April 2, 2002, the Company entered into an Exclusive License and Intellectual Property Rights Agreement (the “License Agreement”) with Pro-Fit Holdings Limited (“Pro-Fit”). The License Agreement granted the Company the exclusive rights to sell or sublicense waistbands manufactured under patented technology developed by Pro-Fit for garments manufactured anywhere in the world for sale in the United States market and to all United States brands. The License Agreement had an indefinite term that extended for the duration of the trade secrets and patented technology licensed under the License Agreement. The Company recorded an intangible asset amounting to $612,500 which has been fully amortized.

 

During the quarter ended March 31, 2012 the Company completed the acquisition from Pro-Fit and related parties of all U.S. patents, applications, trademarks, rights and technology associated with the stretch waistband technology that was formerly exclusively licensed under the License Agreement, and the License Agreement was terminated. During the quarter ended March 31, 2012 the Company also acquired other intellectual property related to accessory components used with a variety of apparel products. The total purchase price and related fees for all intangibles acquired in 2012 totaled $178,722, and is amortized based on the estimated useful lives between 10 and 17 years. Amortization expense for intangible assets for the year ended December 31, 2013 and 2012 was $12,833 and $9,530, respectively.

 

Intangible assets as of December 31, 2013 and 2012 are as follows:

 

   

December 31,

 
   

2013

   

2012

 
                 

Tradename – Talon trademark

  $ 4,110,751     $ 4,110,751  
                 

Intellectual property rights and exclusive license

    178,722       178,722  

Less: Accumulated amortization

    (22,363

)

    (9,530

)

Intellectual property rights, net

    156,359       169,192  

Intangible assets, net

  $ 4,267,110     $ 4,279,943  

 

Convertible Preferred Stock

 

On July 12, 2013 the Company entered into a Securities Redemption Agreement (the “Redemption Agreement”) with CVC California, LLC (“CVC”). Pursuant to the Redemption Agreement, the Company repurchased from CVC all of the 407,160 outstanding shares of the Company’s Series B Convertible Preferred Stock (the “Series B Preferred Stock”) for an aggregate purchase price of $18,800,000. The purchase price was paid by delivery of $13,000,000 in cash and the issuance to CVC of a promissory note in the principal amount of $5,800,000 (the “Promissory Note”). As of the date of the transaction, the total value of the Series B Convertible Preferred Stock was $25,893,686, and a redemption discount (net of redemption costs of $154,429) of $6,939,257 was recorded to accumulated deficit on the consolidated balance sheets, and reflected in the earnings per share calculation of net income available to common stockholders. The Promissory Note was subsequently paid at December 31, 2013.

 

The Company classified its conditionally redeemable convertible preferred shares, which were subject to redemption upon the occurrence of uncertain events not solely within the Company’s control, as temporary equity in the mezzanine section of the consolidated balance sheets, in accordance with the guidance enumerated in FASB ASC No. 480-10 “Distinguishing Liabilities from Equity”, FASB ASC No. 210 “Classification and Measurement of Redeemable Securities” and Rule 5-02.28 of Regulation S-X, when determining the classification and measurement of preferred stock.

 

 
39

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company evaluated the conversion option of its convertible preferred shares in accordance with FASB ASC No. 470-20, “Debt with Conversion and Other Options”, Accounting for Convertible Securities with Beneficial Conversion Features (“BCF”) or Contingently Adjustable Conversion Ratios.  A convertible financial instrument includes a BCF when the fair market value of the preferred stock is lower than the value of common stock when the preferred stock converts to common stock at the issuance date. The BCF is recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of the feature to additional paid-in capital.

 

The convertible preferred shares, which were redeemable preferred securities, were reported at their then current liquidation preference amount. Redeemable securities initially are recorded at their fair value minus the BCF and minus preferred stock issuance costs, and then were subsequently adjusted for changes in the preferred stock value in accordance with the following guidelines:

 

 

When an equity instrument is not currently redeemable, but it is probable that the equity instrument will become redeemable (for example, when the redemption depends solely on the passage of time), then changes in the redemption value are recognized as they occur, and the carrying amount of the instrument is adjusted to equal the current redemption value. An increase in the carrying amount of the instrument reduces income available to common stockholders in the calculation of earnings per share.

 

 

When the liquidation preference increases on preferred shares, it is added to the preferred stock carrying amount, and reduces income available to common stockholders in the calculation of earnings per share.

 

Revenue Recognition

 

Sales are recognized when persuasive evidence of an arrangement exists, product delivery has occurred, pricing is fixed or determinable and collection is reasonably assured. Sales resulting from customer buy-back agreements, or associated inventory storage arrangements are recognized upon delivery of the products to the customer, the customer’s designated manufacturer, or upon notice from the customer to destroy or dispose of the goods. Sales, provisions for estimated sales returns and the cost of goods sold are recorded at the time title transfers to customers. Actual product returns are charged against estimated sales return allowances.

 

Sales rebates and discounts are common practice in the industries in which the Company operates. Volume, promotional, price, cash and other discounts and customer incentives are accounted for as a reduction to gross sales. Rebates and discounts are recorded based upon estimates at the time products are sold. These estimates are based upon historical experience for similar programs and products. The Company reviews such rebates and discounts on an ongoing basis and accruals for rebates and discounts are adjusted, if necessary, as additional information becomes available.

 

Shipping and Handling Costs

 

The Company records shipping and handling costs billed to customers as a component of revenue and shipping and handling costs incurred by the Company for outbound freight are recorded as a component of cost of goods sold.

 

 
40

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Income Taxes

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax benefit carry-forwards. Deferred tax liabilities and assets at the end of each period are determined using enacted tax rates. The Company records deferred tax assets arising from temporary timing differences between recorded net income and taxable net income when and if the Company believes that future earnings will be sufficient to realize the tax benefit. For those jurisdictions where the expiration date of tax benefit carry-forwards or the projected taxable earnings indicate that realization is not likely, a valuation allowance is provided.

 

The provisions of FASB ASC 740, "Income Taxes," (“ASC 740”) require the establishment of a valuation allowance when, based on currently available information and other factors, it is more likely than not that all or a portion of a deferred tax asset will not be realized. ASC 740 provides that an important factor in determining whether a deferred tax asset will be realized is whether there has been sufficient income in recent years and whether sufficient income is expected in future years in order to utilize the deferred tax asset.

 

The Company believes that its estimate of deferred tax assets and determination to record a valuation allowance against such assets are critical accounting estimates because they are subject to, among other things, an estimate of future taxable income, which is susceptible to change and dependent upon events that may or may not occur, and because the impact of recording a valuation allowance may be material to the assets reported on the balance sheet and results of operations. On December 31, 2013 the Company recognised deferred tax assets, net in the amount of $7,491,957 principally associated with our U.S. operating loss carryforwards. As of December 31, 2013, after careful evaluation of the Company’s historical operating results, business operation model, specific cost and income considerations and projected earnings, the Company concluded that there was sufficient evidence to ensure that it is more likely than not that the Company will be able to substantially utilize its U.S. operating loss carryforwards (See Note 8).

 

On January 1, 2007 the Company adopted the provisions of accounting guidance regarding uncertain income tax positions under ASC 740. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides guidance on the recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition associated with income tax liabilities. As a result of the implementation of ASC 740, the Company recognized an increase in liabilities for unrecognized tax benefits of approximately $245,800, which was accounted for as an increase in the January 1, 2007 accumulated deficit. The amount subsequently increased due to interest and penalties accrual. During the years ended December 31, 2013 and 2012, the Company recorded an income tax benefit due to the elimination of a tax liability of $135,177 and $196,423, respectively, recorded in 2007 which was associated with tax positions that could have been subject to reversal upon a regulatory review. The time limit for regulatory assessment of the tax liability expired and the liability was removed (See Note 8).

 

Stock-Based Compensation

 

The Company has employee equity incentive plans, which are described more fully in Note 6. Effective January 1, 2006, the Company adopted FASB ASC 718, “Compensation - Stock Compensation” (“ASC 718”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. Accordingly, the Company measures share-based compensation at the grant date based on the fair value of the award.

 

 
41

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

ASC 718 requires companies to estimate the fair value of share-based payment awards to employees and directors on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Statements of Operations. Stock-based compensation expense recognized in the Statements of Operations for the years ended December 31, 2013, 2012 and 2011 included compensation expense for share-based payment awards granted prior to, but not yet vested as of January 1 of the applicable year based on the grant date fair value estimated in accordance with the pro-forma provisions of ASC 718 and compensation expense for the share-based payment awards granted subsequent to January 1 based on the grant date fair value estimated in accordance with the provisions of ASC 718. For stock-based awards issued to employees and directors, stock-based compensation is attributed to expense using the straight-line single option method. As stock-based compensation expense recognized in the Statements of Operations for 2013, 2012 and 2011 is based on awards expected to vest, ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For the years ended December 31, 2013, 2012 and 2011, expected forfeitures are immaterial and as such the Company is recognizing forfeitures as they occur.

 

The Company’s determination of fair value of share-based payment awards to employees and directors on the date of grant uses the Black-Scholes model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the expected term of the awards and actual and projected employee stock option exercise behaviors. The Company estimates expected volatility using historical data. The expected option term is estimated using the “safe harbor” provisions under ASC 718.

 

Foreign Currency Translation

 

The Company has operations and holds assets in various foreign countries. The local currency is the functional currency for the Company’s subsidiaries in China and India. Assets and liabilities are translated at end-of-period exchange rates while revenues and expenses are translated at the average exchange rates in effect during the period.

 

Equity is translated at historical rates and the resulting cumulative translation adjustments are included as a component of accumulated other comprehensive income (loss) until the translation adjustments are realized. Gains and losses resulting from foreign currency transactions and remeasurement adjustments of monetary assets and liabilities not held in an entity’s functional currency (affects primarily the Company’s subsidiary in Hong Kong where the local currency Hong Kong Dollar is not the functional currency) are included in earnings.

 

Classification of Expenses

 

Cost of Goods Sold - Cost of goods sold primarily includes expenses related to inventory purchases, customs, duty, freight, overhead expenses and reserves for obsolete inventory. Overhead expenses primarily consist of warehouse and operations salaries and other warehouse expenses.

 

Sales and Marketing Expense – Sales and marketing expenses primarily include royalty expense, sales salaries and commissions, travel and entertainment, marketing and other sales-related costs.

 

General and Administrative Expenses - General and administrative expenses primarily include administrative salaries, employee benefits, professional service fees, facility expenses, information technology costs, investor relations, travel and entertainment, depreciation and amortization, bad debts, restructuring costs and other general corporate expenses.

 

 
42

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Interest Expense and Interest Income – Interest expense reflects the cost of borrowing and amortization of deferred financing costs and discounts. Interest expense for the years ended December 31, 2013, 2012 and 2011 was $30,192, $51,117 and $128,188, respectively. Interest income of $4,415, $3,809 and $4,190 for the years ended December 31, 2013, 2012 and 2011, respectively, consists of earnings from outstanding amounts due to the Company under notes and other interest bearing receivables.

 

As of March 31, 2012, the Company elected to change its policy on the classification of interest and penalties associated with tax positions originally recorded in 2007 that could be subject to reversal upon a regulatory review. In accordance with accounting guidance under FASB ASC 740 “Income Taxes” regarding uncertain income tax positions, the Company chose to report interest and penalties associated with uncertain tax positions in the provision for (benefit from) income taxes, net instead of interest expense. This presentation is preferable in order to reflect the full impact of the uncertain income tax position into one classification on our Consolidated Statement of Operations and Comprehensive Income. Historical amounts were insignificant. Due to immateriality, the prior periods presented have not been adjusted to apply the new accounting method retrospectively in accordance with FASB ASC 250 “Accounting Changes and Error Corrections” (See Note 8).

 

Comprehensive Income

 

Comprehensive income consists of net income and unrealized income on foreign currency translation adjustments. The foreign currency translation adjustment represents the net currency translation gains and losses related to our China and India subsidiaries, which have not been reflected in the net income for the periods presented.

 

In the first quarter of 2012, the Company adopted FASB ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”) and ASU 2011-12, “Comprehensive Income (Topic 220)”, which amended ASC Topic 220, “Comprehensive Income”, and was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  The Company chose the option provided by ASU 2011-05 to present the total of comprehensive income (loss), the components of net income (loss) and the components of other comprehensive income (loss) in a single continuous statement. Adoption of the guidance did not have any impact on our results of operations or financial condition.

 

Litigation

 

The Company currently has pending various claims and complaints that arise in the ordinary course of the business. The Company believes that there are meritorious defenses to these claims and that the claims are either covered by insurance or would not have a material effect on its consolidated financial condition if adversely determined against the Company.

 

Fair Value of Financial Instruments

 

Effective January 1, 2008, the Company adopted FASB Accounting Standards Codification (“ASC”) No. 820, “Fair Value Measurements and Disclosures” (“ASC 820”). Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, the guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

 

Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2—Include other inputs that are directly or indirectly observable in the marketplace.

 

 
43

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Level 3—Unobservable inputs which are supported by little or no market activity.

 

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

The Company’s financial instruments include cash and cash equivalents, accounts receivable, other assets, accounts payable, accrued expenses, revolving credit loan, term loan payable and other liabilities. The book value of the financial instruments is representative of their fair values. In accordance with this guidance, the Company measures its cash equivalents at fair value. The Company’s cash equivalents are classified within Level 1. Cash equivalents are valued primarily using quoted market prices utilizing market observable inputs. At December 31, 2013 and 2012, cash equivalents consisted of money market fund balances measured at fair value on a recurring basis; fair value of the Company’s money market funds was approximately $961,000 and $2,230,000, respectively.

 

The Company adopted the FASB staff position that delayed the guidance on fair value measurements for non-financial assets and non-financial liabilities. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.

 

Presentation

 

In order to facilitate the comparison of financial information, certain amounts reported in the prior year have been reclassified to conform to the current year presentation.

 

New Accounting Pronouncements

 

In July 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"), which sets forth explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance is effective for fiscal years, and interim periods beginning after December 15, 2013, with early adoption permitted. The Company adopted ASU 2013-011 as of September 30, 2013 with no impact on the consolidated financial statements.

 

 

 

NOTE 2 - RELATED PARTY NOTES AND TRANSACTIONS

 

On July 12, 2013, the Company entered into the Redemption Agreement with CVC, our controlling stockholder at the time, and repurchased from CVC all of the 407,160 previously outstanding shares of our Series B Preferred Stock for an aggregate purchase price of $18,800,000, which purchase price was paid by delivery to CVC of $13,000,000 in cash and the issuance to CVC of an unsecured Promissory Note in the principal amount of $5,800,000 (See Note 4 and Note 5). Pursuant to the Redemption Agreement, the existing Stockholder’s Agreement with CVC, and with Lonnie D. Schnell, Chief Executive Officer, Chief Financial Officer and a member of the Board of Directors of the Company, and Larry Dyne, President of the Company, was terminated. In connection with the redemption in full of the Series B Preferred Stock, CVC representative on the Company's Board of Directors, Mark Hughes, resigned from the Board of Directors effective July 12, 2013. All obligations under the $5,800,000 Promissory Note due to CVC were paid in full on December 31, 2013.

  

 
44

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In order to provide additional funds necessary for the redemption of the Series B Preferred Stock, the Company raised $5,500,000 of new equity capital through the sale, in a private placement transaction, of 61,111,109 shares of common stock at a price of $0.09 per share. The closing of the private placement was expressly conditioned upon the contemporaneous closing of the transactions under the Redemption Agreement. Zipper Holdings, LLC, a company controlled by Mark Dyne, the Chairman of our Board of Directors, acquired 8,333,333 shares of common stock in the private placement. The Company entered into a Registration Rights Agreement with the investors in the transaction (the “Registration Rights Agreement“) that provides for demand registration rights, such that upon the demand of holders of at least 25% of the shares issued in the private placement and subject to certain conditions, the Company will file a registration statement covering the shares issued in the private placement and requested to be included in such registration. The Registration Rights Agreement also provides certain piggyback rights, in which the holders of shares acquired in the private placement have the right to include those shares in a Company-initiated registration. No demands have been made by the holders to register the shares.

 

Interest expense, interest accrual and interest amount paid related to the notes payable to related parties for the years ended December 31, 2013, 2012 and 2011 were as follows:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Interest expense

  $ -     $ 1,015     $ 9,066  

Accrued interest balance

  $ -     $ -     $ 144,023  

Interest paid

  $ -     $ 145,038     $ 20,083  

 

 

Colin Dyne was a director, officer and significant stockholder of Sequential Brands Group, Inc. through late 2012. He is the brother of both Mark Dyne, the Chairman of the board of directors of the Company and Larry Dyne, the President of the Company. The Company had sales to Sequential Brands Group, Inc. during the year ended December 31, 2011 of $142,530. The Company had no sales to Sequential Brands Group, Inc. in 2012 or 2013.

