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Blue Holdings 10-Q 2008 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q/A
(Amendment
No. 1)
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the Quarterly Period Ended: June 30, 2007
Commission
File Number: 000-33297
BLUE
HOLDINGS, INC.
(Exact
name of registrant as specified in its charter)
4901
Zambrano St., Commerce, CA 90040
(Address
of principal executive offices)
(323)
726-0297
(Registrant’s
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Yes
x
No
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.
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
August 13, 2007, 26,232,200 shares of the registrant’s common stock were
outstanding. TABLE
OF CONTENTS
2
EXPLANATORY
NOTE
Blue
Holdings, Inc. is filing this Amendment No. 1 to its Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2007 filed with the Securities
and
Exchange Commission on August 14, 2007 (the “Form 10-Q”). This filing amends and
restates our unaudited condensed consolidated balance sheet as of June 30,
2007,
and the condensed consolidated statements of operations, stockholders equity
(deficiency), and cash flows for the three and six month periods ending June
30,
2007 to reflect the Company’s failure to record $1,302,842 of inventory
purchased from a vendor that was directly paid for by Mr. Guez. The Company
has
now agreed to a settlement with Mr. Guez relating to these disputed amounts.
The
effects of the settlement agreement on the Form 10-Q for the three and six
months ending June 30, 2007 are detailed in Note 1(d) of the accompanying
restated condensed consolidated financial statements.
This
Amendment No. 1 amends and restates the following items of the Form 10-Q as
described above: (i) Part I, Item 1 – Financial Statements; (ii) Part I, Item 2
– Management’s Discussion and Analysis of Result of Operations and Financial
Condition; (iii) Part I, Item 4 – Controls and Procedures and (iv) Part II, Item
6 - Exhibits.
All
information in the Form 10-Q, as amended by this Amendment No. 1, speaks as
to
the date of the original filing of our Form 10-Q for such period and does not
reflect any subsequent information or events except as noted in this Amendment
No. 1. All information contained in this Amendment No. 1 is subject to updating
and supplementing as provided in our reports, as amended, filed with the
Securities and Exchange Commission subsequent to the date of the initial filing
of the Form 10-Q. 3
PART
I
BLUE
HOLDINGS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED BALANCE SHEETS
SEE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 4
BLUE
HOLDINGS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR
THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2007 AND
2006
SEE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5
BLUE
HOLDINGS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR
THE SIX MONTHS ENDED JUNE 30, 2007 (UNAUDITED) (RESTATED)
SEE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 6
BLUE
HOLDINGS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR
THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
SEE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 7
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
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 June 30, 2007 and the results of operations for the three and six months
ended June 30, 2007 and 2006 and cash flow for the six months ended June 30,
2007 and 2006. The condensed consolidated balance sheet as of December 31,
2006
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, 2006, as
filed with the Securities and Exchange Commission.
The
Company’s results of operations for the three and six months ended June 30, 2007
are not necessarily indicative of the results of operations to be expected
for
the full fiscal year ending December 31, 2007.
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. (the “Company”) was incorporated in the State of Nevada on
February 9, 2000 under the name Marine Jet Technology Corp. 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.
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. 8
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
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 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 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,
Yanuk,
U,
Faith
Connexion
and
Taverniti
So Jeans.
The
Company’s products currently include jeans, jackets, belts, purses and T-shirts.
The Company is currently looking into integrating Life
& Death
as one
of its brands. 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.
(d)
Restatement
The
Company has restated its unaudited condensed consolidated balance sheet as
of
June 30, 2007, and the condensed consolidated statements of operations,
stockholders equity (deficiency), and cash flows for the three and six month
periods ending June 30, 2007.
From
time
to time Paul Guez, the Company’s Chairman of the Board and majority stockholder,
and his spouse Elizabeth Guez made advances to the Company to support its
working capital needs. These advances are part of a line of credit agreement
with Mr. Guez which allows the Company to borrow from him up to a maximum of
$3,000,000 at an interest rate of 6% per annum (the “Revolving Line”). The
Company may repay the advances in full or in part at any time until the
Revolving Line expires and repayment is required on December 31, 2007. The
Company also maintains several due to/from related party accounts with Mr.
Guez
and his affiliated companies where funds are advanced to cover certain operating
expenses. These advances are unsecured, non-interest bearing with no formal
terms of repayment. 9
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
In
early
May 2008, Mr. Guez informed the Company of claims for sums he believed were
due
and owing to him pursuant to advances made to and payments made on behalf of
the
Company during fiscal 2007 that were inaccurately recorded in the Company’s
previously filed financial statements for the three and six month periods ended
June 30, 2007.
The
Audit
Committee commenced a review of these potential errors and instructed management
to review the Registrant’s books and records to obtain a summary of transactions
recorded and amounts owed per such records. These investigations revealed
accounting errors in the Registrant’s related party accounts pertaining to
payables due Mr. Guez as of June 30, 2007. These errors related to the Company
not recording $1,302,842 of inventory purchased from a vendor that was directly
paid for by Mr. Guez. The Company has now agreed to a settlement with Mr. Guez
relating to these disputed amounts.
