| CYGNE DESIGNS INC Item 1A RISK FACTORS You should carefully consider the risks described below before investing in our common stock |
| Although the risks described below are all of the risks that we believe are material, they are not the only risks relating to our business and our common stock |
| Additional risks and uncertainties not currently known to us or those we currently deem to be immaterial may also materially and adversely affect our business operations |
| Any of the following risks could materially adversely affect our business, financial condition or results of operations |
| The trading price of our common stock could decline due to any of these risks and, therefore, you may lose all or part of your investment |
| Risk Factors Relating to Our Operations We rely on a few key customers for the majority of our revenue |
| We historically have been dependent on one or more key customers |
| A significant portion of our sales has been to NY&C Sales to NY&C accounted for approximately 32prca and 82prca respectively, of our net sales from 8 ______________________________________________________________________ continuing operations for the years 2005 and 2004 |
| On a pro forma basis, after giving effect to the acquisition of the branded and private label denim apparel business from Diversified Apparel as if such acquisition had been consummated on the first day of our 2004 fiscal year, our sales to NY&C would have accounted for approximately 19prca and 49prca respectively of our net sales from continuing operations for the years 2005 and 2004 |
| Sales to JCPenney and Kohl’s accounted for approximately 21prca and 18prca, respectively, of net sales for the year 2005 |
| On a pro forma basis, after giving effect to the acquisition of the branded and private label denim apparel business from Diversified Apparel as if such acquisition had been consummated on the first day of our 2004 fiscal year, our sales to JCPenney and Kohl’s would have accounted for approximately 12prca and 10prca respectively of our net sales from continuing operations for the year 2005 |
| On a pro forma basis, after giving effect to the acquisition of the branded and private label denim apparel business from Diversified Apparel as if such acquisition had been consummated on the first day of our 2004 fiscal year, our sales to JCPenney and Kohl’s would have accounted for approximately 22prca and 5prca respectively of our net sales from continuing operations for the year 2004 |
| Although we have long-established relationships with our major customers, NY&C and, through our acquisition of Diversified Apparel’s business, JCPenney and Kohl’s, we do not have long-term contracts with these customers, Our future success will be dependent upon our ability to attract new customers and to maintain our relationships with our present customers |
| We continue to strive to maintain our positive working relationships with our customers by providing on-time deliveries of quality products |
| We cannot assure you that our major customers-NY&C, JCPenney or Kohl’s will continue to purchase merchandise from us at the same rate as they have historically from us or Diversified Apparel, respectively, or at all in the future, or that we will be able to attract new customers |
| In addition, our major customers have the ability to exert significant control over our business decisions, including prices |
| During 2005, all of our products were manufactured outside the United States, at either a related party manufacturer located in Mexico, non-affiliated manufacturers located in Guatemala and in the Far East or at our manufacturing facilities located in Guatemala |
| We produced 25prca of our net sales in our manufacturing facility in Guatemala and 9prca of our net sales in non-affiliated Guatemalan facilities |
| A Mexican facility owned by a related party produced 46prca of our net sales |
| Approximately 20prca of our net sales is from non-affiliated manufactures located in the Far East |
| On a proforma basis for 2005, we produced 15prca of our net sales in our manufacturing facilities in Guatemala, and 5prca of our net sales in non-affiliated Guatemalan facilities |
| We obtained 66prca of our net sales from the related party Mexican facilities, and 14prca from non-affiliated manufacturers located in the Far East |
| Foreign manufacturing is subject to a number of risks, including work stoppages, transportation delays and interruptions, political instability, foreign currency fluctuations, economic disruptions, expropriation, nationalization, the imposition of tariffs and import and export controls, changes in governmental policies (including US policy toward these countries) and other factors which could have an adverse effect on our business |
| In addition, we may be subject to risks associated with the availability of and time required for the transportation of products from foreign countries |
| The occurrence of certain of these factors may delay or prevent the delivery of goods ordered by customers, and such delay or inability to meet delivery requirements would have a severe adverse impact on our results of operations and could have an adverse effect on our relationships with our customers |
