-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LcZsgMsyN6UXxSQSBIAH4S0pcarouqd/jNVURymrsRTlSQ53isJ+/LiOqwhtJzEJ BLOz5WZD3nKyIxNN4m8NAQ== 0001170918-07-000677.txt : 20070814 0001170918-07-000677.hdr.sgml : 20070814 20070814163906 ACCESSION NUMBER: 0001170918-07-000677 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20070630 FILED AS OF DATE: 20070814 DATE AS OF CHANGE: 20070814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TALON INTERNATIONAL, INC. CENTRAL INDEX KEY: 0001047881 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-APPAREL, PIECE GOODS & NOTIONS [5130] IRS NUMBER: 954654481 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13669 FILM NUMBER: 071055939 BUSINESS ADDRESS: STREET 1: 21900 BURBANK BLVD. STREET 2: SUITE 270 CITY: WOODLAND HILLS STATE: CA ZIP: 91367 BUSINESS PHONE: 8184444100 MAIL ADDRESS: STREET 1: 21900 BURBANK BLVD. STREET 2: SUITE 270 CITY: WOODLAND HILLS STATE: CA ZIP: 91367 FORMER COMPANY: FORMER CONFORMED NAME: TAG IT PACIFIC INC DATE OF NAME CHANGE: 19971015 10-Q 1 fm10q-081307.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended June 30, 2007. OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. Commission file number 1-13669 TALON INTERNATIONAL, INC. (Exact Name of Issuer as Specified in its Charter) DELAWARE 95-4654481 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 21900 BURBANK BOULEVARD, SUITE 270 WOODLAND HILLS, CALIFORNIA 91367 (Address of Principal Executive Offices) (818) 444-4100 (Registrant's Telephone Number, Including Area Code) TAG-IT PACIFIC, INC. (Former name, former address and former fiscal year, if changed since last report) 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 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 . See definition of "accelerated filer and large accelerated filer"in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [_] No [X] AT AUGUST 14, 2007 THE ISSUER HAD 20,041,433 SHARES OF COMMON STOCK, $.001 PAR VALUE, ISSUED AND OUTSTANDING. ================================================================================ TALON INTERNATIONAL, INC. (FORMERLY TAG-IT PACIFIC, INC.) INDEX TO FORM 10-Q PART I FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements................................................ 3 Consolidated Balance Sheets as of June30, 2007 (unaudited) and December 31, 2006 ............................................ 3 Consolidated Statements of Operations for the Three Months and the Six Months Ended June 30, 2007 and 2006 (unaudited)....... 4 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006 (unaudited)............... 5 Notes to the Consolidated Financial Statements...................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................................... 15 Item 3. Quantitative and Qualitative Disclosures about Market Risk.......... 29 Item 4. Controls and Procedures............................................. 30 PART II OTHER INFORMATION Item 1. Legal Proceedings................................................... 31 Item 1A. Risk Factors ....................................................... 31 Item 6. Exhibits ........................................................... 32 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS TALON INTERNATIONAL, INC. (FORMERLY TAG-IT PACIFIC, INC.) CONSOLIDATED BALANCE SHEETS June 30, December 31, 2007 2006 ------------ ------------ Assets Current Assets: Cash and cash equivalents ..................... $ 3,822,264 $ 2,934,673 Restricted cash ............................... 9,500,000 -- Accounts receivable, net ...................... 6,040,757 4,664,766 Note receivable ............................... 1,450,051 1,378,491 Inventories, net .............................. 2,555,072 3,051,220 Recoverable legal costs ....................... 1,180,748 107,108 Prepaid expenses and other current assets ..... 675,063 433,926 ------------ ------------ Total current assets ............................. 25,223,955 12,570,184 Property and equipment, net ...................... 5,575,712 5,623,040 Fixed assets held for sale ....................... 826,904 826,904 Note receivable, less current portion ............ 677,601 1,420,969 Due from related party ........................... 722,918 675,137 Other intangible assets, net ..................... 4,110,751 4,139,625 Other assets ..................................... 720,546 437,569 ------------ ------------ Total assets ..................................... $ 37,858,387 $ 25,693,428 ============ ============ Liabilities and Stockholders' Equity Current liabilities: Accounts payable ............................... $ 6,391,504 $ 4,006,241 Accrued legal costs ............................ 1,267,167 427,917 Other accrued expenses ......................... 3,289,601 3,359,267 Demand notes payable to related parties ........ 