 

In November 2009, the Company entered into an agreement with Colin Dyne, to pay a commission on the collected revenues associated with the sales of products to a specific retail brand. The agreement expired during the fourth quarter of 2011. During the year ended December 31, 2011 commissions of $72,640 were earned under this agreement.

 

 

 

NOTE 3 – NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS

 

Notes payable

 

On July 12, 2013 the Company entered into the Redemption Agreement with CVC pursuant to which the Company repurchased all of the 407,160 outstanding shares of Series B Preferred Stock for an aggregate purchase price of $18,800,000. The purchase price was paid to CVC by delivery of $13,000,000 in cash and an unsecured Promissory Note in the principal amount of $5,800,000.

 

 
45

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

On December 31, 2013, the Company entered into a Commercial Credit Agreement (the “Credit Agreement”) with Union Bank, N.A. (“Union Bank”). The Credit Agreement provides for a revolving loan commitment in the amount of up to $3,500,000 (the “Revolving Credit Loan”), consisting of revolving loans and a sublimit of letters of credit not to exceed a maximum aggregate principal amount of $1,000,000. The Credit Agreement also provides for a term loan in the amount of $5,000,000 (the “Term Loan” and together with the Revolving Credit Loan, the “Credit Facilities”). The Company used all of the proceeds of the Term Loan and $800,000 of the proceeds of the Revolving Credit Loan to repay $5,800,000 of the Company’s existing indebtedness to CVC, which was scheduled to mature on January 12, 2014. In addition interest expense relating to the CVC Promissory Note in amount of $27,490 was paid at that date.

 

Notes payable consists of the following:

 

   

December 31,

 
   

2013

   

2012

 
                 

$5,000,000 term loan payable to Union Bank dated December 31, 2013 payable in 36 monthly payments of $138,889 beginning January 31, 2014; interest at a rate per annum of 2.75% in excess of the reference rate, (3.25% as of December 31, 2013)

  $ 5,000,000     $ -  

Term note payable

    5,000,000       -  

Less current portion

    (1,666,667

)

    -  

Term loan payable, net of current portion

  $ 3,333,333     $ -  

 

Future minimum annual payments, including interest, under this term loan payable obligation is as follows:

 

Years ending December 31,

 

Amount

   

Principal

   

Interest

 

2014

  $ 1,924,144     $ 1,666,667     $ 257,477  

2015

    1,822,755       1,666,667       156,088  

2016

    1,721,620       1,666,666       54,954  
                         

Total

  $ 5,468,519     $ 5,000,000     $ 468,519  

 

 

Capital Leases

 

The Company financed one equipment purchase through capital lease obligation, which expired in November 2013. This obligation bore interest at the rate of 15.4% per annum. At December 31, 2013, there were no property and equipment under capital lease obligations. At December 31, 2012, total property and equipment under capital lease obligations and related accumulated depreciation was $10,494.

 

 
46

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4 - DEBT FACILITY

 

Union Bank Credit Facilities

 

On December 31, 2013, as discussed in Note 3, the Company entered into a Credit Agreement with Union Bank. that provides for a Revolving Credit Loan commitment in the amount of up to $3,500,000, and a sublimit of letters of credit not to exceed a maximum aggregate principal amount of $1,000,000. Any loans under the Revolving Credit Loan carry interest at two and one-half percent (2.50%) in excess of Union Bank’s “Reference Rate,” which is an index rate determined by Union Bank from time to time as a means of pricing certain extensions of credit. The Credit Agreement also provides for a Term Loan in the amount of $5,000,000. The Term Loan carries interest at a rate per annum equal to two and three-quarters percent (2.75%) in excess of the Reference Rate. The Company paid $250,000 in financing costs associated with the Credit Agreement.

 

On December 31, 2013, the Company used all of the proceeds of the Term Loan and $800,000 of the proceeds of the Revolving Credit Loan to repay $5,800,000 of the Company’s then existing indebtedness to CVC, which was paid in full. In addition, interest expense relating to the CVC Promissory Note in amount of $27,490 was paid at that date.

 

The Credit Agreement contains representations and warranties, affirmative, negative and financial covenants, and events of default, applicable to the Company and its subsidiaries which are customary for credit facilities of this type including maintaining a Fixed Charge Coverage Ratio (as defined in the Credit Agreement) of not less than 1.25:1.00 as of the close of each fiscal quarter and an Adjusted EBITDA (as defined in the Credit Agreement) of at least $2,750,000 as of the close of each fiscal quarter, for the 12-month period ended as of the last day of the quarter.

 

The payment and performance of all indebtedness and other obligations under the Credit Facilities are secured by liens on substantially all of the Company assets pursuant to the terms and conditions of one or more of the Security Agreements and guaranties, duly executed by the Company and its principle operating subsidiaries including Tag-It., Talon Tech., and Tag-It HK.

 

As of December 31, 2013, the Company had borrowings of $1,000,000 under the Credit Facilities with an additional $1,074,049 available to borrow.

 

Retired CVC Debt Facility

 

The Company originally entered into a Revolving Credit and Term Loan Agreement (the “Loan Agreement”) on June 27, 2007 with Bluefin Capital, LLC (“Bluefin”). Bluefin subsequently assigned its rights and obligations under the Loan Agreement to an affiliate, CVC. On July 30, 2010, the Company entered into a Recapitalization Agreement (the “Recapitalization Agreement”) with CVC in which the Company issued to CVC shares of the Company’s Series B Convertible Preferred Stock in payment of all of the outstanding obligations owed by the Company to CVC under the Loan Agreement. All of the outstanding obligations owed to CVC under the Loan Agreement that became due and payable on July 30, 2010, in the amount of $16,706,685, were converted into Series B Convertible Preferred Stock pursuant to the Recapitalization Agreement. These obligations consisted of outstanding borrowings and accrued interest of $11,548,098 under term notes, and $5,158,587 under a Revolving Credit Note.

 

 
47

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

In connection with the Recapitalization Agreement, the Loan Agreement (now fully paid and expired) was amended to extend the maturity date from July 30, 2010 until July 31, 2012, reducing the maximum borrowings available under the Revolver to $3,000,000, and amended various additional terms and conditions of the Loan Agreement. The Company paid CVC a non-refundable fee in the amount of $60,000 in consideration of CVC entering into the July 2010 amendment and making this facility available and paid a $50,000 commitment fee during the third quarter of 2011 to ensure the availability of the Revolver through July 31, 2012. Upon execution of the amendment, CVC waived all prior events of default under the Loan Agreement. Borrowings under the Loan Agreement were secured by all of the Company’s assets.

 

On July 31, 2012, with no borrowings outstanding, the Loan Agreement expired along with all performance covenants, obligations and liens against any assets of the Company. At December 31, 2011, there were no borrowings under the Revolver portion of the Loan Agreement and no term loans under the Loan Agreement.

 

Interest expense related to the Loan Agreement for the years ended December 31, 2012 and 2011 was $46,667 and $50,833, respectively, comprised of amortization of deferred financing costs of $17,500 and $30,000, respectively, and commitment fee expense of $29,167 and $20,833, respectively.

 

 

 

NOTE 5 - PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

Series B Convertible Preferred Stock Redemption and Private Placement of Common Stock

 

On July 12, 2013 the Company entered into the Redemption Agreement with CVC and repurchased from CVC all of the 407,160 previously outstanding shares of Series B Preferred Stock (described below) for an aggregate purchase price of $18,800,000. The purchase price was paid by delivery to CVC of $13,000,000 in cash and the issuance to CVC of an unsecured Promissory Note in the principal amount of $5,800,000. Pursuant to the Redemption Agreement, the existing Stockholder’s Agreement with CVC, and with Lonnie D. Schnell and Larry Dyne, was terminated (See Note 2). In order to provide additional funds necessary for the redemption of the Series B Preferred Stock, on July 12, 2013 the Company raised $5,500,000 of new equity capital through the offer and sale, in a private placement transaction, of 61,111,109 shares of the Company’s common stock at a price of $0.09 per share. The closing of the private placement was expressly conditioned upon the contemporaneous closing of the transactions under the Redemption Agreement. The closing price of the Company's common stock was $0.058 per share on Friday, July 12, 2013, the last trading day prior to public announcement of the equity financing and redemption transactions.

 

The redemption of the Series B Preferred Stock eliminated the Company’s preferred stock liquidation preference obligation of $25,893,686, which had entitled the preferred stockholders to payment of the preference amount before payment to the common stockholders. The liquidation preference was scheduled to increase to $40,704,105 in 2016, the time which the preferred shares would have become mandatorily redeemable. The Company now has only common shares outstanding. The redemption resulted in an immediate benefit to common stockholders of $6,939,257 (comprised of the redemption discount of $7,093,686 net of redemption costs of $154,429).

 

In connection with the redemption in full of the Series B Preferred Stock, CVC’s representative on the Company Board of Directors, Mark Hughes resigned from the Board of Directors effective July 12, 2013.

 

 
48

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

At the closing of the private placement, the Company entered into a series of Subscription Agreements (the “Subscription Agreements”) with each of the purchasers. The Subscription Agreement entered into with Kutula Holdings Ltd. (“Kutula”) grants Kutula the right to nominate one member of the Company’s Board of Directors, so long as Kutula continues to hold at least 15,500,000 of the shares (as adjusted for stock splits and the like) purchased pursuant to its Subscription Agreement, subject to certain disclosure requirements and other limitations.

 

The Company also entered into a Registration Rights Agreement with the investors in the transaction (the “Registration Rights Agreement“). The Registration Rights Agreement provides for demand registration rights, such that upon the demand of holders of at least 25% of the shares issued in the private placement and subject to certain conditions, the Company will file a registration statement covering the shares issued in the private placement and requested to be included in such registration. The Registration Rights Agreement also provides certain piggyback rights, in which the holders of shares acquired in the private placement have the right to include those shares in a Company-initiated registration.

 

As a result of the redemption, on July 12, 2013 a total of 4,745,600 shares of common stock were issued to the Company’s executive management team upon settlement of previously vested RSU’s pursuant to the 2010 deferral elections.

 

The following table summarizes the Series B Preferred Stock activity: 

 

Series B Preferred Stock as of December 31, 2010

  $ 17,820,464  
         

Series B Preferred Stock liquidation preference increase

    2,851,274  
         

Series B Preferred Stock as of December 31, 2011

    20,671,738  
         

Series B Preferred Stock liquidation preference increase

    3,307,478  
         

Series B Preferred Stock as of December 31, 2012

    23,979,216  

Series B Preferred Stock liquidation preference increase for January 1-July 12, 2013

    1,914,470  

Series B Preferred Stock as of July 12, 2013 per original redemption value

    25,893,686  
         

Series B Preferred Stock redemption discount (1)

    (7,093,686

)

         

Series B Preferred Stock before the Redemption

    18,800,000  
         

Series B Preferred Stock Redemption on July 12, 2013

    (18,800,000

)

         

Series B Preferred Stock as of December 31, 2013

  $ -  

 

 

(1) Does not include $154,429 of associated redemption costs resulting in a net benefit available to common stockholders of $6,939,257.

 

Following the redemption of the Series B Preferred Stock, the Company amended the Corporation’s Certificate of Incorporation to eliminate all of the Series B Convertible Preferred Stock, all of which had been redeemed.

 

 
49

 

 

TALON INTERNATIONAL, INC. 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

Authorized Common Stock and Preferred stock

 

On November 8, 2013, the Company’s stockholders approved an amendment to the Company’s Certificate of Incorporation to increase the number of shares of common stock authorized to be issued by the Company from 100,000,000 to 300,000,000. The stockholders approved an amendment to the Company’s Certificate of Incorporation to allow for a reverse split of the Company’s outstanding shares of common stock as described in the proxy statement, when and if the Board of Directors (the Board) determines that such action is appropriate.

 

In addition, the Company’s Certificate of Incorporation presently authorizes the issuance of 3,000,000 shares of Preferred Stock, having a par value of $0.001 per share.

 

Eliminated Series B Convertible Preferred Stock

 

On July 30, 2010, the Company entered into the Recapitalization Agreement with CVC, pursuant to which the Company issued to CVC an aggregate of 407,160 shares of a newly created series of the Company’s preferred stock, designated Series B Preferred Stock, in payment of an aggregate of $16,706,685 owed by the Company to CVC under the Loan Agreement. Certain rights, preferences, privileges and restrictions of the Series B Preferred Stock are summarized below.

 

The Series B Preferred Stock had the following rights, preferences, privileges and restrictions:

 

 

The Series B Preferred Stock ranked senior to the common stock and to any other preferred stock unless such preferred stock was created and issued on a senior or pari passu basis in accordance with the Company’s certificate of incorporation.

 

 

Each share of Series B Preferred Stock was convertible into 100 shares of the Company’s common stock (subject to adjustment for stock splits, reverse stock split, etc.) at any time and from time to time at each holder’s option, unless the Series B Preferred Stock was exchanged for its Liquidation Preference as noted below.

 

 

Upon the liquidation, dissolution or winding up of the Company, each share of Series B Preferred Stock was entitled to receive upon the surrender and cancellation of such shares (and prior to any distribution to holders of other equity securities), an amount equal to $41.033 per share plus all accrued dividends (the “Liquidation Preference”). A merger, consolidation, share exchange or other reorganization resulting in a change in control of the Company, or any sale of all or substantially all of the Company’s assets, would be deemed a liquidation and winding up for purposes of the Company’s obligation to pay the Liquidation Preference.

 

The Series B Preferred Stock Liquidation Preference increased at the rate of 16% per annum, compounded annually, in the form of a dividend accrual on the Liquidation Preference. The dividend however was only payable in connection with the payment of the Liquidation Preference upon the liquidation, dissolution or winding up of the Company or upon redemption of Series B Preferred Stock, and in each case exchange for the surrender of the Series B Preferred Stock. No portion of the Liquidation Preference or the associated accrued dividends were convertible into common stock, nor would any portion of the Liquidation Preference or the accrued dividends be payable on shares of Series B Preferred Stock in the event of or following the conversion of such shares into common stock.

 

 
50

 

 

 TALON INERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

The Company had the right, at any time upon not less than thirty (30) days’ prior written notice to the holders of Series B Preferred Stock, to redeem the Series B Preferred Stock in whole (but not in part) for a price equal to the then-applicable Liquidation Preference. The holders of Series B Preferred Stock had the option, exercisable at any time and from time to time commencing on July 31, 2016, to require the Company to redeem any or all of the Series B Preferred Stock held by such holders, at the then-applicable Liquidation Preference amount.

 

 

The Series B Preferred Stock voted with the common stock as a single class on all matters submitted or required to be submitted to a vote of the Company’s stockholders, with each share of Series B Preferred Stock having a number of votes equal to the number of shares of common stock that may be acquired upon conversion thereof as of the applicable date of determination. Additionally, the Series B Preferred Stock had the right to vote as a separate class with respect to certain matters affecting the Series B Preferred Stock, including but not limited to (a) the creation or issuance of any other class or series of preferred stock, (b) any amendments with respect to the rights, powers, preferences and limitations of the Series B Preferred Stock, (c) paying dividends or distributions in respect of or in redemption of the Company’s common stock or any other junior securities; and (d) certain affiliate transactions. Any such vote shall require the affirmative vote or consent of a majority of the outstanding shares of Series B Preferred Stock.

 

 

As long as the outstanding Series B Preferred Stock represents 35% or more of the voting shares of the Company, on an as-converted to common stock basis, then (a) our Board of Directors would consist of not more than seven members, (b) the holders of Series B Preferred Stock had the right to elect three directors if the Board has five or fewer total directors, and four directors if the Board has six or seven directors (the directors elected by the Series B Preferred Stock were referred to as the “Series B Directors”), and (c) those members serving on the Board who were not elected by holders of the Series B Preferred Stock had the right to designate all remaining directors. At least two of the Series B Directors were required to be, and remain at all times while serving as a director, an independent director that qualifies for service on the audit committee of a corporation with securities listed on the Nasdaq Stock Market as provided in Nasdaq Marketplace Rule 5605(c)(2) (or any successor thereto). Once the outstanding shares of Series B Preferred Stock represented less than 35% of the voting shares on an as-converted to common stock basis, then the entire Board would thereafter be elected by all stockholders having voting rights, voting as a single class.

 

The conversion of the term notes, revolver and related interest and fees into the Series B Preferred Stock (fair value of $17,277,600 as of July 30, 2010) was considered to be debt extinguishment according to the FASB ASC No.405 “Liabilities” and FASB ASC No. 470-50 “Debt, Modifications and Extinguishments” (“ASC 470-50”). Per ASC 470-50 a loss on extinguishment of debt of $570,915 was recorded on July 30, 2010 and is included in the Consolidated Statement of Operations for the year ended December 31, 2010. The loss on extinguishment is equal to the difference between fair value of the preferred stock and the fair value of the debt extinguished at the transaction date. The fair value of the Series B Preferred Stock on the issuance date was determined by the Company and independent valuation specialists using the option pricing valuation model.  

