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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 2003
Commission file number: 0-18926
INNOVO GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 11-2928178
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5900 S. Eastern Ave., Suite 104 Commerce, CA 90040
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (323) 725-5516
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.10 par value per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months or (for such shorter period
that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of July 15, 2003, there were 18,056,562 shares of the issuer's only
class of common stock outstanding.
INNOVO GROUP INC.
QUARTERLY REPORT ON FORM 10-Q
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets as of
May 31, 2003 (unaudited) and November 30, 2002 3
Consolidated Condensed Statements of Operations
for the three months ended May 31, 2003 and
June 1, 2002, respectively (unaudited) and for
the six months ended May 31, 2003 and June 1,
2002, respectively (unaudited) 4
Consolidated Condensed Statements of Cash
Flows for the six months ended May 31, 2003
and June 1, 2002, respectively (unaudited) 5
Notes to Condensed Consolidated Financial
Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 20
Item 4. Controls and Procedures 20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Certifications 23
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
INNOVO GROUP INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(000's except per share data)
05/31/03 11/30/02
-------- --------
(unaudited)(unaudited)
Assets
CURRENT ASSETS
Cash and cash equivalents $ 882 $ 222
Accounts receivable, and due from factor
net of allowance for uncollectible accounts
of $311 (2003) and $383(2002) 1,895 2,737
Inventories 8,297 5,710
Prepaid expenses & other current assets 644 279
------- -------
TOTAL CURRENT ASSETS 11,718 8,948
------- -------
PROPERTY, PLAND and EQUIPMENT, net 1,442 1,419
GOODWILL 4,271 4,271
INTANGIBLE ASSETS, net 403 487
OTHER ASSETS 18 18
------- -------
TOTAL ASSETS $ 17,852 $ 15,143
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 4,696 $ 2,438
Due to factor 847 --
Due to related parties 3,795 4,250
Current maturities of long-term debt 787 756
------- -------
TOTAL CURRENT LIABILITIES 10,125 7,444
LONG-TERM DEBT, less current maturities 2,230 2,631
8% Redeemable preferred stock, $0.10 par
value: Authorized shares-5,000, 194 shares
(2003) and 194 shares (2002) -- --
STOCKHOLDERS' EQUITY
Common Stock, $0.10 par-shares, Aurhtorized
40,000 Issued and outstanding 15,129 (2003)
and 14,901 (2002) 1,517 1,491
Additional paid-in captial 40,954 40,343
Accumulated deficit (33,719) (33,507)
Pomissory note-officer (703) (703)
Treasury Stock (2,553) (2,537)
Accumulated other comprehensive loss 1 (19)
------- -------
TOTAL STOCKHOLDERS' EQUITY 5,497 5,068
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,852 $ 15,143
------- -------
------- -------
See accompanying notes which are an integral part of these
unaudited consolidated condensed financial statements
INNOVO GROUPINC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(000's except per share data)
(unaudited)
Three Months Ended Six Months Ended
05/31/03 06/01/02 05/31/03 06/01/02
-------- -------- -------- --------
NET SALES $ 12,013 $ 6,802 $ 23,928 $ 10,071
COST OF GOODS SOLD 8,557 4,457 17,162 6,813
------- ------- ------- -------
Gross profit 3,456 2,345 6,766 3,258
OPERATING EXPENSES
Selling, general and administrative 3,694 1,959 6,532 3,195
Depreciation and amortization 85 58 164 116
------- ------- ------- -------
3,779 2,017 6,696 3,311
INCOME (LOSS) FROM OPERATIONS (323) 328 70 (53)
INTEREST EXPENSE (215) (119) (365) (219)
OTHER INCOME (EXPENSE), net 35 14 137 20
------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES (503) 223 (158) (252)
INCOME TAXES (10) 16 53 37
------- ------- ------- -------
NET INCOME (LOSS) $ (493) $ 207 $ (211) $ (289)
------- ------- ------- -------
------- ------- ------- -------
NET INCOME (LOSS) PER SHARE:
Basic (0.03) 0.01 (0.01) (0.02)
Diluted (0.03) 0.01 (0.01) (0.02)
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 15,020 14,859 14,931 14,861
Diluted 15,020 15,330 14,931 14,861
See accompanying notes which are an integral part of these
unaudited consolidated condensed financial statements
INNOVO GROUPINC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(000's except per share data)
(unaudited)
Six Months Ended
05/31/03 06/01/02
-------- --------
CASH FLOWS (USED IN) PROVIDED BY OPERATING $ (1,296) $ 667
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital Expenditures (103) (338)
Proceeds from Real Estate Investment 853 --
Redemption of Preferred Shares (386) --
-------- -------
Cash Provided by (Used In) Investing Activities 382 (338)
CASH FLOWS FROM FINANCING ACTIVITIES
Treasury Stock Acquisitions (16) (35)
Repayments of Notes Payable and Long-Term Debt (370) (489)
Related Party Borrowings 500 --
Factor Borrowings 847 --
Proceeds from Equity Issuance 593 --
-------- -------
Cash Provided by (Used in) Financing Activities 1,554 (524)
Effect of Exchange Rate on Cash 20 --
NET CHANGE IN CASH AND CASH EQUIVIALENTS 660 (195)
CASH AND CASH EQUIVALENTS, at beginning of period 222 292
-------- -------
CASH AND CASH EQIVALENTS, at end of period 882 97
-------- -------
-------- -------
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting of only
normal recurring and consolidating adjustments) considered necessary to
present fairly the balance sheets, the results of operations and cash flows
for the period reported. The accompanying unaudited condensed consolidated
financial statements include the financial results of Innovo Group Inc.
("Innovo Group") and all its wholly-owned subsidiaries (collectively the
"Company"). All intercompany balances have been eliminated.
These accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. The balance sheet
at November 30, 2002 has been derived from the audited financial statements
at that date but does not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
While management believes that the disclosures presented are adequate to
make the information not misleading, it is recommended that the consolidated
financial statements and footnotes be read in conjunction with the
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended November 30, 2002. Operating results for the
three and six month period ended May 31, 2003 are not necessarily indicative
of the results that may be expected for the year ended November 29, 2003.
NOTE 2 - INVENTORY
Inventories are stated at the lower of cost, as determined by the
first-in, first-out method, or market. Inventories consisted of the
following (in thousands except per share data):
5/31/03 11/30/02
------ --------
Finished goods $ 7,430 $ 5,741
Work in Progress 565 --
Raw materials 407 74
------- -------
8,402 5,815
Less allowance for obsolescence and
slow moving items (105) (105)
------- -------
$ 8,297 $ 5,710
------- -------
------- -------
NOTE 3 - LONG-TERM DEBT
A summary of our long-term debt follows.
5/31/03 11/30/02
------- --------
First mortgage loan on Springfield property $ 517 $ 558
Promissory note to Azteca 695 786
Promissory note to Azteca 1,805 2,043
------ --------
Total long-term debt 3,017 3,387
Less current maturities 787 756
------ --------
$ 2,230 $ 2,631
------ --------
------ --------
NOTE 4-SHORT TERM DEBT
On June 10, 2003, the Company amended its existing financing facilities with
CIT Commercial Services ("CIT"), a unit of CIT Group, Inc. The Company
amended the previous credit facility to remove the fixed cap of $800,000 on
its inventory based line for Joe's Jeans, Inc. ("Joe's") and Innovo Azteca
Apparel, Inc. ("IAA") allow for the Company can borrow against its inventory
up to an amount equal to its factored receivables outstanding. As part of
the refinancing, the Company's IAA subsidiary entered into an inventory based
line of credit with CIT based on the same terms as Joe's. IAA did not
previously have an inventory based line of credit. The factoring rate that
the Company pays to CIT to factor its receivables was lowered to 0.4% and the
interest rate associated with borrowings under the inventory lines and
factoring facility were reduced to the Chase prime rate. The Company has also
established a letter of credit facility with CIT whereby the Company can open
letters of credit, for 0.125% of the face value, with international and
domestic suppliers provided the Company has availability on its inventory
line of credit. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital Resources" for a
further discussion of these financing agreements with CIT.
NOTE 5 -- EARNINGS PER SHARE
A reconciliation of the numerator and denominator of basic earnings per
share and diluted earnings per share is as follows (in thousands):
Three Months Ended Six Months Ended
05/31/03 6/01/02 05/31/03 06/01/02
-------- ------- -------- --------
Basic EPS Computation:
Numerator (493) 207 (211) (289)
Denominator:
Weighted Average Common
Shares outstaning 15,020 14,859 14,931 14,861
-------- ------- -------- --------
Total Shares 15,020 14,859 14,931 14,861
-------- ------- -------- --------
Basic EPS $ (0.03) $ 0.01 $ (0.01) $ (0.02)
Diluted EPS Computation:
Numerator (493) 207 (211) (289)
Denominator:
Weighted Average Common
Shares Outstanding 15,020 14,859 14,931 14,861
Incremental Shares Outstanding
from Assumed Exercise of
Options and Warrants -- 471 -- --
-------- ------- -------- --------
Total Shares 15,020 15,330 14,931 14,861
-------- ------- -------- --------
Diluted EPS $ (0.03) $ 0.01 $ (0.01) $ (0.02)
-------- ------- -------- --------
-------- ------- -------- --------
8,214,604 options and warrants were excluded from calculation of diluted EPS
at May 31,2003 as they either had an exercise price in excess of the average
market price of the Company's common stock during the quarter or their
effect would have been anti-dilutive.
8,382,521 options and warrants at June 1, 2002 were excluded from the
calculation of diluted EPS as their effect would have been anti-dilutive.
NOTE 6 - EQUITY ISSUANCE
During the second quarter ended May 31, 2003, the Company consummated two
private placements of its common stock to a limited number of "accredited
investors" pursuant to Rule 506 of Regulation D under the Securities Act of
1933, as amended, resulting in net proceeds of $571,000 to the Company. The
first private placement, completed on March 19, 2003 raised gross proceeds
of $437,000 at $2.65 per share and the second placement completed on March
26, 2003 raised gross proceeds of $168,000 also at $2.65 per share
the two private placements. Capital Wealth Management acted as the
placement agent on a best efforts basis for each of the two private
placements. In consideration of the services rendered by Capital Wealth
Management, Capital Wealth Management was paid 7% of gross proceeds. We
intend to use the proceeds from the transaction for general corporate
purposes.
The buyers of the II Shares have represented to the Company that they
purchased the II Shares for their own account, with the intention of
holding the II Shares for investment and not with the intention of
participating, directly or indirectly, in any resale or distribution of the
II Shares. The II Shares were offered and sold to the buyers in reliance
upon exemptions from registration under the 1933 Act. The buyers have
represented to the Company that they are an "Accredited Investor," as that
term is defined in Rule 501(a) of Regulation D under said Act.