85,176 664,970 Current portion of capital lease obligations .................................. 395,294 432,728 Current portion of notes payable ............... 405,878 1,107,207 Secured convertible promissory notes ........... 12,488,490 12,472,622 ------------ ------------ Total current liabilities ........................ 24,323,110 22,470,952 Capital lease obligations, less current portion ........................................ 351,292 474,733 Notes payable, less current portion .............. 1,000,482 1,061,514 Revolver note payable ............................ 1,307,806 -- Term note payable ................................ 7,106,260 -- Other long term liabilities ...................... 83,651 -- ------------ ------------ Total liabilities ................................ 34,172,601 24,007,199 ------------ ------------ Commitments and contingencies Stockholders' Equity: Preferred stock Series A, $0.001 par value; 250,000 shares authorized; no shares issued or outstanding ................ -- -- Common stock, $0.001 par value, 100,000,000 shares authorized; 20,041,433 shares issued and outstanding at June 30, 2007; 18,466,433 at December 31, 2006 ....... 20,041 18,466 Additional paid-in capital ..................... 54,341,135 51,792,502 Accumulated deficit ............................ (50,675,390) (50,124,739) ------------ ------------ Total stockholders' equity ....................... 3,685,786 1,686,229 ------------ ------------ Total liabilities and stockholders' equity ....... $ 37,858,387 $ 25,693,428 ============ ============ See accompanying notes to consolidated financial statements 3 TALON INTERNATIONAL, INC. (FORMERLY TAG-IT PACIFIC, INC.) CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended June 30, Six Months Ended June 30, --------------------------- ---------------------------- 2007 2006 2007 2006 ------------ ------------ ------------ ------------ Net sales ......................... $ 13,566,981 $ 14,246,087 $ 22,657,099 $ 24,884,303 Cost of goods sold ................ 9,484,488 10,118,850 15,827,411 17,914,341 ------------ ------------ ------------ ------------ Gross profit ................... 4,082,493 4,127,237 6,829,688 6,969,962 Selling expenses .................. 841,326 674,894 1,547,561 1,220,519 General and administrative expenses 2,406,192 2,557,062 5,017,780 5,296,499 ------------ ------------ ------------ ------------ Total operating expenses ....... 3,247,518 3,231,956 6,565,341 6,517,018 Income from operations ............ 834,975 895,281 264,347 452,944 Interest expense, net ............. 265,858 229,139 490,574 516,205 ------------ ------------ ------------ ------------ Income (loss) before income taxes . 569,117 666,142 (226,227) (63,261) Provision for income taxes ........ 78,624 11,500 78,624 11,500 ------------ ------------ ------------ ------------ Net Income (loss) .............. $ 490,493 $ 654,642 $ (304,851) $ (74,761) ============ ============ ============ ============ Basic income (loss) per share ..... $ 0.03 $ 0.04 $ (0.02) $ (0.00) ============ ============ ============ ============ Diluted income (loss) per share ... $ 0.02 $ 0.04 $ (0.02) $ (0.00) ============ ============ ============ ============ Weighted average number of common shares outstanding: Basic .......................... 18,590,884 18,358,360 18,562,151 18,300,027 ============ ============ ============ ============ Diluted ........................ 20,058,682 18,598,442 18,562,151 18,300,027 ============ ============ ============ ============
See accompanying notes to consolidated financial statements. 4 TALON INTERNATIONAL, INC. (FORMERLY TAG-IT PACIFIC, INC.) CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30, ---------------------------- 2007 2006 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ................................................................... $ (304,851) $ (74,761) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization ............................................. 592,011 606,960 Amortization of deferred financing cost and debt discounts ................ 163,593 155,254 Increase (decrease) in allowance for doubtful accounts ................... 61,500 (919,312) Decrease in inventory valuation reserves ................................. (165,280) (3,433,267) Disposal of asset ......................................................... -- 8,502 Stock based compensation .................................................. 125,000 165,377 Changes in operating assets and liabilities: Receivables, including related party ...................................... (1,485,273) 214,518 Inventories ............................................................... 661,428 5,453,233 Recoverable legal costs ................................................... (1,073,640) -- Prepaid expenses and other current assets ................................. (241,137) 74,016 Other Assets .............................................................. 