In
light
of this dispute and settlement, the Audit Committee and Management of the
Company have determined that the Company’s unaudited condensed consolidated
financial statements for the three and six months ended June 30, 2007 need
to be
restated due to accounting errors in the Company’s related party accounts. The
effects of the settlement agreement on the previously filed Form 10-Q for the
three and six months ending June 30, 2007 are summarized as
follows: 10
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
BLUE
HOLDINGS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
11
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
SEE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
12
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
BLUE
HOLDINGS INC. AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR
THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006 (UNAUDITED)
SEE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
13
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
Description
of adjustments:
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 $57,652 and
$119,574 for the three and six months ended June 30, 2007, respectively, as
compared with $69,897 and $576,062 for the same respective periods last year.
(d)
Shipping and Handling Costs
Freight
charges are included in selling, distribution and administrative expenses in
the
statement of operations and approximated $149,960 and $297,235 for the three
and
six months ended June 30, 2007, respectively, as compared to $156,145 and
$324,791 for the same respective periods in the prior year.
14
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
(e)
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 June
30, 2007, only one supplier accounted for more than 10% of our purchases.
Purchases from that supplier were 25.4%. During the six months ended June 30,
2007, three suppliers accounted for more than 10% of our purchases and purchases
from these suppliers were 18.3%, 11.1% and 10.1%, respectively. During
fiscal 2006, three suppliers accounted for more than 10% of our purchases.
Purchases from these suppliers were 19.7%, 14.9% and 10.2% for the three months
ended June 30, 2006, and 13.9%, 11% and 10.9% for the six months ended June
30,
2006, respectively.
(f)
Major Customers
During
fiscal 2007, two customers accounted for more than 10% of the Company’s sales.
Sales to those customers were 13.5% and 10.3%, respectively, for the three
months ended June 30, 2007, and 11.6% and 10.4%, respectively, for the six
months ended June 30, 2007. During the three months ended June 30 2006, two
customers accounted for more than 10% of the Company’s sales. Sales to those
customers were 15% and 11%, respectively. During the six months ended June
30,
2006, one customer accounted for 16% of the Company’s total sales.
International
sales accounted for approximately 17.9% and 21.6% of the Company’s sales during
the three and six months ended June 30, 2007, respectively, including Japan
which accounted for 11.5% and 13.3%, respectively, of our total sales.
International
sales accounted for approximately 23% and 29% of sales in the three and six
months ended June 30, 2006, respectively, including Japan which accounted for
13.2% and 18.5%, respectively, of our total sales.
As
of
June 30, 2007 and December 31, 2006, one customer accounted for 34% and 42%
of
total accounts receivable, respectively.
(g)
Stock-Based Compensation
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards 123R, “Share-Based Payment” (“SFAS
123R”). This statement requires that the cost resulting from all share-based
payment transactions be recognized in the financial statements. This statement
establishes fair value as the measurement objective in accounting for
share-based payment arrangements and requires all entities to apply a fair-value
based measurement method in accounting for share-based payment transactions
with
employees except for equity instruments held by employee share ownership plans.
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS 123R, using the modified prospective method. Under this
method, the provisions of SFAS 123R apply to all awards granted or modified
after the date of adoption and all previously granted awards not yet vested
as
of the date of adoption.
15
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
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
three months ended June 30, 2007 and 2006:
(h)
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 are 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
June
30, 2007 and 2006, potentially dilutive securities consisted of outstanding
common stock options to acquire 489,500 and 685,000 shares, respectively. These
potentially dilutive securities were not included in the calculation of loss
per
share for the quarter ended June 30, 2007 as they are insignificant to the
calculation. Accordingly, basic and diluted earnings per share for each of
the
three and six months ended June 30, 2007 and 2006 are the same.
Issued
but unvested shares of common stock under forfeitable service agreements are
excluded from the calculations of basic and diluted earnings per share until
such shares are earned.
(i)
Reclassifications
Certain
prior year balance sheet items have been reclassified to conform to the current
period presentation.
(j)
Adoption of new accounting policy
Effective
January 1, 2007, the Company adopted Financial Accounting Standards Board
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN
48”)—an
interpretation of FASB Statement No. 109, Accounting for Income
Taxes.”
The
Interpretation addresses the determination of whether tax benefits claimed
or
expected to be claimed on a tax return should be recorded in the financial
statements. Under FIN 48, we may recognize the tax benefit from an uncertain
tax
position only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities, based on the technical
merits of the position. The tax benefits recognized in the financial statements
from such a position should be measured based on the largest benefit that has
a
greater than fifty percent likelihood of being realized upon ultimate
settlement. FIN 48 also provides guidance on derecognition, classification,
interest and penalties on income taxes, accounting in interim periods and
requires increased disclosures. At the date of adoption, and as of June 30,
2007, the Company made a cumulative effect adjustment. See note 8.
16
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
The
Company files income tax returns in the U.S. federal jurisdiction and various
states. The Company is subject to U.S. federal or state income tax examinations
by tax authorities for years after 2002. The Company’s tax returns are currently
under examination by the government. As
of
June 30, 2007, the taxing authorities have not proposed any significant
adjustments to taxable income. The Company does not expect to receive any
adjustments that would result in a material change to its final
position.