 

The Company applied the guidance enumerated in FASB ASC No. 480 “Distinguishing Liabilities from Equity”, FASB ASC No. 210 “Classification and Measurement of Redeemable Securities” and Rule 5-02.28 of Regulation S-X, when determining the classification and measurement of preferred stock. The Company classifies conditionally redeemable convertible preferred shares, which includes preferred shares subject to redemption upon the occurrence of uncertain events not solely within the control of the Company, as temporary equity in the mezzanine section of the consolidated balance sheet. The Series B Preferred Stock was redeemable at the option of the holders after the sixth anniversary of issuance, which was not within the control of the Company.

 

 
51

 

 

 TALON INERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The Company determined that there were no embedded features that would require separate reporting as derivative instruments. Therefore, the Company evaluated the conversion option of the convertible preferred shares under FASB ASC No. 470-20, “Debt with Conversion and Other Options”, Accounting for Convertible Securities with Beneficial Conversion Features (“BCF”) or Contingently Adjustable Conversion Ratios.  A convertible financial instrument included a BCF if the fair value of the instrument was lower than the fair value of shares of the common stock it was convertible into on the issuance date.  The BCF is recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of the conversion feature to additional paid-in capital. The Company has recorded a BCF value of $1,283,343 in connection with the issuance of the Series B Preferred Stock on July 30, 2010.

 

The Series B Preferred Stock was initially recorded at the fair value of $17,277,600 as of July 30, 2010, reduced by the BCF ($1,283,343) as stated above and stock issuance costs ($190,744), for a net value of $15,803,513 as of July 30, 2010. The value of the Series B Preferred Stock was adjusted as follows as a consequence of its redemption features and the following approach was implemented by the Company:

 

 

The Series B Preferred Stock was not currently redeemable, but it was probable that the preferred stock would become redeemable due to the redemption option available to the preferred stock holders on July 30, 2016. Changes in the redemption value were recognized immediately as they occured, and the carrying amount of the instrument was adjusted to equal the redemption value at the end of each reporting period. This method views the end of the reporting period as if it were also the redemption date for the Series B Preferred Stock. Accordingly, the adjustment of $903,172 to record the preferred stock at its redemption value (“Original issue discount”) was charged against the preferred stock carrying value and retained earnings during the year ended December 31, 2010. In addition, the resulting increase in the carrying amount of the Series B Preferred Stock reduced the income applicable to common stockholders reported in the calculation of earnings per share.

 

 

The annual 16% liquidation preference increase on outstanding preferred shares was accrued each reporting period as an addition to the carrying value of the preferred stock and reduced the income applicable to common stockholders reported in the calculation of earnings per share.

 

Eliminated Series A Preferred Stock

 

Following the redemption of the Series B Preferred Stock on July 12, 2013, the Company amended the Corporation’s Certificate of Incorporation to eliminate all of the Series A Preferred Stock (none of which were outstanding).

 

In October 1998, the Company adopted a stockholder’s rights plan. Under the rights plan the Company distributed one preferred share purchase right for each outstanding share of Common Stock outstanding on November 6, 1998. Upon the occurrence of certain triggering events related to an unsolicited takeover attempt of the Company, each purchase right not owned by the party or parties making the unsolicited takeover attempt would entitle its holder to purchase shares of the Company’s Series A Preferred Stock at a value below the then market value of the Series A Preferred Stock. The rights of holders of the Common Stock would be subject to, and may be adversely affected by, the rights of holders of the share purchase rights, the Series A Preferred Stock and any other preferred stock that may be issued in the future. The stockholder rights plan expired in accordance with its terms in 2008.

 

 
52

 

 

 TALON INERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Terminated Stockholders Agreement

 

 

Concurrently with the execution of the Recapitalization Agreement, on July 30, 2010, the Company entered into a Stockholders Agreement with CVC, and with Lonnie D. Schnell, Chief Executive Officer, Chief Financial Officer and a member of the Board of Directors of the Company, and Larry Dyne, President of the Company (“Messrs. Schnell and Dyne”), that provided for certain voting covenants and rights and restrictions with respect to transfers of stock. The Stockholders Agreement was terminated on July 12, 2013 pursuant to the Redemption Agreement entered into on that date with CVC.

 

 

 

NOTE 6—STOCK-BASED COMPENSATION

 

The Company accounts for stock-based awards to employees and directors in accordance with FASB ASC 718, “Compensation - Stock Compensation” (“ASC 718”), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values.

 

Stock Options

 

The Company’s 2008 Stock Plan, which was approved by the Company’s stockholders in 2008, authorized up to 2,500,000 shares of common stock for issuance pursuant to awards granted to individuals under the plan. On November 19, 2010, the Company’s stockholders approved an amendment to the Company’s 2008 Stock Incentive Plan to increase from 2,500,000 to 4,810,000 the number of shares of common stock that may be issued pursuant to awards thereunder, and on November 8, 2013, the Company’s stockholders approved a further amendment to the Company’s 2008 Stock Incentive Plan to increase from 4,810,000 to 15,000,000 the number of shares of common stock that may be issued pursuant to awards under the plan.

 

The Company’s 2007 Stock Plan was approved by the Company’s stockholders in 2007, replaced the 1997 Stock Plan and authorizes up to 2,600,000 shares of common stock for issuance pursuant to awards granted to individuals under the plan.

 

On October 1, 1997, the Company adopted the 1997 Stock Incentive Plan (the “1997 Plan"), which authorized the granting of a variety of stock-based incentive awards.

 

The Board of Directors, who determines the recipients and terms of the award granted, administers the Company’s stock plan. Since 2006, option awards under the Company’s stock plans are generally granted with an exercise price equal to the average market price of the Company’s stock for the five trading days following the date of approval of the grant. Those option awards generally vest over periods determined by the Board from immediate to 4 years of continuous service and have 10 year contractual terms.

 

Options granted for the years ended December 31, 2013, 2012 and 2011 totaled 400,000, 630,000 and 1,405,000, respectively.

 

During the year ended December 31, 2013, an employee exercised options to acquire 11,875 shares of common stock under the 2008 Stock Incentive Plan, and 6,877 shares were retained by the Company in payment of the excrcise price of $0.08 per share and the tax associated with the exercise of the options. At the time of exercise, the intrinsic value of the options exercised was $0.34 per share, and the retained shares valued at $2,339.

 

No options were exercised during the years ended December 31, 2012.

 

 
53

 

 

TALON INERNATIONAL, INC.

 

NOTES TO CONSOLIDTED FINANCIAL STATEMENTS

 

During the year ended December 31, 2011, a former employee exercised options to acquire 109,375 shares of common stock under the 2008 Stock Incentive Plan. Cash received upon exercise was $12,030 or $0.11 per share. At the time of exercise, the intrinsic value of the options exercised was $0.15 per share.

 

The following table summarizes all options issued to employees and directors including those issued outside the plan.

 

   

Number of

Shares

   

Weighted

Average

Exercise Price

 

Employees and Directors

               

Options outstanding - December 31, 2010

    5,147,100     $ 0.35  

Granted

    1,405,000     $ 0.10  

Exercised

    (109,375

)

  $ 0.11  

Cancelled

    (300,625

)

  $ 1.79  

Options outstanding - December 31, 2011

    6,142,100     $ 0.22  

Granted

    630,000     $ 0.05  

Cancelled

    (400,000

)

  $ 0.15  

Options outstanding - December 31, 2012

    6,372,100     $ 0.21  

Granted

    400,000     $ 0.28  

Exercised

    (11,875

)

  $ 0.08  

Cancelled

    (538,500

)

  $ 0.50  

Options outstanding - December 31, 2013

    6,221,725     $ 0.19  

 

The Company’s determination of fair value of share-based payment awards on the date of grant uses the Black-Scholes model and the assumptions noted in the following table for the years indicated. Expected volatilities are based on the historical volatility of the Company’s stock price and other factors. These variables include, but are not limited to, the expected stock price volatility over the expected term of the awards and actual and projected employee stock option exercise behaviors. The expected option term is estimated using the “safe harbor” provisions under ASC 718. The risk free rate for periods within the contractual life of the option is based on the U.S. Treasury yield in effect at the time of the grant.

 

   

Years ended December 31,

 
   

2013

   

2012

   

2011

 

Expected volatility

  330%

 

    140%

 

    134 - 138%

 

Expected term in years

  5.3       5.3 - 6.1       5.3 - 6.1  

Expected dividends

  -       -       -  

Risk-free rate

  1.5%

 

      2.7%  

 

    1.5 - 2.7%

 

 

 
54

 

 

 TALON INTERNATIONAL, INC. 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

A summary of the Company’s stock option information under all Stock Plans as of December 31, 2013 is as follows:

 

   

Number

of

Shares

   

Weighted

Average

Exercise

Price

   

Weighted

Average

Remaining Contractual

Life (Years)

   

Intrinsic

Value

 

Employees and Directors

                               

Outstanding at December 31, 2013

    6,221,725     $ 0.19       5.9     $ 0.10  

Vested and Expected to Vest

    6,211,958     $ 0.19       5.9     $ 0.10  

Exercisable

    5,584,224     $ 0.19       5.6     $ 0.11  

 

 

The aggregate intrinsic value of the stock options was calculated as the difference between the exercise price of a stock option and the quoted price of the Company’s common stock at December 31, 2013. It excluded stock options that have exercise prices in excess of the quoted price of the Company’s common stock at December 31, 2013.

 

There were approximately $118,650 of total unrecognized compensation costs related to non-vested stock options as of December 31, 2013. This cost is expected to be recognized over the weighted-average period of 1.1 years.

 

When options are exercised, the Company’s policy is to issue previously registered, unissued shares of common stock. The Company’s 2008 and 2007 Stock Incentive Plans, as amended, authorize up to 15,000,000 and 2,600,000 shares of common stock, respectively, for issuance pursuant to awards granted to individuals under the plans.

 

Subsequent to December 31, 2013, an employee exercised options to acquire 186,458 shares of common stock under the 2007 and 2008 Stock Incentive Plans, and 148,820 shares were retained by the Company in payment of the excrcise price of $0.18 weighted average per share and the tax associated with the exercise of the options. At the time of exercise, the intrinsic value of the options exercised was $0.27 per share, and the retained shares had a value of $40,181.

 

Restricted Stock Units (RSU’s)

 

 

On July 30, 2010, the Company awarded each of Lonnie Schnell and Larry Dyne a restricted stock unit award (an “RSU Award”) for 5,778,500 shares of the Company’s common stock. Each RSU Award vested 50% on August 30, 2011, and 10% on each date which is 18, 24, 30, 36 and 42 months following the grant date, subject to partial acceleration of vesting as part of the executives’ severance benefits and full acceleration of vesting upon a change in control of the Company. As of July 30, 2010, the RSU’s were valued at $2,263,884, which was reduced by the fair value of the options surrendered by the employees in connection with these grants.

 

On August 30, 2010, Messrs. Schnell and Dyne elected to defer the settlement in common shares of 5,434,200 RSU’s beyond the vesting dates. On July 12, 2013, 4,745,600 shares of common stock were issued upon settlement of previously vested restricted stock units pursuant to the deferral elections.

 

 
55

 

 

 TALON INTERNATIONAL, INC. 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

   

Number of RSU’s

 
   

Total RSU’s

awarded

   

Common

shares issued

   

Intrinsic value

at the time of

 issuance

   

Shares

remaining to

be issued

 

July 30, 2010

    11,557,000       -     $ 0.196          

August 30, 2011

    -       600,000     $ 0.10          

January 30, 2012

    -       900,000     $ 0.05          

July 30, 2012

    -       1,500,000     $ 0.04          

January 30, 2013

    -       1,500,000     $ 0.04          

July 12, 2013

    -       4,745,600     $ 0.06          

July 30, 2013

    -       1,155,700     $ 0.25          

Total at December 31, 2013

    11,557,000       10,401,300               1,155,700  

 

 

Subsequent to December 31, 2013, on January 30, 2014, the remaining 1,155,700 shares of common stock were issued upon settlement of vested restricted stock units, and 544,806 shares were retained by the Company in payment of the tax associated with the vesting of restricted stock units previously granted to the reporting persons. At the time of the issuance, the intrinsic value of these shares was $0.25 per share.

 

As of December 31, 2013, the Company had $36,913 of unamortized stock-based compensation expense related to RSU’s, which will be recognized over the remaining weighted average period of 0.08 years.

 

The following table summarizes RSU’s activity:

 

   

Number of RSU’s

   

Weighted

Average

Grant date

 
   

Unvested

   

Vested

   

Total

    value per RSU  

RSU’s outstanding - December 31, 2010

    11,557,000       -       11,557,000     $ 0.196  

Vested

    (5,778,500

)

    5,778,500       -     $ 0.196  

Common stock issued

    -       (600,000

)

    (600,000

)

  $ 0.196  

RSU’s outstanding - December 31, 2011

    5,778,500       5,178,500       10,957,000     $ 0.196  

Vested

    (2,311,400

)

    2,311,400       -     $ 0.196  

Common stock issued

    -       (2,400,000

)

    (2,400,000

)

  $ 0.196  

RSU’s outstanding - December 31, 2012

    3,467,100       5,089,900       8,557,000     $ 0.196  

Vested

    (2,311,400

)

    2,311,400       -     $ 0.196  

Common stock issued

    -       (7,401,300

)

    (7,401,,300

)

  $ 0.196  

RSU’s outstanding - December 31, 2013

    1,155,700       -       1,155,700     $ 0.196  

  

 
56

 

 

 TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 7—NET INCOME (LOSS) PER SHARE

 

The following is a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share computations:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 
   

Net income (Numerator)

   

Shares (Denominator)

   

Per Share Amount

   

Net income (loss) (Numerator)

   

Shares (Denominator)

   

Per Share Amount

   

Net income (loss) (Numerator)

   

Shares (Denominator)

   

Per Share Amount

 
                                                                         

Net income

  $ 9,731,087       56,213,272     $ 0.17     $ 679,347       22,458,185     $ 0.03     $ 729,133       20,567,640     $ 0.04  

Series B preferred stock liquidation preference increase

    (1,914,470

)

    -       (0.03

)

    (3,307,478

)

    -       (0.15

)

    (2,851,274

)

    -       (0.14

)

Series B preferred stock redemption discount, net (See Note 5)

    6,939,257       -       0.12       -       -       -       -       -       -  

Basic net income (loss) applicable to common stockholders

    14,755,874       56,213,272       0.26       (2,628,131

)

    22,458,185       (0.12

)

    (2,122,141

)

    20,567,640       (0.10

)

Stock options, RSUs and Series B preferred stock with dilutive effect

    -       4,341,449       (0.02

)

    -       -       -       -       -       -  

Diluted net income (loss) applicable to common stockholders

  $ 14,755,874       60,554,721     $ 0.24     $ (2,628,131

)

    22,458,185     $ (0.12

)

  $ (2,122,141

)

    20,567,640     $ (0.10

)

 

 

For the year ended December 31, 2013, options to purchase 3,153,125 shares of common stock exercisable between $0.04 and $0.11 per share and RSU’s to settle for 1,155,700 common shares were included in the computation of diluted net income per share. Options to purchase 3,068,600 shares of common stock exercisable between $0.16 and $5.23 per share were outstanding but were not included in the computation of diluted net income per share applicable to common stockholders because they would have an antidilutive effect on the net income per share.

 

For the year ended December 31, 2012, options to purchase 6,372,100 shares of common stock exercisable between $0.04 and $5.23 per share, RSU’s to settle for 8,557,000 common shares and Series B Preferred Stock to be converted into 40,716,000 shares of common stock were outstanding, but were not included in the computation of diluted net income (loss) per share applicable to common stockholders because they would have an antidilutive effect on the net income (loss) per share.

 

Options to purchase 6,142,100 shares of common stock exercisable between $0.06 and $5.23 per share, RSU’s to settle for 10,957,000 common shares and Series B Preferred Stock to be converted into 40,716,000 shares of common stock were outstanding for the year ended December 31, 2011, but were not included in the computation of diluted net income (loss) per share applicable to common stockholders because they would have an antidilutive effect on the net income (loss) per share.