35,207 (104,029) Accounts payable and accrued expenses ..................................... 2,560,129 (94,087) Accrued legal ............................................................. 769,467 129,020 Income taxes payable .................................................... 77,931 11,500 ------------ ------------ Net cash provided by operating activities ................................ 1,776,085 2,192,924 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of property and equipment ...................................... (514,812) (28,883) Proceeds from sale of equipment ........................................... -- 2,500 ------------ ------------ Net cash used by investing activities .................................... (514,812) (26,383) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Collection of notes receivable ............................................. 671,808 84,514 Proceeds from exercise of stock options and warrants ....................... 42,746 -- Proceeds from issuance of stock and warrants, net of issuance costs ........ 2,313,711 -- Revolver note borrowings ................................................... 1,307,806 -- Term note borrowings, net of issuance costs ................................ 6,842,789 -- Repayment of capital leases ................................................ (160,875) (397,906) Repayment of notes payable ................................................. (1,891,667) (153,630) ------------ ------------ Net cash from (used by) financing activities ........................... 9,126,318 (467,022) ------------ ------------ Net increase in cash and restricted cash ....................................... 10,387,591 1,699,519 Cash at beginning of period .................................................... 2,934,673 2,277,397 ------------ ------------ Cash and restricted cash at end of period $ 13,222,264 $ 3,976,916 ============ ============ Supplemental disclosures of cash flow information: Cash received (paid) during the period for: Interest paid ............................................................ $ (477,176) $ (520,825) Interest received ........................................................ $ 154,263 $ 159,874 Income tax paid .......................................................... $ 95,056 -- Non-cash financing activities: Capital lease obligation ................................................. $ 35,809 $ -- Deferred financing cost .................................................. $ 203,434 $ -- Accounts payable & accrued legal converted to notes payable .............. $ -- $ 1,775,000
See accompanying notes to consolidated financial statements. 5 TALON INTERNATIONAL, INC. (FORMERLY TAG-IT PACIFIC, INC.) NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1. PRESENTATION OF INTERIM INFORMATION The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The accompanying unaudited consolidated financial statements reflect all adjustments that, in the opinion of the management of Talon International, Inc. and its consolidated subsidiaries (collectively, the "Company"), are considered necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. The accompanying financial statements should be read in conjunction with the audited consolidated financial statements of the Company included in the Company's Form 10-K for the year ended December 31, 2006. The balance sheet as of December 31, 2006 has been derived from the audited financial statements as of that date but omits certain information and footnotes required for complete financial statements. On July 20, 2007 the Company changed its name from Tag-It Pacific, Inc. to Talon International, Inc. Certain reclassifications have been made to the prior year financial statements to conform to the 2007 presentation. 6 NOTE 2. EARNINGS (LOSS) PER SHARE The following is a reconciliation of the numerators and denominators of the basic and diluted income (loss) per share computations:
THREE MONTHS ENDED JUNE 30, 2007: INCOME (LOSS) SHARES PER SHARE ------------ ------------ ------------ Basic Income per share: Income available to common stockholders $ 490,493 18,590,884 $ 0.03 Effect of Dilutive Securities: Options ............................... -- 1,463,278 (0.01) Warrants .............................. -- 4,520 -- ------------ ------------ ------------ Income available to common stockholders $ 490,493 20,058,682 $ 0.02 ============ ============ ============ THREE MONTHS ENDED JUNE 30, 2006: Basic Income per share: Income available to common stockholders $ 654,642 18,358,360 $ 0.04 Effect of Dilutive Securities: Options ................................. -- 240,082 -- Warrants ................................ -- -- -- ------------ ------------ ------------ Income available to common stockholders . $ 654,642 18,598,442 $ 0.04 ============ ============ ============ SIX MONTHS ENDED JUNE 30, 2007: Basic loss per share: Loss available to common stockholders . $ (304,851) 18,562,151 $ (0.02) Effect of Dilutive Securities: Options ............................... -- -- -- Warrants .............................. -- -- -- ------------ ------------ ------------ Loss available to common stockholders ... $ (304,851) 18,562,151 $ (0.02) ============ ============ ============ SIX MONTHS ENDED JUNE 30, 2006: Basic loss per share: Loss available to common stockholders . $ (74,761) 18,300,027 $ (0.00) Effect of Dilutive Securities: Options ............................... -- -- -- Warrants .............................. -- -- -- ------------ ------------ ------------ Loss available to common stockholders $ (74,761) 18,300,027 $ (0.00) ============ ============ ============
Warrants to purchase 3,193,813 shares of common stock exercisable at between $0.95 and $5.06 per share, options to purchase 4,746,735 shares of common stock exercisable at between $0.37 and $5.23 per share, and convertible debt of $12,500,000 convertible at $3.65 per share, were outstanding for the three and six months ended June 30, 2007. In connection with the Share-Based Payment calculation (see note 3), 4,880,135 shares were included in the computation of diluted income per share for the three month period ended June 7 30, 2007. These shares were not included in the computation of diluted loss per share for the six months ended June 30, 2007 because exercise or conversion would have an antidilutive effect on the loss per share. Warrants to purchase 1,243,813 shares of common stock exercisable at between $3.50 and $5.06 per share, options to purchase 4,434,888 shares of common stock exercisable at between $0.37 and $5.23 per share, convertible debt of $12,500,000 convertible at $3.65 per share, and other convertible debt of $500,000 convertible at $4.50 per share were outstanding for the three and six months ended June 30, 2006. In connection with the Share-Based Payment calculation (see note 3), 2,775,135 shares were included in the computation of diluted income per share for the three month period ended June 30, 2006. These shares were not included in the computation of diluted loss per share for the six months ended June 30, 2006 because exercise or conversion would have an antidilutive effect on the loss per share. NOTE 3. STOCK BASED COMPENSATION The Company accounts for stock-based awards to employees and directors in accordance with Statement of Financial Accounting Standards No. 123 revised, Share-Based Payment, ("SFAS 123(R)") which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. Options issued to consultants are accounted for in accordance with the provisions of Emerging Issues Task Force (EITF) No. 96-18, "Accounting for Equity Instruments That Are Issued to Others Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services". There were 46,600 options granted to employees during the three and six months ended June 30, 2007 at a weighted average exercise price of $1.02 per share. The estimated fair value of options granted during the three and six months ended June 30, 2007 was $31,700. Common shares of 1,500,000 and warrants to acquire 2,100,000 shares of common stock were issued during the three and six months ended June 30, 2007 to a non-employee in connection with a debt financing facility at a weighted average exercise price of $1.05 per share for the warrants and $0.001 per share for the common shares issued. The estimated total fair value of the warrants and shares of common stock granted during the three and six months was $2,879,020. The relative fair value of warrants and shares of common stock issued, less financing costs, is accounted for as debt discount related to the $9.5 million Term note entered into in June 2007. Assumptions used to value options granted to employees were expected volatility of 69%, expected term of 6.1 years, risk-free interest rate of approximately 5.0%, and an expected dividend yield of zero. Assumptions used to value warrants granted to non-employee were expected volatility of 78%, expected term of 5 years (contractual life), risk-free interest rate of 5.0%, and expected dividend yield of zero. In January, 2007, a consultant exercised options to acquire 75,000 shares of common stock. Cash received upon exercise was $42,750 or $0.57 per share. At the time of exercise, the total intrinsic value of the options exercised was approximately $72,000 (or $0.96 per share). Because the option exercised was a non-qualified stock option, the Company will receive a tax deduction for the intrinsic value amount. As of June 30, 2007, the Company had approximately $537,000 of unamortized stock-based compensation expense related to options issued to employees and directors, which will