The
Company’s policy is to record interest and penalties on uncertain tax provisions
as income tax expense. See note 8.
(k)
Recent accounting pronouncements
In
February 2007, the Financial Accounting Standards Board (FASB) issued FASB
Statement No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities — including an amendment of FASB Statement
No. 115” (FAS 159). FAS 159,
which becomes effective for the company on January 1, 2008, permits
companies to choose to measure many financial instruments and certain other
items at fair value and report unrealized gains and losses in earnings. Such
accounting is optional and is generally to be applied instrument by instrument.
The company does not anticipate that election, if any, of this fair-value option
will have a material effect on its consolidated financial
condition, results of operations, cash flows or disclosures.
In
September 2006, the FASB issued FAS No. 157 (“FAS 157”), “Fair
Value Measurements,” which establishes a framework for measuring fair value in
accordance with GAAP and expands disclosures about fair value measurements.
FAS
157 does not require any new fair value measurements but rather eliminates
inconsistencies in guidance found in various prior accounting pronouncements.
FAS 157 is effective for fiscal years beginning after November 15, 2007.
The Company is currently evaluating the impact this standard will have on its
consolidated financial
condition, results of operations, cash flows or disclosures.
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 and
Taverniti, 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 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 or 50% of the value
of
eligible raw materials and finished goods. As of June 30, 2007, the Company
drew
down $2.4 million of this credit line against inventory, $6.4 million against
accounts receivable and $5.3 million against personal guarantees of Paul Guez,
our Chairman and majority shareholder, and the living trust of Paul and
Elizabeth Guez.
17
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
As
of
June 30, 2007, the factor holds $2,012,054 of accounts receivable purchased
from
us on a without recourse basis and has made advances to us of $587,597 against
those receivables, resulting in a net balance amount Due from Factor of
$1,239,041, net of reserves of $185,417, as of June 30, 2007. 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
June 30, 2007, the factor also held as collateral $6,279,254 of accounts
receivable that were subject to recourse, against which the Company has provided
reserves of $1,029,938 and as of June 30, 2007, the Company received advances
totaling $14,069,439 against such receivables and against eligible inventory.
The Company has included the $6,279,254 in accounts receivable, and has
reflected the $14,069,439 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.
The
factor commission on receivables purchased on a without recourse basis 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 and majority shareholder,
and the living trust of Paul and Elizabeth Guez.
18
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
NOTE
4 - INVENTORIES
Inventories
at June 30, 2007 and December 31, 2006 are summarized as
follows:
NOTE
5 - PROPERTY AND EQUIPMENT
Property
and equipment at June 30, 2007 and December 31, 2006 are summarized as
follows:
19
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
Depreciation
expense for the three months ended June 30, 2007 and 2006 was $97,078 and
$51,450, respectively and for the six months ended June 30, 2007 and 2006 was
$187,679 and $77,470, 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, for $97,680 and $183,302 during the three and six
months ended June 30, 2007, respectively, and $10,092 and $251,658,
respectively, during the same periods in the prior year.
On
January 1, 2006, the Company leased its facility at Commerce, California from
Azteca Production International Inc., as a sub-tenant and is paying it $19,030
per month. Azteca is a company that is co-owned by Paul Guez. Rent expense
includes $57,090 and $114,180, respectively, for three and six months June
30,
2007, paid under this lease.
On
July
5, 2005 the Company entered into a ten-year license agreement with Yanuk Jeans,
LLC. 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 paid and payable
for the three and six months ended June 30, 2006, were $68,312 and $182,931,
respectively. Yanuk has agreed to waive such royalties due for the three and
six
months ended June 30, 2007, and has agreed to waive such royalties through
December 31, 2008. Yanuk Jeans, LLC is solely owned by Paul Guez.
On
October 6, 2005, the Company entered into a five-year license agreement with
Yanuk Jeans, LLC. Under the terms of the agreement, the Company became the
exclusive licensor for the design, development, manufacture, sale, marketing
and
distribution of Yanuk Jeans, LLC’s U
brand
products to the wholesale and retail trade. The Company pays to Yanuk Jeans,
LLC
a royalty of five percent of all net sales of the licensed products and shall
pay 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 six months ended June 30, 2007 paid or payable to Yanuk Jeans, LLC
for
the U
brand
products was $0 and $0, respectively and $0 and $0, respectively, for the same
period last year.
Paul
Guez
and the living trust of Paul and Elizabeth Guez have guaranteed all advances
and
ledger debt due to the Company’s factor.
On
August
27, 2005, the Company opened a retail store on Melrose Avenue, Los Angeles,
California and took over all the obligations of
a
10-year property lease which was entered into by Blue Concept, LLC in April
2005. The lease will expire on March 15, 2015.
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 months ended June 30, 2007 and 2006 were $86,420 and $305,744,
respectively, and $211,757 and $656,526 for the six months ended June 30, 2007
and 2006, respectively.