 

 
57

 

 

TALON INTERNATIONAL, INC. 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 8—INCOME TAXES

 

The components of the provision for income taxes included in the consolidated statements of operations are as follows:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Current:

                       

Federal

  $ 189,530     $ 76,250     $ 161,306  

State

    4,731       3,322       2,528  

Foreign

    164,640       (22,180

)

    84,560  
      358,901       57,392       248,394  

Deferred:

                       

Federal

    (5,822,530

)

    115,736       115,800  

State

    (1,502,877

)

    26,984       26,794  

Foreign

    (33,134

)

    68,001       95,129  
      (7,358,541

)

    210,721       237,723  

Total

  $ (6,999,640

)

  $ 268,113     $ 486,117  

 

A reconciliation of the statutory Federal income tax rate with the Company’s effective income tax rate is as follows:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Current:

                       

Federal statutory rate

    34.0

%

    34.0

%

    34.0

%

State taxes net of federal benefit

    (36.2

)

    2.1       1.6  

Change in effective foreign tax rate

    (10.6

)

    (23.9

)

    (26.0

)

Other permanent differences

    22.3       (54.9

)

    (13.6

)

Foreign withholding taxes

    7.1       13.3       24.7  

Net operating loss valuation allowance

    (268.3

)

    95.7       35.9  

Change in uncertainty in income taxes

    (4.9

)

    (19.8

)

    -  

Other

    0.3       (18.2

)

    (16.6

)

Total

    (256.3

)%

    28.3

%

    40.0

%

 

Net income (loss) before income taxes is as follows:

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 
                         

Domestic

  $ 992,625     $ (163,227

)

  $ (457,736

)

Foreign

    1,738,822       1,110,687       1,672,986  

Total

  $ 2,731,447     $ 947,460     $ 1,215,250  

 

 
58

 

 

 TALON INTERNATIONAL, INC. 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The primary components of temporary differences which give rise to the Company’s deferred tax being presented as part of Prepaid expenses and other current assets, Deferred income tax assets, net, or Deferred income tax liabilities (in long term liabilities) in the Company’s balance sheet are as follows:

 

   

December 31,

 
   

2013

   

2012

 

Net deferred income taxes:

               

Net operating loss carry-forward

  $ 6,668,563     $ 9,381,454  

Intangible assets, net

    (982,994

)

    (811,472

)

Property and equipment, net

    (61,574

)

    (100,606

)

Inventory allowance

    56,958       57,979  

Credit carryforwards

    440,902       13,920  

Stock awards expense

    347,784       739,492  

Payroll

    76,798       63,415  

Other

    144,287       149,694  

Total

    6,690,724       9,493,876  

Less: Valuation allowance

    (277,727

)

    (10,439,419

)

Net deferred income taxes

  $ 6,412,997     $ (945,543

)

Presented as part of:

               

Prepaid expenses and other current assets

  $ 392,983     $ -  

Deferred income tax assets, net

  $ 6,050,402     $ -  

Deferred income tax liabilities

  $ (30,388

)

  $ (945,543

)

 

 

On December 31, 2013, after careful evaluation of the Company’s historical operating results, business operation model, specific cost and income considerations and projected earnings, the Company recognised deferred income tax assets, net in the amount of $7,491,957 principally associated with the U.S. operating loss carryforward, based upon evidence sufficient to ensure that it is more likely than not that the Company will be able to utilize its U.S. operating loss carryforwards.

 

On January 1, 2007 as a result of the implementation of ASC 740, the Company recognized an increase in liabilities for unrecognized tax benefits of $245,800, which was accounted for as an increase in the January 1, 2007 accumulated deficit. Interest recorded per ASC 740 was recorded as part of interest expense in the Company’s statements of operations. At March 31, 2013 and March 31, 2012 the Company recorded an income tax benefit, associated with the elimination of a portion of the ASC 740 tax liability, of $135,177 and $196,423, respectively as the time limit for regulatory assessment of the tax liability had expired.

 

A reconciliation of the ASC 740 adjustments is as follows:

   

Years Ended December 31,

 
   

2013

   

2012

 
                 

Beginning Balance

  $ 133,602     $ 321,325  

Interest and penalties

    1,575       8,700  

Elimination of a tax liability

    (135,177

)

    (196,423

)

Ending Balance

  $ -     $ 133,602  

 

At December 31, 2013 and 2012, the Company had Federal net operating loss carry-forwards (or “NOLs”) of approximately $16.4 million and $22.9 million, respectively, and State NOLs of $19.1 million and $27.5 million, respectively. The Federal NOL and State NOL are available to offset future taxable income through 2032. Section 382 of the Internal Revenue Code places a limitation on the realizability of net operating losses in future periods if the ownership of the Company has changed more than 50% within a three-year period.

 

 
59

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Due to the the private placement that occurred during 2013 (See Note 4 and Note 5) the application of I.R.C. Section 382 was required. As a consequence of the application of Section 382, the Company’s NOL limitation was determined to be approximately $2.2 million annually for each of the first five years and $0.4 million annually for up to 20 years following the date of the transaction. At the date of the Recapitalization transaction the Section 382 limitation reduced the Company’s NOL carry-forwards by approximately $3.8 million for the Federal NOL and $5.9 million for the State NOL. Income taxes are accounted for under the asset and liability method.

 

Due to the Recapitalization Agreement between the Company and CVC on July 30, 2010 (See Note 4 and Note 5) the application of I.R.C. Section 382 was required. As a consequence of the application of Section 382, the Company’s NOL limitation was determined to be approximately $2.2 million annually for each of the first five years and $0.7 million annually for up to 20 years following the date of the transaction. At the date of the Recapitalization transaction the Section 382 limitation reduced the Company’s NOL carry-forwards by approximately $45.0 million for the Federal NOL and $9.0 million for the State NOL. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax benefit carry-forwards. Deferred tax liabilities and assets at the end of each period are determined using enacted tax rates. The Company records deferred tax assets arising from temporary timing differences between recorded net income and taxable net income when and if it believes that future earnings will be sufficient to realize the tax benefit. For those jurisdictions where the expiration date of tax benefit carry-forwards or the projected taxable earnings indicate that realization is not likely, a valuation allowance is provided.

 

The provisions of ASC 740 require the establishment of a valuation allowance unless, based on currently available information and other factors, it is more likely than not that all or a portion of a deferred tax asset will be realized. ASC 740 provides an important factor in determining whether a deferred tax asset will be realized is whether there has been sufficient income realized in recent years and whether sufficient income is expected to be realized in future years to utilize the deferred tax asset. In 2012 and 2011 the Company determined, based upon its cumulative operating losses, that it was not more likely than not that it would fully realize most of its domestic and foreign deferred tax assets in future years. Consequently, at December 31, 2012 the Company recorded a valuation allowance of $10.4 million, which fully reserved the carrying value of its net deferred tax assets.

 

At December 31, 2013 the Company recognised deferred income tax assets, net in amount of $7,491,957, based upon current evidence sufficient to ensure that it is more likely than not that the Company will be able to substantially utilize its U.S. operating loss carryforwards, and part of its India operating loss carryforward. At December 31, 2013, the Company retained a small amount of valuation allowance of $277,727, which reduces the carrying value of its net deferred tax assets.

 

The Company intends to maintain a valuation allowance for its deferred tax assets until evidence exists to support the modification of the allowance. At the end of each period, the Company will review supporting evidence, including the performance against sales and income projections, to determine if a modification of the valuation allowance is warranted. If in future periods it is determined that it is more likely than not that the Company will be not be able to recognize all or a greater portion of its deferred tax assets, the Company will at that time increase the valuation allowance.

 

In 2013 the Company included in its consolidated U.S. federal tax provision $1.5 million dividend due to earnings from the Company’s HK foreign subsidiary.

 

 
60

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 

In 2012 and 2011 there were no undistributed earnings from the Company’s foreign subsidiaries, therefore the Company did not include in its consolidated U.S. federal tax return a deemed dividend due to earnings from the Company’s foreign subsidiary.

 

Tax years subject to examination by the tax authorities for Talon International, Inc. (US) are 2009 through 2013 and for the foreign subsidiaries, 2004 through 2013.

 

 

NOTE 9—COMMITMENTS AND CONTINGENCIES

 

Operating Leases

 

The Company is a party to a number of non-cancelable operating lease agreements involving buildings and equipment, which expire at various dates through 2018. The Company accounts for its leases in accordance with FASB ASC 840 “Leases”, whereby step provisions, escalation clauses, tenant improvement allowances, increases based on an existing index or rate, and other lease concessions are accounted for in the minimum lease payments and are charged to the statement of operations on a straight-line basis over the related lease term.

 

The future minimum lease commitments at December 31, 2013 are approximately as follows:

 

Years Ended December 31,

 

Amount

 
         

2014

  $ 732,000  

2015

    351,000  
2016     54,000  

2017 and after

    24,000  

Total minimum payments

  $ 1,161,000  

 

Total rental expense for the years ended December 31, 2013, 2012 and 2011 aggregated $765,774, $687,371 and $629,699, respectively.

 

Profit Sharing Plan

 

In October 1999, the Company established a 401(k) profit-sharing plan for the benefit of eligible employees. The Company may make annual contributions to the plan as determined by the Board of Directors.

 

Total contributions for the years ended December 31, 2013, 2012 and 2011 amounted to $21,000, $23,129, and $21,184, respectively.

 

Contingencies

 

The Company currently has pending claims and complaints that arise in the ordinary course of the Company’s business. The Company believes that it has meritorious defenses to these claims and that the claims are either covered by insurance or would not have a material effect on the Company’s consolidated financial condition if adversely determined against the Company.

 

 
61

 

 

TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In November 2002, the FASB issued Topics of the FASB ASC 460-10, “Guarantees” (“ASC 460-10”) and FASB ASC 850-10, “Related Party Disclosures” (”ASC 850-10”). The following is a summary of the Company’s agreements that it has determined are within the scope of ASC 460-10 and ASC 850-10:

 

 

In accordance with the bylaws of the Company, officers and directors are indemnified for certain events or occurrences arising as a result of the officer or director’s serving in such capacity. The term of the indemnification period is for the lifetime of the officer or director. The maximum potential amount of future payments the Company could be required to make under the indemnification provisions of its bylaws is unlimited. However, the Company has a director and officer liability insurance policy that reduces its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of the indemnification provisions of its bylaws is minimal and therefore, the Company has not recorded any related liabilities.

 

 

The Company enters into indemnification provisions under its agreements with investors and its agreements with other parties in the normal course of business, typically with suppliers, customers and landlords. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities or, in some cases, as a result of the indemnified party’s activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights, and generally survive termination of the underlying agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has not recorded any related liabilities.

 

 

NOTE 10—SEGMENT REPORTING AND GEOGRAPHIC INFORMATION

 

The Company manufactures and distributes a full range of zipper, trim and waistband items to manufacturers of fashion apparel, specialty retailers and mass merchandisers. The Company’s organization is based on divisions representing the major product lines, and the Company’s operating decisions use these divisions to assess performance, allocate resources and make other operating decisions. Within these product lines there is not enough difference between the types of products to justify segmented reporting by product type or to account for these products separately. The net revenues and operating margins for the three primary product groups are as follows:

 

   

Year Ended December 31, 2013

 
   

Talon

   

Trim

   

Tekfit

   

Consolidated

 

Net sales

  $ 28,756,206     $ 23,611,870     $ 79,311     $ 52,447,387  

Cost of goods sold

    20,459,426       14,938,681       76,429       35,474,536  

Gross profit

  $ 8,296,780     $ 8,673,189     $ 2,882       16,972,851  

Operating expenses

                            14,215,627  

Income from operations

                          $ 2,757,224  

  

 
62

 

 

 TALON INTERNATIONAL, INC. 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

    Year Ended December 31, 2012  
    Talon     Trim     Tekfit     Consolidated  

Net sales

  $ 22,061,303     $ 22,519,125     $ 20,444     $ 44,600,872  

Cost of goods sold

    16,022,334       14,083,017       35,120       30,140,471  

Gross profit (loss)

  $ 6,038,969     $ 8,436,108     $ (14,676     14,460,401  

Operating expenses

                            13,465,633  

Income from operations

                          $ 994,768  

 

 

      Year Ended December 31, 2011  
      Talon       Trim       Tekfit       Tekfit  

Net sales

  $ 22,612,784     $ 19,047,959     $ 7,764     $ 41,668,507  

Cost of goods sold

    16,481,686       11,981,505       1,550       28,464,741  

Gross profit

  $ 6,131,098     $ 7,066,454     $ 6,214       13,203,766  

Operating expenses

                            11,864,518  

Income from operations

                          $ 1,339,248  

 

 The Company distributes its products internationally and has reporting requirements based on geographic regions. Long-lived assets are attributed to countries based on the location of the assets and revenues are attributed to countries based on customer delivery locations, as follows:

 

   

Years Ended December 31,

 
   

2013

   

2012

   

2011

 

Sales:

                       

United States

  $ 4,145,383     $ 4,494,939     $ 3,519,137  

Hong Kong

    14,681,767       14,594,685       14,695,433  

China

    15,078,074       10,759,863       9,557,952  

Bangladesh

    2,617,840       2,242,018       2,092,993  

Other

    15,924,323       12,509,367       11,802,992  

Total 

  $ 52,447,387     $ 44,600,872     $ 41,668,507  

 

Long-lived Assets:      
   

December 31,

 
   

2013

   

2012

   

2011

 

United States

  $ 4,514,104     $ 4,551,101     $ 4,443,691  

Hong Kong

    278,636       419,268       629,373  

China

    88,962       73,344       129,977  

Other

    -       -       319  

Total

  $ 4,881,702     $ 5,043,713     $ 5,203,360  

 

 
63

 

 

TALON INTERNATIONAL, INC. 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 11—MAJOR CUSTOMERS AND VENDORS

 

For the years ended December 31, 2013, 2012 and 2011, the Company’s three largest customers represented approximately 5%, 6% and 8%, respectively, of consolidated net sales.

 

Three vendors, each representing more than 10% of the Company’s purchases, accounted for approximately 57% of the Company’s purchases for the year ended December 31, 2013. Three vendors, each representing more than 10% of the Company’s purchases, accounted for approximately 42% of the Company’s purchases for the year ended December 31, 2012. Four vendors, each representing more than 10% of the Company’s purchases, accounted for approximately 31% of the Company’s purchases for the year ended December 31, 2011.

 

Included in accounts payable and accrued expenses at December 31, 2013 and 2012 is $3,162,148 and $2,907,345 due to these vendors.

 

 

NOTE 12 – QUARTERLY RESULTS (UNAUDITED)

 

Quarterly results for the years ended December 31, 2013 and 2012 are reflected:

 

   

Year Ended December 31, 2013

 
   

1st

   

2nd

   

3rd

   

4th

 

Net sales

  $ 10,139,750     $ 16,640,964     $ 13,728,037     $ 11,938,636  

Gross profit

  $ 3,176,078     $ 5,551,840     $ 4,584,382     $ 3,660,551  

Income from operations

  $ 208,877     $ 1,588,599     $ 939,025     $ 20,723  

Net income

  $ 280,353     $ 1,262,715     $ 700,056     $ 7,487,963  

Net income per share

  $ 0.01     $ 0.05     $ 0.01     $ 0.08  

Basic and diluted net income (loss) per share applicable to Common Stockholders

  $ (0.03

)

  $ 0.01     $ 0.09     $ 0.08  

Total comprehensive income

  $ 279,052     $ 1,293,857     $ 721,277     $ 7,484,194  

 

 

   

Year Ended December 31, 2012

 
   

1st

   

2nd

   

3rd

   

4th

 

Net sales

  $ 8,745,950     $ 13,179,849     $ 11,288,717     $ 11,386,356  

Gross profit

  $ 2,770,756     $ 4,358,729     $ 3,650,872     $ 3,680,044  

Income (loss) from operations

  $ (473,826

)

  $ 974,358     $ 375,232     $ 119,004  

Net income (loss)

  $ (205,630

)

  $ 671,134     $ 186,865     $ 26,978  

Net income (loss) per share

  $ (0.01

)

  $ 0.03     $ 0.01     $ 0.00  

Basic and diluted net income (loss) per share applicable to Common Stockholders

  $ (0.05

)

  $ 0.00     $ (0.03

)

  $ (0.04

)

Total comprehensive income (loss)

  $ (221,264

)

  $ 700,454     $ 162,451     $ 42,959  

 

 
64

 

 

 TALON INTERNATIONAL, INC.

 

NOTES TO CONSOLIDATE FINANCIAL STATEMENTS

 

The Company typically experiences seasonal fluctuations in sales volume consistent with the purchase demands of the apparel industry. In most years, these seasonal fluctuations result in lower sales volumes for the Company’s business in the first and fourth quarters of each year due to the seasonal buying patterns by the majority of the customers. Sales of the Company’s products typically precede the retail sales patterns by 90 to 150 days. The apparel retailers typically experience their highest sales volumes during the fourth quarter in connection with year-end holiday purchases. Backlogs of sales orders are not considered material in the industries in which the Company competes, which reduces the predictability of the Company’s sales and reinforces the volatility of these cyclical buying patterns on the Company’s sales volume.

 

Quarterly and year-to-date computations of per share amounts are made independently. Therefore, the sum of per share amounts for the quarters may not agree with the per share amounts for the year.