be recognized over the weighted average period of 2.3 years. This expected expense will change if any stock options are granted or cancelled prior to the respective reporting periods or if there are any changes required to be made for estimated forfeitures. During the three months ended June 30, 2006, the Company did not grant any stock-based awards to employees or non-employees. During the six months ended June 30, 2006, the Company granted awards of stock for 225,388 shares at an average market price of $0.45 per share and options to acquire 2,685,135 shares at an average exercise price of $0.42 per share. Awards to acquire 1,625,000 shares were granted to employees outside of the 1997 Plan, and awards of stock and options to acquire 165,253 shares were granted to a consultant. The estimated fair value of all awards granted during the six months was $666,000, of which 8 $70,000 was accrued for as of December 31, 2005. Assumptions used to value options granted to employees were expected volatility of 57%, expected term of 5.3 years to 6.1 years, risk-free interest rate of approximately 4.4%, and an expected dividend yield of zero. Assumptions used to value options granted to consultants were expected volatility of 65%, expected term of 10 years (contractual life), risk-free interest rate of 4.5%, and expected dividend yield of zero. The following table summarizes the activity in the Company's share based plans during the three and six months ended June 30, 2007. At June 30, 2007 the Company may issue additional awards to acquire up to a total of 2,502,877 shares of common stock under the 1997 Plan.
Weighted Average Number of Exercise Shares Price ---------- ---------- EMPLOYEES AND DIRECTORS Options and warrants outstanding - January 1, 2007 ..... 5,002,635 $ 1.41 Granted ........................................... -- -- Exercised ......................................... -- -- Cancelled ......................................... (299,500) $ 1.03 ---------- ---------- Options and warrants outstanding - March 31, 2007 ...... 4,703,135 $ 1.44 Granted ........................................... 46,600 $ 1.02 Exercised ......................................... -- -- Cancelled ......................................... (3,000) $ 1.27 ---------- ---------- Options and warrants outstanding - June 30, 2007 ....... 4,746,735 $ 1.44 ========== ========== NON-EMPLOYEES Options and warrants outstanding - January 1, 2007 ..... 1,318,813 $ 4.13 Granted ........................................... -- -- Exercised ......................................... (75,000) $ .57 Cancelled ......................................... (150,000) $ 3.50 ---------- ---------- Options and warrants outstanding - March 31, 2007 ...... 1,093,813 $ 4.46 Granted ........................................... 2,100,000 $ 1.05 Exercised ......................................... -- -- Cancelled ......................................... -- -- ---------- ---------- Options and warrants outstanding - June 30, 2007 ....... 3,193,813 $ 2.22 ========== ==========
NOTE 4. INVENTORIES Inventories are stated at the lower of cost or market value and are all categorized as finished goods. Inventory reserves are recorded for damaged, obsolete, excess and slow-moving inventory. We use estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory. Reserve adjustments are made for the difference between the cost of the inventory and the estimated market value, if lower, and charged to operations in the period in which the facts that give rise to these adjustments become known. Market value of inventory is estimated based on the impact of market trends, an evaluation of economic conditions and the value of current orders relating to the future sales of this type of inventory. 9 Inventories consist of the following: June 30, December 2007 31, 2006 ---------- ---------- Finished goods ....................... $3,631,791 $4,293,220 Less reserves ........................ 1,076,720 1,242,000 ---------- ---------- Total inventories .................... $2,555,071 $3,051,220 ========== ========== NOTE 5. INCOME TAXES On January 1, 2007 the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on the recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition associated with income tax liabilities. As a result of the implementation of FIN 48, the Company recognized an increase in liabilities for unrecognized tax benefits of approximately $245,800, which was accounted for as an increase in the January 1, 2007 accumulated deficit. The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in income tax expense. For the three and six months ended June 30, 2007 the Company recognized accrued interest for unrecognized tax benefits of approximately $4,000. There was no interest or penalties recognized during the three months or six months ended June 30, 2006 