UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2006
COMMISSION FILE NUMBER: 000-33297
BLUE HOLDINGS, INC.
(Exact name of small business issuer as specified in its charter)
NEVADA 88-0450923
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5804 E. SLAUSON AVE., COMMERCE, CA 90040
(Address of principal executive offices)
(323) 725-5555
(Issuer's telephone number)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES [_] No [X]
As of November 13, 2006, 26,057,200 shares of the registrant's common
stock were outstanding.
Transitional Small Business Disclosure Format (Check One):
Yes [_] No [X]
TABLE OF CONTENTS
Page
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PART I Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) 3
Condensed Consolidated Statements of Operations (Unaudited) 4
Condensed Consolidated Statements of Shareholders' Equity
(Unaudited) 5
Condensed Consolidated Statements of Cash Flows (Unaudited) 6
Notes to the Condensed Consolidated Financial Statements
(Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
Item 3. Controls and Procedures 36
PART II Other Information
Item 6. Exhibits 37
2
PART I
ITEM 1. FINANCIAL STATEMENTS
BLUE HOLDINGS INC. (FORMERLY KNOWN AS MARINE JET TECHNOLOGY CORP.)
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2006 AND DECEMBER 31, 2005
ASSETS September 30, December 31,
2006 2005
----------- -----------
Current assets: (Unaudited)
Cash .......................................... $ 122,065 $ 228,127
Due from factor, net of reserves of $50,655
and $96,849, respectively .................. 1,483,464 693,474
Accounts receivable, net of reserves of
$556,980 and $484,421, respectively:
- Purchased by factor with recourse ........ 7,519,219 4,287,163
- Others ................................... 369,068 2,504
Due from related parties ...................... -- 15,974
Inventories ................................... 13,554,453 9,925,162
Deferred income taxes ......................... 646,047 492,574
Prepaid expenses and other current assets ..... 1,092,560 351,919
----------- -----------
Total current assets ....................... 24,786,876 15,996,897
Deferred income taxes ......................... 1,519,740 1,671,135
Property and equipment, less accumulated
depreciation .................................. 1,278,346 198,927
----------- -----------
Total assets ..................................... $27,584,962 $17,866,959
=========== ===========
LIABILITIES AND EQUITY
Current liabilities:
Bank overdraft ................................ $ 21,717 $ 616,020
Accounts payable .............................. 3,465,348 2,911,598
Short-term borrowings ......................... 9,495,943 4,583,936
Due to related parties ........................ 772,261 372,311
Advances from majority shareholder ............ 2,508,900 96,875
Income taxes payable .......................... -- 650,468
Accrued expenses and other current
liabilities ................................ 1,187,213 599,166
----------- -----------
Total current liabilities 17,451,382 9,830,374
----------- -----------
Commitment and contingency
Stockholders' equity:
Common stock $0.001 par value,
75,000,000 shares authorized,
26,057,200 shares issued and outstanding ..... 26,057 26,057
Additional paid-in capital .................... 5,119,935 4,996,752
Retained earnings ............................. 4,987,588 3,013,776
----------- -----------
Total stockholders' equity ................. 10,133,580 8,036,585
----------- -----------
Total liabilities and stockholders' equity ....... $27,584,962 $17,866,959
=========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
BLUE HOLDINGS INC. (FORMERLY KNOWN AS MARINE JET TECHNOLOGY CORP.)
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ---------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
Net sales ..................................................... $ 14,551,581 $ 13,887,689 $ 41,610,112 $ 24,578,736
Cost of goods sold ............................................ 10,116,732 6,927,774 23,797,647 12,355,956
------------ ------------ ------------ ------------
Gross profit .................................................. 4,434,849 6,959,915 17,812,465 12,222,780
Selling, distribution & administrative expenses ............... 4,281,467 3,264,457 13,204,554 6,416,963
------------ ------------ ------------ ------------
Income before other expenses and provision for income taxes ... 153,382 3,695,458 4,607,911 5,805,817
------------ ------------ ------------ ------------
Other expenses:
Interest expense ........................................... 257,997 11,095 643,759 18,683
Expenses relating to abandoned acquisition of Long Rap, Inc. 500,887 -- 500,887 --
Expenses relating to exchange transaction .................. -- 50,000 -- 527,617
------------ ------------ ------------ ------------
Total other expenses .................................... 758,884 61,095 1,144,646 546,300
------------ ------------ ------------ ------------
Income (loss) before provision for income taxes ............... (605,502) 3,634,363 3,463,265 5,259,517
Provision (benefit) for income taxes .......................... (184,642) 1,239,830 1,489,453 1,376,114
------------ ------------ ------------ ------------
Net income (loss) ............................................. $ (420,860) $ 2,394,533 $ 1,973,812 $ 3,883,403
============ ============ ============ ============
Net income (loss) per common share, basic and diluted ......... $ (0.02) $ 0.09 $ 0.08 $ 0.15
============ ============ ============ ============
Weighted average shares outstanding, basic and diluted ........ 26,057,200 26,057,200 26,057,200 26,057,200
============ ============ ============ ============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
BLUE HOLDINGS INC. (FORMERLY KNOWN AS MARINE JET TECHNOLOGY CORP.)
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006
Shares Issued
--------------------------- Additional
Par Value Paid In Retained
Number 0.001 Capital Earnings Total
------------ ------------ ------------ ------------ ------------
Balance, January 1, 2006 ......... 26,057,200 $ 26,057 $ 4,996,752 $ 3,013,776 $ 8,036,585
Fair value of options granted .... -- -- 356,528 -- 356,528
Adjustment to deferred tax benefit
arising from the 2005
acquisition of Taverniti ...... -- -- (233,345) -- (233,345)
Net Income for the period ........ -- -- -- 1,973,812 1,973,812
------------ ------------ ------------ ------------ ------------
Balance, September 30, 2006 ..... 26,057,200 $ 26,057 $ 5,119,935 $ 4,987,588 $ 10,133,580
============ ============ ============ ============ ============
5
BLUE HOLDINGS INC. (FORMERLY KNOWN AS MARINE JET TECHNOLOGY CORP.)
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
Nine Months Ended
September 30,
---------------------------
2006 2005
----------- -----------
Cash flows from operating activities:
Net Income ..................................... $ 1,973,812 $ 3,883,403
Adjustments to reconcile net income to cash
used in operating activities:
Depreciation and amortization ............... 136,644 9,642
Stock based exchange transaction expense .... -- 177,617
Fair value of vested stock options .......... 356,528 --
Changes in assets and liabilities:
Accounts receivable ......................... (3,598,620) (912,853)
Due from factor ............................. (789,990) (1,387,048)
Inventories ................................. (3,629,291) (6,016,091)
Due from related parties .................... 15,974 (209,924)
Deferred income taxes ....................... (235,423) (278,639)
Due to related parties ...................... 399,950 709,010
Prepaid expenses and other current assets ... (740,641) (65,048)
Income tax payable .......................... (650,468) 1,658,873
Bank overdraft .............................. (594,303) --
Accounts payable ............................ 553,751 1,279,924
Other current liabilities ................... 588,046 685,296
----------- -----------
Net cash used in operating activities .......... (6,214,031) (465,838)
----------- -----------
Cash flows from investing activities:
Purchase of equipment ....................... (1,216,063) (116,077)
----------- -----------
Net cash used in investing activities .......... (1,216,063) (116,077)
----------- -----------
Cash flows from financing activities:
Short-term borrowings ....................... 4,912,007 --
Additional paid in capital .................. -- 686,200
Advances from majority shareholder .......... 2,412,025 237,134
----------- -----------
Net cash provided by financing activities ...... 7,324,032 923,334
----------- -----------
Net (decrease) increase in cash ................ (106,062) 341,419
Cash at beginning of period .................... 228,127 84,635
----------- -----------
CASH AT END OF PERIOD .......................... $ 122,065 $ 426,054
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income tax ....................... $ 2,551,605 $ 800
=========== ===========
Cash paid for interest ......................... $ 643,759 $ 18,683
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
FINANCING AND INVESTING ACTIVITIES:
Inventory contributed by a stockholder at
its historical cost ......................... $ -- $ 1,200,000
=========== ===========
Value of common stock issued for finders
fee relating to exchange transaction ........ $ -- $ 177,617
=========== ===========
Adjustment to deferred taxes relating to
the 2005 acquisition of Taverniti ........... $ 233,345 $ --
=========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6
BLUE HOLDINGS INC. (FORMERLY KNOWNS AS MARINE JET TECHNOLOGY CORP.)
AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 2006
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION, ORGANIZATION AND NATURE OF OPERATIONS
(a) BASIS OF PRESENTATION
The interim condensed consolidated financial statements are unaudited,
but in the opinion of management of the Company, contain all adjustments, which
include normal recurring adjustments, necessary to present fairly the financial
position at September 30, 2006, the results of operations for the three and nine
months ended September 30, 2006 and 2005 and cash flow for nine months ended
September 30, 2006 and 2005. The consolidated balance sheet as of December 31,
2005 is derived from the Company's audited financial statements.
Certain information and footnote disclosures normally included in
financial statements that have been presented in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission with respect to
interim financial statements, although management of the Company believes that
the disclosures contained in these financial statements are adequate to make the
information presented therein not misleading. For further information, refer to
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-KSB for the fiscal year ended December 31,
2005, as filed with the Securities and Exchange Commission.
The Company's results of operations for the three and nine months ended
September 30, 2006 are not necessarily indicative of the results of operations
to be expected for the full fiscal year ending December 31, 2006.
The condensed consolidated financial statements include the operations
of Blue Holdings, Inc. and its wholly-owned subsidiaries. Intercompany
transactions and balances are eliminated in consolidation.
(b) ORGANIZATION
Blue Holdings, Inc. (a Nevada corporation formerly known as Marine Jet
Technology Corp.) was incorporated in the State of Nevada on February 9, 2000.
On April 14, 2005, Blue Holdings entered into an Exchange Agreement with Antik
Denim, LLC ("Antik"). At the closing of the transactions contemplated by the
Exchange Agreement, which occurred on April 29, 2005, Blue Holdings acquired all
of the outstanding membership interests of Antik (the "Interests") from the
members of Antik, and the members contributed all of their Interests to Blue
Holdings. In exchange, Blue Holdings issued to the members 843,027 shares of
Series A Convertible Preferred Stock, par value $0.001 per share, of Blue
Holdings ("Preferred Shares"), which, on June 7, 2005, as a result of a change
to Marine Jet Technology Corp.'s name to Blue Holdings, Inc. and a 1 for 29
reverse stock split, were converted into 24,447,783 shares of Blue Holding's
common stock on a post-reverse stock split basis.
7
As such, immediately following the closing and upon the conversion of
the Preferred Shares, the Antik members and Elizabeth Guez, our former Chief
Operating Officer and wife of Paul Guez, owned approximately 95.8% of the total
issued and outstanding common stock of Blue Holdings on a fully-diluted basis.
Following completion of the exchange transaction, Antik became a wholly-owned
subsidiary of Blue Holdings. The acquisition was accounted for as a reverse
merger (recapitalization) in the accompanying financial statements with Antik
deemed to be the accounting acquirer and Blue Holdings deemed to be the legal
acquirer. As such, the financial statements herein include those of Antik since
September 13, 2004 (the date of its inception). All assets and liabilities of
Marine Jet Technology Corp. were assumed by the major shareholder of Blue
Holdings, Inc. prior to the exchange transaction and were inconsequential to the
merged companies.