20
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
NOTE
7 - DUE FROM/TO 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 either owned or 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 June 30,
2007
and December 31, 2006, total trade-related items due to related parties amounted
to $125,734 and $710,153, 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 and
repayment is required, on December 31, 2007. As of June 30, 2007 and December
31, 2007, the balance of these advances was $3,343,958 (as restated) and
$1,876,991 respectively, and accrued interest thereon was $67,501 and $0,
respectively. Interest expense includes $35,490 and $0, for three months ended
June 30, 2007 and 2006, respectively, and $67,501 and $0, for six months ended
June 30, 2007 and 2006, respectively.
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 $0 (as restated) for the six months
ended June 30, 2007 compared to $1,674,095 for the same period of the prior
year.
21
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
The
provision for income taxes consists of the following for the periods ended
June
30:
A
reconciliation of the statutory federal income tax rate to the effective
tax
rate is as follows for the periods ended June 30:
The
Company and its subsidiaries files income tax returns in the U.S. federal
jurisdiction and various state jurisdictions. With few exceptions, the Company
is no longer subject to U.S. federal or state and local income tax examinations
by tax authorities for years before 2002. The Internal Revenue Service (IRS)
commenced an examination of the Company’s U.S. income tax return for 2005 in the
first quarter of 2007 that is anticipated to be completed by the end of 2007.
As
of June 30, 2007, the IRS has not proposed any adjustments.
The
Company adopted the provisions of FASB Interpretation No.48, Accounting for
Uncertainty in Income Taxes, on January 1, 2007. As a result of the
implementation of Interpretation 48, the Company recognized a $52,465 increase
in the liability for unrecognized tax benefits, which was accounted for as
a
reduction to the January 1, 2007 balance of retained earnings. A reconciliation
of the beginning and ending amount of unrecognized tax benefits is as
follows:
22
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
Included
in the balance at June 30, 2007 are $208,966 of tax positions for which the
ultimate deductibility is highly certain but for which there is uncertainty
about the timing of such deductibility. Because of the impact of deferred tax
accounting, other than interest and penalties, the disallowance of the shorter
deductibility period would not affect the annual effective tax rate but would
accelerate the payment of cash to the taxing authority to an earlier
period.
The
Company recognizes accrued interest and penalties related to unrecognized tax
benefits in income tax expense. During the period ended June 30, 2007, the
Company recognized in income tax expense $0 (as restated) for interest and
penalties. The Company included in its balance for unrecognized tax benefits
at
June 30, 2007 $61,489 for the payment of interest and penalties.
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.
23
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
At
June
30, 2007, options outstanding are as follows:
Additional
information regarding options outstanding as of June 30, 2007 is as
follows:
Stock
based compensation expense of $137,747 and $229,198 were recognized during
the
six months ended June 30, 2007 and 2006, respectively, relating to the vesting
of such options. As of June 30, 2007, the unamortized value of these option
awards were $346,865 which will be amortized as a stock based compensation
cost
over the average of approximately three years as the options vest.
NOTE
10 – CO-BRANDING AGREEMENT
On
May
11, 2007, the Company entered into a Letter of Intent with William Adams, aka
will.i.am, of the Black Eyed Peas, pursuant to which the parties agreed to,
within 30 days of the date of execution, enter into (i) a co-branding agreement
for the creation of a collection of premium denim and denim-related apparel
under the name “i.am Antik” or such other similar name upon which the parties
shall agree, and (ii) a joint venture agreement pursuant to which the parties
will design, develop, market, manufacture and distribute apparel products
bearing the “I.Am” trademark subject to a license agreement. The term of each of
the co-branding agreement and the joint venture agreement shall be for five
years, with the first year commencing on the execution of the Letter of Intent
and ending on the last day of February 2008, and each year thereafter commencing
on March 1 and ending on the last day of February. Prior to their entry into
the
Letter of Intent, the parties had no material relationship with each other.
The
Letter of Intent was effective May 11, 2007 and was approved and certified
by
the shareholders of the Company on June 21, 2007.
24
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
Mr.
Adams
is required to perform specific design, marketing and promotional services
under
the term of Letter of Intent. In consideration of such services rendered by
Mr.
Adams, the Company issued to Mr. Adams as base compensation 175,000 shares
of
its common stock on May 21, 2007 and will issue to Mr. Adams 81,250 shares
on
each anniversary of the effective date of the Letter of Intent for a period
of 4
years, subject to the prior effectiveness of a registration statement on Form
S-8 registering the issuance of the shares to Mr. Adams. Mr. Adams will also
be
entitled to receive up to an aggregate of 500,000 additional shares of common
stock from the Company upon achieving certain milestones based on net sales.
Mr.
Adams
is permitted to terminate the co-branding agreement and/or joint venture
agreement in the event that the Company is delisted from the NASDAQ Capital
Market, a final and binding legal determination is made by a body with
appropriate jurisdiction that the Company has failed to comply with the rules
and regulations promulgated by the Securities and Exchange Commission, or the
joint venture’s failure to launch an “I.Am” collection within 12 months from the
date of execution of the definitive joint venture agreement.
The
Company determined that since the shares contain performance requirements and
specific services to be performed, and the shares would be returned if such
services were not preformed, it is appropriate to recognize as expense the
value
of the issued shares that are earned each month. As such, the Company determined
that the 175,000 shares that were issued in May 2007 will be amortized as earned
over a one year period. The shares earned will be valued at the end of each
month based on the fair value of those shares in accordance with EITF 96-18.