| Furthermore, the occurrence of certain of these factors in Guatemala, where we own a manufacturing facility, could result in a loss of our investment located in this country |
| If we experience product quality or late delivery problems with contract manufacturers our business will be negatively affected |
| Historically, a significant portion of our products have been manufactured by non-affiliated contract manufacturers |
| In connection with the acquisition of the assets of Diversified Apparel, we entered into a Supply 9 ______________________________________________________________________ Agreement with AZT International S de RL de CV, or AZT, an affiliate of Diversified Apparel, and will initially be reliant on AZT to supply most of our denim apparel products |
| We have from time to time experienced difficulties in obtaining timely delivery of products of acceptable quality |
| Such difficulties have resulted and may result in cancellation of orders, customer refusals to accept deliveries or reductions in purchase prices, any of which could have a material adverse effect on our financial condition and results of operations |
| We believe that these difficulties have resulted and may continue to result from not having sufficient access to and control over the manufacturing processes of non-affiliated contract manufacturers |
| There can be no assurance that we will not experience difficulties with third parties responsible for the manufacture of our products, including AZT Our direct manufacturing operations increase our operating costs |
| We maintain and operate a manufacturing facility in Guatemala for our non-denim products |
| Operating manufacturing facilities rather than contracting with independent manufacturers requires us to maintain a higher level of working capital |
| In addition, reduced sales would have an even greater adverse impact on our profitability in light of the fixed costs needed to own or lease and operate our own factory |
| Legislation relating to the importation of or decreasing or increasing the cost of textiles and apparel produced abroad could adversely affect our business and financial condition |
| Effective January 1, 2005, the United States (“US”) has discontinued textile import quotas affecting the products sourced by us |
| As a result, the US total imports in 2005 from China and other countries in the Far East, including the product categories manufactured by us in Guatemala and Mexico, have increased substantially |
| The US has established a safeguard program which will limit the increase in apparel imports from China for years 2005 through 2008 |
| Notwithstanding the safeguard program, our results of operations for products manufactured in Guatemala have been adversely affected for the year 2005 and we anticipate that our results of operations for products manufactured in Guatemala will continue to be adversely affected for the year 2006 |
| The Central American countries, which include Guatemala, and the US, have negotiated a Central America Free Trade Agreement (“CAFTA”) |
| CAFTA, which was signed by US on August 2, 2005, will allow the US duty free imports from Guatemala if the woven fabric is manufactured using US yarn |
| After the Republic of Guatemala ratifies this Agreement, we anticipate that, over time, CAFTA may make Guatemala more competitive with imports from China in the categories manufactured by us in Guatemala |
| We have expanded our business through acquisitions that could result in diversion of resources and extra expenses |
| This could disrupt our business and adversely affect our financial condition |
| Historically, we have pursued acquisitions to expand our business |
| Most recently, on July 31, 2005, we acquired Diversified Apparel’s branded and private label denim apparel business |
| The negotiation of potential acquisitions as well as the integration of acquired businesses could divert our management’s time and resources |
| Acquired businesses may not be successfully integrated with our operations |
| We may not realize the intended benefits of any acquisition |
| As a result of the acquisition, we have substantial indebtedness which could decrease our flexibility to react to changing economic conditions |
| Two stockholders now control a majority of our outstanding Common Stock and thus control many decisions, including the election of directors and the sale of our Company |
| The cyclical nature of the apparel industry and uncertainty over future economic prospects could have a material adverse effect on our results of operations |
| The fashion apparel industry in which we operate is cyclical |
| Many factors affect the level of consumer spending in the industry, including, among others: • general business conditions; • interest rates; 10 ______________________________________________________________________ • the availability of consumer credit; • taxation; and • consumer confidence in future economic conditions |
| Consumer purchases of discretionary items, including our products, may decline during recessionary periods and also may decline at other times when disposable income is lower |
| A downturn in the economies in which we sell our products, may adversely affect our sales |