On July 1, 2003, subsequent to the end of the second quarter, the Company
completed another equity private placement of its common stock resulting
in net proceeds of $8,751,200. The Company issued 2,835,481 shares at
$3.33 per share. As part of the transaction, the Company issued a warrant
to the placement agent, Sanders, Morris Harris Group, entitling the
placement agent to purchase 300,000 shares of Company common stock at
$4.50 per share, with the warrant becoming exercisable on January 1, 2004.
See "Note 8-Subsequent Events in the Notes to the Consolidated Financial
Statements" for a further discussion of the SMH private placement
transaction.
NOTE 7 - INCOME TAXES
The Company's income tax expense for the six months ended May 31, 2003
and June 1, 2002 represents estimated state and foreign income and
franchise tax expense.
NOTE 8-SUBSEQUENT EVENTS
SMH Private Placement
On July 1, 2003, subsequent to the end of the second quarter, the
company completed an equity private placement pursuant to which the
Company issued 2,835,481 shares of Company common stock valued at $3.33
per shares ("SMH Shares"). The private placement resulted in net
proceeds of $8,751,200 to the Company. As part of the transaction, the
Company issued a warrant to the placement agent, Sanders, Morris Harris
Group, entitling the placement agent to purchase 300,000 shares of
Company common stock at $4.50 per share, with the warrant having a 6
month holding period from the date of issuance.
The Company has not registered the SMH Shares and the SMH Shares will
not be registered under the Federal Securities Act of 1933, as amended
(the "1933 Act"), on the ground that this transaction is exempt from
such registration under Section 4(2) thereof as part of an issue not
involving a public offering and applicable state securities laws.
The buyers of the SMH Shares have represented to the Company that they
purchased the SMH Shares for their own account, with the intention of
holding the SMH Shares for investment and not with the intention of
participating, directly or indirectly, in any resale or distribution of
the SMH Shares. The SMH Shares were offered and sold to the buyers in
reliance upon exemptions from registration under the 1933 Act. The
buyers have represented to the Company that they are an "Accredited
Investor," as that term is defined in Rule 501(a) of Regulation D under
said Act.
Itochu Letter of Intent
On May 19, 2003, the Company's Joe's Jeans, Inc. ("Joe's") subsidiary
entered into a non-binding letter of intent with Itochu Corporation
("Itochu") of Japan pursuant to which Itochu will be granted the
licensing rights for the Joe's trademark and the distribution rights
for Joe's products in Japan.
The letter of intent grants Itochu the exclusive right to import and
distribute Joe's products in Japan. These imported products will be
purchased directly from Joe's, with Itochu being obligated to
purchase a minimum of $5.75 million of products from Joe's over the
42 month term of the agreement. Additionally, Itochu shall have the
right to develop, produce and distribute certain apparel products
bearing the Joe's mark for which Joe's will receive a royalty payment.
As part of the transaction, Itochu has agreed to purchase the
existing inventory of the Company's Japanese subsidiary Joe's Jeans
Japan, Inc. ("JJJ") for approximately $1 million, assume the
management and operations of JJJ's showroom in Tokyo and employ
certain employees of JJJ.
The Company will continue to operate JJJ until all operations have
ceased, including the fulfillment of existing purchase orders from
customers and the collection of all outstanding accounts receivables.
Upon the cessation of all operating activities, the Company intends
to dissolve the JJJ subsidiary. JJJ will incur additional expenses,
including severance payments, professional and legal fees and other
expenses assoicated with the dissolution of JJJ, of which
approximately $325,000 have been recognized in the second quarter
of 2003. For a more complete description of the terms of Itochu
transaction reference is made to the Letter of Inent which is filed
as Exhibit 10.4 to this Form 10-Q.
Blue Concepts Acquisition
On June 10, 2003 IAA entered into a non-binding letter of intent with
Azteca Production International, Inc. ("Azteca"), whereby it is
contemplated that IAA will purchase certain assets of Azteca's Blue
Concepts Division, which primarily designs, manufactures, and sells on
a wholesale basis denim and other related apparel and products to
American Eagle Outfitters, Inc. ("AEO").
According to the terms of the non-binding letter of intent and
subsequent negotiations with Azteca, IAA will purchase certain assets
of Blue Concepts, including its customer lists and current purchase
orders, for $21.8 million. Additionally, IAA will employ the existing
employees of Blue Concepts. The Company will not be assuming any of
Blue Concept's or Azteca's existing or future liabilities.
The purchase price of $21.8 million will be payabl e through the
issuance of a seven-year promissory note (the "Note"). The Note shall
bear interest at 6% and shall be an interest only note during the first
24 months and then fully amortize during the remaining 5 year period.
Under the terms of the non-binding letter of intent and subsequent
negotiations with Azteca, the Company will as soon is reasonably
predictable after closing the transaction call a shareholder's meeting
at which the Company's shareholders shall vote upon the conversion of
a portion of the Note through the issuance of 3,125,000 shares of
Company common stock valued at the greater of $4 per share or the
market value of the Company's common stock at the date shareholder
approval is obtained. In the event shareholder approval is obtained,
the Note will be reduced to $9.3 million and the shares issued
pursuant to the conversion will be non-transferable and are "locked
up" until 60 days following the end of Period II (defined below) (the
"Locked Up Shares").
As provided in the non-binding letter of intent and subsequent
negotiations with Azteca, in the event that the sales by the newly
formed Innovo Blue Concepts ("IBC") division fall below $70 million
during the first 18 month period ("Period I") following the closing of
the acquisition or $65 million during the 12 month period ("Period
II") following Period I, the Company has negotiated certain provisions
which will allow for a reduction of the purchase price through a
reduction in the principal balance of the Note and/or the return of
Locked Up Shares. In the event the Note is reduced during Period I
and then sales of IBC are greater that $65 million during Period II,
the Note shall be increased by half of the amount greater that $65
million. In the event the principal amount of the Note needs to be
reduced beyond the outstanding principal balance of such Note, then an
amount of the Locked Up Shares equal to the balance of the required
reduction shall be returned to the Company. For these purposes, the
Locked Up Shares shall be valued at $4.00 per share. Additionally, if
uring the 12 month period following the closing, AEO is no longer a
customer of IAA, the Locked Up Shares will be returned to the
Company, and any amount remaining on the balance of the Note will be
forgiven.
In the event the revenues of IBC decrease to $35 million or less
during Period I or Period II, IAA shall have the right to sell the
purchased assets back to Azteca, and Azteca shall have the right to buy
back the purchased assets for the remaining balance of the Note and any
and all Locked Up Shares shall be returned to the Company.
As part of the transaction, IAA and Azteca will enter into a
non-exclusive supply agreement for product s to be sold by IBC. In
addition, IAA will pay to Sweet Sportswear, LLC, an Azteca affiliate,
an amount equal to 2.5% of IAA's revenues generated as a result of
sales to AEO.
There can be no assurance that the parties will be able to enter into
mutually acceptable definitive documents and close the Blue Concepts
transaction.
Expansion of Board
On July 15, 2003, the Company held a board meeting at which the Board
voted to increase the number of board seats from seven to nine. The
Board is currently in the process of filling the two newly created
vacant seats.
NOTE 9-STOCK COMPENSATION
The Company follows the guidance set forth in APB No. 25 as it
pertains to the recording of expenses from the issuance of incentive
stock options. The Company has adopted the disclosure-only provisions
of SFAS No. 123. Accordingly, no compensation expense has been recorded
in conjunction with options issued to employees. Had compensation cost
been determined based on the fair value of the options at the grant
date and amortized over the option's vesting period, consistent with
the method prescribed by SFAS No. 123, the Company's net income (loss)
would have been (in thousands except per share information):
3 Months Ended 6 Months Ended
05/31/03 06/01/02 05/31/03 06/01/02
-------- -------- -------- --------
Net (loss) income as reported $ (493) $ 207 $ (211) $ (289)
Add:
Stock based compensatin expense
included in reported net income,
net of related tax effects 25 22 50 44
Deduct:
Total stock based employee
compensation expense determined
under fair market value based
method for all awards, net of
related tax effects 142 36 295 89
-------- -------- -------- --------
Pro forma net (loss) income (610) 193 (456) (334)
-------- -------- -------- --------
-------- -------- -------- --------
Net (loss) income per share
As reported - basic $ (0.03) $ 0.01 $ (0.01) $ (0.02)
As reported - diluted $ (0.03) $ 0.01 $ (0.01) $ (0.02)
Pro forma - basic $ (0.04) $ 0.01 $ (0.03) $ (0.02)
Prof forma - diluted $ (0.04) $ 0.01 $ (0.03) $ (0.02)
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants in 2003 and 2002; expected volatility of 47% and 38%; risk-free
interest rate of 5.0% and 6.0% expected lives from one to four years and
expected dividends of 0%. The Black-Scholes model was developed for use in
estimating the fair value of traded options, which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected
stock price volatility. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
employee stock options.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
When used in this Quarterly Report on Form 10-Q, the words "may," "will,"
"except," "anticipate," "intend," "estimate," "continue," "believe" and
similar expressions are intended to identify forward-looking statements.
Similarly, statements that describe our future expectations, objectives and
goals or contain projections of our future results of operations or financial
condition are also forward-looking statements. Statements looking forward in
time are included in this Quarterly Report on Form 10-Q pursuant to the "safe
harbor" provision of the Private Securities Litigation Reform Act of 1995.
Such statements are subject to certain risks and uncertainties, which could
cause actual results to differ materially, including, without limitation,
continued acceptance of the Company's product, product demand, competition,
capital adequacy and the potential inability to raise additional capital if
required, and the risk factors contained in the Company's reports filed with
the Securities and Exchange Commission pursuant to the Securities Exchange
Act of 1934, as amended, including its Annual Report on Form 10-K for the
yearended November 30, 2002. Readers are cautioned not to place undue
reliance onthese forward-looking statements, which speak only as of the date
hereof. Our future results, performance or achievements could differ
materially from those expressed or implied in these forward-looking
statements. The Company undertakes no obligation to publicly revise these
forward-looking statementsto reflect events or circumstances occurring after
the date hereof or to reflect the occurrence of unanticipated events.
