Talon International, Inc. Q3 2008 (Qtr End 9/30/2008) Earnings Call Transcript

Nov.17.08 | About: Talon International, (TALN)

Talon International, Inc. (OTCQB:TALN) Q3 2008 Earnings Call November 17, 2008 4:30 PM ET

Executives

Lonnie D. Schnell – Chief Executive Officer

Analysts

[Paul Dipetrio] – Investors Capital

[Benjamin Sexton] – First Wilshire Securities Management

[Bob Richards] – Private Investor

Operator

Good afternoon and thank you for participating in today’s conference call to discuss Talon’s International financial results for the third quarter ended September 30, 2008. Joining us today is Mr. Lonnie Schnell, Chief Executive Officer of Talon International. Following his comments we will open the call for your questions. Before I continue, I’d like to take a minute to read the company’s safe harbor statement.

This presentation contains forward-looking statements as referenced in the Private Securities Litigation Reform Act. Forward-looking statements are inherently unreliable and actual results may differ materially. Examples of forward-looking statements in this presentation include statements about Talon International’s predicted future performance.

Factors which could cause actual results to differ materially from these forward-looking statements include an unfavorable outcome in litigation in which the company is a party; the unanticipated loss of one or more major customers; economic conditions; the availability and cost of financing; pricing pressures and other competitive factors; its ability to acquire new customers for its TekFit product; resolution of the ongoing dispute regarding our license to the TekFit technology; and potential fluctuations in quarterly operating results.

These and other risks are more fully described in the company’s filings with the Securities and Exchange Commission and included in the company’s most recently filed annual report on Form 10-K and quarterly report on Form 10-Q, which should be read in conjunction here with further discussion of important factors that could cause actual results to differ materially from those in the forward-looking statements. The company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I’d like to remind everyone this call will be available for replay through December 17, 2008 starting this evening approximately 30 minutes after the completion of this call. Please refer to today’s press release for dial-in replay information. Now I’d like to turn the call over to Talon International’s CEO, Mr. Lonnie Schnell. Sir, please proceed.

Lonnie D. Schnell

Thank you operator and good afternoon to everyone. Thank you for joining us today to discuss our operating results for the third quarter of 2008. As you saw last Friday, we issued a press release announcing our financial results for the quarter and timely filed our quarterly report with the SEC. I am pleased to report that following a very strong second quarter, in the third quarter of 2008 we again achieved substantial growth across all of our business lines, as well as completed some important initiatives for the company.

Net sales for the third quarter of 2008 were $12.8 million and while we were optimistic going into the quarter, these results exceeded our expectations. Talon zipper sales for the quarter increased $3 million or 68% compared to the same quarter last year and at the same time our trim division reported a respectable 17% increase in revenues over the prior year, adding $785,000 to the quarter. Lastly, our TekFit division delivered just under $100,000; still a relatively small amount, but in line with our expectations and evidence of continued momentum.

For the first nine months of 2008, our Talon zipper sales totaled $24.3 million for a year to year increase to date of 39% over the same period in 2007. These 2008 increases follow compound growth in this division for the last two years of over 23% annually. We believe these rapid growth rates reflect a market that is hungry for a quality, global alternative in the zipper business and the acceptance of Talon as the premier choice in this category.

A substantial portion of our 2008 revenue increases is a result of new brand nominations that we have won, but it also reflects our continued success in achieving program specific approvals directly from numerous factories within Asia and the effectiveness of our expanded footprint throughout China.

While our zipper products continue to lead our revenue growth, our Talon trim division also made important contributions and improvement in both the third quarter and year-to-date. Sales in the trim division for the third quarter of 2008 were $5.5 million or 17% greater than for the same period in 2007. And for the first nine months of 2008, trim sales totaled $16.4 million, a 14% improvement over the same period in 2007.

These increases are solid growth rates in a highly competitive marketplace. Our success in this division is reflective of the excellent brand, specific design and development service we provide; the outstanding quality products we deliver at a value price; and our continuing customer service for each program from start to finish. This customer service driven focus continues to win the confidence of brands looking for that differential edge in their market presentations and results in new program approvals for us and the expansion of our basic key brands served.