for unrecognized tax benefits. At June 30, 2007 the Company had approximately $37,875 accrued in interest and penalties associated with the unrecognized tax liabilities. NOTE 6. CONTINGENCIES AND GUARANTEES In May, 2006, the Company received notice from the American Stock Exchange ("AMEX") that it was not in compliance with certain of the continued listing standards as set forth in the AMEX Company Guide due to the failure to comply with Section 1003(a)(i) and Section 1003(a)(ii) of the Company Guide, which effectively required that the Company maintain shareholders' equity of at least $4,000,000. Following the notice from AMEX the Company was afforded the opportunity to submit a "plan of compliance" to AMEX outlining in detail how the Company expected to achieve the minimum equity requirements and to regain compliance. On August 3, 2006 the Company received notification from AMEX that the Company's plan to regain compliance with the minimum shareholders' equity requirements of the AMEX Company Guide had been accepted and the Company has been granted an extension until November 16, 2007 to achieve the AMEX continued listing requirements. During this period the Company will be subject to periodic review by the AMEX Staff and failure to make progress consistent with the plan or to regain compliance with continued listing standards by the end of the extension period could result in being delisted from the American Stock Exchange. On October 12, 2005, a shareholder class action complaint -- HUBERMAN V.TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex) -- was filed against us and certain of our current and former officers and directors in the United States District Court for the Central District of California, alleging claims under Section 10(b) and Section 20 of the Securities Exchange Act of 1934. A lead plaintiff was appointed, and his amended complaint alleged that defendants made false and misleading statements about the Company's financial situation and its relationship with certain of its large customers. The action was brought on behalf of all purchasers of our publicly-traded securities during the period from November 13, 2003 to August 12, 2005. 10 On February 20, 2007, the Court denied class certification. Plaintiff moved the court to reconsider the ruling, and also to intervene a new plaintiff to pursue class certification. Both of those motions were denied on April 2, 2007. In addition, the same day the Court granted defendants' motion for summary judgment, and on or about April 5, 2007, the Court entered judgment in favor of all defendants. On or about April 30, 2007, plaintiff filed a notice of appeal, and his opening appellate brief is due on October 15, 2007. The Company believes that this matter will be resolved in trial or in settlement within the limits of its insurance coverage. However, the outcomes of this action or an estimate of the potential losses, if any, related to the lawsuit cannot be reasonably predicted, and an adverse resolution of the lawsuit could potentially have a material adverse effect on the Company's financial position and results of operations. On April 16, 2004 the Company filed suit against Pro-Fit Holdings, Limited ("Pro-Fit") in the U.S. District Court for the Central District of California - TAG-IT PACIFIC, INC. V. PRO-FIT HOLDINGS, LIMITED, CV 04-2694 LGB (RCx) -- asserting various contractual and tort claims relating to our exclusive license and intellectual property agreement with Pro-Fit, seeking declaratory relief, injunctive relief and damages. It is the Company's position that the agreement with Pro-Fit gives us the exclusive rights in certain geographic areas to Pro-Fit's stretch and rigid waistband technology. On June 5, 2006 the Court denied the Company's motion for partial summary judgment, but did not find that the Company breached its agreement with Pro-Fit and a trial is required to determine issues concerning our activities in Columbia and whether other actions by Pro-Fit constituted an unwillingness or inability to fill orders. The Court also held that Pro-Fit was not "unwilling or unable" to fulfill orders by refusing to fill orders with goods produced in the United States. The Court has not yet set a date for trial of this matter. The Company has historically derived a significant amount of revenue from the sale of products incorporating the stretch waistband technology and the Company's business, results of operations and financial condition could be materially adversely affected if the dispute with Pro-Fit is not resolved in a manner favorable to the Company. Additionally, the Company has incurred significant legal fees in this litigation, and unless the case is settled, the Company will continue to incur additional legal fees in increasing amounts as the case accelerates to trial. A subsidiary, Tag-It