Results of Operations
The following table sets forth certain statement of operations data for the
years indicated (in thousands):
Six Months Ended
05/31/02 06/01/02 % Change
------- -------- --------
Net Sales $ 12,013 $ 6,802 77%
Cost of Goods Sold 8,557 4,457 92%
------- ------- ------
Gross Profit 3,456 2,345 47%
Selling, General & Administrative 3,694 1,959 89%
Depreciation & Amortization 85 58 47%
------- ------- ------
Income (Loss) from Operations (323) 328 -198%
Interest Expense (215) (119) 81%
Other Income (Expense) 35 14 150%
------- ------- ------
Income (Loss) before Income Taxes (503) 223 -326%
Income Taxes (10) 16 -163%
------- ------- ------
Net Income (Loss) $ (493) $ 207 -338%
Six Months Ended
05/31/02 06/01/02 % Change
-------- -------- --------
Net Sales $23,928 $ 10,071 138%
Cost of Goods Sold 17,162 6,813 152%
------- ------- ------
Gross Profit 6,766 3,258 108%
Selling, General & Administrative 6,532 3,195 104%
Depreciation & Amortization 164 116 41%
------- ------- ------
Income (Loss) from Operations 70 (53) -232%
Interest Expense (365) (219) 67%
Other Income (Expense) 137 20 585%
------- ------- ------
Income (Loss) before Income Taxes (158) (252) -37%
Income Taxes 53 37 43%
------- ------- ------
Net Income (Loss) $ (211) $ (289) -27%
Comparison of Three Months Ended May 31, 2003, to Three Months Ended
June 1, 2002
Overview
During the second quarter of 2003, compared to the second quarter of 2002,
the Company increased its revenues by 77% to $12,013,000. The Company
generated a net loss of $493,000 compared to a net income of $207,000 in
the 2002 period. The comparative loss is the result of lower gross margins
coupled with increased wages at its two consumer apparel operating
subsidiaries. The increased wages are primarily a function of new
employees hired to support the expansion of Joe's Jeans apparel line
beyond its existing product categories and to launch three new brands
within the branded division of IAA.
During the period the Company also experienced a significant increase in
legal, accounting, and other professional fees and insurance associated
with the increasing size of the Company. Furthermore, the Company
experienced one-time severance and professional expenses of approximately
$325,000 in connection with the Itochu transaction, whereby the Company
will license the Joe's Jeans brand in Japan, and the anticipated
dissolution of the Joe's Jeans Japan subsidiary in the second half of 2003.
Reportable Segments
During the three months ended May 31, 2003 and June 1, 2002, the Company
operated in two segments, accessories and apparel. The accessories segment
represents the Company's historical line of business as conducted by
Innovo, Inc. ("Innovo"). The apparel segment is comprised of the operations
of Joe's Jeans, Inc. ("Joe's") and Innovo Azteca Apparel, Inc. ("IAA"). The
Company's real estate operations and corporate activities are categorized
under "other." The operating segments have been classified based upon the
nature of their respective operations, customer base and the nature of the
products sold.
The following table sets forth certain statement of operations data by
segment for the periods indicated (in thousands):
Three Months Ended
May 31, 2003 Accessories Apparel Other(A) Total
----------- ------- ------- -----
Net Revenues $ 3,185 $ 8,828 $ -- $12,013
Gross Profit 799 2,657 -- 3,456
Depreciation & Amortization 7 52 26 85
Interest Expense 57 145 13 215
Three Months Ended
June 1, 2002 Accessories Apparel Other(A) Total
----------- ------- ------- -----
Net Revenues $ 2,895 $ 3,907 $ -- $ 6,802
Gross Profit 950 1,395 -- 2,345
Depreciation & Amortization 2 56 -- 58
Interest Expense 26 72 21 119
Three Months Ended
5/31/03 to 6/1/02 Accessories Apparel Other(A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
------- -------- -------- -------- ------- -------- -------- --------
Net Revenues $ 290 10% $ 4,921 126% $ -- N/A $ 5,211 77%
Gross Profit (151) (16) 1,262 90 -- N/A 1,111 47
Depreciation & Amortization 5 250 (4) (7) 26 N/A 27 47
Interest Expense 31 119 73 101 (8) (38) 96 81
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
Net Revenues
Net revenues for the three months ended May 31, 2003 increased to $12,013,000
or 77% from $6,802,000 for the three months ended June 1, 2002. During the
period, the Company experienced a significant increase in sales to its private
label customers in both the apparel and accessories segments. In addition the
Company also experienced growth in its Joe's Jeans branded apparel and its
craft products.
Accessory
Innovo. The Company's accessory business had net revenues to $3,186,000 in the
second quarter of fiscal 2003 as compared to $2,895,000 in the second quarter
of fiscal 2002, representing a 10% increase. The increase is primarily a
result of increased sales to private label customers, which increased from
gross revenues of $640,000 in the second quarter of fiscal 2002 to gross
revenues of $1,501,000 in the second quarter of fiscal 2003. Innovo also
experienced an increase in revenues from its craft business and Bongo product
line. Innovo's craft business increased from gross revenues of $1,284,000 in
the second quarter of 2002 to $1,406,000 in the second quarter of fiscal 2003.
Additionally, Innovo's Bongo gross revenues decreased to $362,000 for the
second quarter of fiscal 2003 from $709,000. The decreased sales of our Bongo
product line are primarily related to early shipments for back-to-school
product in the second quarter a year ago.
Apparel
Joe's. During the second quarter of fiscal 2003, Joe's net revenues increased
to $2,638,000 compared to $2,452,000 in the second quarter of fiscal 2002,
resulting in an increase of 8%.
Joe's domestic sales for the current period were $1,705,000 versus with the
remaining $933,000 of sales representing international sales from Joe's
Japanese subsidiary, Joe's Jeans Japan, Inc. and sales to international
distributors. The increase in sales s attributable to growing brand awareness
and Joe's continued marketing efforts in the overseas markets. On July 14,
2003 the Company entered into a licensing and distribution agreement with
Itochu Corporation of Japan granting Itochu the exclusive licensing and
distribution rights for Joe's trademark and products in Japan. The Company
also entered into an Asset Purchase Agreement with Itochu. For a further
discussion of the Itochu transactions see "Note 8-Subsequent Events in the
Notes to the Consolidated Financial Statements."
IAA. IAA conducts is business through two divisions, its private label
division which sells apparel products to private label customers and its
branded division which develops branded apparel products for sale to retail
customers. IAA, increased its net revenues to $6,189,000 for second quarter
of fiscal 2003 compared with $1,455,000 the same quarter a year ago,
representing an increase of approximately 325%. IAA's significant increase in
revenues is largely attributable to an increase in sales by IAA's private
label division to Target Corporation's Mossimo division. IAA's private label
division's products during t he second quarter of fiscal 2003 primarily
consisted of denim jeans.
On June 10, 2003, IAA entered into a non-binding letter of intent with Azteca
Production International, Inc. ("Azteca"), whereby it is contemplated that IAA
will purchase certain assets of Azteca's Blue Concepts Division, which
primarily designs, manufactures, and sells on a wholesale basis denim and
other related apparel and products to American Eagle Outfitters ("AEO").
According to the terms of the non-binding letter of intent and subsequent
negotiations, IAA will purchase certain assets of Blue Concepts, including its
customer lists and current purchase orders, for $21.8 million. Additionally,
IAA will employ the existing employees of Blue Concepts. The Company will not
be assuming any of Blue Concept's or Azteca's existing or future liabilities.
For a further discussion of the Blue Concepts transaction, see "Note 8-
Subsequent Events in the Notes to the Consolidated Financial Statements."
IAA's branded division is currently comprised of three branded product lines,
Shago by Bow Wow, Fetish by Eve and Hot Wheels by Mattel. In the second
quarter of 2003, IAA's branded division commenced the shipping of its Shago
product line. During the second quarter the Company shipped $66,000 of Shago
products to retail department stores and boutiques nationwide. It is
anticipated that the Company will begin shipping the Fetish and Hot Wheels
products in the fourth quarter of 2003.
Gross Margin
The Company's gross margin decreased to 29% in the second fiscal quarter of
2003 from 35% in th e second fiscal quarter of 2002. The decline was
attributable to a higher percentage of sales coming from the private label
apparel segment of IAA which typically carries lower margins than the
Company's other products coupled with lower margins from the Company's
accessory division.
Accessory
Innovo. Innovo's gross margin is largely a function of Innovo's product mix
for the given period. Innovo's branded products have traditionally
experienced higher gross margins than its craft and private label businesses.
Innovo's gross margin in the second quarter of fiscal 2003 was lower than its
historical gross margin average as a result of Innovo's private label and
craft businesses representing a greater percentage of Innovo's total revenues
than in the year ago period.
The Company's accessory segment's gross margin decreased from approximately
33% in the second quarter of fiscal 2002 to 25% in the second quarter of
fiscal 2003 resulting in an 8 percentage point decrease of which 4 percentage
points are attributable to payment discounts taken by department stores and 4
percentage points are attributable to a reduction in the gross margin
associated with increased private label sales. Furthermore, while
distribution costs were down as a percent of sales the direct cost of goods
which represents the vast majority of the total cost of goods sold increased
as a percentage of sales.
Apparel
Joe's. Joe's gross margins increased from 45% in second quarter of fiscal
2002 to 56% in second quarter of fiscal 2003. During the second quarter of
fiscal 2003, Joe's cost of goods sold for its products decreased.
Consequently, Joe's gross margins in second quarter of fiscal 2003 reflect
the impact of this decrease in cost.
IAA. IAA's gross margins decreased in the second quarter of fiscal 2003 to
19% from 20% in the same quarter a year ago. The majority of the decrease is
attributable to slightly higher raw material costs for certain goods sold
during the period.
Selling, General and Administrative Expense
The Company's selling, general and administrative ("SG&A") expenses
increased in the quarter by approximately 89% from $1,959,000 in the second
quarter of fiscal 2002 to $3,694,000 in the second quarter of fiscal 2003.
The increase in SG&A expenses is largely a result of an increase in expenses
to support the Company's 77% revenue growth during the period, to hire
personnel and establish the infrastructure needed for the future revenues
expected in the second half of the year from the branded apparel division
within the IAA subsidiary.
In addition, the Company incurred approximately $325,000 of costs associated
with the licensing agreement with Itochu and the severance of certain
employees at the Joe's Jeans Japan subsidiary. See "Note 8-Subsequent Events
in the Notes to the Consolidated Financials Statements" for a further
discussion of the Itochu transactions. During the period the Company
incurred a notable increase in wages, professional fees, sales samples,
insurance and other expenses incurred to facilitate the Company's continued
growth and launch of the branded product lines by IAA's branded division.
Accessory
Innovo. Innovo's SG&A expenses decreased by approximately 4% to $724,000
for the three months ended May 31, 2003 compared to $757,000 for the three
months ended June 1, 2002. During the quarter, wage increases of
approximately 36% to $271,000 were offset by cost control efforts focused on
lowering shipping costs, reducing commissions, and managing travel expenses.