On June 7, 2005, Marine Jet Technology Corp. changed its name to Blue
Holdings, Inc., and increased its authorized number of shares of common stock to
75,000,000.
On October 31, 2005, the Company entered into an exchange agreement
with Taverniti So Jeans, LLC, a California limited liability company
("Taverniti"), and the members of Taverniti (the "Taverniti Members"). Under the
exchange agreement, the Company acquired all of the outstanding membership
interests of Taverniti (the "Taverniti Interests") from the Taverniti Members,
and the Taverniti Members contributed all of their Taverniti Interests to the
Company. In exchange, the Company issued to the Taverniti Members, on a pro rata
basis, an aggregate of 500,000 shares of the Common Stock, par value $0.001 per
share, of the Company, and paid to the Taverniti Members, on a pro rata basis,
an aggregate of Seven Hundred Fifty Thousand Dollars ($750,000). At the closing
of the exchange transaction, Taverniti became a wholly-owned subsidiary of the
Company. Paul Guez, the Company's Chairman, Chief Executive Officer, President
and majority shareholder, was and remains the sole manager and was a member of
Taverniti. Elizabeth Guez, Paul Guez's spouse and the Company's former Chief
Operating Officer, was also a member of Taverniti. Two other members of Mr. and
Mrs. Guez's family, including Gregory Abbou, the President of Taverniti, were
the remaining members of Taverniti. The transaction was accounted for as a
combination of entities under common control. As such, the financial statements
herein have been presented to include the operations of Taverniti since
September 13, 2004, the date of its inception, and the $750,000 payment was
considered as a deemed distribution to the members of Taverniti upon the closing
of the combination.
(c) NATURE OF OPERATIONS
The Company operates exclusively in the wholesale apparel industry. The
Company designs, develops, markets and distributes high fashion jeans and
accessories under the brand names "Antik Denim", "Taverniti So Jeans", and
"Yanuk". The Company's products currently include jeans, jackets, belts, purses
and T-shirts. The Company currently sells its products in the United States,
Canada, Japan and the European Union directly to department stores and boutiques
and through distribution arrangements in certain foreign jurisdictions. The
Company is headquartered in Commerce, California and maintains showrooms in New
York and Los Angeles. The Company opened a retail store in Los Angeles during
August 2005 and another store in San Francisco in September 2006. These retail
operations are not yet significant to the consolidated operations.
8
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues. On an
ongoing basis, we evaluate estimates, including those related to returns,
discounts, bad debts, inventories, intangible assets, income taxes,
contingencies and litigation. We base our estimates on historical experience and
on various assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
(b) REVENUE RECOGNITION:
Revenue is recognized when merchandise has been shipped against a
customer's written purchase order, the risk of ownership has passed, selling
price has been fixed and determined and collectibility is reasonably assured
either through payment received, or fulfillment of all the terms and conditions
of the particular purchase order. Revenue is recorded net of estimated returns,
charge backs and markdowns based on management's estimates and historical
experience.
(c) ADVERTISING
Advertising costs are expensed as of the first date the advertisements
take place. Advertising expenses included in selling expenses approximated
$51,420 and $627,482 for the three and nine months ended September 30, 2006,
respectively, compared to $254,276 and $324,442 for the three and nine months
ended September 30, 2005, respectively.
(d) CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose the Company to
concentration of credit risk, consist primarily of cash, trade accounts
receivable, and amounts due from our factor. With respect to trade accounts
receivable at September 30, 2006, one customer comprised approximately 42% of
our total receivables. The Company extends unsecured credit to its customers in
the normal course of business.
The Company's cash balances on deposit with banks are guaranteed by the
Federal Deposit Insurance Corporation up to $100,000. The Company may be exposed
to risk for the amounts of funds held in one bank in excess of the insurance
limit. In assessing the risk, the Company's policy is to maintain cash balances
with high quality financial institutions.
The Company's products are primarily sold to department stores and
specialty retail stores. These customers can be significantly affected by
changes in economic, competitive or other factors. The Company makes substantial
sales to a relatively few, large customers. In order to minimize the risk of
loss, the Company assigns certain amounts of domestic accounts receivable to a
factor without recourse or requires letters of credit from its customers prior
to the shipment of goods. For non-factored receivables, account-monitoring
procedures are utilized to minimize the risk of loss. Collateral is generally
not required.
9
(e) SHIPPING AND HANDLING COSTS
Freight charges are included in selling, distribution and
administrative expenses in the statement of operations and approximated $263,861
and $588,672 for the three and nine months ended September 30, 2006,
respectively, compared to $89,055 and $168,279 for the same periods of 2005,
respectively.
(f) MAJOR SUPPLIERS
We purchase our fabric, thread and other raw materials from various
industry suppliers within the United States and abroad. We do not currently have
any long-term agreements in place for the supply of our fabric, thread or other
raw materials. The fabric, thread and other raw materials used by us are
available from a large number of suppliers worldwide. During the three months
ended September 30, 2006, three suppliers accounted for more than 10% of our
purchases. Purchases from these suppliers were 31.5%, 13.0% and 11.8%
respectively. During the nine months ended September 30, 2006, two suppliers
accounted for more than 10% of our purchases and purchases from these suppliers
were 13.6% and 12.9%, respectively.
(g) MAJOR CUSTOMERS
During fiscal 2006, two customers accounted for more than 10% of the
Company's sales. Sales to those customers were 30.3% and 11.6% for the three
months ended September 30, 2006, and 15.6% and 14.3% for the nine months ended
September 30, 2006, respectively.
International sales accounted for approximately 25% and 30% of sales in
the three and nine months ended September 30, 2006, respectively.
Geographically, Japan has become one of our major growth areas. During the three
months and nine months ended September 30, 2006, Japan accounted for 16% and
17%, respectively, of our total sales.
(h) STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), established a fair value method of
accounting for stock-based compensation plans and for transactions in which an
entity acquires goods or services from non-employees in exchange for equity
instruments. SFAS No. 123 was amended by Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation -Transition and
Disclosure", which required companies to disclose in interim financial
statements the pro forma effect on net income (loss) and net income (loss) per
common share of the estimated fair market value of stock options or warrants
issued to employees. Through December 31, 2005, the Company accounted for
stock-based compensation utilizing the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"), with pro forma disclosures of net income (loss) as if
the fair value method had been applied. Accordingly, compensation cost for stock
options was measured as the excess, if any, of the fair market price of the
Company's stock at the date of grant over the amount an employee must pay to
acquire the stock.
As the exercise price of stock options and warrants issued to employees
was not less than the fair market value of the Company's common stock on the
date of grant, and in accordance with accounting for such options utilizing the
intrinsic value method, there was no related compensation expense recorded in
the Company's 2005 consolidated financial statements. The fair value of stock
options and warrants issued to officers, directors and employees at not less
than fair market value of the Company's common stock on the date of grant was
estimated using the Black-Scholes option-pricing model, and the
10
effect on the Company's results of operations was shown in a proforma disclosure
as if such stock options and warrants had been accounted for pursuant to SFAS
No. 123.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 123 (revised 2004), "Share Based Payment" ("SFAS No. 123R"), a
revision to SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No.
123R superseded APB No. 25 and amended SFAS No. 95, "Statement of Cash Flows".
Effective January 1, 2006, SFAS No. 123R requires that the Company measure the
cost of employee services received in exchange for equity awards based on the
grant date fair value of the awards, with the cost to be recognized as
compensation expense in the Company's financial statements over the vesting
period of the awards.
Accordingly, the Company recognizes compensation cost for equity-based
compensation for all new or modified grants issued after December 31, 2005. In
addition, commencing January 1, 2006, the Company recognizes the unvested
portion of the grant date fair value of awards issued prior to adoption of SFAS
No. 123R based on the fair values previously calculated for disclosure purposes
over the remaining vesting period of the outstanding stock options and warrants.
The Company adopted SFAS No. 123R effective January 1, 2006, and is
using the modified prospective method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of SFAS No. 123R
for all share-based payments granted after the effective date and (b) based on
the requirements of SFAS No. 123R for all awards granted to employees prior to
the effective date of SFAS No. 123R that remain unvested on the effective date.
The total stock based compensation expense for the three and nine
months ended September 30, 2006 was $127,330 and $356,528, respectively. As of
September 30, 2006, the unamortized value of these option awards was $1,016,300
which will be amortized as compensation cost in future periods as the options
vest. The fair value of options was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for the periods indicated:
Nine Months
Ended
September 30, 2006
------------------
Dividend yield ............................................. --
Risk-free interest rate .................................... 4.50%
Expected volatility ........................................ 46.01%
Expected life of options ................................... 5 years
During the three and nine months ended September 30, 2005, the Company
did not grant any options to purchase shares of its common stock, nor were there
any options vesting during that period. Accordingly, no proforma information for
September 30, 2005 is required.
11
(i) EARNINGS PER SHARE
Statement of Financial Accounting Standards No. 128, "Earnings per
Share", requires presentation of basic earnings per share ("Basic EPS") and
diluted earnings per share ("Diluted EPS"). Basic earnings (loss) per share is
computed by dividing net income by the weighted average number of common shares
outstanding during the period. Diluted earnings per share reflects the potential
dilution, using the treasury stock method, that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the Company. In computing diluted earnings per share, the treasury
stock method assumes that outstanding options and warrants are exercised and the
proceeds are used to purchase common stock at the average market price during
the period. Options and warrants will have a dilutive effect under the treasury
stock method only when the average market price of the common stock during the
period exceeds the exercise price of the options and warrants.
At September 30, 2006 and 2005, potentially dilutive securities
consisted of outstanding common stock options to acquire 682,000 and 0 shares,
respectively. These potentially dilutive securities were not included in the
calculation of loss per share for the quarter ended September 30, 2006 as these
dilutive securities were antidilutive for the nine months ended September 30,
2006 and 2005, as they are insignificant. Accordingly, basic earnings per share
for each of the three and nine months ended September 30, 2006, and 2005, are
the same as diluted loss per share.
(j) RECLASSIFICATIONS
Certain prior year balance sheet items have been reclassified to
conform to the current period presentation.
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
FASB Statement of Financial Accounting Standards (SFAS) No. 157, "Fair Value
Measurements," establishes a formal framework for measuring fair value under
GAAP. It defines and codifies the many definitions of fair value included among
various other authoritative literature, clarifies and, in some instances,
expands on the guidance for implementing fair value measurements, and increases
the level of disclosure required for fair value measurements. Although SFAS no.
157 applies to and amends the provisions of existing FASB and AICPA
pronouncements, it does not, of itself, require any new fair value measurements,
nor does it establish valuation standards. SFAS No. 157 applies to all other
accounting pronouncements requiring or permitting fair value measurements,
except for; SFAS no. 123 (R), share-based payment and related pronouncements,
the practicability exceptions to fair value determinations allowed by various
other authoritative pronouncements, and AICPA Statements of Position 97-2 and
98-9 that deal with software revenue recognition. This statement is effective
for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years.
12
NOTE 3 - DUE FROM FACTOR
We use a factor for working capital and credit administration purposes.
Under the various factoring agreements entered into separately by Blue Holdings,
Antik Denim, LLC and Taverniti So Jeans, LLC, the factor purchases all the trade
accounts receivable assigned by the Company and its subsidiaries and assumes all
credit risk with respect to those accounts approved by it.