Our renewed sales focus we set in motion at the beginning of this year, that included some new organization of our sales team, helped create a very strong second quarter which has now continued into the third. We are beginning to see the opportunities and the synergies that occurs with the cross selling of each of our product groups at the brand level. Our team’s ability to provide innovative and quality products with competitive pricing and delivery opens the door to our success, but it’s also the groups’ responsiveness and flexibility that closes the sale and brings customers back for more.

During the third quarter of 2008, we reported TekFit sales of $95,000; although still modest, this reflected some positive results from our efforts over the last year to reestablish our TekFit product line. Our products are now in retail stores and are being promoted under our TekFit name by a major retailer. As the product sales materialize at this level, we hope to see increasing replenishment orders.

Other opportunities with major brands continue; however, we are dependent upon the new product introduction cycles of these brands, as well as their production choices relative to garment manufacturers and locations. As an example, a major brand we’ve been negotiating with this year recently decided to move their garment production from northern China to Bangladesh.

This decision extends the introduction cycle for the new garment and requires us to retool our program to support their new decision. Consequently, the production start-up in this TekFit product line continues to be slow and, as usual, we remain cautious in our expectations. However, our enthusiasm and excitement about the product remain.

As for our contractual position with the TekFit products, there have been no changes during the most recent quarter. Talon’s license for the technology for this waistband remains in place. The owner of the technology remains under administration within the UK and all litigation has been stayed by the court. We anticipate that at some point, although it’s strictly at the discretion of the appointed administrator, the disposition of the owner’s assets, including intellectual property, will be decided upon. Any disposition of these assets is subject to Talon’s continuing license and right to use the technology.

With the eventual new ownership, we are hopeful litigation and all disputes will end. As we have noted before, the primary issue in our litigation with the owner was the control of the license and the intellectual property rights rather than monetary damages. And we believe the risk of monetary damages are even more remote now than they were a year ago.

Anyone looking forward into the next several quarters within the retail sector of the global economy must do so with a good deal of concern and trepidation. Our products are directly connected to the steps and trends of the retail sector. However, despite the new worldwide economic realities, we remain positive about our opportunities for growth.

We continue to see a strong interest, particularly among value brands, for quality global supply alternatives. And we believe our business model and strategy provides them with a premium, reliable choice for this competitive and responsive to their needs. Furthermore, our growth has not been dependent upon the overall growth of the apparel industry but on our ability to improve our market share and gaining new business.

Even with a weaker overall retail industry, Talon’s share of the worldwide apparel market is quite small. And we believe our opportunity for growth remains strong. Tough times create new opportunities as well as new challenges, and as the weaker competitors fall the survivors frequently emerge larger and stronger. At Talon we strongly believe we are survivors and that with the aid of our extraordinary brand name, our seasoned management team, we will be an effective competitor in these difficult times and will emerge stronger and better positioned to serve the industry.

Gross profit for the third quarter totaled $3.2 million as compared to $2.5 million in the same quarter in 2007. Gross profit for the nine months ended September 30 was $10.9 million, an increase of $1.6 million over the same period in prior year. The increase in gross profits for the quarter and the nine months was attributable to higher overall sales volumes, partially offset by increased costs in manufacturing, freight and delivery.

The gross margin as a percentage of sales in 2008 was slightly lower than 2007 for the quarter and the first nine months as a result of a higher mix of lower margin zipper products in 2008 as compared to 2007, as well as some volume price discounts to certain zipper brands in 2008. The selling, general and administrative expenses for the third quarter of 2008 were $3.4 million as compared to $3.5 million for the same period in 2007. The selling, general and administrative expenses for the nine months were $11.3 million as compared to $9.9 million for the same period last year.

Increased employee costs and business expenses in connection with the company’s growth and expansion primarily account for the increase in operating expenses in the first nine months of 2008, which by the way also includes charges of $724,000 associated with the severance of former executives.

In addition to the selling, general and administrative expenses, operating expense for the third quarter of this year also includes two non-cash charges totaling $1.5 million; $1 million of these charges represents a full write-off of the marketable securities we obtained earlier in the year. As you may recall, in January, 2008 we obtained these marketable securities in settlement of a note receivable [Azteca] Corporation owed to us in which they had defaulted on late in 2007.