| In addition, various retailers, including some of our customers, have experienced financial difficulties during recent years, which has increased our risk of losing customers and increased the risk of extending credit to such retailers |
| The seasonal nature of our business makes management more difficult, severely reduces cash flow and liquidity during parts of the year and could force us to curtail operations |
| Our greatest volume of shipments and sales occur from late spring through the summer, which coincides with our second and third fiscal quarters |
| Historically, our cash flow is strongest in the third and fourth fiscal quarters |
| Unfavorable economic conditions affecting retailers during the fall and holiday seasons in any year could have a material adverse effect on our results of operations for the year |
| We are likely to experience periods of negative cash flow throughout each year and a drop-off in business commencing each December, which could force us to curtail operations if adequate liquidity is not available |
| We cannot assure you that the effects of such seasonality will diminish in the future |
| If we lose the services of our key personnel, our business will be harmed |
| Our future success depends on Bernard Manuel, Chairman of the Board and Chief Executive Officer and other key personnel |
| Manuel and any negative market or industry perception arising from the loss of his services could have a material adverse effect on us and the price of our shares |
| Our continued success is also dependent upon our ability to attract and retain qualified employees to support our future growth |
| We face intense competition in the worldwide apparel industry |
| We face a variety of competitive challenges from other domestic and foreign fashion-oriented apparel producers |
| We do not currently hold a dominant competitive position in any market, including the private label apparel market, which is highly fragmented |
| We compete with competitors such as Kellwood, Jones Apparel Group, and VF Corp |
| primarily on the basis of: • anticipating and responding to changing consumer demands in a timely manner, • maintaining favorable brand recognition, • developing innovative, high-quality products in sizes, colors and styles that appeal to customers, • appropriately pricing products, • providing strong and effective marketing support, • creating an acceptable value proposition for retail customers, • ensuring product availability and optimizing supply chain efficiencies with manufacturers and retailers, and • obtaining sufficient retail floor space and effective presentation of our products at retail |
| 11 ______________________________________________________________________ In addition, we face competition from our own customers, who have their own internal product development and sourcing capabilities |
| We believe that many of our customers who have the know-how and internal resources to develop and source directly a portion of their requirements constitute our major competition |
| Most of our competitors are larger in size and have greater resources than we do, and there can be no assurance that we will be successful in competing with them in the future |
| Our business could be negatively impacted by the financial instability or consolidation of our customers |
| Our customers are retailers located in the United States |
| Financial difficulties of a customer could cause us to curtail business with that customer |
| Our receivables are factored without recourse |
| Furthermore, in recent years, the retail industry has experienced consolidation and other ownership changes |
| Some of our customers have operated under the protection of the federal bankruptcy laws |
| While to date these changes in the retail industry have not had a material adverse effect on our business or financial condition, our business could be materially affected by these changes in the future |
| We are currently dependent on supply and distribution agreements with Diversified Apparel and its related entities for a substantial portion of our supply, distribution and back office capabilities |
| In connection with our acquisition of the Acquired Business, we entered into a Supply and a Distribution Agreement for a two-year period starting July 31, 2005 with Diversified Apparel and its affiliated entities which we collectively refer to as Diversified Apparel |
| Under the terms of the Supply Agreement, Diversified Apparel will manufacture and supply us with our entire requirements of branded and private label denim apparel products |
| Although Diversified Apparel is obligated to deliver denim products ordered by us under the Supply Agreement, we have no obligation to source denim products from AZT Under the terms of the Distribution Agreement, Diversified Apparel will provide us with specified distribution and back office operations services |
| In addition, Diversified is our vendor for all Far East finished goods purchases |
| The loss of our Supply and our Distribution Agreements with Diversified Apparel could adversely affect our current supply responsibilities |
| Our trademark and other intellectual property rights may not be adequately protected outside of the United States |