de Mexico, S.A. de C.V., operated under the Mexican government's Maquiladora Program, which entitled Tag-It de Mexico to certain favorable treatment as respects taxes and duties regarding certain imports. In July of 2005, the Mexican Federal Tax Authority asserted a claim against Tag-It de Mexico alleging that certain taxes had not been paid on imported products during the years 2000, 2001, 2002 and 2003. In October of 2005, the Company filed a procedural opposition to the claim and submitted documents to the Mexican Tax Authority in opposition to this claim, supporting the Company's position that the claim was without merit. The Mexican Federal Tax Authority failed to respond to the opposition filed, and the required response period by the Tax Authority has lapsed. In addition, a controlled entity incorporated in Mexico (Logistica en Avios, S.A. de C.V.) through which the Company conducted its operations in 2005, may be subjected to a claim or claims from the Mexican Tax Authority, as identified directly above, and additionally to other tax issues, including those arising from employment taxes. The Company believes that any such claim is defective on both procedural and documentary grounds and does not believe there will be a material adverse effect on us. The Company currently has pending a number of other claims, suits and complaints that arise in the ordinary course of our business. The Company believes that we have meritorious defenses to these claims and that the claims are either covered by insurance or, after taking into account the insurance in place, would not have a material effect on the Company's consolidated financial condition if adversely determined against the Company. In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others - and interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34." The following is a summary of the Company's agreements that it has determined are within the scope of FIN 45: 11 In accordance with the bylaws of the Company, officers and directors are indemnified for certain events or occurrences arising as a result of the officer or director's serving in such capacity. The term of the indemnification period is for the lifetime of the officer or director. The maximum potential amount of future payments the Company could be required to make under the indemnification provisions of its bylaws is unlimited. However, the Company has a director and officer liability insurance policy that reduces its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of the indemnification provisions of its bylaws is minimal and therefore, the Company has not recorded any related liabilities. The Company enters into indemnification provisions under its agreements with investors and its agreements with other parties in the normal course of business, typically with suppliers, customers and landlords. Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company's activities or, in some cases, as a result of the indemnified party's activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights. These indemnification provisions generally survive termination of the underlying agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal. Accordingly, the Company has not recorded any related liabilities. NOTE 7. NEW ACCOUNTING PRONOUNCEMENTS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, and does not require any new fair value measurements. The application of SFAS No. 157 however may change current practice within an organization. SFAS No. 157 is effective for all fiscal years beginning after November 15, 2007, with earlier application encouraged. We do not believe that SFAS No. 157 will have a material impact on our financial position, results of operations or cash flows. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115," ("SFAS No. 159") which expands the use of fair value. Under SFAS No. 159 a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees, issued debt and other eligible financial instruments. SFAS No. 159 is effective for years beginning after November 15, 2007. We do not believe that SFAS No. 159 will have a material impact on our financial position, results of operations or cash flows. 12 NOTE 8. GEOGRAPHIC INFORMATION The Company specializes in the distribution of a full range of apparel zipper and trim items to manufacturers of fashion apparel, specialty retailers and mass merchandisers. There is not enough difference between the types of products developed and distributed by the Company to account for these products separately or to justify segmented reporting by product type. The Company distributes its products internationally and has reporting requirements based on geographic regions. Long-lived assets are attributed to countries based on the location of the assets and revenues are attributed to countries based on customer delivery locations, as follows: Three Months Ended Six Months Ended June 30, June 30, ------------------------- ------------------------- Country / Region 2007 2006 2007 2006 ----------- ----------- ----------- ----------- United States .......... $ 1,048,400 $ 1,025,100 $ 1,890,900 $ 1,938,400 Asia ................... 