Our acceptance of these securities was the last effort to secure any potential cash from this note which originated in 2005, after Azteca had failed to pay its accounts receivable for nearly two years. You will note that the operating expense for the third quarter of 2007 reflects the original write-off of this note receivable for $2.1 million. And in the last quarter 2007 we reflected a partial recovery when we obtained these marketable securities.

Unfortunately, the poor performance of the company whose securities we obtained, together with the current economic and market decline, made it evident this quarter that this stock would not recover to the values we carried it at and that the full value of the securities is permanently impaired.

The second portion of the $1.5 million of impairment reserves reflected in the third quarter of this year is a $500,000 non-cash charge to write down the value of certain manufacturing equipment that we now believe we will not be successful in redeploying into the operations in China. We have been working for the last several years to secure the right manufacturing partners and the utilization of the manufacturing assets from our North Carolina operations, and we are finalizing agreements reflecting these partnerships now.

However, as we negotiated specifics, there were certain assets that simply would not be practical for redeployment within China. The $500,000 charge is the adjustment necessary to reflect the ultimate value we will realize upon the sale or disposal of these select assets.

The net loss for the third quarter of 2008, including an impairment charge of $1.5 million, is

$2.4 million or a net loss of $0.12 a share as compared to a net loss of $3.7 million or a net loss of $0.18 per share for the same period in 2007. To insure proper comparison, please note that the net loss for the third quarter of 2007 also included impairment reserves of $2.1 million.

For the nine months ended September 30 the net loss including the impairment charge of

$1.5 million totaled $3.7 million or a net loss of $0.18 per share. And this compares to a net loss, including impairment charges of $2.1 million in 2007, of $4 million or net loss of $0.21 per share for the same period. The net loss for the third quarter and the net loss for the first nine months of 2008 includes net interest expense of $625,000 and $1.8 million respectively.

Approximately one-half of this interest cost for 2008 represents non-cash interest charges associated with the equity component issued to Blue Fin Capital in connection with our debt facilities that we secured in June of 2007. In today’s economic environment, virtually all companies and investors are extremely focused upon liquidity and want to know where these matters stand. At Talon, these matters have been under close scrutiny since we began this turnaround in 2006.

I am pleased to say that our revolving credit facility with our lender is secure and we do not anticipate any restrictions or modifications to that facility. We ended the period at September 30, 2008 with approximately $2 million in cash and more than $800,000 in available borrowings under our revolving credit line. In addition, later this year and in early 2009, we will see the completion of several contractual commitments the company has serviced for the last several years.

These include the consulting agreements with Colin Dyne and Jonathan Burstein; the severance arrangements with the former CEO and COO; the elimination of the mortgage on the North Carolina plant; and the completion of several capital equipment leases. By mid-year 2009, we expect the conclusion of these contracts, all other things being equal to have made available an additional $540,000 in cash and by the end of 2009, the conclusion of these legacy agreements will have made available over $1.3 million in cash for operations.

Accordingly, we believe that we will have more than adequate funds available to complete our fiscal operating plans and expectations for the next year. As always, we continue to focus on the close management of our operating capital and on the generation of positive operating cash flow.

Finally, I am pleased to report that on October 23, we concluded the sale of our North Carolina plant that was closed in 2005 in connection with the restructuring efforts at that time. The plant was sold for $725,000 and allowed us to fully liquidate our outstanding mortgage of approximately $670,000, resulting in essentially a breakeven from a cash flow and operating impact after closing fees, etc.

The completion of this sale after nearly three years on the market and in today’s real estate environment, we believe, represents a successful conclusion of an important initiative for the company. And we were very pleased to see this transaction completed. Once again, thank you for your interest and participation. I’m looking forward to our next call where I hope I can continue to report positive results from our efforts and the objectives we have underway during this current quarter. Now I’ll take this time to address any questions. Operator.

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions) And it appears we have no questions from the phones at this time. I’d like to turn the call back over to Mr. Lonnie Schnell.