 

 

NOTE 13 – SUBSEQUENT EVENTS

 

The Company evaluated subsequent events after the balance sheet date of December 31, 2013 through the date of the filing of this report.

 

 
65

 

 

ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

 

 

ITEM 9A.     CONTROLS AND PROCEDURES

 

Evaluation of Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities Exchange Commission's rules and forms, including to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act.

 

As of the end of the period covered by this report, management, with the participation of Lonnie D. Schnell, our principal executive and principal financial officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon that evaluation, Mr. Schnell concluded that these disclosure controls and procedures were effective as of the end of the period covered by this Annual Report on Form 10-K.

 

Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, the Company’s management has conducted an assessment, including testing, using the criteria in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on its assessment, our management has concluded that control over financial reporting was effective as of December 31, 2013.

 

Pursuant to applicable law, this annual report is not required to include an attestation report of our registered public accounting firm regarding internal control over financial reporting.

 

Changes in Internal Control over Financial Reporting

 

No change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fourth quarter of our fiscal year ended December 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

ITEM 9B.     OTHER INFORMATION

 

None.

 

 
66

 

 

PART III

 

 

 

ITEM 10.        DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The following table sets forth the name, age and position of each of our executive officers and directors as of March 24, 2014.

 

Name

 

Age

 

Position

         

Directors:

       
         

Mark Dyne (1)

 

53

 

Chairman of the Board of Directors

         

Lonnie D. Schnell

 

65

 

Chief Executive Officer, Chief Financial Officer and Director

         

David Ellis  

 

50

 

Director

         

Morris Weiss

 

54

 

Director

         

Robert L. Golden (2)

 

51

 

Director

         

Other Executive Officers and Significant Employees:

       
         

Larry Dyne (1)

 

41

 

President

         

Nancy Agger-Nielsen (3)

 

51

 

Vice President Finance

         

 

 

(1)

Mark Dyne and Larry Dyne are brothers.

 

(2)

Mr. Golden was appointed on September 10, 2013.

 

(3)

Ms. Agger-Nielsen was appointed on March 3, 2014 to serve as Vice President Finance on an interim basis, until her appointment as Chief Financial Officer on April 1, 2014 becomes effective.

 

 

Directors:

 

Mark Dyne

Mr. Dyne has served as Chairman of the Board of Directors since 1997.  Mr. Dyne currently serves as the Chief Executive Officer and the Managing Partner of Europlay Capital Advisors, LLC, a merchant banking and advisory firm.  Mr. Dyne previously served on the Board of Directors of Skype Global S.a.r.l. the world’s leader in V.O.I.P. communications. Mr. Dyne was also previously Chairman and Chief Executive Officer of Sega Gaming Technology Inc. (USA), and Chairman and Chief Executive Officer of Virgin Interactive Entertainment Ltd. Mr. Dyne was a founder and former director of Sega Ozisoft Pty Ltd. Mr. Dyne was nominated to our Board of Directors for his extensive domestic and international management experience.

 

 
67

 

 

Lonnie D. Schnell

Mr. Schnell joined us in January 2006 as our Chief Financial Officer, was appointed as Chief Executive Officer in February 2008 and has served on our Board of Directors since May 2008.  Mr. Schnell served as Vice President of Finance for Capstone Turbine Corporation, a manufacturer of micro-turbine electric generators from 2004 until 2005, and as Chief Financial Officer of EMSource, LLC, an electronic manufacturing service company from 2002 to 2004.  Previously, Mr. Schnell served as Chief Financial Officer of Vintage Capital Group, a private equity investment firm, and Chief Financial Officer of Need2Buy, Inc. a business-to-business internet marketplace for electronic components.  Mr. Schnell completed an executive MBA program with the Stanford University Executive Institute, and earned his Bachelor of Science in Accounting at Christian Brothers University.  Mr. Schnell was a Certified Public Accountant with the international accounting firm of Ernst & Young LLP for more than five years.  Mr. Schnell was nominated to our Board of Directors for his extensive domestic and international management experience, knowledge of associated industry practices and trends, and for his financial management expertise.

   
   

David Ellis

David Ellis has served on our Board of Directors since October 2010. Mr. Ellis is a co-founder of GemCap, a provider of asset-based loans, ranging from $1 million to $10 million, as a senior-secured lender. Through 2006, Mr. Ellis served as the President of Buxbaum Group. Mr. Ellis has twenty years of experience in the acquisition, insolvency and turnaround management businesses during which he built several international businesses, with an emphasis in the apparel industry. Mr. Ellis was nominated to our Board of Directors for his extensive domestic and international management experience, and knowledge of associated industry practices and trends, and for his financial and investment management expertise.

   
   

Morris Weiss

Morris Weiss has served on our Board of Directors since May 2012. Mr. Weiss is a partner at the law firm Hohmann, Taube & Summers, LLP, where Mr. Weiss specializes in commercial bankruptcy and restructuring matters as well as complex commercial litigation.  Prior to joining Hohmann, Taube & Summers, LLP in 2010, Mr. Weiss was the Managing Director of IP Navigation Group, LLC, an international patent monetization company, from April 2010 to August 2010.  Mr. Weiss was the Managing Director of Investment Banking of MDB Capital Group, LLC, an independent broker dealer, from May 2009 to April 2010.  From January 2009 to April 2010, Mr. Weiss served on the board of directors of Atlas Mining Company (n/k/a Applied Minerals, Inc. (OTCQB: AMNL.OB)), the leading global producer of Halloysite Clay solutions, and from November 2008 to April 2009, Mr. Weiss served as the company’s Chief Restructuring Officer.  From February 2002 to October 2008, Mr. Weiss was the Managing Director and Head of Investment Banking of Tejas Securities Group, Inc., a full service, independent broker dealer. Mr. Weiss was nominated to our Board of Directors for his extensive domestic and international management experience, knowledge of associated industry practices and trends, and for his strategic growth management expertise.

 

 
68

 

 

Robert L. Golden

Mr. Golden joined our Board of Directors in September 2013.  Mr. Golden has served as a partner at the accounting firm of Fenton & Ross in Los Angeles, California since 2013. Mr. Golden has also served as Chief Financial Officer, since 2008, for Promo Shop, Inc., a promotional merchandising and marketing services company that provides creative branded merchandise and custom premiums. From 2004 to 2012, Mr. Golden was a Principal with the accounting firm of Saffer and Flint LLP in Los Angeles. Prior to 2004, Mr. Golden spent nearly 20 years with national and regional accounting firms beginning with Ernst & Young in 1984. Mr. Golden was licensed as a Certified Public Accountant through 2006.  Mr. Golden earned his Bachelor of Science in Business Administration with an emphasis in Accounting from the University of Southern California. Mr. Golden was nominated to our Board of Directors for his extensive management experience, knowledge of associated industry practices and trends, and for his financial management expertise.

   
 

Other Executive Officers and Significant Employees:

 

Larry Dyne

Larry Dyne was appointed as our President in May 2009. He has been our employee since 1992, and was formerly Executive Vice President of Sales as well as Vice President of Product Development and Global sourcing, and Vice President of Trim Sales including responsibility for all domestic print production. Through these positions, Mr. Dyne has established extensive and long-term relationships with the world’s top brands and clothing retailers.

   
   

Nancy Agger-Nielsen

Ms. Agger-Nielsen joined us in March 2014 as Vice President Finance, and effective April 1, 2014 will become our Chief Financial Officer.  Ms. Agger-Nielsen previously served as CFO of Med-Legal, LLC, a leading California provider of litigation support services, from 2013 to 2014, and as Vice President of Finance for NDC Infrared Engineering from 2004 until 2013.  A division of Spectris plc, NDC is the leading, global supplier of on line measurement instrumentation for the manufacturing industry.  Ms. Agger-Nielsen completed an MBA program with the Peter F. Drucker School of Management at Claremont Graduate University in Claremont, CA, and earned a Bachelor of Science in Business Administration with an emphasis in Accounting at California State Polytechnic University in Pomona, CA. 

 

 

Director Nominations

 

Common Stock Director Nominations

 

The Subscription Agreement with Kutula Holdings Ltd. grants Kutula the right to nominate one member of the Company’s Board of Directors, so long as Kutula (See Note 2 in the accompanying Notes to Consolidated Financial Statements) continues to hold at least 15,500,000 of the shares purchased pursuant to its Subscription Agreement. At this time Kutula has not elected to nominate a director.

 

We do not currently have a standing nominating committee of the Board of Directors. The entire Board of Directors performs the dutites of the nominating committe and is responsible for considering and approving nominations of candidates for directors, including determining the appropriate qualifications and experience required of such candidates, and related matters.

 

 
69

 

 

In carrying out their function to nominate candidates for election to the Board of Directors, the Board considers the mix of skills, experience, character, commitment, and diversity of background of the Board of Directors at the time of such nominations. The Board of Directors believe that each candidate should be an individual who has demonstrated integrity and ethics in such candidate’s personal and professional life, has an understanding of elements relevant to the success of a publicly-traded company and has established a record of professional accomplishment in such candidate’s chosen field. Each candidate should be prepared to participate fully in board activities, including attendance at, and active participation in, meetings of the Board of Directors, and not have other personal or professional commitments that would, in the Board’s judgment, interfere with or limit such candidate’s ability to do so. The Board of Directors has no stated specific, minimum qualifications that must be met by a candidate for a position on our Board.

 

The Board of Directors’ methods for identifying candidates for election to the Board of Directors (other than those proposed by our stockholders, as discussed below) include the solicitation of ideas for possible candidates from a number of sources including members of the Board of Directors, our executives, and other sources. The Board of Directors may also from time to time retain one or more third-party search firms to identify suitable candidates.

 

Our common stockholders may nominate one or more persons for election as a director at an annual meeting of stockholders if the stockholder complies with the notice, information and consent provisions contained in our Bylaws. The notice must be made in writing and include (i) the qualifications of the proposed nominee to serve on the Board of Directors, (ii) the principal occupations and employment of the proposed nominee during the past five years, (iii) directorships currently held by the proposed nominee and (iv) a statement that the proposed nominee has consented to the nomination. The recommendation should be addressed to our Secretary.

 

 

Board Committees

 

Since the closing of the Recapitalization Agreement on July 30, 2010, we have not maintained a separately designated audit, compensation, nominating or governance committee of the Board of Directors. The functions customarily delegated to these committees are performed by our full Board of Directors.

 

The Board forms ad hoc committees from time to time to assist our Board in fulfilling its responsibilities with respect to matters that are the subject of the ad hoc committee’s mandate. During fiscal year 2012 and part of 2013, the Board maintained a Special Committee to assist our Board by making recommendations on alternative capital structures, transactions and initiatives that the committee believes are reasonably likely to maximize stockholder value. The Special Committee consisted of David Ellis, Mark Dyne and Morris Weiss, and was dissolved following the closing of the redemption transaction with CVC California, LLC and related private placement financing transaction in July 2013.

 

In 2013, the Board also formed a special ad hoc Financing Committee to review and comment on the terms of the proposed redemption of all the outstanding Series B Preferred Stock from CVC and the related private placement financing transaction. The Financing Committee consisted of David Ellis and Morris Weiss, both of whom were determined to be disinterested directors with respect to the redemption and private placement transactions. The Financing Committee was dissolved following the closing of the transactions in July 2013.

 

 
70

 

 

Audit Committee and Audit Committee Financial Expert

 

The Company is not a “listed company” under SEC rules and is therefore not required to have a separate audit committee comprised of independent directors. Our full Board of Directors performs the functions of the audit committee. The Company has, however, determined that as of December 31, 2013, each of Mssrs. Ellis, Weiss and Golden is “independent” as that term is defined in Section 5605 of the NASDAQ Marketplace Rules applicable to companies listed on The NASDAQ Stock Market, and has also determined that each of Messrs. Schnell and Ellis and Golden is an “audit committee financial expert” as defined in Item 407(d)(5) of Regulation S-K. The director biographies included above under this Item 10 describe the relevant experience of each director.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934 requires our executive officers, directors and persons who own more than ten percent of a registered class of our equity securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission.  Executive officers, directors and greater-than-ten percent stockholders are required by Securities and Exchange Commission regulations to furnish us with all Section 16(a) forms they file.  Based solely on our review of the copies of the forms received by us and written representations from certain reporting persons that they have complied with the relevant filing requirements, we believe that, during the year ended December 31, 2013, all of our executive officers, directors and greater-than-ten percent stockholders complied with all Section 16(a) filing requirements.

 

Code of Ethics

 

We have adopted a Code of Ethical Conduct that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, as well as to our other employees and directors generally.  A copy of our Code of Ethical Conduct is filed as an exhibit to our Annual Report on Form 10-K.

 

 

 

ITEM 11.     EXECUTIVE COMPENSATION

 

COMPENSATION DISCUSSION AND ANALYSIS

 

The full Board of Directors is responsible for determining the compensation to be paid to our officers and directors, with recommendations from management as to the amount and/or form of officer compensation. 

 

Our executive compensation program is administered by the Board of Directors.  The Board is responsible for, among other functions: (1) reviewing and approving corporate goals and objectives relevant to the Chief Executive Officer’s compensation and evaluating the performance of the Chief Executive Officer in light of these corporate goals and objectives; (2) administering our incentive-compensation and equity based plans; and (3) negotiating, reviewing and recommending the annual salary, bonus, stock options and other benefits, direct and indirect, of the Chief Executive Officer, and other current and former executive officers.  

 

The Board of Directors also has the authority to select and/or retain outside counsel, compensation and benefits consultants, or any other consultants to provide independent advice and assistance in connection with the execution of its responsibilities. During the course of 2013, the Company utilized the services of a nationally recognized compensation consulting firm to recommend improvements to our executive and board compensation plans for alignment with our current business strategy.  While the compensation consultant’s analysis did not affect 2013 executive compensation, the Board of Directors will consider the results from this study in formulating compensation plans for our executives beginning in 2014.

 

 
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Our named executive officers for 2013 were as follows:

 

 

Lonnie D. Schnell, Chief Executive Officer & Chief Financial Officer;

 

 

Larry Dyne, President; and

 

 

James E. Reeder, Vice President, Corporate Controller.

 

Mr. Reeder resigned from his position on February 28, 2014.

 

Compensation Philosophy

 

Our executive compensation program is designed to drive company performance to maximize stockholder value while meeting our needs and the needs of our employees. The specific objectives of our executive compensation program include the following:

 

 

Alignment – to align the interests of executives and stockholders through equity-based compensation awards;

 

 

Retention – to attract, retain and motivate highly qualified, high performing executives to lead our continued growth and success; and

 

 

Performance – to provide rewards commensurate with performance by emphasizing variable compensation that is dependent upon the executive’s achievements and company performance.

 

In order to achieve these specific objectives, our executive compensation program is guided by the following core principles:

 

 

Rewards under incentive plans are based upon our short-term and longer-term financial results and increasing stockholder value;

 

 

Senior executive pay is set at sufficiently competitive levels to attract, retain and motivate highly talented individuals who are necessary for us to achieve our goals, objectives and overall financial success;

 

 

Compensation of an executive is based on such individual’s role, responsibilities, performance and experience, taking into account the desired pay relationships within the executive team; and

 

 

Our executive compensation program places a strong emphasis on performance-based variable pay to ensure a high pay-for-performance culture. Annual performance of our company, primarily in terms of performance measured by an adjusted earnings before interest, taxes, depreciation and amortization for the year, and the executive are taken into account in determining annual bonuses that ensure a high pay-for-performance culture.

 

Compensation Elements

 

We compensate senior executives through a variety of components, including base salary, annual incentives, equity incentives and benefits and perquisites, in order to provide our employees with a competitive overall compensation package. The mix and value of these components are impacted by a variety of factors, such as responsibility level, individual negotiations, performance and market practice. The purpose and key characteristics for each component are described below.

 

 
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Base Salary

 

Base salary provides executives with a steady income stream and is based upon the executive’s level of responsibility, experience, individual performance and contributions to our overall success. Competitive base salaries, in conjunction with other pay components, enable us to attract and retain highly talented executives. The Board typically sets base salaries for our senior executives at market levels. However, base salaries will vary in practice based upon an individual’s performance, individual experience and negotiations, and for changes in job responsibilities.

 

Management Incentive Bonuses

 

Management incentive bonuses are a variable performance-based component of compensation. The primary objective of an annual incentive bonus is to reward executives for achieving corporate and individual goals and to align a meaningful portion of total pay opportunities for executives and other key employees to the attainment of our company’s performance goals. These awards are also used as a means to recognize the contribution of our executive officers to overall financial, operational and strategic success.

 

Equity Incentives

 

Equity incentives are intended to align senior executive and stockholder interests by linking a meaningful portion of executive pay to long-term stockholder value creation and financial success over a multi-year period. Equity incentives are also provided to our executives to attract and enhance the retention of executives and other key employees and to facilitate stock ownership by our senior executives. The Board of Directors also considers individual and company performance when determining long-term incentive opportunities.