Compensation expense for the six months ended June 30, 2007 amounted to $6,300
based upon the amortization of the shares earned from June 21, 2007, the revised
effective date of the agreement.
NOTE
11 – COMMITMENTS AND CONTINGENCIES
License
agreements:
On
January 12, 2007, the Company entered into a License Agreement with Faith
Connexion S.A.R.L., a company formed under the laws of France (“Faith”).
Pursuant to the License Agreement, Faith granted an exclusive right and
license
to use
the Faith
Connexion
trademark for the manufacture, marketing, promotion, sale, distribution and
other exploitation of men’s and women’s hoodies, t-shirts, sweatshirts,
sweatpants and hats in North America (including Canada), South America, Japan
and Korea. Compensation for use of the Faith
Connexion
trademark will consist of a royalty calculated as 9% of the Company’s net sales
arising from products bearing the Faith
Connexion
trademark in the first two years, and 9.5% of net sales in year three. The
License Agreement has a term of three years as follows: the first year is
comprised of 18 months, year two is comprised of the next six months, and year
three is comprised of the following 12 months. Per the agreement, the Company
has agreed to a guarantee payment of royalties on identified minimum net sales
amounts ranging from $3.5 to $10 million over each of the three years (equal
to
minimum royalties of $450,000, $315,000, and $950,000, in each of years one
(first eighteen months), two (next 6 months) and three (next twelve months),
respectively, and to spend at least 3% of actual net sales amounts on marketing
and advertising the Faith
Connexion
trademarked products in the territory. During three months ended June 30, 2007,
the Company recorded royalty expense of $75,000.
On
April
27, 2007, Antik Denim, LLC (“Antik”), a California limited liability company and
our wholly-owned subsidiary, executed a License Agreement (the “Mercier License
Agreement”) dated to be effective as of April 18, 2007, by and between Antik and
Mercier SARL, a company formed under the laws of France
(“Mercier”).
25
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
Pursuant
to the Mercier License Agreement, Antik granted an exclusive right and license
to use the Antik
Denim
trademark for the manufacture, marketing, promotion, sale, distribution and
other exploitation of denim and sportswear apparel in Europe. Compensation
for
use of the Antik
Denim
trademark will consist of a royalty calculated as 10% of Mercier’s net sales
arising from products bearing the Antik
Denim
trademark. The Mercier License Agreement has an initial term of twenty (20)
months, and includes four (4) one (1)-year extension options available to
Mercier to the extent it achieves specified minimum net sales. Mercier has
agreed to guarantee payment of royalties on an identified minimum net sales
amount of $2.5 million during the initial twenty (20) month term, and on
identified minimum net sales amounts ranging from $2.5 million to $10 million
over the eligible extension terms. In connection with these minimum net sales,
the Mercier License Agreement provides for an upfront minimum guarantee advance
of $250,000 which has been received by the Company and recorded as a deferred
revenue as of June 30, 2007, and an aggregate of minimum royalty payments of
$2.5 million for the years 2009 though 2012 assuming the Mercier License
Agreement is renewed at the end of 2008.
On
April
27, 2007, in anticipation of Antik’s entry into the Mercier License Agreement,
Antik executed Amendment No. 1 to License Agreement (the “Amendment”), dated to
be effective as of April 25, 2007, by and between Antik and North Star, LLC
(“North Star”). The sole purpose of the Amendment was to remove the European
territory from the rights previously granted to North Star.
On
May 1,
2007, Antik executed a License Agreement (the “Max Ray License Agreement”) dated
to be effective as of May 1, 2007, by and between Antik and Max Ray, Inc.,
a
California corporation (“Max Ray”). Pursuant to the Max Ray License Agreement,
Antik granted an exclusive right and license to use the Antik
Denim
trademark for the manufacture, marketing, promotion, sale, distribution and
other exploitation of small leather goods consisting of belts, handbags, small
leather accessories and scarves in the United States and its territories.
Compensation for use of the Antik
Denim
trademark will consist of a royalty calculated as 8% of Max Ray’s net sales
arising from products bearing the Antik
Denim
trademark. The Max Ray License Agreement has an initial term of eighteen (18)
months, and includes four (4) one (1)-year extension options available to Max
Ray unless earlier terminated by Max Ray. Max Ray has agreed to guarantee
payment of royalties on an identified minimum net sales amount of $1.1 million
during the initial eighteen (18) month term, and on identified minimum net
sales
amounts ranging from $3 million to $10 million over the eligible extension
terms. In connection with these minimum net sales, the Max Ray License Agreement
provides for an upfront minimum guarantee advance of $20,000 to be applied
against the minimum guaranty for the aggregate initial term, and an aggregate
of
minimum royalty payments of $2.1 million for the years 2009 though 2012 assuming
the Max Ray License Agreement is renewed at the end of 2008.
Legal
proceedings:
On
July
17, 2006, Taverniti Holdings, LLC (THL), an independent entity not owned or
controlled by us, and Jimmy Taverniti, an individual, filed an action in the
United States District Court for the Central District of California (Case No.