Lonnie D. Schnell

Well, thank you operator and I want to thank everyone again for joining us this afternoon, as well as for your interest and question. As always they are appreciated and I hope that our segments today have answered any that you had to your satisfaction. We appreciate your continued support and I look forward to speaking with you again in the very near future.

Operator

Pardon the interruption, sir. This is the operator. It does look like we have had one questioner queue up at this time.

Lonnie D. Schnell

All right. Let’s go ahead with that then, operator.

Operator

Your first question comes from [Paul Dipetrio] – Investors Capital.

Paul Dipetrio – Investors Capital

My question is if we throw out the consultant agreements, the severance pay, the plant that we just sold looking out with all these charges being removed, we could believe that 2009 some of the growth that you’ve been showing on the top line can make its way to the shareholder on the net income side?

Lonnie D. Schnell

If I understand your question properly, Paul, what you’re asking is if –

Paul Dipetrio – Investors Capital

When will we make money?

Lonnie D. Schnell

When will we make money? When will these charges reflect themselves on the bottom line? Well as I pointed out in the discussion, you know, we expect improved cash flow from these items about $1.3 million through the end of 2009. Not all of those, however, have been going through our P&L. Several of those have been liabilities that have been reflected on our balance sheet and our orderly liquidation of those liabilities. Probably a third to half of that would probably materialize itself on the net income line.

Paul Dipetrio – Investors Capital

And February, somewhere on or near, will mark your one year anniversary as CEO. Is that correct?

Lonnie D. Schnell

That is correct. February.

Paul Dipetrio – Investors Capital

Considering that you would have hit the one year milestone, do you see yourself sometime after February maybe getting a little bit more active with the investor community? Or will just continue to focus on operations?

Lonnie D. Schnell

Obviously operations are my primary focus. And my plan was always to try to get out to the investing public and speak a little bit more about the company and the opportunities we have early in 2009. That still is on my agenda; however, our world economic situations really intensifies our focus. We’re going to continue to look very hard at our operations and stay focused on our bottom line performance more so than getting out and trying to do investor conferences at this point.

Operator

Your next question comes from [Benjamin Sexton] – First Wilshire Securities Management.

Benjamin Sexton – First Wilshire Securities Management

I guess I had a few questions here. The first one you sort of touched on, with regard to the $500,000 idle equipment impairment that you took on that. You said that that wasn’t going to affect your loan covenants in any way, correct?

Lonnie D. Schnell

That’s correct. It does not.

Benjamin Sexton – First Wilshire Securities Management

Does it put you closer to being concerned about those impairments – about those covenants?

Lonnie D. Schnell

No. The impairment charges that we took were items that we negotiated with our lender, are non-cash items, they don’t affect our covenants with those lenders and so they don’t affect us in that regard at all. And we are compliant with our covenants.

Benjamin Sexton – First Wilshire Securities Management

So those assets aren’t securitizing any of those loans, are they?

Lonnie D. Schnell

All of our manufacturing equipment, all of our assets securitize the loans. So these do have an ultimate effect but these are not assets that are necessarily being – they were eliminating. This is the write down of the value that we were carrying those assets at.

Benjamin Sexton – First Wilshire Securities Management

Another question that I was curious about was if you could talk a little bit about on the zipper side what the concentration of your top three customers or top five customers was?

Lonnie D. Schnell

Well, if you – first of all, from a customer standpoint, I don’t have the most recent figures in front of me. But I don’t believe that we have any customer per se that represents 5% or more of our total business. Our customers, keep in mind, are multiple, multiple factories [farma] factories throughout the world and principally throughout Southeast Asia.

From a brand standpoint, we’re not locked into any particular brands but we do monitor to some degree our brand performance, based on the information that we can obtain from all the factories. And sometimes we’re not clear exactly where the factory goods are actually ending up. But from a brand performance, some of our top brands are Wal-Mart, Penny’s, Abercrombie, Kohl’s and a number of the other as I just named the value brand companies.

Benjamin Sexton – First Wilshire Securities Management

How should we read into this sort of the impairment reserve that you’ve taken? I believe that you were kind of – you were thinking about possibly partnering with a manufacturing facility there?