 

Health & Welfare and 401-K Benefits

 

The named executive officers participate in a variety of retirement, health and welfare and paid time-off benefits designed to enable us to attract and retain our workforce in a competitive marketplace. Health and welfare and paid time-off benefits help ensure that we have a productive and focused workforce.

 

Severance and Change of Control Arrangements

 

We do not have a formal plan for severance or separation pay for our employees, but we typically include a severance provision in the employment agreements of our executive officers that is triggered in the event of involuntary termination without cause or in the event of a change in control.

 

In order to preserve the morale and productivity and encourage retention of our key executives in the face of the disruptive impact of an actual or rumored change in control, we provide a bridge to future employment in the event that an executive’s job is eliminated as a consequence of a change in control. This provision is intended to align executive and stockholder interests by enabling executives to consider corporate transactions that are in the best interests of the stockholders and other constituents without undue concern over whether the transactions may jeopardize the executive’s own employment. Our employment agreements with our current named executive officers provide a lump sum payment and benefits continuation as a result of an involuntary termination without cause or for good reason following a change in control, plus accelerated vesting of stock or option awards.

 

Other Benefits

 

In order to attract and retain highly qualified executives, we provide some of our named executive officers, with automobile allowances that we believe are consistent with current market practices. Our executives also may participate in a 401(k) plan under which we match contributions for all employees up to 100% of an employee’s contributions to a maximum of $1,000 and subject to any limitations imposed by ERISA.

 

 
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Other Factors Affecting Compensation

 

Accounting and Tax Considerations 

 

We consider the accounting implications of all aspects of our executive compensation program. Our executive compensation program is designed to achieve the most favorable accounting (and tax) treatment possible as long as doing so does not conflict with the intended plan design or program objectives.

 

Process for Setting Executive Compensation

 

When making pay determinations for named executive officers, the Board considers a variety of factors including, among others: (1) actual company performance as compared to pre-established goals; (2) overall company performance and size relative to industry peers; (3) individual executive performance and expected contribution to our future success; (4) changes in economic conditions and the external marketplace and (5) in the case of named executive officers, other than Chief Executive Officer, the recommendation of our Chief Executive Officer. Ultimately, the Board uses its judgment when determining how much to pay our executive officers. The Board evaluates each named executive officer’s performance during the year against established goals, leadership qualities, business responsibilities, current compensation arrangements and long-term potential to enhance stockholder value. The opinions of outside consultants may also be taken into consideration in deciding what salary, bonus, long-term incentives and other benefits and severance to give each executive in order to meet our objectives stated above.

 

The Board considers compensation information from data gathered from annual reports and proxy statements from companies that the Board generally considers comparable to us; compensation of other Company employees for internal pay and equity purposes; and levels of other executive compensation plans from compensation surveys.

 

The Board sets the pay for the named executive officers and other executives, by element and in the aggregate, at levels that it believes are competitive and necessary to attract and retain talented executives capable of achieving our long-term objectives.

 

Factors Considered

 

In administering the compensation program for senior executives, including named executive officers, the Board considers the following:

 

 

Cash versus non-cash compensation. The pay elements are cash-based except for the long-term incentive program, which may be cash-based, equity-based, or a combination. In 2010, long-term incentive compensation included grants of restricted stock units to our Chief Executive Officer and to our President, which grants were made in connection with the recapitalization transaction that closed in July 2010;

 

 

Prior year’s compensation. The Board of Directors considers the prior year’s bonuses and long-term incentive awards when approving bonus payouts or equity grants;

 

 

Adjustments to Compensation. On an annual basis, and in connection with setting executive compensation packages, the Board of Directors reviews our operating income growth, earnings before interest and taxes growth, earnings per share growth, cash flow growth, operating margin, revenue growth and total stockholder return performance. In addition, the Board of Directors considers peer group pay practices, emerging market trends and other factors. No specific weighing is assigned to these factors nor are particular targets set for any particular factor. Total compensation from year to year can vary significantly based on our and the individual executive’s performance; and

 

 

Application of discretion. It is our policy and practice to use discretion in determining the appropriate compensation levels considering performance.

 

 
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REPORT OF COMPENSATION COMMITTEE

 

The full Board of Directors performs the functions of a compensation committee and is responsible for considering and making decisions regarding executive compensation and is responsible for administering our stock option and executive incentive compensation plans.

 

The Board of Directors has reviewed and discussed with management the Compensation Discussion and Analysis included in this report. Based on the review and discussion with management, the Board of Directors has determined that the Compensation Discussion and Analysis should be included in the Company’s Annual Report on Form 10-K.

 

Board of Directors

Mark Dyne

Lonnie D. Schnell

David Ellis      

Morris Weiss

Robert L. Golden

 

March 24, 2014

 

 

EXECUTIVE COMPENSATION

 

Summary Compensation Table

 

The following table sets forth, as to each person serving as Chief Executive Officer and Chief Financial Officer during 2013 and the two mostly highly compensated executive officers other than the Chief Executive Officer and Chief Financial Officer at the end of the 2013 whose compensation exceeded $100,000 (referred to as “named executive officers”), information concerning all compensation earned for services to us in all capacities for 2011, 2012 and 2013.

 

 
75

 

 

 

Year

 

Salary

   

Bonus

(1)

   

Option

Award (2)

   

Non-Equity

Incentive Plan Compensation

 (3)

   

All Other Compensation

(4)

   

Total

 

Lonnie D. Schnell

                                                 

Chief Executive Officer

2013

  $ 375,000     $ 36,268     $ -     $ 344,500     $ 40,672     $ 796,440  

and Chief Financial

2012

    375,002       15,546       -       172,146       39,733       602,427  

Officer

2011

    349,519       80,436       -       -       39,288       469,243  

Larry Dyne

                                                 

President

2013

  $ 350,000     $ 36,268     $       $ 323,000     $ 24,783     $ 734,051  
 

2012

    350,001       15,546       -       160,669       23,438       549,654  
 

2011

    324,519       75,436       -       -       22,693       422,648  

James E. Reeder

                                                 

Vice President,

2013

  $ 180,000     $ -     $ -     $ -     $ 26,987     $ 206,987  

Corporate Controller

2012

    176,981       5,000       -       -       22,346       204,327  
 

2011

    175,000       15,000       9,091       -       20,470       219,561  

 

 

(1)

Bonus compensation consists of discretionary bonuses awarded to the named executives based upon performance, and discretionary bonuses associated with the tax consequences of RSU settlements. Bonuses are reported for the year in which they were earned and are generally paid in the first quarter of the subsequent year.

 

 

(2)

The option award represents the aggregate grant date fair value computed in accordance with ASC 718 with respect to option awards or stock awards granted in the applicable year. Pursuant to SEC rules, the amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. For additional information on the valuation assumptions with respect to these grants, refer to Note 6 of our accompanying Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. These amounts do not reflect the actual value that may be realized by the named executive officers which depends on the value of our shares in the future.

 

 

(3)

Non-equity incentive plan compensation for 2013 and 2012 consists of awards from the EBITDA Bonus Plan, a cash incentive plan, which was established pursuant to our employment agreements with Mr. Schnell and Mr. Dyne. Bonuses are reported for the year in which they were earned and are generally paid in the first quarter of the subsequent year.

 

 
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(4)

All other compensation consists of the following (amounts in dollars):

 

 

Year

 

Health and 

medical

insurance

 premiums

   

Life and

disability

 insurance

   

401k company matching contributions

   

Automobile allowances

   

Total

 
                                           

Lonnie D. Schnell

2013

  $ 28,729     $ 1,722     $ 1,000     $ 9,221     $ 40,672  
 

2012

    27,408       1,722       1,000       9,603       39,733  
 

2011

    27,727       301       1,000       10,260       39,288  
                                           

Larry Dyne

2013

  $ 16,505     $ 5,747     $ 1,000     $ 1,531     $ 24,783  
 

2012

    15,250       5,572       1,000       1,616       23,438  
 

2011

    15,438       4,084       1,000       2,171       22,693  
                                           

James E. Reeder

2013

  $ 24,894     $ 1,093     $ 1,000     $ -     $ 26,987  
 

2012

    20,275       1,071       1,000       -       22,346  
 

2011

    19,169       301       1,000       -       20,470  

 

Executive Compensation

 

Chief Executive Officer and Chief Financial Officer. The 2011, 2012 and 2013 base salary and other compensation for Lonnie Schnell, our Chief Executive Officer, was determined in accordance with our employment agreement and related amendments. The terms and conditions established in this agreement were the result of consideration of our operating performance levels, at the time of entering into the agreement and for prior periods, comparative industry compensation levels and negotiations with Mr. Schnell. The base compensation was evaluated in conjunction with the long-term equity awards and annual bonus incentives to establish a compensation arrangement providing a substantial incentive for the achievement of our long-term objectives and for adding stockholder value. On July 30, 2010 Mr. Schnell was granted a restricted stock unit award (“RSU Award”) for 5,778,500 shares of our common stock. The RSU Award vested 50% on a date which was 13 months following the grant date, and vested an additional 10% on each date which was 18, 24, 30, 36 and 42 months following the grant date, subject to full acceleration of vesting upon a change in control of the Company, as defined in the RSU Award agreement. The settlement of vested shares under the RSU Award is subject to non-revocable deferral elections delivered by Mr. Schnell.

 

In addition to the long-term equity incentive, Mr. Schnell was entitled to receive an annual cash bonus in 2011, 2012 and 2013 in an amount equal to a percentage of his base salary upon the Company achieving actual adjusted earnings before interest, taxes, depreciation and amortization (“EBITDA”) within a range, starting at 80%, of target adjusted EBITDA. The EBITDA bonus award under Mr. Schnell’s employment agreement and related amendment for 2011, 2012 and 2013 is shown in the table above as non-equity incentive plan compensation.

 

 
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President. The 2011, 2012 and 2013 base salary and other compensation for Larry Dyne, our President, was determined in accordance with our employment agreement and related amendments. The terms and conditions established in this agreement were the result of consideration of our operating performance levels at the time of entering into the agreements and for prior periods, comparative industry compensation levels and negotiations with Mr. Dyne. The base compensation was evaluated in conjunction with the long-term equity awards and annual bonus incentives to establish a compensation arrangement providing a substantial incentive for the achievement of our long-term objectives and for adding stockholder value. On July 30, 2010 Mr. Dyne was granted a RSU Award for 5,778,500 shares of our common stock. The RSU Award vested 50% on a date which was 13 months following the grant date, and vested an additional 10% on each date which was 18, 24, 30, 36 and 42 months following the grant date, subject to full acceleration of vesting upon a change in control of our Company, as defined in the RSU Award agreement. The settlement of vested shares under the RSU Award is subject to non-revocable deferral elections delivered by Mr. Dyne. In addition to the long term incentive, Mr. Dyne was entitled to receive an annual cash bonus in 2011 2012 and 2013 in an amount equal to a percentage of his base salary upon the Company achieving actual adjusted EBITDA within a range, starting at 80%, of target adjusted EBITDA. The EBITDA bonus award under Mr. Dyne’s employment agreement and related amendment for 2011, 2012 and 2013 is shown in the table above as non-equity incentive plan compensation.

 

Vice President, Corporate Controller. The compensation for James E. Reeder, our former Vice President, Corporate Controller, was in accordance with our at-will employment agreement with him. The terms and conditions established in this agreement were the result of consideration of our operating performance levels, and consistant with comparative industry compensation levels. The base compensation was evaluated in conjunction with the long-term equity awards and annual bonus incentives to establish a compensation arrangement providing a substantial incentive for the achievement of our long-term objectives and for adding stockholder value. In 2011 long-term equity in the form of options for 100,000 shares of common stock, respectively, were granted to Mr. Reeder as an inducement to maximize performance and increase stockholder value. The option grants were established to vest monthly over a four-year term, after a minimum initial term of twelve months. Bonuses for 2011 and 2012 were discretionary incentive awards based on Mr. Reeder’s individual performance and contributions.

 

 

Grants of Plan-Based Awards in Fiscal 2013

 

No equity awards were granted to any named executive officer in 2013.

 

 
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Outstanding Equity Awards at Fiscal Year 2013

 

The following table provides information with respect to outstanding stock options and stock awards held by each of the named executive officers as of December 31, 2013

 

     

Option Awards

 

RSU Stock Awards

 

 
     

Number of Securities

 underlying Unexercised

Options

           

Number of

Shares or

Units of

    Market
Value of
Shares or
 

Name

Grant

Date

 

(#)

Exercisable

   

(#) 

Unexercisable

     

Option 

Exercise

Price ($) 

 

Option

Expiration

Date

 

Stock That

Have Not

Vested

(#)(2)

    Units of
Stock
That Have
Not
Vested
($)(3)
 

Lonnie D. Schnell

6/25/08

    900,000       -     $ 0.20  

06/24/18

               
 

8/6/09

    700,000       -     $ 0.09  

8/6/19

               
 

7/30/10

                              577,850       144,463  

Larry Dyne

6/25/08

    700,000       -     $ 0.20  

06/24/18

               
 

8/6/09

    510,000       -     $ 0.09  

8/6/19

               
 

7/30/10

                              577,850       144,463  

James E. Reeder

6/1/09

    200,000       -     $ 0.11  

6/1/19

               
 

1/13/11

    72,917       27,083  (1)     $ 0.10  

1/13/21

               

 

 

 

(1)

These options become exercisable with respect to 25% of the total options shares at the end of one year from the date of the grant and the remaining shares shall become exercisable in 36 monthly installments equal to 1/48th of the Option shares on the last day of each calendar month thereafter until fully exercisable.

 

 

(2)

Each RSU original award of 5,778,500 vested 50% on a date which is 13 months following the grant date, and 10% on each date which is 18, 24, 30, 36 and 42 months following the grant date, subject to partial acceleration of vesting as part of the executives’ severance benefits and full acceleration of vesting upon a change in control of the Company, as defined in the RSU Award agreement. Issuance of the common shares upon settlement of the vested portion of the RSU Award is subject to irrevocable deferral elections delivered by the recipients.

 

 

(3)

Based on the closing price of the Common Stock on December 31, 2013 of $0.25, as reported by the OTCQB.

 

 
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Option Exercises and Stock Vested in Fiscal Year 2013

 

The following table provides information with respect to restricted stock award vesting for each of the named executive officers during 2013. There were no options exercised by named executive officers during 2013.

 

   

Stock Awards

acquired on vesting

 
Name  

Number of
Shares

(#)(1)

   

Value

Realized
($)(1)(2)

 

Lonnie D. Schnell

    1,155,700       167,577  

Larry Dyne

    1,155,700       167,577  

Total

    2,311,400       335,154  

 

 

 

(1)

The shares shown in the table above indicate 577,850 shares that vested under the RSU Awards on each of January 30, 2013 and July 30, 2013 for each of the named executives.

 

 

(2)

Based on the closing price of the Common Stock of $0.04 and $0.25 on January 30, 2013 and July 30, 2013, respectively, as reported by the OTCQB.

 

 

(3)

The following table provides information with respect to restricted stock award settlements in common stock for each of the named executive officers during 2013 puruant to deferral elections of previously vested RSU’s:

 

   

Acquired on settlement

of RSU’s

   

Acquired on settlement of

RSU’s due to Series B

redemption

 
Name  

 

Number of
Shares

(#)(1)

   

Value Realized
($)(1)(3)

   

Number of
Shares

(#)(2)

   

Value Realized ($)(2)(3)

 

Lonnie D. Schnell

    1,327,850       174,463       2,372,800       142,368  

Larry Dyne

    1,327,850       174,463       2,372,800       142,368  

Total

    2,655,700       348,926       4,745,600       284,736  

 

 

 

(1)

The shares shown in the table above indicate 750,000 and 577,850 shares that settled into common shares under the RSU Awards on January 30, 2013 and July 30, 2013, respectively for each of the named executives.

 

 

(2)

The shares shown in the table above indicate RSU Awards settled in Common Stock on July 13, 2013 due to acceleration of settlement as a result of a change in control.

 

 

(3)

Based on the closing price of the Common Stock of $0.04, $0.06 and $0.25 on January 30, 2013, July 13, 2013 and July 30, 2013, respectively, as reported by the OTCQB.

 

 
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Employment Agreements, Termination of Employment and Change of Control Arrangements

 

Employment Agreements

 

We have entered into the following employment agreements and related amendments with Lonnie D. Schnell and Larry Dyne. Mr. Reeder does not have an employment agreement.