Of note, royalty expenses for the quarter decreased by 77% to $16,000 mainly
associated with a decrease in the sale of licensed goods which require
royalty payments. And Innovo's shipping costs also decreased by
approximately 51% during the period as a result of Innovo's ability to pass
shipping costs through to its customers.
Apparel
Joe's. Joe's SG&A expenses increased by approximately 121% to $1,507,000
during the quarter compared to $681,000 in the quarter a year ago. Joe's
wage expense increased significantly as a result of the increase in staff to
support Joe's expansion of its product lines beyond its current offerings.
In the aggregate, wages and commissions, which grew 35%, accounted for over
37% of Joe's SG&A. In connection with the licensing of the Joe's brand to
Itochu in Japan and the expected dissolution of the Joe's Jeans Japan
("JJJ") subsidiary, in the second half of 2003, the Company incurred a
certain employee severance expense of $253,000,or 17% of SG&A. See "Note 8-
Subsequent Events in the Notes to the Consolidated Financial Statements" for
a further discussion of the licensing and distribution agreement, and asset
purchase agreement with Itochu Corporation. Excluding the severance
expense and related professional fees, Joe's SG&A would have grown 74%.
In order to continue to achieve revenue growth, the Company actively
invests in marketing the Joe's brand through participation in trade shows
and advertising the Joe's brand in national print publications. During the
quarter, Joe's sales show and sales sample expense increased by 155% to
$102,000 and its advertising expenses increased by 242% to $89,000 compared
to the prior year's second quarter.
IAA. IAA's SG&A expenses in the second quarter of fiscal 2003 increased to
$764,000 from $170,000 in the quarter a year ago, representing a 349%
increase. As a result of a significant increase in revenues and an increase
in factored revenues as a percentage of total revenues, factoring expenses
increased at a faster pace rising from $16,000 n the second fiscal quarter
of 2002 to $97,000 in the second fiscal quarter of 2003. During the quarter,
the Company directed additional resources towards IAA's branded division's
development of the Shago product line, which began shipping at the end of
the second quarter, and the Fetish and Hot Wheels branded product lines
which are anticipated to begin generating revenues in the fourth quarter of
fiscal 2003. As a result, wages more than doubled to $268,000. The majority
of the increase in wages was due to the hiring of design, development,
distribution, and other personnel for the development and launch of the
branded apparel lines. For the period, IAA incurred expense of $203,000
or 27% of IAA's SG&A, for design, sales shows, samples, an d advertising
related to the branded product lines.
Other
IGI. IGI, which reflects the corporate expenses of the Company and
operates under the "other" segment does not have revenues. For the second
quarter of fiscal 2003, IGI's expenses, excluding interest, depreciation and
amortization, increased by approximately 117% to $682,000 compared to
$314,000 in the quarter a year ago. The most notable increase in expense
for IGI is the increase in its professional fees, management wages, and
nsurance. During the quarter, IGI's professional fee's expense increased
approximately 150% to $293,000 compared to the same quarter a year ago. The
increase in professional fees is largely attributable to additional legal
and accounting fees. IGI's management wages increased over 174% during the
quarter to $170,000 as the Company continued to hire additional personnel,
including the Company's new Chief Financial Officer and Chief Operating
Officer. IGI's remaining expenses did not differ materially compared to
the second quarter of fiscal 2002.
LMI. During the quarter, Leasall Management, Inc. ("LMI"), a wholly-owned
subsidiary of the Company, incurred $10,000 of expense in order to maintain
and operate the Company's former manufacturing facility and headquarters
located in Springfield, TN, which is now partially leased to third party
tenants.
Depreciation and Amortization Expenses
Depreciation and Amortization expenses for the Company increased in the
three-month period ended May 31, 2003 to $85,000 from $58,000 in the prior.
year period, representing an increase of 47%. The increase is primarily
attributable to an increase in LMI's depreciation of the Springfield
facility and the amortization of the licensing rights to the Joe's Jeans
trademark acquired upon the creation of Joe's. During fiscal 2002, the
Company made significant leasehold improvements to its Springfield, TN
facility. As a result, depreciation of the facility increased 150% from
$8,000 in the second quarter of fiscal 2002 to $20,000 in the second
quarter of fiscal 2003. The remaining depreciation expense is associated
with the depreciation of small operational assets such as furniture,
fixtures, leasehold improvements, machinery and software.
Interest Expense
The Company's combined interest expense for the quarter ended May 31, 2003
increased by approximately 81% to $215,000 compared to $119,000 for the
quarter ended June 1, 2002. The Company's interest expense is primarily
associated with its factoring and inventory lines of credit, the knit
acquisition purchase note, the loan to the Company by an officer of the
Company, and the note associated with the Company's former manufacturing
facility and headquarters in Springfield, TN. See "Managements Discussion
and Analysis of Financial Condition and Results of Operations-Liquidity and
Capital Resources" for a further discussion of these financing
arrangements.
Accessory
Innovo. For the three months ended May 31, 2003, Innovo's interest
expense was $57,000 compared to $26,000 for the three months ended June 1,
2002. This represents interest expense incurred from borrowings under
Innovo's factoring facility and increased borrowings under its inventory
based line of credit. See "Managements Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources" for a further discussion of these financing arrangements.
Apparel
Joe's. Joe's interest expense for the three months ended May 31, 2003 was
approximately $13,000 compared to $5,000 for the three months ended June 1,
2002. While Joe's typically factors fewer receivables than Innovo and IAA,
Joe's borrowings against its credit facility increased in the second
quarter of 2003 compared to 2002 as a result of increased borrowing on its
inventory based credit line. Additionally, Joe's increase in interest
expense reflects the interest expense associated with borrowing under Joe's
inventory based line of credit. See "Managements Discussion and Analysis
of Financial Condition and Results of Operations-Liquidity and Capital
Resources" for a further discussion of these financing arrangements.
IAA. IAA's interest expense increased for the three months ended May 31,
2003 as a result of IAA factoring a vast majority of its receivables and
then borrowing funds against these receivables. However, offsetting a
portion of the increased interest expense is a decrease in the interest
payments on a note issued pursuant to the acquisition and creation of the
IAA subsidiary. For the three months ended May 31, 2003, IAA's interest
expense increased by approximately 94% to $132,000 compared to the three
months ended June 1, 2002. See "Managements Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources" for a further discussion of these financing arrangements.
Other Income
The Company had other income net of other expenses of $35,000 in the
second quarter of 2003 compared to other income net of other expenses of a
$14,000 in second quarter of 2002.
IRI. Other income for the three months ended May 31, 2003, includes
$74,000 of income from a management fee that Innovo Realty, Inc. ("IRI")
receives pursuant to an investment the Company made through its IRI
subsidiary in the second quarter of fiscal 2002. Since the investment was
not made until the second quarter of fiscal 2002, there was not income
affiliated with IRI for the second quarter of fiscal 2002.
Additionally, the Company had $20,000 of other income from IGI. Offsetting
the majority of other income generated during the quarter were other
expenses, the two largest being rental expenses of $20,000 from tenants who
are occupying the Company's former manufacturing facility located in
Springfield, TN and unrealized Japanese currency translation expense of
$54,000.
Net Income
The Company generated a net loss of $493,000 for the three months ended
May 31, 2003 compared to net income of $207,000 for the three months ended
June 1, 2002. The loss for the quarter versus the prior period a year ago
is largely the result of increased wages at its two consumer apparel
operating subsidiaries. The increased wages are primarily a function of
new employees hired to support the expansion of Joe's beyond its existing
denim based product lines and to launch three new brands within the
branded division of IAA.
During the period the Company experienced an increase in legal,
accounting, and other professional fees and insurance expense associated
with the increasing size of the Company. Furthermore, the Company
experienced approximately $325,000 of expense associated with the
licensing and distribution agreement and asset purchase agreement with
Itochu and the anticipated dissolution of Joe's Jeans Japan in the second
half of 2003 and $54,000 of expense for of currency translation expense
as a result of the Company's Japanese operations.
Comparison of Six Months Ended May 31, 2003, to Six Months Ended June 1,
2002 Overview
During the first six months of fiscal 2003, compared to the first six
months of fiscal 2002, the Company's revenues increased by 138% to
$23,928,000 while generating a net loss of $211,000 compared to a net loss
of $289,000 in the prior year same period. All three of the Company's main
operating subsidiaries experienced significant increases in revenues
during the period. The decreased net loss is primarily attributable to the
lower SG&A expenses as a percent of revenues in the first six months of
2003 versus the comparable period a year ago despite lower gross margins
and certain one-time expenses and professional fees of approximately
$325,000 associated with the Company's Joe's Jean's Japan subsidiary. See
"Note 8-Subsequent Events in the Notes to the Consolidated Financial
Statements" for a further discussion of the licensing and distribution
agreement, and asset purchase agreemetn with Itochu Corporation.
Reportable Segments
During the six months ended May 31, 2003 and June 1, 2002, the Company
operated in two segments, accessories and apparel. The accessories
segment represents the Company's historical line of business as conducted
by Innovo. The apparel segment is comprised of the operations of Joe's
and IAA. The Company's real estate operations and corporate activities
are categorized under "other." The operating segments have been
classified based upon the nature of their respective operations, customer
base and the nature of the products sold.
The following table sets forth certain statement of operations data by
segment for the periods indicated (in thousands):
Six Months Ended
May 31, 2003 Accessories Apparel Other(A) Total
----------- ------- ------- -----
Net Revenues $ 5,928 $ 18,000 $ -- $23,928
Gross Profit 1,593 5,173 -- 6,766
Depreciation & Amortization 14 104 46 164
Interest Expense 95 248 22 365
Six Months Ended
June 1, 2002 Accessories Apparel Other(A) Total
----------- ------- ------- -----
Net Revenues $ 4,371 $ 5,700 $ -- $10,071
Gross Profit 1,320 1,938 -- 3,258
Depreciation & Amortization 9 86 21 116
Interest Expense 36 150 33 219
Six Months Ended
5/31/03 to 6/1/02 Accessories Apparel Other(A) Total
$ Change % Change $ Change % Change $ Change % Change $ Change % Change
------- -------- -------- -------- ------- -------- -------- --------
Net Revenues $ 1,557 36% $ 12,300 216% $ -- N/A $ 13,857 138%
Gross Profit 273 21 3,235 167 -- N/A 3,508 108
Depreciation & Amortization 5 56 18 21 25 119 48 41
Interest Expense 59 164 98 65 (11) (33) 146 67
(A) Other includes corporate expenses and assets and expenses related to real
estate operations.