The factor agreements provide that we can borrow an amount up to 90% of
the value of our purchased customer invoices, less a reserve of 10% of unpaid
accounts purchased and 100% of all such accounts which are disputed. The factor
agreements provide for automatic renewal after July 24, 2006 subject to 120
days' termination notice from any party. The factor also makes available to all
three companies a combined line of credit up to the lesser of $2.4 million
(increased from $1.5 million effective as of January 1, 2006) and 50% of the
value of eligible raw materials and finished goods. The increase in this line of
credit - from $1.5 million to $2.4 million - became effective as of January 1,
2006. As of September 30, 2006, the Company drew down $2.4 million of this
credit line against inventory.
As of September 30, 2006, the factor holds $3,982,414 of accounts
receivable purchased from us on a without recourse basis and has made advances
to us of $2,448,295 against those receivables, resulting in a net balance amount
Due from Factor of $1,483,464 net of reserves of $50,655 as of September 30,
2006. The Company has accounted for the sale of receivables to the factor in
accordance with SFAS No.140, "Accounting for the Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities".
As of September 30, 2006, the factor also held $7,971,026 of accounts
receivable that were subject to recourse, against which the Company has provided
reserves of $451,807 and as of September 30, 2006, the Company received advances
totaling $9,495,943 against such receivables and against eligible inventory. The
Company has included the $7,519,219 in accounts receivable, and has reflected
the $9,495,943 as short term borrowings on the accompanying balance sheet. The
factor commission against such receivables is 0.4% and interest is charged at
the rate of 1% over the factor's prime lending rate per annum.
Before January 1, 2006, the factor commission on receivables purchased
on a without recourse basis was 0.8% of the customer invoice amount for terms up
to 90 days, plus one quarter of one percent (0.25%) for each additional
thirty-day term. Effective January 1, 2006, the factor commission is 0.75% if
the aggregate amount of approved invoices is below $10 million per annum, 0.70%
if between $10 million and $20 million and 0.65% if between $20 million and $30
million. The Company is contingently liable to the factor for merchandise
disputes, customer claims and the like on receivables sold to the factor. To the
extent that the Company draws funds prior to the deemed collection date of the
accounts receivable sold to the factor, interest is charged at the rate of 1%
over the factor's prime lending rate per annum. Factor advances are
collateralized by the non-factored accounts receivable, inventories and the
personal guarantees of Paul Guez, our Chairman, Chief Executive Officer,
President and majority shareholder, and the living trust of Paul and Elizabeth
Guez.
13
NOTE 4 - INVENTORIES
Inventories at September 30, 2006 and December 31, 2005 are summarized as
follows:
September 30, December 31,
2006 2005
----------- -----------
Raw Materials ...................... $ 4,061,236 $ 3,850,916
Work-in-Process .................... 2,990,167 2,842,531
Finished Goods ..................... 6,503,050 3,231,715
----------- -----------
TOTAL .............................. $13,554,453 $ 9,925,162
=========== ===========
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment at September 30, 2006 and December 31, 2005 are
summarized as follows:
September 30, December 31,
2006 2005
----------- -----------
Furniture ........................................ $ 12,973 $ 11,217
Leasehold Improvements ........................... 831,279 44,600
Computer Equipment ............................... 590,287 162,659
----------- -----------
1,434,539 218,476
Less: Accumulated depreciation and Amortization .. (156,193) (19,549)
----------- -----------
$ 1,278,346 $ 198,927
=========== ===========
Depreciation expenses for the three months ended September 30, 2006 and
2005 were $59,174 and $3,680, respectively and for the nine months ended
September 30, 2006 and 2005 were $136,644 and $8,489, respectively.
NOTE 6 - RELATED PARTY TRANSACTIONS
The Company purchased fabric at cost from Blue Concept, LLC which is
owned by Paul Guez, the Company's Chairman and Chief Executive Officer.
Purchases during the three and nine months ended September 30, 2006 amounted to
$10,555 and $262,213, respectively. During the same periods last year, they
amounted to $247,470 and $1,526,223, respectively.
Azteca Production International Inc. is one of our contractors in
Mexico and is co-owned by Paul Guez, our majority stockholder. During the three
and nine months ended September 30, 2006, we were invoiced for sewing and other
sub-contracting charges in the amounts of $867,358 and $2,237,872 respectively,
14
and $0 and $391,479 for the three and nine months ended September 30, 2005.
Azteca principally provided manufacturing services to Taverniti.
Since January 1, 2006, the Company has leased its facility at Commerce,
California from Azteca Production International Inc. as a sub-tenant and is
paying it $19,030 per month.
On July 5, 2005 the Company entered into a ten-year license agreement
with Yanuk Jeans, LLC, effective as of July 1, 2005. Under the terms of the
agreement, the Company became the exclusive licensor for the design,
development, manufacture, sale, marketing and distribution of the "Yanuk" brand
products to the wholesale and retail trade. The Company pays to Yanuk Jeans, LLC
a royalty of six percent of all net sales of the licensed products and a
guaranteed minimum royalty on an annual basis. In addition, during the term of
the license agreement, the Company has the option to purchase from Yanuk Jeans,
LLC the property licensed under the agreement. The royalties for the three and
nine months ended September 30, 2006 paid or payable to Yanuk Jeans, LLC totaled
$60,902 and $243,833, respectively, and $117,987 for the three and nine months
ended September 30, 2005, respectively. Yanuk Jeans, LLC is solely owned by Paul
Guez, our majority stockholder.
Paul Guez and the living trust of Paul and Elizabeth Guez have
guaranteed all advances and ledger debt due to the Company's factor.
Taverniti is the exclusive licensee for the design, development,
manufacture, sale, marketing and distribution of the "Taverniti So Jeans"
trademark in the denim and knit sports wear categories for men and women. It is
paying royalties to Taverniti Holdings, LLC in the ranges of 5-8 percent
depending on the net sales of the licensed products pursuant to a license
agreement with Taverniti Holdings, LLC. Taverniti Holdings, LLC is jointly owned
by Paul Guez (60%) and Jimmy Taverniti (40%), the designer of the products for
the brand, and Mr. Guez is the sole manager. The license agreement was signed in
May 2004 and expires on December 31, 2015. Royalties paid or payable for the
three and nine months ended September 30, 2006 amounted to $217,728 and
$874,254, respectively, and $152,000 and $303,629 for the three and nine months
ended September 30, 2005, respectively.
NOTE 7 - DUE TO/FROM RELATED PARTIES
The related parties are the Company's majority shareholder (who is also
the Chairman, Chief Executive Officer and President of the Company) and limited
liability companies that are co-owned by the majority shareholder. These amounts
are all unsecured and non-interest bearing. All non-trade related advances from
related parties have been repaid. Trade-related outstanding items follow regular
payment terms as invoiced. As of September 30, 2006 and December 31, 2005, total
trade-related items due to related parties amounted to $772,261 and $372,311,
respectively.
From time to time, the Company's majority shareholder, Mr. Paul Guez,
made advances to the Company to support its working capital needs. These
advances were non-interest bearing and unsecured, with no formal terms of
repayment. On July 1, 2006, Mr. Guez converted the advances to a line of credit
in an agreement with the Company. The line of credit allows the Company to
borrow from him up to a maximum of $3 million at an interest rate of 6% per
annum. The Company may repay the advances in full or in part at any time until
the credit line expires on December 31, 2007. As of September 30, 2006 and
December 31, 2005, the balance of these advances was $2,508,900 and $96,785,
respectively, and accrued interest thereon was $35,372 and $0, respectively.
15
NOTE 8 - INCOME TAX
The Company accounts for income taxes and the related accounts under
the liability method. Deferred tax liabilities and assets are determined based
on the difference between the financial statement and tax bases of assets and
liabilities using enacted rates expected to be in effect during the year in
which the basis differences reverse.
The Company's provision for income taxes was $1,489,453 for the nine
months ended September 30, 2006 compared to $1,376,114 for the same period last
year. For the four months ended April 29, 2005 the income earned and related
Federal and State income tax obligations for the period of Antik Denim, LLC were
passed through to its previous members. For the nine months ended September 30,
2005 the income earned and related Federal and State income tax obligations for
the period of Taverniti So Jeans, LLC were passed through to its previous
members. The Company recorded no provision for such taxes.
The provision for income taxes consists of the following for the
periods ended September 30:
2006 2005
----------- -----------
Current
Federal ............................... $ 1,305,011 $ 1,234,518
State ................................. 419,865 420,235
Deferred
Federal ............................... (189,462) (207,845)
State ................................. (45,961) (70,794)
----------- -----------
Provision for income tax expense ......... $ 1,489,453 $ 1,376,114
=========== ===========
A reconciliation of the statutory federal income tax rate to the
effective tax rate is as follows for the periods ended September 30:
2006 2005
-------- --------
Statutory federal rate ............................... 34.0% 34.0%
State taxes, net of federal benefit .................. 7.1 4.8
Income not taxed at the Company level ................ 2.0 (11.7)
Permanent differences ................................ (0.1) 1.8
Other ................................................ 0.0 (0.5)
-------- --------
Effective tax rate ................................... 43.0% 28.4%
======== ========
In connection with the 2005 Taverniti transaction, in exchange for 100%
ownership of Taverniti, the Company issued 500,000 shares of Common Stock of the
Company and paid $750,000 in cash to the previous owners of Taverniti. For
income tax purposes this transaction was a taxable event. For accounting
purposes this transaction was accounted for as combination of entities under
common control.
16
Goodwill in the amount of $4,181,399 was recognized solely for income
tax purposes. The tax effect of this goodwill of $1,687,682 was reported as a
deferred tax asset. Additional paid in capital of the Company was increased by
an equal amount. During the nine months ended September 30, 2006 the previous
owners of Taverniti finalized the filing of their 2005 tax returns which
included certain differences than previously estimated. The ultimate effect was
previously recognized goodwill was reduced by $583,000, and the resulting tax
effect of the change to the deferred tax benefit of $233,345 was reflected as
adjustment to additional paid in capital of the Company during the nine months
ending September 30, 2006.
NOTE 9 - STOCK OPTIONS
Under the Company's 2005 Stock Incentive Plan (the "Company Plan"), the
Company may grant qualified and nonqualified stock options and stock purchase
rights to selected employees. The Company reserved 2,500,000 shares of common
stock for issuance under the Company Plan. Options to purchase 270,000 shares of
common stock were granted in 2006. No options to purchase shares of common stock
were exercised and 15,000 options were cancelled in 2006.
At September 30, 2006, options outstanding are as follows:
Weighted
average
Number of exercise
options price
-------- --------
Balance at January 1, 2006 .. 427,000 $ 7.18
Granted ..................... 270,000 $ 5.20
Exercised ................... -- --
Cancelled ................... (15,000) $ 5.20
-------- --------
Balance at September 30, 2006 682,000 $ 6.44
======== ========
Additional information regarding options outstanding as of September
30, 2006 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- ----------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average Aggregate
Exercise Number Contractual Exercise Number Exercise Intrinsic
Price Outstanding Life Price Exercisable Price Value
------------- ----------- ----------- -------- ----------- -------- ---------
$8.10 62,000 8.68 $ 8.10 22,000 $ 8.10 $ 73,480
$7.40 300,000 8.86 $ 7.40 100,000 $ 7.40 $ 305,000
$5.30 65,000 8.87 $ 5.30 25,000 $ 5.30 $ 54,750
$5.20 255,000 9.25 $ 5.20 --
-------------------------------------------------------------------------
$5.20 - $8.10 682,000 8.99 $ 6.44 147,000 $ 7.15 $ 433,230
=========================================================================
17
NOTE 10 - TERMINATION OF MATERIAL DEFINITIVE AGREEMENTS
On October 5, 2006, we terminated the Letter of Intent previously
entered into with Global Fashion Group, SA ("Global Fashion Group") on March 31,
2006, which would have formed a new joint venture company with a license to
produce, manufacture and distribute apparel and accessories for the Registrant's
three principal brands, Antik Denim, Taverniti So Jeans and Yanuk, throughout
Europe and other territories. The parties were unable to resolve certain
differences in the terms of the license to be held by the joint venture company
contemplated under the Letter of Intent.