| We believe that our trademarks, whether licensed to or owned by us, and other proprietary rights will be important to our success and our competitive position in the branded market |
| We may, however, experience conflict with various third parties who acquire or claim ownership rights in certain trademarks |
| We cannot assure that the actions we have taken to establish and protect these trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as a violation of the trademarks and proprietary rights of others |
| In addition, enforcing rights to our intellectual property may be difficult and expensive, and we may not be successful in combating counterfeit products and stopping infringement of our intellectual property rights, which could make it easier for competitors to capture market share |
| Furthermore, our efforts to enforce our trademark and other intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our trademark and other intellectual property rights |
| If we are unsuccessful in protecting and enforcing our intellectual property rights, continued sales of such competing products by third parties could harm our brand and adversely impact our business, financial condition and results of operations |
| 12 ______________________________________________________________________ Our debt levels may limit our flexibility in obtaining additional financing and in pursuing other business opportunities |
| We have a significant amount of debt |
| At January 31, 2006, after giving effect to our acquisition of the Acquired Business from Diversified Apparel, we had indebtedness of dlra40 million and during the year 2005 we have received advances from our factor of approximately 90prca of our factored receivables or dlra49dtta6 million |
| Our level of indebtedness could have important consequences to us, including the following: • our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such financing may not be available on favorable terms; • we will need a substantial portion of our cash flow to make principal and interest payments on our indebtedness, reducing the funds that would otherwise be available for our operations and future business opportunities; • we may need a substantial portion of our authorized common shares to convert for the purpose of making principal and interest payments on our indebtedness, reducing the shares that would otherwise be available for financing our future business opportunities and potentially diluting our common stock; • our debt level may make us more vulnerable than our competitors with less debt to competitive pressures or a downturn in our business or the economy generally; and • our debt level may limit our flexibility in responding to changing business and economic conditions |
| In addition, any indebtedness we incur will be subject and subordinated to our obligations to Milberg Factors and the Secured Subordinated Promissory Note (“Note”) |
| Our ability to service our indebtedness will depend upon, among other things, our future financial and operating performance and cash flows, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control |
| If our operating results and cash flows are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing or delaying our business activities, acquisitions, investments and/or capital expenditures, selling assets, restructuring or refinancing our indebtedness, or seeking additional equity capital or bankruptcy protection |
| We may not be able to affect any of these remedies on satisfactory terms, or at all |
| In addition, our obligations under the factoring agreement with Milberg Factors and our obligations under the Note are secured by substantially all our assets and if we are unable to repay our indebtedness, the lenders could seek to foreclose on such assets |
| If new debt is added to our current debt levels, the related risks that we now face could intensify |
| We are subject to risks associated with war and terrorist activities |
| Terrorism, or the threat of terrorism, may have an impact on the general economy, including reduced shopping activity as a result of public safety concerns and disruption in the receipt and delivery of merchandise |
| Earthquakes or other events outside of our control may damage our facilities or the facilities of third parties on which we depend |
| Our warehouse facility is located in California near major earthquake faults that have experienced earthquakes in the past |
| An earthquake or other natural disaster could disrupt our operations |
| Additionally, the loss of electric power, such as the temporary loss of power caused by power shortages in the grid servicing our warehouse facility, could disrupt operations or impair critical systems |
| Any of these disruptions or other events outside of our control could affect our business negatively, harming our operating results |
| In addition, if any facilities of our suppliers or customers are affected by earthquakes, power shortages, floods, hurricanes (monsoons), terrorism or other events outside of our control, our business could suffer |
| 13 ______________________________________________________________________ Risk Factors Related to Ownership of Our Common Stock A small number of shareholders are in a position to substantially control matters requiring a stockholder vote |