Net Revenues
Net revenues for the six months ended May 31, 2003 increased to $23,928,000
or 138% from $10,071,000 for the six months ended June 1, 2002. During the
period, the Company experienced a significant increase in sales from its three
main operating subsidiaries.
Accessory
Innovo. Innovo increased its net revenues to $5,928,000 in the first six
months of fiscal 2003 compared to $4,371,000 in the first six months of fiscal
2002, representing a 36% increase. The increase is primarily a result of
increased sales to private label customers, which increased from gross
revenues of $743,000 in the first six months of fiscal 2002 to gross revenues
of $2,339,000 in the first six months of fiscal 2003. Innovo also experienced
an increase in revenues from its craft business and Bongo product line.
Innovo's craft business increased from gross revenues of $2,378,000 in the
first six months of 2002 to $2,884,000 in the first six months of fiscal 2003.
Innovo's Bongo gross revenues decreased to $781,000 for the first six months
of fiscal 2003 from $1,021,000 in the year ago period due to timing of back-
to-school sales that shipped early in the period a year ago.
Apparel
Joe's. During the first six months of fiscal 2003, Joe's net revenues
increased to $4,766,000 compared to $3,443,000 in the first six months of
fiscal 2002, resulting in an increase of 38%.
During the first six months of fiscal 2003, Joe's domestic sale s were
$3,575,000 an increase of 16% versus $3,079,000 in the year ago period. The
increase was primarily attributable to demand for Joe's brand despite a weaker
market in general for denim. Sales from international markets such as Joe's
Japanese subsidiary, Joe's Jeans Japan, Inc. and sales to international
distributors were $1,191,000 for the six month period ended May 31, 2003
representing an increase of 227% from the $364,000 in sales generated in the
six month period ended June 1, 2002. Joe's is growing brand awareness and
sales in the international markets through continued marketing efforts
overseas, Furthermore, in an effort to continue to grow its share of the
domestic and international markets, Joe's plans to increase the size of its
apparel line to include different fabrics across additional categories as a
complement to its denim pants.
IAA. IAA, which is comprised of a private label and branded division,
increased its net revenues to $13,233,000 for the first six months of fiscal
2003 compared with $2,257,000 the same quarter a year ago, representing an
increase of approximately 486%. IAA's significant increase in revenues is
largely attributable to an increase in sales to Target Corporation's Mossimo
division and other private label accounts.
On May 10, 2003, the Company, through its IAA's private label d ivision,
entered into a letter of intent with Azteca Product ional International, Inc.
("Azteca"), whereby it is contemplated that the Company will purchase certain
assets of Azteca's Blue Concepts Division. According to the terms of the non-
binding letter of intent, IAA will purchase certain assets of Blue Concepts,
including its customer lists and current purchase orders, for $21.8 million.
Additionally, IAA will employ the existing employees of Blue Concepts. The
Company will not be assuming any of Blue Concept's or Azteca's existing or
future liabilities. For a further discussion of the Blue Concepts
transaction, see "Note 8-Subsequent Events in the Notes to the Consolidated
Financial Statements."
IAA's branded division is currently comprised of three branded product
lines, Shago by Bow Wow, Fetish by Eve and Hot Wheels by Mattel. In the
second quarter of 2003, IAA's branded division commenced the shipping of its
Shago product line. During the second quarter the Company shipped $66,000 of
Shago products to retail departments and boutiques nationwide. It is
anticipated that the Company will begin shipping the Fetish and Hot Wheels
products in the fourth quarter of 2003.
Gross Margin
The Company's gross margin decreased from 32% in the second fiscal quarter
of 2002 to 28% in the second fiscal quarter of 2003. The decline was
attributable to a higher percentage of sales coming from the private label
apparel segment, which typically carries lower margins than the Company's
other products and reduced margins in the accessory segment.
Accessory
Innovo. The Company's accessory segment's gross margin decreased from
approximately 30% in the first six months of fiscal 2002 to 27% in the first
six months of fiscal 2003. The 3% decrease was attributable to extraordinary
payment discounts taken by department stores and a reduction in the gross
margin associated with increased private label sales. Furthermore, while
distribution costs were down as a percent of sales during the period, the
direct cost of goods which represents the vast majority of the total cost of
goods sold increased as a percent of sales
Apparel
Joe's. Joe's gross margins increased from 44% in the first six months of
fiscal 2002 to 58% in the irst six months of fiscal 2003. During the first
six months of fiscal 2003, Joe's cost of goods sold for its products
decreased. Consequently, Joe's gross margins in the first six months of
fiscal 2003 reflect the impact of this decrease in cost.
IAA. IAA's gross margins decreased in the first six months of fiscal 2003
to 18% from 20% in the same quarter a year ago. The majority of the decrease
is attributable to higher costs for certain goods sold during the period.
Selling, General and Administrative Expense
The Company's selling, general and administrative ("SG&A") expenses
increased in the quarter by approximately 104% from $3,195,000 in the first
six months of fiscal 2002 to $6,532,000 in the first six months of fiscal
2003. The increase in SG&A expenses is largely a result of an increase in
expenses to support the Company's revenue growth during the period, the
increase in personnel to support the launch of branded apparel products in
the second half of 2003, and costs associated with the licensing of the Joe's
Jeans brand in Japan and the anticipated dissolution of the Joe's Jeans Japan
subsidiary.
Accessory
Innovo. Innovo's SG&A expenses increased by approximately 22% to $1,455,000
for the six months ended May 31, 2003 compared to $1,197,000 for the six
months ended June 1, 2002. Innovo's increase in SG&A expenses is largely
attributable to expenses which were necessary to support or associated with
Innovo's 36% increase in revenues. During the period, Innovo's wages
increased by approximately 51% to $536,000 as a result of staff members the
Company added at its headquarters in Knoxville, TN and to its showroom in New
York City during the second half of fiscal 2002. Additionally, Innovo's wages
increased from the addition of employees at Innovo's sourcing office in Hong
Kong.
Apparel
Joe's. Joe's SG&A expenses increased by approximately 155% to $2,738,000
during the quarter compared to $1,075,000 in the quarter a year ago. Joe's
wage expense increased significantly as a result of the employee increase
to support Joe's growth and certain severance payment and professional
fees in connection with the licensing of the Joe's brand to Itochu in
Japan and the anticipated dissolution of the Joe's Jeans Japan subsidiary
in the second half of 2003. In the aggregate, wages and commissions,
which grew 71%, accounted for over 39% of Joe's SG&A. Excluding the
severance payment and related expenses, Joe's SG&A expense would have
been $2,413,000 a 124% increase.
In order to continue to achieve revenue growth, the Company actively
invests in marketing the Joe's brand through participation in trade shows
and advertising the Joe's brand in national print publications. During
the first six months of fiscal 2003, Joe's sales show and sales sample
expense increased by 160% to $229,000 and its advertising expenses
increased by 178% to $217,000 compared to the prior year's the first six
months. In response to sales growth, Joe's factoring expense increased
111% to $40,000 in the first six months due to an increase in the number
of receivables Joe's factored. See "Management's Discussion and Analysis
of Financial Condition and Results of Operation-Liquidity and Capital
Resources" for a further discussion of the f actoring agreement between
Joe's and the CIT Group, Inc.
IAA. IAA's SG&A expenses in the first six months of fiscal 2003
increased to $1,176,000 from $277,000 in the period a year ago,
representing a 325% increase. SG&A grew more slowly than revenues despite
increased cost associated with the branded apparel lines launch. During
the period, the Company directed additional resources towards the
development of three branded product lines, which are anticipated to
begin generating material revenues in the second half of fiscal 2003.
Wages during the period increased 66% to $387,000 from $233,000 with the
vast majority of the increase occurring in the second quarter of fiscal
2003. For the period, IAA incurred expenses of $333,000 or 28% of IAA's
SG&A, for design, sales shows, samples, and advertising related to the
branded product lines.
Other
IGI. IGI, which reflects the corporate expenses of the Company and
operates under the "other" segment does not have revenues. For the first
six months of fiscal 2003, IGI's expenses, excluding interest,
depreciation and amortization, increased by approximately 87% to
$1,138,000 compared to $609,000 in the same period a year ago. The most
notable increase in expense for IGI is the increase in its professional
fees and management wages. During the six month period, IGI's
professional fee's expense increased approximately 143% compared to the
same period a year ago. The increase in professional fees is largely
attributable to additional legal and accounting fees. IGI's management
wages increased over 141% during the six month period to $280,000 as the
Company continues to hire additional personnel to support the Company's
growth and development, including the addition of the Company's new Chief
Financial Officer and Chief Operating Officer. IGI's remaining expenses
did not differ materially compared to the first six months of fiscal
2002.
LMI. During the quarter, Leasall Management, Inc. ("LMI"), a wholly-
owned subsidiary of the Company, incurred $19,000 of expense in order
to maintain and operate the Company's former manufacturing facility and
headquarters located in Springfield, TN, which is now partially leased
to third party tenants.
Depreciation and Amortization Expenses
Depreciation and Amortization expenses for the Company increased in the
six-month period ended May 31, 2003 to $164,000 from $116,000 in the
prior year period, representing an increase of 41%. The increase is
primarily attributable to an increase in LMI's depreciation of the
Springfield facility and the amortization of the licensing rights to the
Joe's Jeans trademark acquired upon the creation of Joe's. During fiscal
2002, the Company made significant leasehold improvements to its
Springfield, TN facility. As a result, depreciation of the facility
increased 147% from $15,000 in the first six months of fiscal 2002 to
$37,000 in the first six months of fiscal 2003. The remaining
depreciation expense is associated with the depreciation of small
operational assets such as furniture, fixtures, leasehold improvements,
machinery and software.
Interest Expense
The Company's combined interest expense for the six months ended May 31,
2003 increased by approximately 67% to $365,000 compared to $219,000 for
the six months ended June 1, 2002. The Company's interest expense is
primarily associated with its factoring and inventory lines of credit,
the knit acquisition purchase note, the loan to the Company by an officer
of the Company, and the note associated with the Company's former
manufacturing facility and headquarters in Springfield, TN. See
"Managements Discussion and Analysis of Financial Condition and Results
of Operations-Liquidity and Capital Resources" for a further discussion
of these financing arrangements.
Accessory
Innovo. For the six months ended May 31, 2003, Innovo's interest
expense was $95,000 compared to $36,000 for the six months ended June 1,
2002. This represents interest expense incurred from borrowings under
Innovo's factoring facility and inventory based line of credit. See
"Managements Discussion and Analysis of Financial Condition and Results
of Operations-Liquidity and Capital Resources" for a further discussion
of these financing arrangements.