On October 9, 2006 we reached a mutual agreement with Long Rap, Inc. to
terminate our proposed agreement to acquire the company and its retail
operations, which was previously announced on June 20, 2006. Both companies have
determined that it would be in the best interests of their respective
shareholders not to proceed with the acquisition at this time. The accompanying
statement of operations for the nine months ended September 30, 2006 includes
$500,887 of costs relating to the abandonment of this acquisition.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Statements made in this Form 10-QSB (the "Quarterly Report") that are
not historical or current facts are "forward-looking statements" made pursuant
to the safe harbor provisions of Section 27A of the Securities Act of 1933, as
amended (the "Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). The Company intends that such forward-looking
statements be subject to the safe harbors for such statements. The Company
wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. Any
forward-looking statements represent management's best judgment as to what may
occur in the future. The forward-looking statements included herein are based on
current expectations that involve numerous risks and uncertainties. Assumptions
relating to the foregoing involve judgments with respect to, among other things,
future economic, competitive and market conditions and future business
decisions, all of which are difficult or impossible to predict accurately and
many of which are beyond the control of the Company. Although the Company
believes that the assumptions underlying the forward-looking statements are
reasonable, any of the assumptions could be inaccurate and, therefore, there can
be no assurance that the forward-looking statements included in this Form 10-QSB
will prove to be accurate. In light of the significant uncertainties inherent in
the forward-looking statements included herein, the inclusion of such
information should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be achieved. The
Company disclaims any obligation to subsequently revise any forward-looking
statements to reflect events or circumstances after the date of such statement
or to reflect the occurrence of anticipated or unanticipated events.
The words "we," "us," "our," and the "Company," refer to Blue Holdings,
Inc. The words or phrases "may," "will," "expect," "believe," "anticipate,"
"estimate," "approximate," or "continue," "would be," "will allow," "intends
to," "will likely result," "are expected to," "will continue," "is anticipated,"
"estimate," "project," or similar expressions, or the negative thereof, are
intended to identify "forward-looking statements." Actual results could differ
materially from those projected in the forward-looking statements as a result of
a number of risks and uncertainties, including but not limited to: (a) our
failure to implement our business plan within the time period we originally
planned to accomplish; and (b) other risks that are discussed in this Form
10-QSB or included in our previous filings with the Securities and Exchange
Commission ("SEC").
DESCRIPTION OF BUSINESS
OVERVIEW
We design, manufacture and market high-end fashion jeans, apparel and
accessories under the principal brand names ANTIK DENIM, TAVERNITI SO JEANS and
YANUK. Our products include jeans, jackets, belts, purses and T-shirts. We sell
premium denim products and accessories in high-end department stores and fashion
boutiques that cater to fashion conscious consumers. Our products are currently
sold in the United States, Canada, Japan and the European Union directly to
department stores and boutiques, including Bloomingdales, Nordstrom, Macy's,
Saks and Fred Segal, and through distribution arrangements in a number of
countries abroad.
We operate in the high-end fashion denim industry. Our current
competitors are companies that market such brands as Joe's Jeans, True Religion,
Seven For All Mankind and Citizens of Humanity.
19
Our goal is to build a broad and diversified portfolio of brands
selling premium denim products and accessories across a range of retail price
points through wholesale and retail distribution channels.
CORPORATE BACKGROUND
We were incorporated in the State of Nevada on February 9, 2000 under
the name Marine Jet Technology Corp. From our inception through January 2005, we
focused on developing and marketing boat propulsion technology. Between January
and February 2005, we entered into separate transactions whereby, among other
matters, Keating Reverse Merger Fund, LLC ("KRM Fund"), one of our existing
shareholders, agreed to purchase a substantial majority of our outstanding
common stock, and Intellijet Marine, Inc., a company formed by our former
majority shareholder and principal executive officer and director, Jeff P.
Jordan, acquired all of our boat propulsion technology assets and assumed all of
our then existing liabilities.
Between February 4, 2005 and April 29, 2005, we existed as a public
"shell" company with nominal assets.
SIGNIFICANT DEVELOPMENTS
On September 15, 2006, we entered into a Joint Venture Agreement Term
Sheet with Philippe Naouri and Alexandre Caugant, the members of Life & Death,
LLC ("L&D"), pursuant to which we acquired 50% of the membership interests of
L&D. L&D owns the LIFE & DEATH trademark application and designs, develops,
manufactures and distributes knit apparel under the brand LIFE & DEATH. We share
50% in the profits and losses of L&D based on our membership interest in L&D.
Alexandre Caugant and Philippe Naouri are the principal designers of LIFE AND
DEATH.
On October 5, 2006, we agreed to terminate the Letter of Intent
previously entered into with Global Fashion Group, SA ("Global Fashion Group")
on March 31, 2006, which would have formed a new joint venture company with a
license to produce, manufacture and distribute apparel and accessories for our
three principal brands, ANTIK DENIM, TAVERNITI SO JEANS and YANUK, throughout
Europe and other territories. The initial term of the license would have been
for two years, with automatic renewal for an additional three-year term if the
joint venture achieved target net sales and was not in breach of the license. We
were unable to come to an agreement with Global Fashion Group on the final terms
of the license to be held by the joint venture company contemplated under the
Letter of Intent.
On October 10, 2006, we mutually agreed with Long Rap, Inc. to
terminate the Agreement and Plan of Merger ("Merger Agreement") previously
entered into on June 19, 2006 among LR Acquisition Corporation, a District of
Columbia corporation and our wholly-owned subsidiary ("LR Acquisition"), Long
Rap, the stockholders of Long Rap and Charles Rendelman, as the Long Rap
stockholders' representative, pursuant to which Long Rap would have merged with
and into LR Acquisition with LR Acquisition surviving the merger. We determined,
along with Long Rap, that it would be in the best interests of our respective
stockholders not to proceed with the merger at this time. We incurred $500,887
relating to the abandonment of this acquisition.
In accordance with the provisions of the Merger Agreement, we paid Long
Rap $50,000 and have undertaken to pay 50% of the invoices (fees and expenses)
delivered by Long Rap's independent registered public accounting firm in
connection with the audit of Long Rap's financial statements, which amounted to
about $ 150,000. It has been agreed that we will pay the final invoice for audit
services directly to the independent registered public accounting firm and remit
to Long Rap the difference between the amount of such final invoice and 50% of
the total audit fees and expenses.
20
OUR PRODUCTS AND BRANDS
We offer multiple brands of apparel in the premium and better denim
segments. As a result of a license agreement with Yanuk Jeans, LLC and the
acquisition of Taverniti So Jeans, LLC, our wholly-owned subsidiary
("Taverniti"), we currently market our products under the ANTIK DENIM, TAVERNITI
SO JEANS and YANUK brands. Our products are sold in the United States and abroad
to upscale retailers and boutiques. We currently sell men's and women's styles
and have launched a children's line for both ANTIK DENIM and TAVERNITI SO JEANS.
In addition, Antik Denim, LLC, our wholly-owned subsidiary ("Antik Denim"), is a
party to a license agreement with Titan Industries, Inc. that provides Titan
with an exclusive right to use the ANTIK DENIM brand for the sale of men's and
women's footwear in the United States, Canada and Mexico, and a right of first
refusal for similar use of the brand in Europe and South America. The footwear
line was launched in July 2006.
Our products are made from high quality fabrics milled in the United
States, Japan, Italy and Spain and are processed with cutting-edge treatments
and finishes. Our concepts and designs, including ANTIK DENIM's distinct vintage
western flair, and our extraordinary fit, embellishments, patent pending
pockets, unique finishes, hand stitching, embroidery detail and other attention
to detail and quality give our products a competitive advantage in the high-end
fashion denim and accessories market.
Our jeans are available in multiple combinations of washes, fabrics and
finishes, with as many as 20 different combinations of colors, fabrics and
finishes on certain styles. We typically introduce new versions of our major
styles each month in different colors, washes and finishes. Although our denim
products have accounted for the substantial majority of our total sales, our
product lines include knits, woven tops and accessories, the sales of which we
anticipate will continue to increase.
DESIGN AND DEVELOPMENT
Each of our brands has an independent design team striving to develop a
distinct look and feel to the products based on an overall design philosophy.
Product mix between denim and non-denim products and retail price points vary by
brand.
ANTIK DENIM. The designers of ANTIK DENIM are Philippe Naouri and
Alexandre Caugant, both of whom have significant experience in the denim
industry, in both selling and designing vintage inspired offerings. Their
principal design philosophy is based on vintage western styling featuring a very
unique and distinctive back pocket.
TAVERNITI SO JEANS. The designer of the TAVERNITI SO JEANS line is
Jimmy Taverniti, well known as an Italian couture designer with significant
experience as a denim designer. The principal design philosophy is sportswear
driven looks with vintage and rock and roll styling.
YANUK. The designer of the YANUK line is Benjamin Taverniti, the son of
Jimmy Taverniti. The principal design philosophy is focused less on embroidery
and more on subtle design details and fit.
Mr. Guez participates in design efforts and provides significant input
with respect to the development of new lines and brands. We do not have in place
any formal design and development plan at this time. However, since our
inception in 2004, we have allocated significant resources to our design and
development activities. In the three and nine months ended September 30, 2006,
our design and development expenses were approximately $0.37 million and $1.27
million, respectively.
21
MANUFACTURING AND SOURCING
We purchase our fabric, thread and other raw materials from various
industry suppliers within the United States and abroad. We do not currently have
any long-term agreements in place for the supply of our fabric, thread or other
raw materials. The fabric, thread and other raw materials used by us are
available from a large number of suppliers worldwide. During the three months
ended September 30, 2006, three suppliers accounted for more than 10% of our
purchases. Purchases from these suppliers were 31.5%, 13.0% and 11.8%,
respectively. During the nine months ended September 30, 2006, two suppliers
accounted for more than 10% of our purchases, and purchases from these suppliers
were 13.6% and 12.9%, respectively. We have the ability to replace our suppliers
of raw materials as needed without significantly affecting our business or
operations.
We presently outsource all of our manufacturing needs to contract
vendors using just in time ordering. We use several contract vendors for our
manufacturing needs with the bulk of purchases (approximately 70%) currently
made from domestic manufacturers. We are increasing the use of contract
manufacturers in Mexico and the Far East. We do not rely on any one manufacturer
and we believe additional manufacturing capacity is available to meet our
current and planned needs. We maintain rigorous quality control systems for both
raw and finished goods. We will continue to outsource the majority of our
production capacity to maintain low fixed expenses. We will add contract
manufacturers as required to meet our needs. During the three months ended
September 30, 2006, two sub-contractors accounted for 17.9% and 13.6% of our
manufacturing, and two contractors accounted for 19.2% and 14.2% of our
manufacturing during the nine months ended September 30, 2006. One of these
sub-contractors, which principally provided manufacturing services to Taverniti,
is Azteca Production International Inc., a company co-owned by Paul Guez, our
Chairman, Chief Executive Officer and President.