Lonnie D. Schnell

Well, as I commented we’re finalizing the negotiations on that. We actually have equipment in transit now to China and probably three-fourths or more of all of the equipment that we have, that we had from the North Carolina facility, is being redeployed in China. We’re very optimistic about that. Our rolling mill that we had in North Carolina is being redeployed, all of the chain making equipment and all of the dying equipment. The equipment that has been written down was a variety of sundry equipment that was more particularly focused to the types of operations that are handled in Central America more so than in Southeast Asia.

Benjamin Sexton – First Wilshire Securities Management

You talked in the press release about expansion into mainland China. Can you kind of expand on that?

Lonnie D. Schnell

Well, we’ve talked about that previously in terms of the offices that we opened during 2006 and 2007 in mainland China. We have not expanded the number of those offices. At this point, I believe we’re in about nine different cities principally in China.

Benjamin Sexton – First Wilshire Securities Management

One last question about the margins here, I guess looking at it quarter over quarter for Talon, is it just – can you just break out how we should think about what’s impacting those margins right now? Is –

Lonnie D. Schnell

Well, we do disclose in our public documents and in our segment breakdown that allows you to look at it by product line. But as I pointed out it’s – to a large degree, it’s a combination. It’s principally associated with mix. I believe in the third quarter of last year, the Talon products represented 46 to 47% of our total revenues, where as in this year – in the third quarter this year it was over 56%. What that does is it tends to drive the overall company margins down because our zipper products typically come in and margins that are in the low 20 percents whereas our trim products are typically in the mid to higher 30%.

And so as that mix between our zipper and our trim business shifts, it tends to drive the overall

company margins down.

Benjamin Sexton – First Wilshire Securities Management

So low 20 percents is a good run rate for the growth margin for zipper right now for Talon?

Lonnie D. Schnell

We’ve consistently been at that rate. I think the third quarter was a little bit wider than what we had hoped for. As I said we experienced some cost increases in some other areas as well. But year-to-date I think we’ve been in the 23% range roughly on the Talon zipper products.

Operator

Your next question comes from [Bob Richards] – Private Investor.

Bob Richards – Private Investor

I just have a question about future impairments. Should we expect anything further regarding marketable securities or any debts that maybe the common investor might not be aware of?

Lonnie D. Schnell

Well, typically your impairment provisions and reserves are associated with long term assets that have been – where the net realizable value over a period of time has been impaired. We no longer carry any additional marketable securities on our balance sheet. And all of our long term assets - the efforts that we’re currently perceiving right now is to redeploy the assets that I spoke about from our North Carolina facility represent all of the remaining assets that were idle for the last year-and-a-half.

So I don’t anticipate any impairment reserves in that area. We certainly have to look at that on a quarter to quarter basis. And we will continue to do so with all of our assets. The other long term asset that we look at on a regular basis is the intangible value of the Talon brand name, which I believe we carry on our balance sheet for about $4 million. Our valuations and our analysis of that clearly show it’s worth far more than that. So there’s been no issues in that regard.

Bob Richards – Private Investor

How are we doing on our receivables? Or note receivables, are we keeping up with the same rates? Or are we widening the gap time wise or working on giving a little more leeway to the higher volumes purchases?

Lonnie D. Schnell

Well, in terms of notes receivable, we do not carry any further notes receivable on our balance sheet. The last note receivable we had was – excuse me, I take that back. We do have a note receivable from one of our former executives that we’re collecting over a period of time. It’s about $600,000. But all other notes receivable have been dealt with and eliminated at this point.

Accounts receivable are – we monitor them very carefully and closely. Our average receivable turn is probably in the 50 to 60 day term at this point in time. And we feel comfortable with where those are stated. We have not seen any major deterioration in the aging or collections receivables in the last 60 or 90 days. And we certainly will be cautious and watch for any of that in these tough financial times, but we don’t see anything now.

Bob Richards – Private Investor

And then just a little bit about the strategy going into Asia. What kind of a sales strategy? What kind of a management strategy are you guys pursuing there? Are you using local staff or are you traveling over there quite a bit yourself to keep an eye on manufacturing? And then kind of is there client relations or what kind of, if I may, what kind of a set up and how do you see strategically going forward? Do you see more of a shift towards Bangladesh like this one client has moved or other areas of Asia? Or do you still feel like China is the strategic fit right now that is – despite market circumstances, heading in the longer term [inaudible] right direction?