Apparel
Joe's. Joe's interest expense for the six months ended May 31, 2003 was
approximately $29,000 compared to $9,000 for the six months ended June 1,
2002. While Joe's typically factors fewer receivables than Innovo and
IAA, with the significant increase n revenues, Joe's borrowings against
its factoring facility increased significantly in the first six months of
2003 compared to 2002. Additionally, Joe's increase in interest expense
reflects the interest expense associated with borrowing under Joe's
inventory based line of credit. See "Managements Discussion and Analysis
of Financial Condition and Results of Operations-Liquidity and Capital
Resources" for a further discussion of these financing arrangements.
IAA. IAA's interest expense increased for the six months ended May 31,
2003 as a result of IAA factoring a vast majority of its receivables and
then borrowing funds against these receivables. However, offsetting a
portion of the increased interest expense is a decrease in the interest
payments on a note issued pursuant to the acquisition and creation of the
IAA subsidiary. For the six months ended May 31, 2003, IAA's interest
expense increased by approximately 55% to $219,000 compared to the six
months ended June 1, 2002.
Other Income
The Company had other income net of expenses of $136,000 in the first
six months of 2003 compared to other income net of expenses of a $19,000
in the first six months of 2002.
IRI. The increase in other income for the six months ended March 1,
2003, is largely attributable to $159,000 of income from a management fee
that Innovo Realty, Inc. ("IRI") receives pursuant to an investment the
Company made through its newly formed IRI subsidiary in the first six
months of fiscal 2002, thus there was not other income affiliated with
IRI for the first six months of fiscal 2002 since the investment was not
made until the first six months of 2002.
Net Income (Loss)
The Company generated a net loss of $211,000 for the six months ended
May 31, 2003 compared to a net loss of $289,000 for the six months ended
June 1, 2002. The decreased net loss is primarily attributable to the
lower SG&A as a percent of revenues in the first six months of 2003
versus the comparable period a year ago despite lower gross margins and
a one-time severance payment and professional fees associated with the
Company's Japanese operations of approximately $325,000.
Liquidity and Capital Resources
The Company's primary sources of liquidity are cash flows from
operations, trade payables credit from vendors and related parties and
borrowings from the factoring of accounts receivables and borrowing
against inventory.
Cash used for operating activities during the six months ended May 31,
2003 was $1,296,000 compared to cash provided by operating activities of
$667,000 during the six months ended June 1, 2002. During the period,
cash generated from the reduction of receivables that the Company did not
factor with CIT was offset by an increase in inventory and a decrease in
related party payables and an increase in prepaid expenses resulting in a
net use of cash for operating activities of $1,296,000. Cash used in
operating activities combined with cash generated by investing
activities, cash generated through a related party borrowing of $500,000,
proceeds from an equity issuance of $593,000 and borrowings under the
Company's asset backed line of credit resulted in a $660,000 increase in
cash during the period.
The Company is dependent on credit arrangements with suppliers and
factoring and inventory based lines of credit agreements for working
capital needs. From time to time, the Company has obtained short-term
working capital loans from senior members of management and from members
of the Board of Directors, and conducted equity financing through private
placements.
The Company relied on the following primary sources to fund operations
during the second quarter of fiscal 2003:
- - A financing and inventory based line of credit agreements with CIT
Commercial Services, a unit of CIT Group, Inc. ("CIT")
- - Cash balances- Trade payables credit with its domestic and international
suppliers
- - Trade payables credit from related parties
- - Two equity financings through private placements
On June 1, 2000, the Company, through its three main operating
subsidiaries, Joe's, Innovo, and IAA, entered into a financing agreement
with CIT for the factoring of the Company's accounts receivables.
Pursuant to the terms of the agreements the Company, at its option, can
sell its accounts receivables to CIT and then borrow up to 85% of the
amount factored against the receivables on a non-recourse basis,
provided that CIT approves the receivables in advance. The Company may
at its option also factor non-approved receivables on a recourse basis.
The Company continues to be obligated in the event of product defects
and other disputes, unrelated to the credit worthiness of the customer.
The agreements called for a 0.8% factoring fee on invoices factored with
CIT and a per annum rate equal to the greater of the Chase prime rate
plus 0.25% on funds borrowed against the factored receivables or 6.5%
per annum.
In August 2002, Joe's and Innovo amended their factoring agreements
with CIT to include an inventory based line of credits for Joe's and
Innovo. According to the terms of the agreements, amounts loaned
against inventory were to bear an interest rate equal to the greater
of the Chase prime rate plus 0.75% or 6.5% per annum. Under these
agreements, the Company was restricted in regards to how much CIT will
loan against the inventory. The restrictions limited the amount Joe's
and Innovo could borrow against its inventory at $400,000 for each
subsidiary.
On June 10, 2003, the Company amended its existing financing facilities
with CIT. The Company amended the previous credit facility to remove
the fixed caps on its inventory based line for Joe's and Innovo allowing
the Company to borrow against its inventory up to an amount equal to its
eligible receivables. As part of the refinancing, the Company's IAA
subsidiary entered into an inventory based line of credit with CIT based
on the same terms as Joe's and Innovo since IAA did not previously have
an inventory based line of credit. Additionally, the factoring rate that
the Company pays to CIT for factoring its receivables was lowered to
0.4% and the interest rate associated with borrowings under the
inventory lines and factoring facility were reduced to the Chase prime
rate. The Company has also established a letter of credit facility with
CIT.
Based on the Company's anticipated internal growth in 2003, the Company
believes that it has the working capital resources necessary to meet the
operational needs associated with such growth. During and subsequent to
the second quarter, the Company raised additional working capital
through equity financing. The Company believes that with the equity
financing and the amended financing agreements with CIT, it has
addressed its short-term working capital needs. See "Management's
Discussion and Analysis on Financial Results and Operational Conditions-
- -Equity Financing."
However, if the Company continues to grow at its current rate and due
to the seasonality of the Company's business, the Company believes that
it might be necessary to obtain additional working capital through debt
or equity financing. The Company believes that any additional capital,
to the extent needed, could be obtained from the sale of equity
securities or short-term working capital loans. There can be no
assurance that this or other financing will be available if needed. The
inability of the Company to be able to fulfill any interim working
capital requirements would force the Company to constrict its
operations. The Company believes that the relatively moderate rate of
inflation over the past few years has not had a significant impact on
the Company's revenues or profitability.
Equity Financing
During the second quarter ended May 31, 2003, the Company consummated
two private placements resulting in net proceeds of $571,000. The first
private placement, completed on March 19, 2003 raised gross proceeds of
$437,000 at $2.65 per share and the second placement executed on March
26, 2003 raised gross proceeds of $168,000 also at $2.65 per share. In
aggregate the Company issued 228,500 shares as a result of the two
private placements. See Item 2 for further information on these two
private placements.
On July 1, 2003, subsequent to the end of the second quarter, the
Company completed another equity private placement of its common stock
resulting in net proceeds of $8,751,200. The Company issued 2,835,481
shares at $3.33 per share. As part of the transaction, the Company
issued a warrant to the placement agent, Sanders, Morris Harris Group,
entitling the placement agent to purchase 300,000 shares of Company
common stock at $4.50 per share, with the warrant becoming exercisable
on January 1, 2004. See "Note 8-Subsequent Events in the Notes to the
Consolidated Financial Statements" for a further discussion of the SMH
private placement transaction.
Short-Term Debt
Crossman Loan
On February 7, 2003 the Company entered into a loan agreement with
Marc Crossman, a member of the Company's Board of Directors and the
Company's current Chief Financial Officer. The loan was funded in two
phases of $250,000 each on February 7, 2003 and February 13, 2003 for
an aggregate loan value of $500,000. In the event of default, each
phase is collateralized by 125,000 shares of the Company's common
stock as well as a general unsecured claim on the assets of the
Company, subordinate to existing lenders. Each phase matures six
months and one day from the date of its respective funding, at which
point the principal amount and any accrued interest is due in full.
The loan carries an 8% annualized interest rate with interest due on a
monthly basis. The loan may be repaid by the Company at any time
during the term of the loan without penalty. Further, the Company has
the option to extend the term of the loan for an additional period of
six months and one day at anytime before maturity. The disinterested
directors of the Company approved the loan from Mr. Crossman.
On June 10, 2003, the Company amended its financing agreements with
CIT. At end of the second quarter, the Company had a loan balance with
CIT of $5,655,000 of which $4,691,000 was collateralized against non
recourse factored receivables.The remaining balance was collateralized
by the Company's inventory. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations-Liquidity and Capital
Resources" for further discussion of the Company's financing agreement
with CIT.
Long-Term Debt
Long-term debt consists of the following (in thousands):
5/31/03 11/30/02
------- --------
First mortgage loan on Springfield property $ 517 $ 558
Promissory note to Azteca 695 786
Promissory note to Azteca 1,805 2,043
------- -------
Total long-term debt 3,017 3,387
Less current maturities 787 756
------- -------
$ 2,230 $ 2,631
------- -------
------- -------
The first mortgage loan, held by First Independent Bank of
Gallatin, is collateralized by a first deed of trust on real
property in Springfield, TN (with a carrying value of $1,186,000 at
May 31, 2003), and by an assignment of key-man life insurance on
the President of the Company, Pat Anderson, in the amount of $1
million. The loan bears interest at 2.75% over the lender's prime
rate per annum and requires monthly principal and interest payments
of $9,900 through February 2010. The loan is also guaranteed by the
Small Business Administration ("SBA"). In exchange for the SBA
guarantee, the Company, Innovo, Nasco Products International, Inc.,
a wholly-owned subsidiary of the Company, and the President of the
Company, Pat Anderson, have also agreed to act as guarantors for the
obligations under the loan agreement.
In connection with the acquisition of the knit division from Azteca
Production International, Inc., the Company issued promissory notes
in the face amounts of $1.0 million and $2.6 million, which bear
interest at 8.0% per annum and require monthly payments of $20,276
and $52,719, respectively. The notes have a five-year term and are
unsecured.
The $1.0 million note was subject to adjustment in the event that
the sales of the knit division did not reach $10.0 million during
the 18-month term following the closing of the Acquisition. The
principal amount was to be reduced by an amount equal to the sum of
$1.5 million less 10% of the net sales of the knit division during
the 18 months following the Acquisition. For the 18-month period
following the closing of the knit acquisition, nets sales for the
knit division exceeded the $10 million threshold.
In the event that the Company determines, from time to time, at the
reasonable discretion of the Company's management, that its
available funds are insufficient to meet the needs of its business,
the Company may elect to defer the payment of principal due under
the promissory notes for as many as six months in any one year (but
not more than three consecutive months) and as many as eighteen
months, in the aggregate, over the term of the notes. The term of
the notes shall automatically be extended by one month for each
month the principal is deferred, and interest shall accrue
accordingly.