We believe we can realize significant cost savings in product
manufacturing because of our strong relationships with a diverse group of U.S.
and international contract manufacturers established by our management team
through their prior experience in the apparel industry. In addition, the
increase in production volume as a result of our multi-brand strategy will give
us economies of scale to achieve further cost savings.
MARKETING, DISTRIBUTION AND SALES
We market, distribute and sell our products in the United States and
internationally in a number of other countries such as Canada, Belgium, France,
Germany, Sweden, Italy, Korea and Japan.
Our products are sold in the United States in department stores and
boutiques such as Saks, Neiman Marcus, Nordstrom, Bloomingdales, Atrium, Fred
Segal, Intermix, Kitson and Henri Bendel, as well as smaller boutiques
throughout the country. Our products are sold internationally to department
stores and boutiques such as Lane Crawford in Hong Kong, Harrods and Harvey
Nichols in the United Kingdom, Barneys New York and Isetan in Japan, Galleries
Lafayette in France, and Holt Renfrew in Canada.
We market and distribute our products by participating in industry
trade shows, as well as through our show rooms in Los Angeles and New York. We
maintain distributor relationships in the United Kingdom, France, Germany,
Sweden, Greece, Belgium, Italy, Mexico and Japan. Except for Mexico, Japan and
Canada, we currently have no exclusive or long term distribution agreements with
any party covering any territory, and do not depend on any single distributor to
distribute our products. Our distributors often, but not always, purchase
products from us at a discount for resale to their
22
customers in their respective territories. Our distributors warehouse our
products at their expense and they ship to and collect payment from their
customers directly.
TRADEMARKS AND OTHER INTELLECTUAL PROPERTY
Antik Denim is the holder of trademark applications for the ANTIQUE
DENIM and ANTIK DENIM marks in the United States and various other foreign
jurisdictions. Antik Denim also owns several proprietary concepts and designs,
including pending trademark and patent applications on its pocket designs. Yanuk
Jeans, LLC, from whom we hold exclusive licenses to exploit products based on
the YANUK and U brands, is the holder of several United States and foreign
trademarks.
Taverniti is the exclusive licensee for the design, development,
manufacture, sale, marketing and distribution of the TAVERNITI SO JEANS
trademark in the denim and knit sportswear categories for men and women. It is
paying royalties to Taverniti Holdings LLC in the range of five to eight percent
depending on the net sales of the licensed products pursuant to a license
agreement with Taverniti Holdings LLC. Taverniti Holdings LLC is jointly owned
by Paul Guez (60%) and Jimmy Taverniti (40%), the designer of the products for
the brand, and Mr. Guez is the sole manager. The license agreement was signed in
May 2004 and expires on December 31, 2015.
We have made and will continue to make efforts to minimize domestic and
international counterfeiting of ANTIK DENIM'S stylized pocket design and
infringement of our other intellectual property rights, including through
litigation if necessary.
GOVERNMENT REGULATION AND SUPERVISION
We benefit from certain international treaties and regulations, such as
the North American Free Trade Agreement (NAFTA), which allows for the duty and
quota free entry into the United States of certain qualifying merchandise.
International trade agreements and embargoes by entities such as the World Trade
Organization also can affect our business, although their impact has
historically been favorable.
We have implemented various programs and procedures, including
unannounced inspections, to ensure that all of the apparel manufacturers with
whom we contract fully comply with employment and safety laws and regulations
governing their place of operation.
EMPLOYEES
As of November 7, 2006, we had 114 employees, not including our three
executive officers, Paul Guez, our Chairman, Chief Executive Officer and
President, Patrick Chow, our Chief Financial Officer and Secretary, and Gregory
Abbou, President of Taverniti. Mr. Guez leads our product development, marketing
and sales, and Mr. Chow oversees all financial aspects of our business. Our
employees are not unionized. Except for agreements with Messrs. Naouri and
Caugant, who comprise the design team for our ANTIK DENIM brand, no employees,
including our executive officers, are subject to existing employment agreements
with us.
FACILITIES
PRINCIPAL EXECUTIVE OFFICES
Our principal executive offices are located at 5804 East Slauson
Avenue, Commerce, California 90040. Our telephone number is (323) 725-5555.
23
DESCRIPTION OF PROPERTY
On April 27, 2006, we entered into a Sublease with Azteca Production
International, Inc. to lease approximately 73,193 square feet of office and
warehouse space located at 5804 East Slauson Avenue, Commerce, California, the
location of our current principal executive offices, warehouse and distribution
center. Azteca is co-owned by Mr. Guez, our Chief Executive Officer, President
and Chairman. We previously occupied approximately 67,000 square feet of the
office and warehouse space covered under the Sublease pursuant to our Service
Agreement with Blue Concept, LLC. The Service Agreement with Blue Concept, LLC
expired by its terms on December 31, 2005.
Although executed on April 27, 2006, the term of the Sublease became
effective as of January 1, 2006, and will continue on a month-to-month basis
with termination by either party permitted upon 90-days prior written notice. We
pay monthly rent of approximately Nineteen Thousand Thirty Dollars ($19,030) to
Azteca. The Sublease was approved by a majority of our Board of Directors,
including all of the independent directors.
We also maintain showrooms in both Los Angeles and New York City. The
cost of operations at the Commerce facility and the showrooms was shared by
several companies and the portion of the cost that we paid in 2005 was allocated
to us under our Service Agreement with Blue Concept, LLC. Since January 1, 2006,
we have been paying for the use of these showrooms based on our actual use.
On August 27, 2005, we opened a retail store in Los Angeles, California
and assumed all the obligations of a 10-year property lease, which was
previously signed by Blue Concept, LLC in April, 2005. We are paying $21,840 per
month for the lease of the shop space. More recently, On July 18, 2006, we
entered into lease agreements with Emporium Development, L.L.C. ("Emporium") to
lease approximately 3,272 square feet of space located at 865 Market Street, San
Francisco, California 94103. Although executed on July 18, 2006, the term of the
Sublease became effective as of July 5, 2006, and will continue for a term
expiring on January 31, 2017. We will pay annual rent to Emporium ranging from
$261,760 at the commencement of the term to $326,902 at the end of the term. We
will also pay, as percentage rental, six percent (6%) of gross sales made in and
from the premises in excess of annual breakpoints ranging from $4,362,667 at the
commencement of the term to $5,448,373 at the end of the term.
We believe that the facilities utilized by us are well maintained, in
good operating condition and adequate to meet our current and foreseeable needs.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 2006, net cash used in
operating activities was $(6.2 million). The deficit was primarily due to an
increase of $3.6 million in inventory and $3.6 million in accounts receivables
and was offset by an increase in accounts payable of $0.6 million and an
increase in due to related parties of $0.4 million. Net cash provided by
financing activities was $7.3 million that included $4.9 million from short-term
borrowings and $2.4 million advanced from the majority shareholder. We utilized
$1.2 million in investing activities which primarily consist of $0.8 million for
leasehold improvements at our new store in San Francisco and $0.4 million for
purchases of fixed assets.
We use a factor, FTC Commercial Corp., for working capital and credit
administration purposes. Under the various factoring agreements entered into
separately by Blue Holdings, Antik Denim, LLC and Taverniti So Jeans, LLC, the
factor purchases all the trade accounts receivable assigned by us and assumes
all credit risk with respect to those accounts approved by it.
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The factor agreements provide that we can obtain an amount up to 90% of
the value of our purchased customer invoices, less a reserve of 10% of unpaid
accounts purchased and 100% of all accounts that are disputed. The factor
agreements provide for the automatic renewal of the agreements after July 24,
2006, subject to 120 days' termination notice from any party. We receive amounts
against purchased customer invoices on a recourse basis or a non-recourse basis
under these agreements. Amounts received against customer invoices purchased on
a recourse basis are classified as "short-term borrowings" and amounts received
against customer invoices purchased on a non-recourse basis are reflected on a
net basis against such receivables purchased by the factor in "due from factor"
on the balance sheets included in our financial statements.
In addition, the factor also makes available to all three companies a
combined line of credit up to the lesser of $2.4 million (increased from $1.5
million effective as of January 1, 2006) and 50% of the value of eligible raw
materials and finished goods. The increase in this line of credit - from $1.5
million to $2.4 million - became effective as of January 1, 2006. As of
September 30, 2006, we drew down $2.4 million of this credit line.
Before January 1, 2006, the factor commission was 0.8% of the customer
invoice amount for terms up to 90 days, plus one quarter of one percent (.25%)
for each additional thirty-day term. Effective January 1, 2006, the factor
commission is 0.75% if the aggregate amount of approved invoices is below $10
million per annum, and will be reduced by 5 basis points for each increase by
$10 million in the aggregate amount of approved invoices. We are contingently
liable to the factor for merchandise disputes, customer claims and the like on
receivables sold to the factor. To the extent that we draw funds prior to the
deemed collection date of the accounts receivable sold to the factor, interest
is charged at the rate of 1% over the factor's prime lending rate per annum.
Factor advances and ledger debt are collateralized by the non-factored accounts
receivable, inventories and the personal guarantees of Paul Guez, our Chairman,
Chief Executive Officer, President and majority shareholder, and the living
trust of Paul and Elizabeth Guez.
The factor also purchased customer invoices on a "with recourse" basis.
These advances and the advances against inventory were classified as "short-term
borrowings". These short-term borrowings amounted to $10 million as of September
30, 2006. The factor commission is 0.4% for receivables purchased subject to
recourse. Receivables subject to recourse approximated $8.2 million net of
reserves as of September 30, 2006. Although the arrangement with our factor is
important to our liquidity and capital resources, management believes that cash
flow from operations, and our ability to obtain other debt or equity financing,
permits us to adequately support and manage our ongoing operations.
From time to time, the Company's majority shareholder, Mr. Paul Guez,
made advances to the Company to support its working capital needs. These
advances were non-interest bearing. On July 1, 2006, Mr. Guez converted the
advances to a line of credit in an agreement with the Company. The line of
credit allows the Company to borrow from him up to a maximum of $3 million at an
annual interest rate of 6%. The Company may repay the advances in full or in
part at any time until the credit line expires on December 31, 2007. As of
September 30, 2006, the balance of these advances was $2,508,900.
Our primary source of liquidity is expected to be cash flow generated
from operations, cash and cash equivalents currently on hand, and working
capital attainable through our factor. We may seek to finance future capital
needs through various means and channels, such as issuance of long-term debt or
sale of equity securities.
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OFF-BALANCE SHEET ARRANGEMENTS
Financial instruments that potentially subject the Company to
off-balance sheet risk consist of factored accounts receivable. The Company
sells certain of its trade accounts receivable to a factor and is contingently
liable to the factor for merchandise disputes and other customer claims.
As of September 30, 2006, the factor holds $3,982,414 of accounts
receivable purchased from us on a without recourse basis and has made advances
to us of $2,448,295 against those receivables, resulting in a net balance due
from the factor of $ 1,483,464, net of reserves of $50,655, as of September 30,
2006. The Company has accounted for the sale of receivables to the factor in
accordance with SFAS No.140, "Accounting for the Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities."