CV06-4522 DDP) against Henri Levy alleging that defendant has infringed THL’s
mark J. TAVERNITI and further infringed Mr. Taverniti’s commercial publicity
rights, by defendant’s adoption and use of the mark TAVERNITY. We have been
informed that in a counter-claim against THL, defendant has also named our
company and Taverniti as purported counter defendants. As it relates to
Taverniti and our company, the counter claim seeks only a declaration of rights,
to the effect that Taverniti and our company have conspired with THL to defeat
defendant’s alleged rights in his TAVERNITY mark, and a further declaration that
as a result of such alleged misconduct, neither Taverniti nor our company have
any enforceable rights in the TAVERNITI SO JEANS mark. It does not seek any
monetary relief against either Taverniti or our company.
26
BLUE
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE
THREE AND SIX MONTHS ENDED JUNE 30, 2007 (AS RESTATED)
We
have
taken the position that neither Taverniti nor our company can properly be added
as new parties to this lawsuit by naming us as counter defendants, and that
we
can only be named as third party defendants. The defendant has not, as yet,
served either Taverniti or us with the counter claim, and so we are not yet
formally parties to the case. At such time, if ever, that the defendant takes
the necessary action to formally serve us with the counter claim, we intend
to
deny all the material charging allegations of the defendant’s claim for
declaratory relief and to vigorously defend against his claims. At this time,
we
are unable to express an opinion whether it is likely that the defendant will
take such actions, or whether, if he does, it is likely or unlikely that he
will
be able to prevail against us on his claim for declaratory relief.
NOTE
12-SUBSEQUENT EVENTS
On
July
24, 2007, the Company appointed Glenn S. Palmer as its new Chief Executive
Officer and President. The Employment Agreement is effective as of July 1,
2007
and will terminate on December 31, 2009. Under the terms of the Employment
Agreement, Mr. Palmer will receive base compensation for each of the third
and
fourth quarters of fiscal 2007 of $87,500 and minimum annual compensation for
each of fiscal 2008 and 2009 of $400,000. Mr. Palmer is also entitled to receive
an annual bonus equivalent to 2.5% of the Company’s earnings before interest,
taxes, depreciation and amortization for each of the years ended December 31,
2008 and 2009, and is eligible to receive a bonus for the period ended December
31, 2007, if any, as determined by the Compensation Committee of the Company’s
Board of Directors. Mr. Palmer is also entitled to four weeks paid vacation
and
reimbursement of expenses, including up to $2,000 per month for all expenses
incurred by Mr. Palmer with respect to his personal automobile. The Company
has
also agreed to provide Mr. Palmer with a furnished apartment or comparable
living space in Los Angeles, California suitable to his position for the initial
twelve months of the term of the Employment Agreement. Additionally, the Company
has agreed to pay for no more than two coach or economy class round trip tickets
per month from Los Angeles to New Jersey for Mr. Palmer. As an inducement
material to Mr. Palmer’s decision to enter into employment with the Company, the
Company agreed to grant Mr. Palmer an option to purchase 625,000 shares of
the
Company’s common stock. The option has a term of 10 years, a per share exercise
price of $1.40 and will vest over a period of two years, with 125,000 shares
vesting on the date of grant and 125,000 shares vesting on each subsequent
six-month anniversary of the date of grant. All unexercised options outstanding
as of the date of any termination of Mr. Palmer’s employment with the Registrant
will expire.
27
Forward-Looking
Statements
Statements
made in this Form 10-Q (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”). We intend that such forward-looking statements be subject to
the safe harbors for such statements. We wish 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 our control.
Although we believe 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 Quarterly Report 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 us or any other person that our objectives and plans will
be
achieved. We disclaim any obligation subsequently to 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 Quarterly
Report or included in our previous filings with the Securities and Exchange
Commission (“SEC”).
Description
of Business
Overview
Blue
Holdings, Inc. designs, develops, markets and distributes high end fashion
jeans, apparel and accessories under the brand name names Antik
Denim,
Yanuk,
U,
Faith
Connexion
and
Taverniti
So Jeans.
We plan
to also design, develop, market and distribute jeans and accessories under
other
brands that we may license or acquire from time to time. We are currently
looking into integrating Life
& Death
as one
of our brands. Our products currently include jeans, jackets, belts, purses
and
T-shirts. We currently sell our 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. We are headquartered
in Commerce, California and maintain two showrooms in New York and Los Angeles.
We opened a retail store in Los Angeles during August 2005 and another in San
Francisco in September 2006.
28
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”), an existing shareholder
of the Company, 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 in Second Quarter
On
January 12, 2007, we entered into a three-year License Agreement (the “Faith
License Agreement”) with Faith Connexion S.A.R.L. (“Faith”) pursuant to which
Faith granted us an exclusive right and license to use the Faith
Connexion
trademark for the manufacture, marketing, promotion, sale, distribution and
other exploitation of men’s and women’s hoodies, t-shirts, sweatshirts,
sweatpants and hats in North America, South America, Japan and Korea.