 

Lonnie D. Schnell, Chief Executive Officer and Chief Financial Officer. On July 30, 2010, we entered into an Executive Employment Agreement with Mr. Schnell as amended on June 15, 2012 and November 8, 2013. Mr. Schnell’s employment agreement, as amended, provides that he will continue to serve as our Chief Executive Officer. The employment agreement has a term continuing through December 31, 2014, and may be extended to December 31, 2016. Pursuant to this agreement, Mr. Schnell received an annual base salary of $325,000 for the period starting on July 30, 2010 through December 31, 2010, $350,000 for the year ended December 31, 2011 and $375,000 for the years ended December 31, 2012 and 2013. Starting on January 1, 2014, Mr. Schnell’s annual base salary will be $425,000 through the remainder of the term of this agreement Such base salary may be increased, but not decreased, at the discretion of the Board. Mr. Schnell is entitled to receive an annual cash bonus in an amount equal to a percentage of his base salary upon the Company achieving actual adjusted EBITDA within a range and meeting certain performance objectives, starting at 80%, of target adjusted EBITDA as determined by the Board of Directors.

 

Mr. Schnell is entitled to an auto allowance of $1,000 per month, and reimbursement of up to $10,000 for legal fees incurred in connection with the negotiation of his employment agreement. In the event that prior to the end of the term, Mr. Schnell’s employment is terminated by us “without cause” (as defined in the agreement), by Mr. Schnell for “good reason” (as defined in the agreement) or due to Mr. Schnell’s death or disability, then conditional upon his execution of a release of claims, Mr. Schnell or his estate will be entitled to receive, in addition to all accrued salary, (1) severance payments equal to 18 months of Mr. Schnell’s base salary, (2) all options issued to Mr. Schnell shall remain outstanding for 18 months following termination, and (3) continued medical coverage for Mr. Schnell and his dependents for 18 months following termination.

 

Larry Dyne, President. On July 30, 2010, we entered into an Executive Employment Agreement with Mr. Dyne as amended on June 15, 2012 and November 8, 2013. Mr. Dyne’s employment agreement, as amended, provides that he will continue to serve as our President. The employment agreement and related amendment has a term continuing through December 31, 2014, and may be extended to December 31, 2016. Pursuant to this agreement, Mr. Dyne received an annual base salary of $300,000 for the period starting on July 30, 2010 through December 31, 2010, $325,000 for the year ended December 31, 2011 and $350,000 for the years ended December 31, 2012 and 2013. Starting on January 1, 2014 through the remainder of the term of this agreement, Mr. Dyne’s annual base salary will be $400,000. Such base salary may be increased, but not decreased, at the discretion of the Board. Mr. Dyne is entitled to receive an annual cash bonus in an amount equal to a percentage of his base salary upon the Company achieving actual adjusted EBITDA within a range and meeting certain performance objectives, starting at 80%, of target adjusted EBITDA as determined by the Board of Directors.

 

Mr. Dyne is entitled to an auto allowance of $950 per month, and reimbursement of up to $10,000 for legal fees incurred in connection with the negotiation of his employment agreement. In the event that prior to the end of the term, Mr. Dyne’s employment is terminated by us “without cause” (as defined in the agreement), by Mr. Dyne for “good reason” (as defined in the agreement) or due to Mr. Dyne’s death or disability, then conditional upon his execution of a release of claims, Mr. Dyne or his estate will be entitled to receive, in addition to all accrued salary, (1) severance payments equal to 18 months of Mr. Dyne’s base salary, (2) all options issued to Mr. Dyne shall remain outstanding for 18 months following termination, and (3) continued medical coverage for Mr. Dyne and his dependents for 18 months following termination.

 

 
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Potential Severance Payments

 

Under the Executive Employment Agreements as described above, Messrs. Schnell and Dyne will be entitled to receive severance benefits in the event that the executive’s employment is terminated due to executive’s death or disability, by us without “cause” or by the executive for “good reason.” The following table sets forth severance payments and benefits that we would have been obligated to pay to Messrs. Schnell and Dyne assuming a triggering event had occurred under each of their respective employment agreements as of December 31, 2013 as follows:

 

Name

 

Cash

Severance

Payment

($)(1)

   

Non-Equity

Incentive Plan Compensation

($)

   

Continuation of

Health Benefits

 ($)

   

Total Severance Benefits ($)

 

Lonnie D. Schnell

    715,547       344,500       46,341       1,106,388  

Larry Dyne

    666,287       323,000       22,932       1,012,219  

 

 

(1)

Includes (a) earned and unpaid base salary through the date of termination, (b) accrued but unpaid vacation and (c) severance payments equal to 18 months of base salary and payable in a lump sum or periodic payments as provided in the executive’s employment agreement and (d) car allowance payments due at the first day of the month during the severance period (18 months) as provided in the executive’s employment agreement.

 

Potential Change in Control Payments

 

Each RSU Award to Messrs. Schnell and Dyne will vest 100% upon a change in control of our Company, as defined in the RSU Award agreement. In addition, in accordance with their deferral elections, the entire vested portion of the RSU Award subject to a deferral will be immediately settled in common shares upon a change in control transaction. The following table sets forth the change in control benefits that we would have been obligated to pay to our named executive officers assuming a change of control had occurred as of December 31, 2013.

 

Name

 

Value of

Acceleration of 

Vesting of Equity 

Awards ($)(1)

 

Lonnie D. Schnell

    144,463  

Larry Dyne

    144,463  

 

 

(1)

Based on the closing price of the Common Stock on December 31, 2013 of $0.25, as reported by the OTCQB.

 

Director Compensation

 

The general policy of the Board of Directors is that compensation for independent directors should be a mix of cash and equity-based compensation. We do not pay management directors for Board service in addition to their regular employee compensation. The full Board of Directors has the primary responsibility for reviewing and considering any revisions to director compensation.

 

 
82

 

 

The following table details the total compensation earned by our non-employee directors in 2013.

 

Name

 

Fees earned or 

paid in cash

   

Option 

awards (6)

   

Total

 

Mark Dyne (1)

  $ 35,500     $ 35,000     $ 70,500  

David Ellis (2)

    70,000       35,000       105,000  

Morris Weiss (3)

    69,000       35,000       104,000  

Robert L. Golden (4)

    4,833       31,000       35,833  

Mark J. Hughes (5)

    7,000       -       7,000  

Total

  $ 186,333     $ 136,000     $ 322,333  

 

  (1) As of December 31, 2013, Mr. Mark Dyne held options to purchase a total of 415,000 shares.

 

 

(2)

As of December 31, 2013 Mr. David Ellis held options to purchase a total of 300,000 shares.

 

 

(3)

As of December 31, 2013, Mr. Morris Weiss held options to purchase a total of 200,000 shares.

 

 

(4)

As of December 31, 2013, Mr. Robet L. Golden held options to purchase a total of 100,000 shares.

 

 

(5)

Mr. Hughes resigned from his position as board member on July 12, 2013.

 

 

(6)

The grant date fair value is generally the amount we would expense in our financial statements over the award’s service period, but does not include a reduction for forfeitures.

 

 

Our current policy, adopted as of January 1, 2014, is to pay non-employee directors an annual retainer of $25,000 for service on our Board of Directors as well as $1,000 for their attendance at any meeting of the Board of Directors, regardless of whether such meeting is held in person or telephonically. In addition, our current policy is to annually grant to each non-employee director an option to purchase 50,000 shares of our common stock immediately following reelection as directors at each annual meeting of stockholders. The options vest in 12 equal monthly installments on the last day of each calendar month, and become fully vested one year from the date of grant.

 

Our Board of Directors does not have standing audit, compensation or nominating committees. The Board of Directors handles all audit, compensation and nominating committee matters. We also reimburse directors for their reasonable travel expenses incurred in attending board meetings or committee meetings.

 

The Board of Directors approved the foregoing new Board compensation policies effective for 2014 based, in part, on the results of a compensation study provided by a nationally recognized compensation consulting firm engaged by the Board in 2013. 

 

Prior to our adoption of the current policy, from January 1, 2011 through December 31, 2013 our policy was to pay non-employee directors an annual retainer of $10,000 (or $15,000 in the case of the Chairman of the Board), $1,000 for their personal attendance at any meeting of the Board of Directors or of a committee of the Board of Directors, and $500 for attendance at any telephonic meeting of the Board of Directors or of a committee of the Board of Directors. In addition, our prior policy provided for an annual grant to each non-employee director of options to purchase 100,000 shares of our common stock.

 

During 2013, members of the Special Committee received for service on that committee an additional monthly retainer of $2,000, members of the Financing Committee received for their service on that committee a retainer of $10,000 plus $2,000 for each meeting attended (whether held in person or telephonically).

 

On August 14, 2013, we issued 100,000 options to each of the Messrs. Mark Dyne, David Ellis and Morris Weiss in connection with the reelection as directors. On September 17, 2013, we issued 100,000 options to Robert L. Golden in connection with his appointment as a director.

 

 
83

 

 

Risk Assessment Regarding Compensation Policies and Practices

 

Our compensation program for employees does not create incentives for excessive risk taking by our employees or involve risks that are reasonably likely to have a material adverse effect on our Company.  Our base salary component of compensation does not encourage risk-taking because it is a fixed amount.  Our executive bonus plan for senior executives and our equity compensation awards have the following risk-limiting characteristics:

 

 

Cash awards to each executive officer under management incentive bonus plans are set in a market range and are limited by the terms of the plan for senior executives to a fixed maximum specified in the plan;

 

 

Equity and discretionary cash awards are made based on a review of a variety of indicators of performance, thus diversifying the risk associated with any single indicator of performance;

 

 

Neither cash nor equity awards are tied to formulas that could focus executives on specific short-term outcomes;

 

 

Members of the Board of Directors approve the final cash incentive awards made under the executive bonus plan for senior executives in their discretion, after the review of executive and corporate performance;

 

 

Members of the Board of Directors approve all equity awards for senior executives in their discretion; and

 

 

An equity award’s value is delivered in the form of stock and options that vest over multiple years, which aligns the interests of executive officers to long-term stockholder interests.

  

 

Compensation Committee Interlocks and Insider Participation

 

The Board of Directors currently performs the function of a compensation committee. None of our current executive officers has served as a member of the board of directors or compensation committee of any entity for which a member of our Board of Directors has served as an executive officer.

 

 
84

 

 

ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

Equity Compensation Plan Information

 

The following table sets forth certain information as of December 31, 2013 regarding equity compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance:

 

Name

 

Number of

securities to be

issued upon 

exercise of

outstanding 

options, 

warrants and

rights

   

Weighted-

average 

exercise price

of outstanding

options,

warrants, and

rights

   

Number of 

securities

remaining

available for

future issuance 

under equity 

compensation

 plans

 

Equity compensation plans approved by security holders

    6,221,725     $ 0.19       11,534,063  

Equity compensation plans not approved by security holders

    1,155,700       -       -  

 

 

Equity compensation plans not approved by security holders consist of restricted stock units (“RSU”) awarded to certain executives in 2010. On July 30, 2010, we awarded each of Lonnie Schnell and Larry Dyne an RSU Award for 5,778,500 shares of our common stock. Each RSU Award vested 50% on August 30, 2011, and 10% on each date which was 18, 24, 30, 36 and 42 months following the grant date, subject to partial acceleration of vesting as part of the executives’ severance benefits and full acceleration of vesting upon a change in control of the Company. As of July 30, 2010, the RSU’s were valued at $2,263,884, which was reduced by the fair value of the options surrendered by the employees in connection with these grants.

 

On August 30, 2010, Messrs. Schnell and Dyne elected to defer the settlement in common shares of 5,434,200 RSU’s beyond the vesting dates. On July 12, 2013, 4,745,600 shares of common stock were issued upon settlement of previously vested restricted stock units pursuant to the deferral elections.

 

   

Number of RSU’s

 
   

Total RSU’s

awarded

   

Common

shares issued

   

Intrinsic value

at the time of issuance

   

Shares 

remaining to

 be issued

 

 

July 30, 2010

    11,557,000       -     $ 0.196          

August 30, 2011

    -       600,000     $ 0.10          

January 30, 2012

    -       900,000     $ 0.05          

July 30, 2012

    -       1,500,000     $ 0.04          

January 30, 2013

    -       1,500,000     $ 0.04          

July 12, 2013

    -       4,745,600     $ 0.06          

July 30, 2013

    -       1,155,700     $ 0.25          

Total at December 31, 2013

    11,557,000       10,401,300               1,155,700  

 

 
85

 

 

 

Subsequent to December 31, 2013, on January 30, 2014, 1,155,700 shares of common stock were issued upon settlement of vested restricted stock units, and 544,806 were retained by the Company in payment of the tax associated with the vesting of restricted stock units previously granted to the reporting persons. At the time of the issuance the intrinsic value of these shares was $0.25 per share.

 

Each of the above plans provides that the number of shares with respect to which options and warrants may be granted, and the number of shares of common stock subject to an outstanding option or warrant, shall be proportionately adjusted in the event of a subdivision or consolidation of shares or the payment of a stock dividend on common stock.

 

Security Ownership of Certain Beneficial Owners and Management

 

The following table presents information regarding the beneficial ownership of our common stock as of March 24, 2014:

 

 

each person who is known to us to be the beneficial owner of more than 5% of our outstanding common Stock;

 

 

each of our current directors;

 

 

each of our named executive officers; and

 

 

all of our directors and executive officers as a group.

 

 Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission that deem shares to be beneficially owned by any person who has shares voting or investment power with respect to such shares. Shares of Common Stock underlying warrants or options currently exercisable or exercisable within sixty (60) days of the date of this information are deemed outstanding for purposes of computing the percentage ownership of the person holding such warrants or options but are not deemed outstanding for computing the percentage ownership of any other person. As a result, the percentage of outstanding shares of any person as shown in this table does not necessarily reflect the person’s actual ownership or voting power with respect to the number of shares of Common Stock actually outstanding at March 24, 2014. Unless otherwise indicated, the persons named in this table have sole voting and sole investment power with respect to all shares shown as beneficially owned, subject to community property laws where applicable.

 

As of March 24, 2014, we had 91,990,747 shares of Common Stock issued and outstanding. The address of each person listed is in our care, at 21900 Burbank Boulevard, Suite 270, Woodland Hills, California 91367, unless otherwise set forth below such person’s name.

 

 
86

 

 

   

Common
Stock

 

Name of Beneficial Owner

 

Shares

   

%

 
                 

Executive Officers and Directors:

               
                 

Lonnie D. Schnell (1)

    6,943,097       7.4  

Larry Dyne (2)

    6,557,697       7.0  

Mark Dyne (3)

    9,559,000       10.3  

David Ellis (4)

    275,000       *  

Morris Weiss (4)

    150,000       *  

Robert L. Golden (4)

    66,667       *  
                 

Executive Officers and Directors as a Group (6 persons) (5)

    23,551,461       24.6  
                 

5% Stockholders:

               

Kutula Holdings Ltd.

Fascinatio Boulevard 764

2909 VA Capelle aan den Ijssel,

Netherlands

    38,888,889       42.3  
                 

Perrtech Pty Limited

Level 3, 11 New South Head Road
Edgecliff NSW 2027, Sydney,

Australia

    8,333,333       9.1  

 

 

*

Less than 1%.

 

(1)

Consists of (i) 5,343,097 shares of Common Stock and (ii) 1,600,000 shares of Common Stock reserved for issuance upon exercise of stock options that are currently exercisable.

 

(2)

Consists of (i) 5,347,697 shares of Common Stock and (ii) 1,210,000 shares of Common Stock reserved for issuance upon exercise of stock options that are currently exercisable.

 

(3)

Consists of (i) 9,169,000 shares of Common Stock and (ii) 390,000 shares of Common Stock reserved for issuance upon exercise of stock options that are currently exercisable or will become exercisable within 60 days.

 

(4)

Consists entirely of shares of Common Stock reserved for issuance upon exercise of stock options that are currently exercisable or will become exercisable within 60 days.

 

(5)

Consists of (i) 19,859,794 shares of Common Stock and (ii) 3,691,667 shares of Common Stock reserved for issuance upon exercise of stock options that are currently exercisable or will become exercisable within 60 days.

 

The information as to shares beneficially owned has been individually furnished by our respective directors, named executive officers, and our other stockholders, or taken from documents filed with the Securities and Exchange Commission.

 

 
87

 

 

ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

Review and Approval of Related Party Transactions

 

We have adopted a policy that requires Board of Director’s approval of transactions with related persons as defined by SEC regulations, including any sales or purchase transaction, asset exchange transaction, operating agreement, or advance or receivable transaction that could put our assets or operating performance at risk. All of our directors and executive officers are required at all times, but not less than annually, to disclose all relationships they have with companies or individuals that have conducted business with, or had an interest in, us. Our executive officers monitor our operations giving consideration to the disclosed relationships and refer potential transactions to the Board of Directors for approval. The Board of Directors considers a related party transaction for its potential economic benefit to us, to ensure the transaction is “arms length” and in accordance with our policies and that it is properly disclosed in our reports to stockholders.