RESULTS OF OPERATIONS
The acquisition of Antik Denim, LLC in 2005 was accounted for as a
reverse merger (recapitalization) in the accompanying financial statements with
Antik Denim deemed to be the accounting acquirer, and Blue Holdings deemed to be
the legal acquirer. The exchange transaction with Taverniti So Jeans, LLC was
accounted for as a combination of entities under common control, and its 2005
results were combined with those of Antik Denim and Blue Holdings, respectively.
Accordingly, our results of operations before the completion of these
transactions, including our operating results before April 29, 2005 (when we
completed the acquisition of Antik Denim), reflect the operations of Antik Denim
and Taverniti.
THREE MONTHS ENDED SEPTEMBER 30, 2006 VS. 2005
Net sales increased from $13.9 million for the three months ended
September 30, 2005 to $14.6 million for the three months ended September 30,
2006. The growth was slower than expected due to the failure of a major European
distributor to fulfill its projections and the cancellation of some orders
caused by the production delays of a major vendor.
Gross profit was $4.4 million in the third quarter of 2006 as compared
with $6.9 million for the same period last year. The decrease in gross profit is
largely attributable to sales discounts given to retailers on the disposal of
inventory produced in anticipation of projected European orders that did not
materialize and merchandise that were late from production.
Selling, distribution and administrative expenses for the three months
ended September 30, 2006 totaled $4.3 million or 29% of net sales compared with
$3.3 million or 23.5% of net sales for the same period last year. The increase
was caused by the expansion of overhead at the beginning of the year in
anticipation of higher revenue and higher sales projections and resources and
expenses committed to the terminated transaction with the proprietor of a chain
of retail stores. The principal components during the three months ended
September 30, 2006 were payroll of $2.28 million (compared to $0.63 million for
the same period last year), trade shows expenses $0.27 million (compared to $.06
million for the same period last year), royalties of $0.51 million ($0.27
million in same period of 2005), stock-based compensation of $0.13 million (none
in 2005) and non-recurring expenses of $0.06 million on opening of the San
Francisco store (none in 2005).
Net Income (Loss) after provision for taxes in the third quarter of
2006 was ($0.4 million) or 2.9% of net sales compared to $2.4 million or 17% of
net sales in the third quarter of 2005. Basic and diluted earnings (loss) per
share were ($0.02) in the third quarter of 2006 compared to $0.09 in the same
period of last year. For the three months ended September 30, 2006, the Company
provided ($0.18
26
million) for income tax compared to $1.24 million in the same period last year.
During the three months ended September 30, 2005, the income (loss) and related
Federal and State income tax obligations were passed through to the previous
members of Taverniti So Jeans, LLC.
NINE MONTHS ENDED SEPTEMBER 30, 2006 VS. 2005
Net sales increased from $24.6 million for the nine months ended
September 30, 2005 to $41.6 million for the nine months ended September 30,
2006. The growth was slower than expected due to the failure of a major European
distributor to fulfill its projections and the cancellation of some orders in
the third quarter of 2006 caused by the production delays of a major vendor.
Gross profit for the nine months ended September 30, 2006 increased to
$17.8 million, or 42.8% of net sales from $12.2 million or 49.7 % of net sales
for the same period last year. The decline in gross profit percentage to net
sales is due to sales discounts given to retailers on disposal of merchandise
produced in anticipation of European orders that did not materialize and
merchandise late from production in the third quarter of 2006.
Selling, distribution and administrative expenses for first nine months
of 2006 totaled $13.2 million compared with $6.4 million for the same period
last year. The increase was caused by the expansion of overhead at the beginning
of the year in anticipation of higher revenue and higher sales projections for
the year [and resources and expenses committed to the terminated transaction
with the proprietor of a chain of retail stores]. The principal components
during the first nine months of 2006 were payroll of $5.8 million (compared to
$1.2 million during the same period last year), advertising and trade show
expenses of $1.03 million ($0.46 million in the same period of 2005), travel
expenses of $0.48 million ($0.19 million in the same period of 2005), royalties
of $1.3 million ($0.42 million in 2005) and stock-based compensation of $0.36
million (none in 2005).
Net Income after provision for taxes for nine months ended September
30, 2006 was $1.9 million or 4.7% of net sales compared to $3.9 million or 15.8%
of net sales during the same period last year. Basic and diluted earnings per
share were $0.08 for the nine months of 2006 compared to $0.15 in the same
period of last year. For the nine months ended September 30, 2006, the Company
provided $1.5 million for income tax compared to $1.4 million in the same period
last year. During the nine months ended September 30, 2005, the income (loss)
and related Federal and State income tax obligations for the period were passed
through to the previous members of Taverniti So Jeans, LLC. These tax
obligations for Antik Denim, LLC between January 1 and April 29, 2005 were also
passed through to its previous members. The Company only recorded provisions for
income taxes on the income of Antik Denim, LLC between April 30 and September
30, 2005 during nine months ended September 30, 2005.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues. On an
ongoing basis, we evaluate estimates, including those related to returns,
discounts, bad debts, inventories, intangible assets, income taxes,
contingencies and litigation. We base our estimates on historical experience and
on various assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
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REVENUE
Revenue is recognized when merchandise has been shipped against a
customer's written purchase order, the risk of ownership has passed, selling
price has been fixed and determined and collectibility is reasonably assured
either through payment received, or fulfillment of all the terms and conditions
of the particular purchase order. Revenue is recorded net of estimated returns,
charge backs and markdowns based on management's estimates and historical
experience.
ACCOUNTS RECEIVABLE
Trade accounts receivable are recorded at invoiced amounts, less
amounts accrued for returns, discounts and allowances. An allowance is provided
for specific customer accounts where collection is doubtful and for inherent
risk in our ability to ultimately collect those receivables. There is no
off-balance sheet credit exposure related to customer receivables.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined on the first-in, first-out ("FIFO") method.
INCOME TAXES
We account for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under SFAS No. 109, income taxes are recognized
for the amount of taxes payable or refundable for the current year and deferred
tax liabilities and assets are recognized for the future tax consequences of
transactions that have been recognized in our financial statements or tax
returns. A valuation allowance is provided when it is more likely than not that
some portion or all of the deferred tax asset will not be realized.
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
FASB Statement of Financial Accounting Standards (SFAS) No. 157, "Fair Value
Measurements," establishes a formal framework for measuring fair value under
GAAP. It defines and codifies the many definitions of fair value included among
various other authoritative literature, clarifies and, in some instances,
expands on the guidance for implementing fair value measurements, and increases
the level of disclosure required for fair value measurements. Although SFAS no.
157 applies to and amends the provisions of existing FASB and AICPA
pronouncements, it does not, of itself, require any new fair value measurements,
nor does it establish valuation standards. SFAS No. 157 applies to all other
accounting pronouncements requiring or permitting fair value measurements,
except for; SFAS no. 123 (R), share-based payment and related pronouncements,
the practicability exceptions to fair value determinations allowed by various
other authoritative pronouncements, and AICPA Statements of Position 97-2 and
98-9 that deal with software revenue recognition. This statement is effective
for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years.
SFAS No. 158 requires that for public companies the full funding status of
defined benefit pension and other postretirement plans to be recognized on the
balance sheet as an asset (for overfunded plans) or as a liability (for
underfunded plans). In addition, SFAS No. 158 calls for recognition in other
comprehensive income or gains or losses and prior service costs or credits that
are not yet included as components of
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periodic benefit expense. Finally, SFAS No. 158 requires that the measurement of
defined benefit plan assets and obligations be as of the balance sheet date. The
Company plans to adopt the recognition provisions of SFAS No. 158 as of the end
of the fiscal year end after December 15, 2006 and the measurement date
provisions as of the balance sheet date for fiscal years ending after December
15, 2008.
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER
INFORMATION CONTAINED IN THIS DESCRIPTION BEFORE PURCHASING SHARES OF OUR COMMON
STOCK OR OTHER SECURITIES. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE
OF RISK. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES
FACING US. ADDITIONAL RISKS AND UNCERTAINTIES THAT WE ARE NOT AWARE OF, OR THAT
WE CURRENTLY DEEM IMMATERIAL, ALSO MAY BECOME IMPORTANT FACTORS THAT AFFECT US.
IF ANY OF THE FOLLOWING EVENTS OR OUTCOMES ACTUALLY OCCURS, OUR BUSINESS,
OPERATING RESULTS AND FINANCIAL CONDITION WOULD LIKELY SUFFER. AS A RESULT, THE
TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR PART OF
THE MONEY YOU PAID TO PURCHASE OUR COMMON STOCK.
RISKS RELATED TO OUR BUSINESS
WE HAVE A LIMITED OPERATING HISTORY, MAKING IT DIFFICULT TO EVALUATE WHETHER WE
WILL OPERATE PROFITABLY.
Antik Denim and Taverniti, our wholly-owned subsidiaries, were formed
in September 2004 to design, develop, manufacture, market, distribute and sell
high end fashion jeans, apparel and accessories. As a result, we do not have a
meaningful historical record of sales and revenues nor an established business
track record. While our management believes that we have an opportunity to be
successful in the high end fashion jean market, there can be no assurance that
we will be successful in accomplishing our business initiatives, or that we will
achieve any significant level of revenues, or continue to recognize net income,
from the sale of our products.
Unanticipated problems, expenses and delays are frequently encountered
in increasing production and sales and developing new products, especially in
the current stage of our business. Our ability to continue to successfully
develop, produce and sell our products and to generate significant operating
revenues will depend on our ability to, among other matters:
- successfully market, distribute and sell our products or enter
into agreements with third parties to perform these functions
on our behalf; and
- obtain the financing required to implement our business plan.
Given our limited operating history, our license agreements with Yanuk
Jeans, LLC, our acquisition of Taverniti, and our lack of long-term sales
history and other sources of revenue, there can be no assurance that we will be
able to achieve any of our goals and develop a sufficiently large customer base
to be profitable.
WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE.
We may not be able to fund our future growth or react to competitive
pressures if we lack sufficient funds. Currently, management believes we have
sufficient cash on hand and cash available through our factor to fund existing
operations for the foreseeable future. However, in the future, we may
29
need to raise additional funds through equity or debt financings or
collaborative relationships, including in the event that we lose our
relationship with our factor. This additional funding may not be available or,
if available, it may not be available on commercially reasonable terms. In
addition, any additional funding may result in significant dilution to existing
shareholders. If adequate funds are not available on commercially acceptable
terms, we may be required to curtail our operations or obtain funds through
collaborative partners that may require us to release material rights to our
products.
FAILURE TO MANAGE OUR GROWTH AND EXPANSION COULD IMPAIR OUR BUSINESS.
Management believes that we are poised for significant growth in 2006.
However, no assurance can be given that we will be successful in maintaining or
increasing our sales in the future. Any future growth in sales will require
additional working capital and may place a significant strain on our management,
management information systems, inventory management, sourcing capability,
distribution facilities and receivables management. Any disruption in our order
processing, sourcing or distribution systems could cause orders to be shipped
late, and under industry practices, retailers generally can cancel orders or
refuse to accept goods due to late shipment. Such cancellations and returns
would result in a reduction in revenue, increased administrative and shipping
costs and a further burden on our distribution facilities.
Additionally, we intend from time to time to open and/or license retail
stores focusing on the ANTIK DENIM, YANUK, TAVERNITI SO JEANS and other brands,
and to acquire and/or license other businesses and brands, as applicable, as we
deem appropriate. If we are unable to adequately manage our retail operations,
or to properly integrate any business or brands we acquire and/or license, this
could adversely affect our results of operation and financial condition.