| As reflected in the Schedule 13D/A filed January 6, 2006, of the 11cmam973cmam571 shares of Common Stock outstanding as of that date, (i) Mr |
| Guez is a 32dtta2prca owner and the manager and, as such, may be deemed to beneficially own the shares owned by Diversified Apparel, (iii) 1cmam570cmam915 shares are held by the Guez Living Trust dated December 6, 1996 (“Guez Living Trust”), of which Mr |
| Guez may be deemed to be the beneficial owner of the shares owned by the trust, (iv) 1cmam379cmam225 shares are owned by 215 GZ Partners which is 100prca owned by Guez Living Trust, and accordingly Mr |
| Guez may be deemed to beneficially own the shares held by 215 GZ Partners, (v) 584cmam220 shares are owned by Griffin James Aron Irrevocable Trust dated January 1, 1996 (“Griffin Guez Trust”) of which Mr |
| Guez’s son is the sole beneficiary and Mr |
| Guez’s mother, Marguerite Ester Guez, is the trustee, and as such, Mr |
| Guez may be deemed to beneficially own the shares owned by Griffin Guez Trust, and (vi) 584cmam220 shares are owned by Stephan Avner Felix Guez Irrevocable Trust dated January 1, 1996 (“Stephan Guez Trust”) of which Mr |
| Guez’s son Stephen Guez is the trustee and sole beneficiary, and as such Mr |
| Guez may be deemed to beneficially own the shares owned by Stephan Guez Trust |
| Guez disclaims beneficial ownership of the securities held by Diversified Apparel and Guez Living Trust except to the extent of his pecuniary interest therein |
| Guez disclaims beneficial ownership of the securities held by Griffin Guez Trust and Stephan Guez Trust |
| Guez controls approximately 11cmam973cmam571 shares of our common stock, which constitutes approximately 49prca of our outstanding common stock Accordingly, Mr |
| Guez and Diversified Apparel effectively have the ability to control the outcome on all matters requiring stockholder approval, including, but not limited to, the election of directors and any merger, consolidation or sale of all or substantially all of our assets |
| Manuel owns 4cmam946cmam975 shares of our common stock, which constitutes approximately 20prca of our outstanding common stock |
| Our certificate of incorporation, as amended, prohibits any stockholder from acquiring more than 5prca of our outstanding common stock without the prior approval of our Board of Directors |
| Our incorporation documents and Delaware law have provisions that could delay or prevent a change in control of our company, which could negatively affect your investment |
| In addition to Diversified Apparel and Mr |
| Guez together beneficially owning approximately 49prca of our common stock as of January 31, 2006, our certificate of incorporation and bylaws and Delaware law contain provisions that could delay or prevent a change in control of our company that stockholders may consider favorable |
| Some of these provisions: • limit the persons who can call special stockholder meetings; • require the approval of our Board of Directors for specified transfers of our capital stock; • require the approval of our Board of Directors for any person to acquire more than five percent of our common stock; and • authorize the issuance of up to 1cmam000cmam000 shares of preferred stock that can be created and issued by our board of directors without prior stockholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock |
| These and other provisions in our incorporation documents and Delaware law could allow our Board of Directors to affect your rights as a stockholder by making it more difficult for stockholders to replace Board members or take control of us |
| Because our Board of Directors is responsible for appointing members of our management team, these provisions could in turn affect any attempt to replace the current management team |
| In addition, these provisions could deprive our stockholders of opportunities to realize a premium on the shares of common stock owned by them |
| 14 ______________________________________________________________________ The price of our common stock has fluctuated significantly and could continue to fluctuate significantly |
| Between February 1, 2004 and January 31, 2006, the market price of our common stock has ranged from a low of dlra0dtta25 to a high of dlra6dtta74 per share |
| On April 21, 2006, the last reported sale price of our common stock on the NASDAQ National Market was dlra3dtta69 |
| The market price of our common stock may change significantly in response to various factors and events beyond our control, including: • fluctuations in our quarterly revenues or those of our competitors as a result of seasonality or other factors; • a shortfall in revenues or net income from that expected by securities analysts and investors; • changes in securities analysts’ estimates of our financial performance or the financial performance of our competitors or companies in our industry generally; • announcements concerning our competitors; • changes in product pricing policies by our competitors or our customers; • general conditions in our industry; and • general conditions in the securities markets |