Compensation for use of the Faith
Connexion
trademark will consist of a royalty of 9% of our net sales arising from products
bearing the Faith
Connexion
trademark in the first two years, and 9.5% of net sales in year three. The
Faith
License Agreement has a term of three years as follows: the first year is
comprised of 18 months, year two is comprised of the next six months, and year
three is comprised of the following 12 months. We have agreed to guarantee
payment of royalties on identified minimum net sales amounts ranging from $3.5
to $10 million over each of the three years (equal to minimum royalties of
$450,000, $315,000, and $950,000, in each of years one (first eighteen months),
two (next 6 months) and three (next twelve months), respectively, and to spend
at least 3% of actual net sales amounts on marketing and advertising the
Faith
Connexion
trademarked products in the territory. During the quarter ended June 30, 2007,
we recorded royalty expense of $75,000 pursuant to the minimum guaranteed
royalty.
In
March
2007, the United States Internal Revenue Service initiated an examination of
our
Federal income tax return for the year ended December 31, 2005. As of June
30,
2007, the taxing authorities have not proposed any significant adjustments
to
taxable income. We do not expect to receive any adjustments that would result
in
a material change to our final position.
In
March
2007, we appointed Scott J. Drake as our President of Sales and Chief Operating
Officer. Mr. Drake has over 25 years of experience in the apparel
business.
On
April
27, 2007, Antik Denim, LLC (“Antik”), a California limited liability company and
our wholly-owned subsidiary, executed a License Agreement (the “Mercier License
Agreement”) dated to be effective as of April 18, 2007, by and between Antik and
Mercier SARL, a company formed under the laws of France
(“Mercier”).
Pursuant
to the Mercier License Agreement, Antik granted an exclusive right and license
to use the Antik
Denim
trademark for the manufacture, marketing, promotion, sale, distribution and
other exploitation of denim and sportswear apparel in Europe. Compensation
for
use of the Antik
Denim
trademark will consist of a royalty calculated as 10% of Mercier’s net sales
arising from products bearing the Antik
Denim
trademark. The Mercier License Agreement has an initial term of twenty (20)
months, and includes four (4) one (1)-year extension options available to
Mercier to the extent it achieves specified minimum net sales. Mercier has
agreed to guarantee payment of royalties on an identified minimum net sales
amount of $2.5 million during the initial twenty (20) month term, and on
identified minimum net sales amounts ranging from $2.5 million to $10 million
over the eligible extension terms. In connection with these minimum net sales,
the Mercier License Agreement provides for an upfront minimum guarantee advance
of $250,000 which has been received by the Company and recorded as a deferred
revenue as of June 30, 2007, and an aggregate of minimum royalty payments of
$2.5 million for the years 2009 though 2012 assuming the Mercier License
Agreement is renewed at the end of 2008.
29
On
April
27, 2007, in anticipation of Antik’s entry into the Mercier License Agreement,
Antik executed Amendment No. 1 to License Agreement (the “Amendment”), dated to
be effective as of April 25, 2007, by and between Antik and North Star, LLC
(“North Star”). The sole purpose of the Amendment was to remove the European
territory from the rights previously granted to North Star.
On
May 1,
2007, Antik executed a License Agreement (the “Max Ray License Agreement”) dated
to be effective as of May 1, 2007, by and between Antik and Max Ray, Inc.,
a
California corporation (“Max Ray”). Pursuant to the Max Ray License Agreement,
Antik granted an exclusive right and license to use the Antik
Denim
trademark for the manufacture, marketing, promotion, sale, distribution and
other exploitation of small leather goods consisting of belts, handbags, small
leather accessories and scarves in the United States and its territories.
Compensation for use of the Antik
Denim
trademark will consist of a royalty calculated as 8% of Max Ray’s net sales
arising from products bearing the Antik
Denim
trademark. The Max Ray License Agreement has an initial term of eighteen (18)
months, and includes four (4) one (1)-year extension options available to Max
Ray unless earlier terminated by Max Ray. Max Ray has agreed to guarantee
payment of royalties on an identified minimum net sales amount of $1.1 million
during the initial eighteen (18) month term, and on identified minimum net
sales
amounts ranging from $3 million to $10 million over the eligible extension
terms. In connection with these minimum net sales, the Max Ray License Agreement
provides for an upfront minimum guarantee advance of $20,000 to be applied
against the minimum guaranty for the aggregate initial term, and an aggregate
of
minimum royalty payments of $2.1 million for the years 2009 though 2012 assuming
the Max Ray License Agreement is renewed at the end of 2008.
Subsequent
Significant Developments
On
July
24, 2007, we appointed Glenn S. Palmer as our new Chief Executive Officer and
President. Mr. Palmer’s Employment Agreement is effective as of July 1, 2007 and
will terminate on December 31, 2009. Under the terms of the Employment
Agreement, Mr. Palmer will receive base compensation for each of the third
and
fourth quarters of fiscal 2007 of $87,500 and minimum annual compensation for
each of fiscal 2008 and 2009 of $400,000. Mr. Palmer is also entitled to receive
an annual bonus equivalent to 2.5% of our earnings before interest, taxes,
depreciation and amortization for each of the years ended December 31, 2008
and
2009, and is eligible to receive a bonus for the period ended December 31,
2007,
if any, as determined by the Compensation Committee of our Board of Directors.
Mr. Palmer is also entitled to four weeks paid vacation and reimbursement of
expenses, including up to $2,000 per month for all expenses incurred by Mr.