Lonnie D. Schnell

Without going into great detail, basically we serve garment manufacturers throughout the world. And as our brand customers move their manufacturing from Central America to Asia or from Asia to Bangladesh, or wherever the case may be we tend to move with those with our product chain network of manufacturers. Probably 75 to 80% of the garment business that we focus on is currently in the Southeast Asia or China region. And we’ll continue to stay focused in that area and be dominant in that.

As market opportunities occur in other parts of the world, we’ll certainly look into those and move to those. But our current focus right now is to stay focused, narrow and deep and stay within the markets and customers that we know best.

Operator

Your next question comes from Benjamin Sexton – First Wilshire Securities Management.

Benjamin Sexton – First Wilshire Securities Management

When I asked you the 5% customer concentration question, you kind of brought something to my mind. When we – how should we think about this partnership going forward with this manufacturer in terms of getting to the end customers? Is that going to give you leverage in terms of finding out more about product runs and getting a better idea of which brand names are doing what? Do they have contacts that you don’t have yet?

Lonnie D. Schnell

Let me just clarify that a little bit. The “partnership” if you will was arranged with – and it’s not a true partnership in the terminology of most people when you’re talking about a legal structure. But it is a – this company and this particular manufacturer is one of our predominant suppliers in the China region now. We probably represent somewhere between 75 and 80% of this individual’s manufacturing capacity. Our partnership with him is an arrangement where he is expanding his manufacturing facility and we’re helping to equip that manufacturing facility with our equipment.

We have a working arrangement where both of us will gain from the manufacturing of that. And we will control the production that flows off of this equipment so that it becomes an immediate and natural increase for us and our capacity through this particular supplier. In that regard, we see it as an excellent redeployment of the assets allowing us to without having to operate them directly ourselves, to work with our partner in doing so and to expand our capacity – our productive capacity from these goods.

Benjamin Sexton – First Wilshire Securities Management

What’s your strategy to try and figure out what these brand name companies are – who they’re selling to when they’re doing a production run? How are you going to work on that sort of getting that information?

Lonnie D. Schnell

Our salesmen on both continents, here in the U.S. and in Asia, work closely with the brands, identify for us where they’re manufacturing the goods. We go to their representative factories that are supporting these brands and we then meet head to head with the other zipper manufacturers who potentially may be nominated there as well, typically the largest one being YKK and we fight for the orders within that garment manufacturer to secure a stronger position with that manufacturer and with the brand.

I mean, that’s our ultimate strategy and we continue to work that strategy day in and day out, almost on an order by order basis.

Benjamin Sexton – First Wilshire Securities Management

And how many manufacturers typically will a brand go with?

Lonnie D. Schnell

It certainly varies by the brand. It’s not unusual to see some of the major brands – and certainly I’m not referring to Wal-Mart, but some of the other more specialty brands that we deal with may have 15, 20, 30 different factories that they target their manufacturing at. It just depends. They typically produce worldwide.

Benjamin Sexton – First Wilshire Securities Management

And your suppliers pretty well connected with sort of the industry in terms of – I mean, what do the relationships look like for these manufacturers? Are they – does everyone know who everyone is? Or is it sort of a lot of isolated, scattered –

Lonnie D. Schnell

It’s a large industry but it’s a very small world.

Benjamin Sexton – First Wilshire Securities Management

So getting into that –

Lonnie D. Schnell

Everybody is pretty familiar with the companies and who’s involved. Yes.

Operator

At this time this concludes our question-and-answer session. I’d now like to turn the call back over to Mr. Schnell. Mr. Schnell, please proceed.

Lonnie D. Schnell

All right. Well, once again thanks everyone for joining us. I certainly appreciate the continued support that everyone has given us. And we look forward to our next call and hopefully reporting some very positive news for you at that point in time as well. Thank you very much.

Operator

Thank you, ladies and gentlemen, for joining us today for our presentation. You may now disconnect your lines.

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