At the election of Azteca, the balance of the promissory notes may
be offset against monies payable by Azteca or its affiliates to the
Company for the exercise of issued and outstanding stock warrants
that are owned by Azteca or its affiliates (including the Commerce
Investment Group).
The following table sets forth the Company's contractual
obligations and commercial commitments as of May 31, 2003:
CONTRACTUAL
OBLIGATIONS Payments Due by Period
Total Less than 1-3 years 4-5 After 5
1 year years years
Long Term Debt 3,016,978 385,949 1,699,938 844,228 86,863
Operating Leases 593,228 69,135 238,616 285,478
Other Long Term
Obligations-Minimum
Royalties 3,624,611 257,000 2,302,278 1,065,333
Licenses
On July 14, 2003, Joe's consummated a licensing and distribution
agreement with Itochu Corporation ("Itochu") of Japan pursuant to
which Itochu has been granted the licensing and distribution rights
for the Joe's trademark and Joe's products in the Japanese
marketplace. See "See Note 8-Subsequent Events in the Notes to the
Consolidated Financial Statements" for a further discussion of the
Itochu licensing and distribution agreement.
Seasonality
The Company's business is seasonal. The majority of the marketing
and sales activities take place from late fall to early spring. The
greatest volume of shipments and sales are generally made from late
spring through the summer, which coincides with the Company's
second and third fiscal quarters and the Company's cash flow is
strongest in its third and fourth fiscal quarters. Due to the
seasonality of the business, the third quarter results are not
necessarily indicative of the results for the fourth quarter.
Management's Discussion of Critical Accounting Policies
Management believes that the accounting policies discussed below
are important to an understanding of our financial statements
because they require management to exercise judgment and estimate
the effects of uncertain matters in the preparation and reporting
of financial results. Accordingly, management cautions that these
policies and the judgments and estimates they involve are subject
to revision and adjustment in the future. While they involve less
judgment, management believes that the other accounting policies
discussed in Note 2 "Summary of Significant Accounting Polices" of
the Consolidated Financial Statements included in our Annual
Report on Form 10-K for the year ended November 30, 2002 are also
important to an understanding of our financial statements. The
Company believes the following critical accounting policies affect
our more significant judgments and estimates used in the
preparation of our consolidated financial statements.
Revenue Recognition
Revenues are recorded on the accrual basis of accounting when the
Company ships products to its customers. Sales returns must be
approved by the Company and are typically only allowed for damaged
goods. Such returns have historically not been material.
Shipping and Handling Costs
The Company has outsourced some of its distribution needs to the
Commerce Investment Group, an affiliated company. Shipping and
handling costs include costs to warehouse, pick, pack and deliver
inventory to customers. In certain cases the Company is
responsible for the cost of freight to deliver goods to the
customer. Shipping and handling costs were approximately $254,000
and $288,000 for the three months ended May 31, 2003 and June 1,
2002, respectively. For the six months ended May 31, 2003 and
June 1, 2002, shipping and handling costs were approximately
$459,000 and $438,000, respectively.
Accounts Receivable-Allowance for Returns, Discounts and Bad
Debts
The Company evaluates its ability to collect on accounts
receivable and charge-backs (disputes from the customer) based
upon a combination of factors.In circumstances where the Company
is aware of a specific customer's inability to meet its
financial obligations (e.g., bankruptcy filings, substantial
downgrading of credit sources), a specific reserve for bad debts
is taken against amounts due to reduce the net recognized
receivable to the amount reasonably expected to be collected.
For all other customers, the Company recognizes reserves for bad
debts and charge-backs based on the Company's historical
collection experience. If collection experience deteriorates
(i.e., an unexpected material adverse change in a major
customer's ability to meet its financial obligations to the
Company), the estimates of the recoverability of amounts due us
could be reduced by a material amount.
As of May 31, 2003, the balance in the allowance for returns,
discounts and bad debts reserves was $311,000 compared to
$383,000 at November 30, 2002.
Inventory
We continually evaluate the composition of our inventories,
assessing slow-turning, ongoing product as well as product
from prior seasons. Market value of distressed inventory is
valued based on historical sales trends of our individual
product lines, the impact of market trends and economic
conditions, and the value of current orders relating to the
future sales of this type of inventory.
Valuation of Long-lived and Intangible Assets and Goodwill
The Company assesses the impairment of identifiable
intangibles, long-lived assets and goodwill whenever events or
changes in circumstances indicate that the carrying value may
not be recoverable. Factors considered important that could
trigger an impairment review include the following:
- - a significant underperformance relative to expected
historical or projected future operating results;
- - a significant change in the manner of the use of
the acquired asset or the strategy for the overall
business; or
- - a significant negative industry or economic trend.
When the Company determines that the carrying value of
intangibles, long-lived assets and goodwill may not be
recoverable based upon the existence of one or more of the
above indicators of impairment, the Company will measure
any impairment based on a projected discounted cash flow
method using a discount rate determined by our management.
No impairment indicators existed as of May 31, 2003.
In 2002, the Statement of Financial Accounting Standards
(SFAS) No. 142 "Goodwill and Other Intangible Assets," became
effective. This statement establishes financial accounting
and reporting for acquired goodwill and other intangible
assets and supersedes APB Opinion No. 17, Intangible Assets.
The Company adopted SFAS No. 142 beginning with the first
quarter of 2002. SFAS No. 142 requires that goodwill and
intangible assets that have indefinite useful lives not be
amortized but, instead, tested at least annually for impairment
while intangible assets that have finite useful lives continue
to be amortized over their respective useful lives. Accordingly,
the Company has not amortized goodwill.
SFAS No. 142 requires that goodwill and other intangibles be
tested for impairment using a two-step process. The first step
is to determine the fair value of the reporting unit, which may
be calculated using a discounted cash flow methodology, and
compare this value to its carrying value. If the fair value exceeds
the carrying value, no further work is required and no impairment
loss would be recognized. The second step is an allocation of the
fair value of the reporting unit to all of the reporting unit's
assets and liabilities under a hypothetical purchase price
allocation.
Income Taxes
As part of the process of preparing the Company's consolidated
financial statements, management is required to estimate income
taxes in each of the jurisdictions in which it operates. The
process involves estimating actual current tax expense along with
assessing temporary differences resulting from differing
treatment of items for book and tax purposes. These timing
differences result in deferred tax assets and liabilities, which
are included in the Company's consolidated balance sheet.
Management records a valuation allowance to reduce its deferred
tax assets to the amount that is more likely than not to be
realized. Management has considered future taxable income and
ongoing tax planning strategies in assessing the need for the
valuation allowance. Increases in the valuation allowance result
in additional expense to be reflected within the tax provision in
the consolidated statement of income. Reserves are also estimated
for ongoing audits regarding Federal, state and international issues
that are currently unresolved. The Company routinely monitors the
potential impact of these situations and believes that it is
properly reserved.
Contingencies
The Company accounts for contingencies in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 5,
"Accounting for Contingencies". SFAS No. 5 requires that
the Company record an estimated loss from a loss contingency
when information available prior to issuance of theCompany's
financial statements indicates that it is probable that an
asset has been impaired or a liability has been incurred at
the date of the financial statements and the amount of the
loss can be reasonably estimated. Accounting for contingencies
such as legal and income tax matters requires management to
use judgment. Many of these legal and tax contingencies can
take years to be resolved. Generally, as the time period
increases over which the uncertainties are resolved, the
likelihood of changes to the estimate of the ultimate
outcome increases. Management believes that the accruals for
these matters are adequate.
New Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." This
standard sets forth the impairment of long-lived assets,
whether they are held and used or are disposed of by sale
or other means. It also broadens and modifies the
presentation of discontinued operations. The standard is
effective for the Company's fiscal year 2003. The
adoption did not have a material effect on the Company.
The Company is in the process of evaluating the adoption
of this standard, but does not believe it will have a
material impact on its consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections." This
Statement rescinds or modifies existing authoritative
pronouncements including FASB Statement No. 4 "Reporting
Gains and Losses from Extinguishment of Debt." As a
result of the issuance of SFAS No. 145, gains and losses
from extinguishment of debt should be classified as
extraordinary items only if they meet the criteria in
Opinion 30. "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events
and Transactions." Applying the provisions of Opinion 30
will distinguish transactions that are part of an entity's
recurring operations from those that are unusual or
infrequent or that meet the criteria for classification
as an extraordinary item. The provisions of this Statement
related to the rescission of Statement 4 shall be applied
in fiscal years beginning after May 15, 2002. Any gain or
loss on extinguishment of debt that was classified as an
extraordinary item in prior periods presented that does
not meet the criteria in Opinion 30 for classification as
an extraordinary item shall be reclassified. The adoption
of SFAS No. 145 did not have a material impact on the
interim financial statements of the Company.
In June 2002, the FASB issued Statement of Financial
Accounting Standards No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (Statement
No. 146). Under Statement No. 146, it addresses
financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging
Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The provisions of
this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002,
with early application encouraged. The Company adopted
Statement No. 146 in the first quarter of 2003 with no
material effect on its results of operations, financial
position or cash flows.
In December 2002, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards
No. 148 "Accounting for Stock-Based Compensation-
ransition and Disclosure" (SFAS 148), which amends SFAS
No. 123, "Accounting for Stock-Based Compensation".
Statement 148 provides alternative methods of transition
for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In
addition, Statement 148 amends the disclosure requirements
of Statement 123 to require more prominent and more frequent
disclosures in financial statements about the effects of
stock-based compensation. The transition guidance and annual
disclosure provisions of Statement 148 are effective for
fiscal years ending after December 15, 2002, with earlier
application permitted in certain circumstances. The interim
disclosure provisions are effective for financial reports
containing financial statements for interim periods
beginning after December 15, 2002. The Company did not
change its method of accounting for stock-based employee
compensation and has provided the new disclosure beginning
with its quarterly report for the period ended May 31, 2003.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"),
which requires variable interest entities (commonly referred
to as SPEs) to be consolidated by the primary beneficiary of
the entity if certain criteria are met. FIN 46 is effective
immediately for all new variable interest entities created
or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 become effective for the Company during
the fourth quarter of 2003. For variable interest entities
acquired prior to February 1, 2003, any difference between
the net amount added to the balance sheet and the amount of
any previously recognized interest in the variable interest
entity will be recognized as a cumulative effect of an
accounting change. The Company does not believe it has any
variable interest entities that will require consolidation.