THE LOSS OF PAUL GUEZ OR OUR LEAD DESIGNERS WOULD HAVE AN ADVERSE EFFECT ON OUR
FUTURE DEVELOPMENT AND COULD SIGNIFICANTLY IMPAIR OUR ABILITY TO ACHIEVE OUR
BUSINESS OBJECTIVES.
Our success is largely dependent upon the expertise and knowledge of
our Chairman, Chief Executive Officer and President, Paul Guez, and our lead
designers, and our ability to continue to hire and retain other key personnel.
The loss of Mr. Guez, or any of our other key personnel, could have a material
adverse effect on our business, development, financial condition, and operating
results. We do not maintain "key person" life insurance on any of our management
or key personnel, including Mr. Guez.
WE CURRENTLY OWN OR LICENSE, AND OPERATE, A LIMITED NUMBER OF PRINCIPAL BRANDS.
IF WE ARE UNSUCCESSFUL IN MARKETING AND DISTRIBUTING THOSE BRANDS OR IN
EXECUTING OUR OTHER STRATEGIES, OUR RESULTS OF OPERATIONS AND FINANCIAL
CONDITION WILL BE ADVERSELY AFFECTED.
While our goal is to employ a multi-brand strategy that will ultimately
diversify the fashion and other risks associated with reliance on a limited
product line, we currently operate, directly and through our wholly-owned
subsidiaries Antik Denim and Taverniti, a limited number of principal brands,
most of which are being operated pursuant to very recent license or acquisition
agreements. If we are unable to successfully market and distribute our branded
products, or if the recent popularity of premium denim brands decreases, or if
we are unable to execute on our multi-brand strategy to acquire and/or license
additional companies and/or brands, as applicable, identified by our management
from time to time, our results of operations and financial condition will be
adversely affected.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
Management expects that we will experience substantial variations in
our net sales and operating results from quarter to quarter. We believe that the
factors which influence this variability of quarterly results include:
30
- the timing of our introduction of new product lines;
- the level of consumer acceptance of each new product line;
- general economic and industry conditions that affect consumer
spending and retailer purchasing;
- the availability of manufacturing capacity;
- the seasonality of the markets in which we participate;
- the timing of trade shows;
- the product mix of customer orders;
- the timing of the placement or cancellation of customer
orders;
- the weather;
- transportation delays;
- quotas and other regulatory matters;
- the occurrence of charge backs in excess of reserves; and
- the timing of expenditures in anticipation of increased sales
and actions of competitors.
As a result of fluctuations in our revenue and operating expenses that
may occur, management believes that period-to-period comparisons of our results
of operations are not a good indication of our future performance. It is
possible that in some future quarter or quarters, our operating results will be
below the expectations of securities analysts or investors. In that case, our
common stock price could fluctuate significantly or decline.
THE LOSS OF BUSINESS FROM ANY SIGNIFICANT CUSTOMER WOULD AFFECT OUR RESULTS OF
OPERATIONS.
We have one customer who accounted for approximately 42% of our total
receivables at September 30, 2006 and two customers who accounted for 30.3% and
11.6%, respectively, of our sales for the three months ended September 30, 2006.
A decrease in business from or loss of a any significant customer could have a
material adverse effect on our results of operations. Additionally, certain
retailers, including some of our customers, have experienced in the past, and
may experience in the future, financial difficulties, which increase the risk of
extending credit to such retailers and the risk that financial failure will
eliminate a customer entirely. These retailers have attempted to improve their
own operating efficiencies by concentrating their purchasing power among a
narrowing group of vendors. There can be no assurance that we will remain a
preferred vendor for our existing customers. Further, there can be no assurance
that our factor will approve the extension of credit to certain retail customers
in the future. If a customer's credit is not approved by the factor, we could
assume the collection risk on sales to the customer itself, require that the
customer provide a letter of credit, or choose not to make sales to the
customer.
OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS.
A portion of our import operations are subject to tariffs imposed on
imported products and quotas imposed by trade agreements. In addition, the
countries in which our products are imported may from time to time impose
additional new duties, tariffs or other restrictions on their respective imports
or adversely modify existing restrictions. Adverse changes in these import costs
and restrictions, or our suppliers' failure to comply with customs or similar
laws, could harm our business. We cannot assure that future trade agreements
will not provide our competitors with an advantage over us, or increase our
costs, either of which could have an adverse effect on our business and
financial condition.
Our operations are also subject to the effects of international trade
agreements and regulations such as the North American Free Trade Agreement, and
the activities and regulations of the World Trade Organization. Generally, these
trade agreements benefit our business by reducing or eliminating the duties
assessed on products or other materials manufactured in a particular country.
31
However, trade agreements can also impose requirements that adversely affect our
business, such as limiting the countries from which we can purchase raw
materials and setting duties or restrictions on products that may be imported
into the United States from a particular country.
Our ability to import raw materials in a timely and cost-effective
manner may also be affected by problems at ports or issues that otherwise affect
transportation and warehousing providers, such as labor disputes. These problems
could require us to locate alternative ports or warehousing providers to avoid
disruption to our customers. These alternatives may not be available on short
notice or could result in higher transit costs, which could have an adverse
impact on our business and financial condition.
OUR DEPENDENCE ON INDEPENDENT MANUFACTURERS AND SUPPLIERS OF RAW MATERIALS
REDUCES OUR ABILITY TO CONTROL THE MANUFACTURING PROCESS, WHICH COULD HARM OUR
SALES, REPUTATION AND OVERALL PROFITABILITY.
We depend on independent contract manufacturers and suppliers of raw
materials to secure a sufficient supply of raw materials and maintain sufficient
manufacturing and shipping capacity in an environment characterized by declining
prices, labor shortages, continuing cost pressure and increased demands for
product innovation and speed-to-market. This dependence could subject us to
difficulty in obtaining timely delivery of products of acceptable quality. In
addition, a contractor's failure to ship products to us in a timely manner or to
meet the required quality standards could cause us to miss the delivery date
requirements of our customers. The failure to make timely deliveries may cause
our customers to cancel orders, refuse to accept deliveries, impose
non-compliance charges through invoice deductions or other charge-backs, demand
reduced prices or reduce future orders, any of which could harm our sales,
reputation and overall profitability.
We do not have long-term contracts with any of our independent
contractors and any of these contractors may unilaterally terminate their
relationship with us at any time. While management believes that there exists an
adequate supply of contractors to provide products and services to us, to the
extent we are not able to secure or maintain relationships with independent
contractors that are able to fulfill our requirements, our business would be
harmed.
We have initiated standards for our suppliers, and monitor our
independent contractors' compliance with applicable labor laws, but we do not
control our contractors or their labor practices. The violation of federal,
state or foreign labor laws by one of our contractors could result in us being
subject to fines and our goods that are manufactured in violation of such laws
being seized or their sale in interstate commerce being prohibited. To date, we
have not been subject to any sanctions that, individually or in the aggregate,
have had a material adverse effect on our business, and we are not aware of any
facts on which any such sanctions could be based. There can be no assurance,
however, that in the future we will not be subject to sanctions as a result of
violations of applicable labor laws by our contractors, or that such sanctions
will not have a material adverse effect on our business and results of
operations.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS.
The loss of or inability to enforce our trademarks or any of our other
proprietary or licensed designs, patents, know-how and trade secrets could
adversely affect our business. If any third party copies or otherwise gains
access to our trademarks or other proprietary rights, or develops similar
products independently, it may be costly to enforce our rights and we would not
be able to compete as effectively. Additionally, the laws of foreign countries
may provide inadequate protection of intellectual property rights, making it
difficult to enforce such rights in those countries.
32
We may need to bring legal claims to enforce or protect our
intellectual property rights. Any litigation, whether successful or
unsuccessful, could result in substantial costs and diversions of resources. In
addition, notwithstanding the rights we have secured in our intellectual
property, third parties may bring claims against us alleging that we have
infringed on their intellectual property rights or that our intellectual
property rights are not valid. Any claims against us, with or without merit,
could be time consuming and costly to defend or litigate and therefore could
have an adverse affect on our business.
OUR BUSINESS IS GROWING MORE INTERNATIONAL AND CAN BE DISRUPTED BY FACTORS
BEYOND OUR CONTROL.
We have been reducing our reliance on domestic contractors and
expanding our use of offshore manufacturers as a cost-effective means to produce
our products. During the three and nine months ended September 30, 2006, we
sourced a significant majority of our finished products from suppliers located
outside the United States and we also continued to increase our purchase of
fabrics outside the United States. In addition, we have been increasing our
international sales of product primarily through our licensees and distributors.
As a result of our increasing international operations, we face the
possibility of greater losses from a number of risks inherent in doing business
in international markets and from a number of factors which are beyond our
control. Such factors that could harm our results of operations and financial
condition include, among other things:
- Political instability or acts of terrorism, which disrupt
trade with the countries in which our contractors, suppliers
or customers are located;
- Local business practices that do not conform to legal or
ethical guidelines;
- Adoption of additional or revised quotas, restrictions or
regulations relating to imports or exports;
- Additional or increased customs duties, tariffs, taxes and
other charges on imports;
- Significant fluctuations in the value of the dollar against
foreign currencies;
- Increased difficulty in protecting our intellectual property
rights in foreign jurisdictions;
- Social, legal or economic instability in the foreign markets
in which we do business, which could influence our ability to
sell our products in these international markets; and
- Restrictions on the transfer of funds between the United
States and foreign jurisdictions.
RISKS RELATED TO OUR INDUSTRY
OUR SALES ARE HEAVILY INFLUENCED BY GENERAL ECONOMIC CYCLES.
Apparel is a cyclical industry that is heavily dependent upon the
overall level of consumer spending. Purchases of apparel and related goods tend
to be highly correlated with cycles in the disposable income of our consumers.
Our customers anticipate and respond to adverse changes in economic conditions
and uncertainty by reducing inventories and canceling orders. As a result, any
substantial deterioration in general economic conditions, increases in interest
rates, acts of war, terrorist or political events that diminish consumer
spending and confidence in any of the regions in which we compete, could reduce
our sales and adversely affect our business and financial condition.
OUR BUSINESS IS HIGHLY COMPETITIVE AND DEPENDS ON CONSUMER SPENDING PATTERNS.
The apparel industry is highly competitive. We face a variety of
competitive challenges including:
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- anticipating and quickly responding to changing consumer
demands;
- developing innovative, high-quality products in sizes and
styles that appeal to consumers;
- competitively pricing our products and achieving customer
perception of value; and
- the need to provide strong and effective marketing support.
WE MUST SUCCESSFULLY GAUGE FASHION TRENDS AND CHANGING CONSUMER PREFERENCES TO
SUCCEED.
Our success is largely dependent upon our ability to gauge the fashion
tastes of our customers and to provide merchandise that satisfies retail and
customer demand in a timely manner. The apparel business fluctuates according to
changes in consumer preferences dictated in part by fashion and season. To the
extent we misjudge the market for our merchandise, our sales may be adversely
affected. Our ability to anticipate and effectively respond to changing fashion
trends depends in part on our ability to attract and retain key personnel in our
design, merchandising and marketing staff. Competition for these personnel is
intense, and we cannot be sure that we will be able to attract and retain a
sufficient number of qualified personnel in future periods.