Palmer with respect to his personal automobile. We have also agreed to provide
Mr. Palmer with a furnished apartment or comparable living space in Los Angeles,
California suitable to his position for the initial twelve months of the term
of
the Employment Agreement. Additionally, we have agreed to pay for no more than
two coach or economy class round trip tickets per month from Los Angeles to
New
Jersey for Mr. Palmer. As an inducement material to Mr. Palmer’s decision to
enter into employment with us, we agreed to grant Mr. Palmer an option to
purchase 625,000 shares of our common stock. The option has a term of 10 years,
a per share exercise price of $1.40 and will vest over a period of two years,
with 125,000 shares vesting on the date of grant and 125,000 shares vesting
on
each subsequent six-month anniversary of the date of grant. All unexercised
options outstanding as of the date of any termination of Mr. Palmer’s employment
with us will expire.
30
Mr.
Palmer has commenced the implementation of a comprehensive action plan with
key
strategic initiatives focused on cutting costs to reduce our SG&A by
approximately 10% by the end of the year, selling off our excess inventory,
and
aggressively reviewing and evaluating the long-term viability of our brands,
licensees and retail strategy.
Results
of Operations
Three
Months Ended June 30, 2007 vs. 2006
Net
sales
decreased from $15.2 million for the three months ended June 30, 2006 to $8.4
million for the three months ended June 30, 2007. The sales were less than
during the same period last year for a variety of reasons. Firstly, due to
the
lack of European distributors, our international sales reduced from 23% during
the three months ended June 30, 2006 to 17.9% during three months ended June
30,
2007. Secondly, we are still recovering from our third and fourth quarter
delivery problems. During the latter part of the second quarter of 2007, several
major retailers re-established their sales orders with us. In addition, in
May
2007, we signed a European license agreement.
Gross
profit for the three months ended June 30, 2007 decreased to $3.43 million
from
$7.43 million in the three months ended June 30, 2006. The decrease in gross
profit was largely due to reduced sales during the quarter ended June 30, 2007.
However, we expect our gross margin to be maintained at approximately 50% in
the
future.
Selling,
distribution and administrative expenses for the three months ended June 30,
2007 totaled $4.06 million compared with $4.32 million for the three months
ended June 30, 2006. The principal components in the second quarter of 2007
were
payroll of $1.7 million (compared to $1.7 million in the second quarter last
year), rent expense of $0.30 million ($0.12 million in the same period of 2006),
professional fee expenses of $0.26 million ($0.3 million in the same period
of
2006), royalties of $0.16 million ($0.37 million in 2006) and stock-based
compensation of $0.08 million ($0.11 million in the same period last
year).
Net
Loss
after provision for taxes in the second quarter of 2007 was $(1.04) million
or
(12%) of net sales compared to net income of $1.7 million or 11% of net sales
in
the second quarter of 2006. Basic and diluted earnings per share decreased
to
$(0.04) from $0.07 in the same period of last year. For the three months ended
June 30, 2007, the Company provided $0 million for income tax compared to $1.18
million for the three months ended June 30, 2006. 31
Six
Months Ended June 30, 2007 vs. 2006
Net
sales
decreased from $27.1 million for the six months ended June 30, 2006 to $16.8
million for the six months ended June 30, 2007. The sales were less than during
the same period last year for a variety of reasons. First, due to the lack
of
European distributors, our international sales decreased from 29% in 2006 to
21.6% during the six months ended June 30, 2007. Secondly, we are still
recovering from our third and fourth quarter delivery problems. However, in
the
latter part of the second quarter of 2007, several major retailers
re-established their sales orders with us. In addition, in May 2007, we signed
a
European license agreement.
Gross
profit for the six months ended June 30, 2007 decreased to $8.26 million from
$13.38 million during the same period last year. The decrease in gross profit
was largely due to reduced sales during the six months ended June 30, 2007.
However, we expect our gross margin to be maintained at approximately 50% in
the
future.
Selling,
distribution and administrative expenses for the six months ended June 30,
2007
totaled $8.58 million compared with $8.92 million for the same period last
year.
The principal components during the six months ended June 30, 2007 were payroll
of $3.4 million (compared to $3.5 million in the same period last year),
professional fee expenses of $0.65 million ($0.58 million in the same period
of
2006), advertising and trade show expenses of $0.55 million ($0.71 million
in
the same period of 2006), rent expense of $0.47 million ($0.37 million in the
same period of 2006), royalties of $0.36 million ($0.83 million in 2006) and
stock-based compensation of $0.14 million ($0.23 million in the same period
last
year).
Net
Loss
after provision for taxes during the six months ended June 30, 2007 was $(1.07)
million or (6%) of net sales compared to $2.39 million or 8.9% of net sales
during the same period of 2006. Basic and diluted earnings per share decreased
to $(0.04) from $0.09 in the same period of last year. For the six months ended
June 30, 2007, the Company provided $0 million for income tax compared to $1.67
million for the six months ended June 30, 2006.
Liquidity
and Capital Resources
We
believe we currently have adequate resources to fund our anticipated cash needs
through December 31, 2007 and beyond. However, an adverse business development
could require us to raise additional financing sooner than
anticipated.
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