The Company has entered into agreements and transaction
with related parties and the Company has adopted a policy
requiring that any material transactions between the Company
and persons or entities affiliated with officers, Directors
or principal stockholders of the Company be on terms no less
favorable to the Company than reasonably could have been
obtained in arms' length transactions with independent third
parties.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
The Company is exposed to certain market risks arising from
transactions in the normal course of its business, and from
debt incurred in connection with the acquisitions it has made.
Such risk is principally associated with interest rate and
foreign exchange fluctuations, as well as changes in the
Company's credit standing.
Interest Rate Risk
The Company's long-term debt bears a fixed interest rate.
However, because the Company's obligations under its receivable
and inventory financing agreements bear interest at floating
rates (primarily JPMorgan Chase prime rate), the Company is
sensitive to changes in prevailing interest rates. A 10% increase
or decrease in market interest rates that affect the Company's
financial instruments would have a material impact on earning or
cash flows during the next fiscal year.
Foreign Currency Exchange Rates
Foreign currency exposures arise from transactions, including
firm commitments and anticipated contracts, denominated in a
currency other than an entity's functional currency, and from
foreign-denominated revenues translated into U.S. dollars. Our
primary foreign currency exposures relate to the Joe's Jeans
Japan subsidiary and resulting Yen Investments. The Company
believes that a 10.0% adverse change in the Yen rate in respect
to the US dollar would not have a material impact on earning or
cash flows during the next fiscal year because of the relatively
small size of the subsidiary compared to the rest of the Company.
The Company generally purchases its products in U.S. dollars.
However, the Company sources most of its products overseas and,
as such, the cost of these products may be affected by changes
in the value of the relevant currencies. Changes in currency
exchange rates may also affect the relative prices at which the
Company and its foreign competitors sell products in the same
market. The Company currently does not hedge its exposure to
changes in foreign currency exchange rates. The Company
cannot assure that foreign currency fluctuations will not
have a material adverse impact on the Company's financial
condition and results of operations.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the
participation of the Company's management, including the
chief executive officer and acting chief financial officer,
of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based on that evaluation, the
Company's management, including the chief executive officer
and chief financial officer, concluded that the Company's
disclosure controls and procedures are effective. There were
no significant changes in the Company's internal controls or
other factors that could significantly affect these internal
controls subsequent to the date of the completion of their
evaluation.
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
During the second quarter ended May 31, 2003, the Company
consummated two private placements of its common stock to a
limited number of "accredited investors" pursuant to Rule
506 of Regulation D under the Securities Act of 1933, as
amended, resulting in net proceeds of $571,000 to the
Company. The first private placement, completed on March 19,
2003 raised gross proceeds of $437,000 at $2.65 per share and
the second placement completed on March 26, 2003 raised gross
proceeds of $168,000 also at $2.65 per share. In aggregate the
Company issued 228,500 shares ("II Shares") as a result of the
two private placements. Capital Wealth Management acted as the
placement agent on a best efforts basis for each of the two
private placements. In consideration of the services rendered
by Capital Wealth Management, Capital Wealth Management was
paid 7% of gross proceeds. We intend to use the proceeds from
the transaction for general corporate purposes.
The buyers of the II Shares have represented to the Company
that they purchased the II Shares for their own account, with
the intention of holding the II Shares for investment and not
with the intention of participating, directly or indirectly,
in any resale or distribution of the II Shares. The II Shares
were offered and sold to the buyers in reliance upon
exemptions from registration under the 1933 Act. The buyers
have represented to the Company that they are an "Accredited
Investor," as that term is defined in Rule 501(a) of
Regulation D under said Act.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 22, 2003, the Company held its 2002 Annual Shareholders
Meeting. At the meeting there were three items of business
brought before the shareholders. The first item voted upon was
the election of seven directors to serve on the Board of
Directors until the next annual meeting of stockholders. All
nominated Directors were re-elected for one (1) year terms
with the following totals:
For Withheld
Director % Shares % Shares
- -------- - ------ - ------
Sam Furrow 100% 14,312,543 0% 10,354
Pat Anderson 100% 14,312,543 0% 10,354
Jay Furrow 100% 14,312,543 0% 10,354
Daniel Page 82% 11,760,991 18% 2,561,906
Marc B. Crossman 100% 14,314,643 0% 8,254
Dr. John Looney 100% 14,314,643 0% 8,254
Suhail Rizvi 100% 14,313,793 0% 9,104
The second item brought before the shareholders was to approve
the 2000 Employee Stock Plan Amendments to increase the aggregate
number of shares of the Company's Common Stock that may be issued
under the 2000 Employee Stock Incentive Plan by 2,000,000 shares
from 1,000,000 to 3,000,000 shares and to increase the maximum
number of shares of the Company's Common Stock that may be
granted to an individual during any calendar year from 500,000
shares to 1,250,000 shares. The vote totals on the second
proposal were as follows: 8,321,655 in favor of, 465,629
against, 1,948,523 abstaining and 3,587,090 not voted.
% Shrares
--- -------
For 58.1% 8,321,655
Against 3.3% 465,629
Abstaining 13.6% 1,948,523
Not Voted 25.0% 3,587,090
The third and final item of business to be brought forth
for shareholder approval was the appointment of Ernst & Young,
LLP as the independent auditors for the fiscal year ending
November 30, 2003. The votes totals on the third proposal were
as follows: 14,296,486 in favor of, 20,799 against and 5,612
abstaining.
% Shrares
--- -------
For 99.8% 14,296,486
Against 0.1% 20,799
Abstaining 0.0% 5,612
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The following exhibit is filed herewith.
Exhibit No. Description
4.1 Stock Purchase and Subscription Agreement Form for
Private Placements completed on March 19, 2003 and
March 26, 2003 (filed herewith).
4.2 Private Placement Agreement between Innovo Group
Inc. and Sanders Morris Harris, Inc. dated June3
23, 2003 (filed herewith).
4.3 Common Stock Purchase Warrant Agreement between
Innovo Group Inc. and Sanders Morris Harris, Inc.
dated June 30, 2003 (filed herewith).
4.4 Registration Rights Agreement between Innovo Group
Inc. and Purchasers dated June 30, 2003 (filed
herewith).
10.1 Supply Agreement by and between Innovo Group Inc.
and Commerce Investment Group, LLP dated August
11, 2000 (filed herewith).
10.2 Distribution Agreement by and between Innovo
Group Inc. and Commerce Investment Group, LLP
dated August 11, 2000 (filed herewith).
10.3 License Agreement between Innovo, Inc. and
Michael Caruso & Company, Inc. dated
March 26, 2001 and Amendment Letter dated
July 26, 2002 (filed herewith).
10.4 Letter of Intent between Joe's
Jeans Japan, Inc., Joe's Jeans, Inc.
and Itochu Corporation
dated May 19, 2003 (filed herewith).
10.5 Letter of Intent for Purchase of the
Assets of the Blue Concepts Division of
Azteca Productions International, Inc.
between Innovo Azteca Apparel, Inc. and
Azteca Productions International Inc.
dated June 10, 2003 (filed herewith).
10.6 Amendment to Factoring Agreement originally
dated June 1, 2001 between Joe's Jeans, Inc.
and CIT Commercial Services dated April 23,
2003 (filed herewith).
10.7 Amendment to Factoring Agreement originally
dated September 10, 2001 between Innovo Azteca
Apparel, Inc. and CIT Commercial Services dated
April 23, 2003 (filed herewith).
10.8 Amendment to Factoring Agreement originally dated
June 1, 2001 between Innovo, Inc. and CIT Commercial
Services dated April 23, 2003 (filed herewith).
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 90 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K
Date Purpose
July 15, 2003 To report a press release dated July 15, 2003
announcing the Company's earnings for the
third quarter ended May 31, 2003.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized.
INNOVO GROUP INC.
Dated: July 15, 2003 By: /s/ Samuel Joseph Furrow, Jr.
-------------- ------------------------------
Samuel Joseph Furrow, Jr.,
Chief Executive Officer
Dated: July 15, 2003 By: /s/ Marc B. Crossman
-------------- ---------------------
Marc Barry Crossman,
Chief Financial Officer
(Principal Accounting Officer)
CERTIFICATION BY SAMUEL JOSEPH FURROW, JR. AS CHIEF EXECUTIVE
OFFICER
I, Samuel Joseph Furrow, Jr. certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Innovo Group Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made,
in light of the circumstances under which such statements
were made, not misleading with respect to the period covered
by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies
and material weaknesses.
Date: July 15, 2003
/s/ Samuel Joseph Furrow, Jr
----------------------------
Samuel Joseph Furrow, Jr.
Chief Executive Officer
CERTIFICATION BY MARC B. CROSSMAN AS CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING OFFICER)
I, Marc B. Crossman, certify that:
1. I have reviewed this quarterly report on Form 10-Q
of Innovo Group Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements
made, in light of the circumstances under which such
statements were made, not misleading with respect to the
period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and
other financial information included in this quarterly
report, fairly present in all material respects the
financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies
and material weaknesses.
Date: July 15, 2003
/s/ Marc B. Crossman
--------------------
Marc B. Crossman
Chief Financial Officer
Exhibit Index
Exhibit No. Description
99.1 Certification Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002.
Exhibit No. 99.1
Certification of Chief Executive Officer of Innovo Group Inc.
This certification is provided pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and accompanies the quarterly report
on Form 10-Q (the "Form 10-Q") for the quarter ended May 31,
2003 of Innovo Group Inc. (the "Issuer").
I, Samuel Joseph Furrow, Jr., the Chief Executive Officer of
Issuer certify that to the best of my knowledge:
(i) the Form 10-Q fully complies with the requirements of
section 13(a) or section 15(d) of the Securities Exchange Act
of 1934 (15 U.S.C. 78m(a) or 78o(d)); and
(ii) the information contained in the Form 10-Q fairly
presents, in all material respects, the financial condition
and results of operations of the Issuer.
Dated: July 15, 2003
/s/ Samuel Joseph Furrow, Jr
----------------------------
Name: Samuel Joseph Furrow, Jr.
Exhibit No. 99.2
Certification of Chief Financial Officer of Innovo Group Inc.
This certification is provided pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and accompanies the quarterly report
on Form 10-Q (the "Form 10-Q") for the quarter ended May 31, 2003
of Innovo Group Inc. (the "Issuer").
I, Marc B. Crossman, the Chief Financial Officer of Issuer certify
that to the best of my knowledge:
(i) the Form 10-Q fully complies with the requirements of section
13(a) or section 15(d) of the Securities Exchange Act of 1934
(15 U.S.C. 78m(a) or 78o(d)); and
(ii) the information contained in the Form 10-Q fairly presents,
in all material respects, the financial condition and results
of operations of the Issuer.
Dated: July 15, 2003
/s/ Marc B. Crossman
--------------------
Name: Marc B. Crossman