OUR BUSINESS MAY BE SUBJECT TO SEASONAL TRENDS RESULTING IN FLUCTUATIONS IN OUR
QUARTERLY RESULTS, WHICH COULD CAUSE UNCERTAINTY ABOUT OUR FUTURE PERFORMANCE
AND HARM OUR RESULTS OF OPERATIONS.
In the experience of our management, operating results in the high end
fashion denim industry have been subject to seasonal trends when measured on a
quarterly basis. These trends are dependent on numerous factors, including:
- the markets in which we operate;
- holiday seasons;
- consumer demand;
- climate;
- economic conditions; and
- numerous other factors beyond our control.
DIFFICULTY IN MANAGING ANTICIPATED GROWTH COULD HAVE A MATERIAL ADVERSE IMPACT
ON OUR BUSINESS AND OPERATING RESULTS.
We anticipate growing our business in part through the acquisition of
additional companies and/or license of additional brands depending upon a
company's and/or a brand's sales revenues, name and brand recognition, and/or
synergies with our existing brands. The acquisition and integration of these
businesses and or brands will be complex and time and resource-consuming, and
our management will have to dedicate substantial effort to it. These efforts
could divert management's focus and resources from other strategic opportunities
and from operational matters during the integration process, which could
adversely impact our business and operating results.
OTHER RISKS RELATED TO US
OUR SALE OF SECURITIES IN ANY EQUITY OR DEBT FINANCING COULD RESULT IN DILUTION
TO OUR SHAREHOLDERS AND HAVE A MATERIAL ADVERSE EFFECT ON OUR EARNINGS.
Any sale of shares by us in future private placement or other offerings
could result in dilution to our existing shareholders as a direct result of our
issuance of additional shares of our capital stock. In addition, our business
strategy may include expansion through internal growth, by acquiring
complementary businesses, by acquiring or licensing additional brands, or by
establishing strategic relationships with targeted customers and suppliers. In
order to do so, or to fund our other activities, we may issue additional equity
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securities that could dilute our shareholders' stock ownership. We may also
assume additional debt and incur impairment losses related to goodwill and other
tangible assets if we acquire another company and this could negatively impact
our results of operations.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR
SHAREHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS.
As of November 13, 2006, our Chief Executive Officer, Paul Guez, Chief
Financial Officer, Patrick Chow and two members of our design team, Messrs.
Naouri and Caugant, owned approximately 79.7% of the outstanding shares of our
common stock. Paul and Elizabeth Guez, Mr. Guez's wife and our former Chief
Operating Officer, alone owned approximately 72% of the outstanding shares of
our common stock at November 13, 2006. Accordingly, our executive officers and
key personnel have the ability to affect the outcome of, or exert considerable
influence over, all matters requiring shareholder approval, including the
election and removal of directors and any change in control. This concentration
of ownership of our common stock could have the effect of delaying or preventing
a change of control of us or otherwise discouraging or preventing a potential
acquirer from attempting to obtain control of us. This, in turn, could have a
negative effect on the market price of our common stock. It could also prevent
our shareholders from realizing a premium over the market prices for their
shares of common stock.
OUR STOCK PRICE HAS BEEN VOLATILE.
Our common stock is quoted on the NASDAQ Capital Market, and there can
be substantial volatility in the market price of our common stock. The market
price of our common stock has been, and is likely to continue to be, subject to
significant fluctuations due to a variety of factors, including quarterly
variations in operating results, operating results which vary from the
expectations of securities analysts and investors, changes in financial
estimates, changes in market valuations of competitors, announcements by us or
our competitors of a material nature, loss of one or more customers, additions
or departures of key personnel, future sales of common stock and stock market
price and volume fluctuations. In addition, general political and economic
conditions such as a recession, or interest rate or currency rate fluctuations
may adversely affect the market price of our common stock.
In addition, the stock market in general has experienced extreme price
and volume fluctuations that have affected the market price of our common stock.
Often, price fluctuations are unrelated to operating performance of the specific
companies whose stock is affected. In the past, following periods of volatility
in the market price of a company's stock, securities class action litigation has
occurred against the issuing company. If we were subject to this type of
litigation in the future, we could incur substantial costs and a diversion of
our management's attention and resources, each of which could have a material
adverse effect on our revenue and earnings. Any adverse determination in this
type of litigation could also subject us to significant liabilities.
ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO INVESTORS.
Some investors favor companies that pay dividends, particularly in
general downturns in the stock market. We have not declared or paid any cash
dividends on our common stock. We currently intend to retain any future earnings
for funding growth, and we do not currently anticipate paying cash dividends on
our common stock in the foreseeable future. Because we may not pay dividends,
your return on an investment in our common stock likely depends on your selling
such stock at a profit.
OUR BOARD IS AUTHORIZED TO ISSUE PREFERRED STOCK, WHICH MAY MAKE IT DIFFICULT
FOR ANY PARTY TO ACQUIRE US AND ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK.
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Under our articles of incorporation, our Board of Directors has the
power to authorize the issuance of up to 5,000,000 shares of preferred stock and
to determine the price, rights, preferences, privileges and restrictions,
including voting rights, of those shares without further vote or action by the
shareholders. Accordingly, our Board of Directors may issue preferred stock with
terms that could have preference over and adversely affect the rights of holders
of our common stock.
The issuance of any preferred stock may:
- make it difficult for any party to acquire us, even though an
acquisition might be beneficial to our stockholders;
- delay, defer or prevent a change in control of our company;
- discourage bids for the common stock at a premium over the
market price of our common stock;
- adversely affect the voting and other rights of the holders of
our common stock; and
- discourage acquisition proposals or tender offers for our
shares.
The provisions allowing the issuance of preferred stock could limit the
price that investors might be willing to pay in the future for shares of our
common stock.
ITEM 3. CONTROLS AND PROCEDURES
As of September 30, 2006, the end of the period covered by this
Quarterly Report on Form 10-QSB, we conducted an evaluation, under the
supervision and with the participation of our Chief Executive Officer and Chief
Financial Officer, of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that as of
September 30, 2006, our disclosure controls and procedures were effective.
During the quarter ended September 30, 2006, there were no changes in
the internal control over financial reporting (as defined in Rule 13a-15(f)
under the Exchange Act) that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
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PART II
ITEM 6. EXHIBITS
See Exhibit Index.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
BLUE HOLDINGS, INC.
Date: November 14, 2006 By: /s/ Patrick Chow
---------------------------------------
Patrick Chow
Chief Financial Officer and Secretary
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EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------- -----------------------------------------------------------------------
10.1 Amendment No. 1 to License Agreement dated October 5, 2005, dated July
14, 2006, between the Company and Yanuk Jeans, LLC.
10.2 Lease dated July 18, 2006, between the Company and Emporium
Development, L.L.C.
10.3 Lease Addendum dated July 18, 2006, between the Company and Emporium
Development, L.L.C.
10.4 Assignment, Assumption and Amendment Agreement dated July 31, 2006,
among Taverniti So Jeans, LLC, Caitac International, Inc. and Blue
Concept, LLC.
10.5 Inventory Loan Facility Agreement dated July 25, 2005, between the
Company and FTC Commercial Corp.
10.6 Inventory Loan Facility Agreement dated July 25, 2005, between Antik
Denim, LLC and FTC Commercial Corp.
10.7 Inventory Loan Facility Agreement dated October 31, 2005, between
Taverniti So Jeans, LLC and FTC Commercial Corp.
10.8 Amendment No. 1 to Inventory Loan Facility Agreement dated July 25,
2005, dated August 4, 2006 and Effective as of July 26, 2005, between
the Company and FTC Commercial Corp.
10.9 Amendment No. 2 to Inventory Loan Facility Agreement dated July 25,
2005, dated August 4, 2006 and Effective as of October 31, 2005,
between the Company and FTC Commercial Corp.
10.10 Amendment No. 3 to Inventory Loan Facility Agreement dated July 25,
2005, dated August 4, 2006 and Effective as of January 1, 2006, between
the Company and FTC Commercial Corp.
10.11 Amendment No. 1 to Inventory Loan Facility Agreement dated July 25,
2005, dated August 4, 2006 and Effective as of July 26, 2005, between
Antik Denim, LLC and FTC Commercial Corp.
10.12 Amendment No. 2 to Inventory Loan Facility Agreement dated July 25,
2005, dated August 4, 2006 and Effective as of October 31, 2005,
between Antik Denim, LLC and FTC Commercial Corp.
10.13 Amendment No. 3 to Inventory Loan Facility Agreement dated July 25,
2005, dated August 4, 2006 and Effective as of January 1, 2006, between
Antik Denim, LLC and FTC Commercial Corp.
10.14 Amendment No. 1 to Inventory Loan Facility Agreement dated October 31,
2005, dated August 4, 2006 and Effective as of January 1, 2006, between
Taverniti So Jeans, LLC and FTC Commercial Corp.
10.15 Guaranty dated October 31, 2005, between Taverniti So Jeans, LLC and
FTC Commercial Corp.
10.16 Guaranty dated October 31, 2005, between Taverniti So Jeans, LLC and
FTC Commercial Corp.
10.17 Guaranty dated July 25, 2005 between Antik Denim, LLC and FTC
Commercial Corp.
10.18 Indemnity Agreement for Factor and Supplier Guarantees, dated August 4,
2006 and Effective January 1, 2006, among the Company and FTC
Commercial Corp.
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10.19 Indemnity Agreement for Factor and Supplier Guarantees, dated August 4,
2006 and Effective January 1, 2006, among Antik Denim, LLC and FTC
Commercial Corp.
10.20 Indemnity Agreement for Factor and Supplier Guarantees, dated August 4,
2006 and Effective January 1, 2006, among Taverniti So Jeans, LLC and
FTC Commercial Corp.
10.21 Continuing Security Agreement dated June 25, 2005, between the Company
and FTC Commercial Corp.
10.22 Continuing Security Agreement dated June 25, 2005, between Antik Denim,
LLC and FTC Commercial Corp.
10.23 Continuing Security Agreement dated October 31, 2005, between Taverniti
So Jeans, LLC and FTC Commercial Corp.
10.24 Amendment to Continuing Security Agreement dated June 25, 2005, dated
August 4, 2006 and Effective October 31, 2005, between the Company and
FTC Commercial Corp.
10.25 Amendment to Continuing Security Agreement dated June 25, 2005, dated
August 4, 2006 and Effective October 31, 2005, between Antik Denim, LLC
and FTC Commercial Corp.
10.26 Revolving Promissory Note dated August 7, 2006, between the Company and
Paul Guez.
10.27.1 Joint Venture Agreement Term Sheet dated September 15, 2006, among the
Company, Philippe Naouri and Alexandre Caugant.
10.27.2 Membership Acquisition Agreement dated September 20, 2006, between the
Company and Life & Death, LLC.
10.27.3 Operating Agreement of Life & Death, LLC.
10.28 Assignment and Assumption of Lease effective as of August 1, 2005,
among the Company, Blue Concept, LLC and Melrose Edinburgh, LLC.
10.29 Letter terminating Letter of Intent with Global Fashion Group, SA.
10.30 Letter terminating Agreement and Plan of Merger with Long Rap, Inc.
31.1 Certification of Principal Executive Officer pursuant to Securities
Exchange Act Rules 13a-14(a) or 15d-14(a) as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Securities
Exchange Act Rules 13a-14(a) or 15d-14(a) as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of Principal Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
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