 

Reportable Related Party Transactions

 

Other than the employment arrangements described elsewhere in this report and the transactions described below, since January 1, 2013, there has not been, nor is there currently proposed, any transaction or series of similar transactions to which we were or will be a party:

 

 

in which the amount involved exceeds $120,000; and

 

 

in which any director, executive officer, stockholder who beneficially owns 5% or more of our common stock or any member of their immediate family had or will have a direct or indirect material interest.

 

On July 12, 2013, we entered into the Redemption Agreement with CVC (our controlling stockholder at the time) and repurchased from CVC all of the 407,160 previously outstanding shares of our Series B Preferred Stock for an aggregate purchase price of $18,800,000, which purchase price was paid by delivery to CVC of $13,000,000 in cash and an unsecured Promissory Note in the principal amount of $5,800,000. Pursuant to the Redemption Agreement, the Stockholder’s Agreement with CVC, and with Lonnie D. Schnell, Chief Executive Officer, Chief Financial Officer and a member of our Board of Directors, and Larry Dyne, our President, was terminated. In connection with the redemption in full of the Series B Preferred Stock, CVC representative on our Board of Directors, Mark Hughes, resigned from Board of Directors effective July 12, 2013. All obligations under the $5,800,000 Promissory Note due to CVC were paid in full on December 31, 2013.

 

In order to provide additional funds necessary for the redemption of the Series B Preferred Stock, we raised $5,500,000 of new equity capital through the sale, in a private placement transaction, of 61,111,109 shares of common stock at a price of $0.09 per share. The closing of the private placement was expressly conditioned upon the contemporaneous closing of the transactions under the Redemption Agreement. Zipper Holdings, LLC, a company controlled by Mark Dyne, the Chairman of our Board of Directors, acquired 8,333,333 shares of common stock in the private placement. At the closing of the private placement, the Company entered into Subscription Agreements with each of the purchasers. We also entered into a Registration Rights Agreement with the investors in the transaction. The Registration Rights Agreement provides for demand registration rights, such that upon the demand of holders of at least 25% of the shares issued in the private placement and subject to certain conditions, we will file a registration statement covering the shares issued in the private placement and requested to be included in such registration. The Registration Rights Agreement also provides certain piggyback rights, in which the holders of shares acquired in the private placement have the right to include those shares in a Company-initiated registration.

 

 
88

 

 

Director Independence

 

Because our common stock is quoted on the OTCQB, we are not subject to the listing requirements of any securities exchange or Nasdaq regarding the independence of our directors. However, we have determined that, as of December 31, 2013, each of Mssrs. Ellis, Weiss and Golden is “independent” as that term is defined in Section 5605 of the NASDAQ Marketplace Rules applicable to companies listed on The NASDAQ Stock Market. The other members of our Board of Directors are not “independent” under such rules.

 

 

 

ITEM 14.     PRINCIPAL ACCOUNTING FEES AND SERVICES

 

Services Provided by the Independent Auditors

 

Our Board of Directors performed the functions of the audit committee and is responsible for the appointment, compensation, retention and oversight of the work of the independent auditors.

 

SingerLewak LLP served as our independent registered public accounting firm for each of the fiscal years ended December 31, 2013, 2012 and 2011.

 

Audit Fees - The aggregate fees billed by our independent registered public accounting firm for professional services rendered for the audit of our annual financial statements and review of our financial statements included in our Forms 10-Q or services that are normally provided in connection with statutory and regulatory filings were $307,000 for fiscal year 2013, $315,000 for fiscal year 2012 and $326,000 for fiscal year 2011.

 

Audit-Related Fees - No fees were billed by our independent registered public accounting firm for professional services rendered for assurance and related services reasonably related to the performance of the audit or review of our financial statements (other than those reported above) for fiscal years 2013, 2012 and 2011.

 

Tax Fees - The aggregate fees billed by our independent registered public accounting firm for professional services rendered for tax compliance, tax advice and tax planning were $0 for fiscal year 2013 and 2012 and $31,000 for fiscal year 2011.

 

All Other Fees – The aggregate fees billed by our independent public registered accounting firm for services rendered to us other than the services described above under “Audit Fees,” “Audit-Related Fees” and “Tax Fees” were $4,000 for fiscal year 2013 and 2012 and $0 for fiscal year 2011 which was primarily related to governmental regulations not related to our annual or quarterly financial statements.

 

The Board of Directors approved all of the foregoing services provided by SingerLewak LLP.

 

 
89

 

 

Policy Regarding Pre-Approval of Services Provided by the Independent Auditors

 

The Board of Directors has established a general policy requiring its pre-approval of all audit services and permissible non-audit services provided by the independent auditors, along with the associated fees for those services. For both types of pre-approval, the Board of Directors considers whether the provision of a non-audit service is consistent with the SEC’s rules on auditor independence, including whether provision of the service (1) would create a mutual or conflicting interest between the independent auditors and us, (2) would place the independent auditors in the position of auditing its own work, (3) would result in the independent auditors acting in the role of management or as our employee, or (4) would place the independent auditors in a position of acting as an advocate for us. Additionally, the Board of Directors considers whether the independent auditors are best positioned and qualified to provide the most effective and efficient service, based on factors such as the independent auditors’ familiarity with our business, personnel, systems or risk profile and whether provision of the service by the independent auditors would enhance our ability to manage or control risk or improve audit quality or would otherwise be beneficial to us.

 

 

PART IV

 

ITEM 15.      EXHIBITS, FINANCIAL STATEMENT SCHEDULE

 

(a) List the following documents filed as a part of this report:

 

(1)   Financial Statements

 

See Index to Financial Statements in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference.

 

(2)   Financial Statement Schedule

 

Schedule II – Valuation and Qualifying Accounts Reserves is included beginning on the following page.

 

(3)   Exhibits

 

See Exhibit Index attached to this Annual Report on Form 10-K, which is incorporated herein by reference.

 

 
90

 

 

Schedule II – Valuation and Qualifying Accounts and Reserves

 

Description

 

Balance at

Beginning

of Year

   

Additions (Adjustments)

   

Deductions

   

Balance

at End of

Year

 

2013

                               

Allowance for doubtful accounts deducted from accounts receivable in the balance sheet

  $ 1,000     $ 42,000     $ 1,000     $ 42,000  

Reserve for inventory valuation deducted from inventories on the balance sheet

    261,000       65,000       96,000       230,000  

Valuation reserve deducted from deferred income tax assets

    10,439,000       (8,538,000

)

    1,623,000       278,000  
    $ 10,701,000     $ (8,431,000

)

  $ 1,720,000     $ 550,000  

2012

                               

Allowance for doubtful accounts deducted from accounts receivable in the balance sheet

  $ 53,000     $ (26,000

)

  $ 26,000     $ 1,000  

Reserve for inventory valuation deducted from inventories on the balance sheet

    485,000       48,000       272,000       261,000  

Valuation reserve deducted from deferred income tax assets

    9,194,000       1,245,000       -       10,439,000  
    $ 9,732,000     $ 1,267,000     $ 298,000     $ 10,701,000  

2011

                               

Allowance for doubtful accounts deducted from accounts receivable in the balance sheet

  $ 133,000     $ 32,000     $ 112,000     $ 53,000  

Reserve for inventory valuation deducted from inventories on the balance sheet

    884,000       (36,000

)

    363,000       485,000  

Valuation reserve deducted from deferred income tax assets

    9,397,000       541,000       744,000       9,194,000  
    $ 10,414,000     $ 537,000     $ 1,219,000     $ 9,732,000  

 

 

(1)

Additions to the allowance for doubtful accounts include provisions for uncollectible accounts. Bad debt expense includes (and additions above exclude) net direct write-offs of approximately $0, $2,000 and $4,000 for the years ended December 31, 2013, 2012 and 2011, respectively. Additions to the inventory valuation reserve include current year provisions. Additionally, in 2013, 2012 and 2011 there were direct write-offs of $143,000, $168,000 and $243,000, respectively.

 

 

(2)

Deductions from the allowance for doubtful accounts include amounts applied to write-offs and reversals of prior period provisions. Deductions from the inventory valuation reserve include application of the reserve against obsolete, excess, slow-moving or disposed inventory.

 

 
91

 

 

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.

 

TALON INTERNATIONAL, INC.

 

Date: March 24, 2014

 

/s/ Lonnie D. Schnell          
By: Lonnie D. Schnell

 

Its: Chief Executive Officer & Chief Financial Officer

(Principal Executive Officer, Principal Financial Officer & Principal Accounting Officer)

 

 
92

 

 

POWER OF ATTORNEY

 

Each person whose signature appears below constitutes and appoints Lonnie D. Schnell and Mark Dyne, and each of them, as his true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution, for him and his name, place and stead, in any and all capacities, to sign any or all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the foregoing, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their substitutes, may lawfully do or cause to be done by virtue hereof.

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signature

 

Title

Date

       
       

/s/ Lonnie D. Schnell  

     
Lonnie D. Schnell   Chief Executive Officer, Chief Financial Officer and Director March 24, 2014
       

/s/ Mark Dyne

   

 

Mark Dyne   Chairman of the Board of Directors March 24, 2014
       

/s/ David Ellis  

   

 

David Ellis   Director March 24, 2014
       

/s/ Morris Weiss

 

 

 

Morris Weiss   Director March 24, 2014
       

/s/ Robert L. Golden  

 

 

 

Robert L. Golden   Director March 24, 2014

 

 
93

 

 

EXHIBIT INDEX

 

Exhibit

Number


Exhibit Description

   

3.1

Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to Form SB-2 filed on October 21, 1997, and the amendments thereto.

   

3.1.1

Certificate of Amendment of Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.4 to Annual Report on Form 10-KSB, filed March 28, 2000.

   

3.1.2

Certificate of Amendment of Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1.3 to Form 8-K filed on August 4, 2006.

   

3.1.3

Certificate of Ownership and Merger. Incorporated by reference to Exhibit 3.1 to Form 8-K filed on July 20, 2007.

   

3.1.4

Certificate of Amendment of Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to Form 8-K filed on November 24, 2010.

   

3.1.5

Certificate of Amendment of Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to Form 8-K filed on November 12, 2013.

   

3.2.1

Bylaws of Registrant. Incorporated by reference to Exhibit 3.2 to Form SB-2 filed on October 21, 1997, and the amendments thereto.

   

3.2.2

Certificate of Amendment to the Bylaws of Talon International, Inc., dated as of August 2, 2011. Incorporated by reference to Exhibit 3.2 to Form 8-K filed on August 4, 2011.

   

4.1

Specimen Stock Certificate of Common Stock of Registrant. Incorporated by reference to Exhibit 4.1to Form SB-2 filed on October 21, 1997, and the amendments thereto.

   

10.1

Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.1to Form SB-2 filed on October 21, 1997, and the amendments thereto.

   

10.2+

Amended and Restated 1997 Stock Incentive Plan. Incorporated by reference to Exhibit 10.7 to Form 10-Q filed on November 13, 2006.

   

10.3+

Form of Non-statutory Stock Option Agreement. Incorporated by reference to Exhibit 10.30 to Form SB-2 filed on October 21, 1997, and the amendments thereto.

   

10.4

Form of Investor Rights Agreements dated December 28, 2001. Incorporated by reference to Exhibit 99.4 to Form 8-K filed on January 23, 2002.

   

10.5+

2007 Stock Plan. Incorporated by reference to Exhibit 10.20 to the Form 10-K filed on April 25, 2008.

   

10.6

Registration Rights Agreement, dated June 27, 2007, by Talon International, Inc., for the benefit of holders. Incorporated by reference to Exhibit 4.10 to Registration Statement on Form S-3 filed on August 10, 2007.

   

10.7+

Amended and Restated Talon International, Inc. 2008 Stock Incentive Plan. Incorporated by reference to Exhibit 10.20 to Form 10-K filed on March 28, 2011.

 

 
94

 

 

Exhibit

Number


Exhibit Description

   

10.9+

Executive Employment Agreement, dated July 30, 2010, between Registrant and Lonnie D. Schnell. Incorporated by reference to Exhibit 10.25 to Form 10-Q filed on August 8, 2011.

   

10.9.1+

Amendment No. 1 to Executive Employment Agreement, dated as of June 15, 2012, between Registrant and Lonnie D. Schnell. Incorporated by reference to Exhibit 10.16.1 to Form 10-Q filed on August 13 2012.

   

10.9.2+

Amendment No. 2 to Executive Employment Agreement, dated as of November 6, 2013, between Registrant and Lonnie D. Schnell. Incorporated by reference to Exhibit 10.2 to Form 8-K filed on November 12, 2013.

   

10.10+

Executive Employment Agreement, dated July 30, 2010, between Registrant and Larry Dyne. Incorporated by reference to Exhibit 10.26 to Form 10-Q filed on August 8, 2011.

   

10.10.1+

Amendment No. 1 to Executive Employment Agreement, dated as of June 15, 2012, between Registrant and Larry Dyne. Incorporated by reference to Exhibit 10.17.1 to Form 10-Q filed on August 13 2012.

   

10.10.2+

Amendment No. 2 to Executive Employment Agreement, dated as of November 6, 2013, between Registrant and Larry Dyne. Incorporated by reference to Exhibit 10.3 to Form 8-K filed on November 12, 2013.

   

10.11+

Restricted Stock Unit Agreement, dated July 30, 2010, between Registrant and Lonnie D. Schnell. Incorporated by reference to Exhibit 10.8 to Form 8-K filed on August 5, 2010.

   

10.12+

Restricted Stock Unit Agreement, dated July 30, 2010, between Registrant and Larry Dyne. Incorporated by reference to Exhibit 10.9 to Form 8-K filed on August 5, 2010.

   

10.13

Securities Redemption Agreement dated July 12, 2013 among the Registrant, CVC California, LLC, Lonnie D. Schnell and Larry Dyne. Incorporated by reference to Exhibit 10.1 to Form 8-K filed on July 16, 2013.

   

10.14

$5,800,000 Promissory Note dated July 12, 2013 issued by the Registrant in favor of CVC California, LLC. Incorporated by reference to Exhibit 10.1 to Form 8-K filed on July 16, 2013.

   

10.15

Subscription Agreement dated July 12, 2013 between the Registrant and Kutula Holdings Ltd. Incorporated by reference to Exhibit 10.1 to Form 8-K filed on July 16, 2013.

   

10.16

Form of Subscription Agreement dated July 12, 2013. Incorporated by reference to Exhibit 10.1 to Form 8-K filed on July 16, 2013.

 

 
95

 

 

Exhibit

Number


Exhibit Description

   

10.17

Registration Rights Agreement dated July 12, 2013 among the Registrant, Kutula Holdings Ltd., Perrtech Pty Limited, Zipper Holdings, LLC, Fairways Investments, LLC and Manifest Capital, LLC. Incorporated by reference to Exhibit 10.1 to Form 8-K filed on July 16, 2013.

   

10.18

Commercial Credit Agreement dated December 31, 2013 between the Registrant and Union Bank, N.A. Incorporated by reference to Exhibit 10.1 to Form 8-K filed on January 7, 2014.

   

10.19

Security Agreement dated December 31, 2013 between the Registrant and Union Bank, N.A. Incorporated by reference to Exhibit 10.2 to Form 8-K filed on January 7, 2014.

   

10.20

Form of Continuing Guaranties. Incorporated by reference to Exhibit 10.3 to Form 8-K filed on January 7, 2014.

   

10.21

Form of Security Agreements. Incorporated by reference to Exhibit 10.4 to Form 8-K filed on January 7, 2014.

   

10.22

Debenture dated December 31, 2013 between Tag-It Pacific Limited and Union Bank, N.A. Incorporated by reference to Exhibit 10.5 to Form 8-K filed on January 7, 2014.

   

10.13

Securities Redemption Agreement dated July 12, 2013 among the Registrant, CVC California, LLC, Lonnie D. Schnell and Larry Dyne. Incorporated by reference to Exhibit 10.1 to Form 8-K filed on July 16, 2013.

   

14.1

Code of Ethics. Incorporated by reference to Exhibit 14.1 to Form 10-K filed on March 30, 2004.

   

21.1

Subsidiaries.

   

23.1

Consent of SingerLewak LLP.

   

24.1

Power of Attorney (included on signature page).

   

31.1

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended.

   

32.1

Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended.

   

101.INS*

XBRL Instance

 

 
96

 

 

Exhibit

Number


Exhibit Description

   

101.SCH*

XBRL Taxonomy Extension Schema

   

101.CAL*

XBRL Taxonomy Extension Calculation

   

101.DEF*

XBRL Taxonomy Extension Definition

   

101.LAB*

XBRL Taxonomy Extension Labels

   

101.PRE(*

XBRL Taxonomy Extension Presentation

   

+

Indicates a management contract or compensatory plan.

 

*

XBRL information is furnished and not filed or a part of a registration statement or prospectus for purpose of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

 

97