11,531,500 8,418,400 18,554,800 14,738,800 Mexico ................. 319,400 1,444,200 599,400 2,579,700 Dominican Republic ..... 269,600 2,631,300 654,700 4,272,100 Other .................. 398,100 727,100 957,300 1,355,300 ----------- ----------- ----------- ----------- $13,567,000 $14,246,100 $22,657,100 $24,884,300 =========== =========== =========== =========== June 30, December 31, 2007 2006 ----------- ----------- LONG-LIVED ASSETS: United States ........................ $ 9,459,100 $ 9,531,659 Asia ................................. 439,500 386,516 Mexico ............................... 1,400 5,078 Dominican Republic ................... 613,500 668,067 ----------- ----------- $10,513,500 $10,591,320 =========== =========== NOTE 9. DEBT FACILITY On June 27, 2007 the Company entered into a Revolving Credit and Term Loan Agreement with Bluefin Capital, LLC that provides for a $5.0 million revolving credit loan and a $9.5 million term loan for a three year period ending June 30, 2010. The revolving credit portion of the facility permits borrowings based upon a formula including 75% the Company's eligible receivables and 55% of eligible inventory, and provides for monthly interest payments at prime plus 2%. The term loan bears interest at 8 1/2% annually with quarterly interest payments. Both of the notes are secured by all of the assets of the Company and mature on June 30, 2010. At closing the proceeds of the term loan were deposited into a restricted cash escrow account and $3.0 million of the borrowings available under the revolving credit note were reserved and held for payment of the Company's $12.5 million convertible promissory notes maturing in November 2007. During July 2007 waivers were obtained from all holders of the convertible promissory notes allowing for early payment of their notes without penalty, and as of July 31, 2007 all of the note holders had been paid in full. At June 30, 2007 the convertible promissory notes payable are reflected in current liabilities. 13 As of June 30, 2007 the Company had borrowed $9.5 million under the term note, and $1,307,806 under the revolving credit note. The proceeds of the term note were held in a restricted cash escrow for future payment of the convertible promissory notes, and the proceeds of the borrowings under the revolving credit note were used to pay the related party note payable and accrued interest due to Mark Dyne, Chairman of the Board of the Company, in the amount of $1,004,306, and to pay the initial loan and legal fees due at closing. In connection with the Revolving Credit and Term Loan Agreement, the Company issued 1,500,000 shares of common stock to the lender for $0.001 per share, and issued 2,100,000 warrants for the purchase of common stock. The warrants are exercisable over a five-year period and 700,000 warrants are exercisable at $0.95 per share; 700,000 warrants are exercisable at $1.05 per share; and 700,000 warrants are exercisable at $1.14 per share. The relative fair value of the equity ($2,380,962, which includes a reduction for financing costs) of the equity issued with this debt facility was allocated to paid-in-capital and reflected as a debt discount to the face value of the term note. This discount will be accreted over the term of the note and recognized as additional interest cost as amortized. Costs associated with the debt facility included debt fees, commitment fees, registration fees, and legal and professional fees of $548,000. The costs allocable to the debt instruments are reflected in other assets as deferred financing costs and are being amortized over the term of the notes. NOTE 10. SUBSEQUENT EVENTS During July 2007 the Company obtained waivers from all of the convertible promissory note holders to accept payment of their notes without penalty. All of the restricted cash escrow funds, together with an additional $3.0 million borrowed under the revolving credit note at July 31, 2007 were used during the month to pay the convertible promissory notes in full. On July 31, 2007, at the Company's annual meeting of stockholders, the 2007 Stock Plan was approved which replaces the 1997 Stock Plan upon its expiration on October 1, 2007. The 2007 Stock Plan authorizes up to 2,600,000 shares of common stock for issuance pursuant to awards granted to individuals under the plan. At June 30, 2007 2,502,877 shares were available for issuance under the 1997 Stock Plan which expires on October 1, 2007 if not issued. At June 30, 2007 we have an outstanding note receivable from Azteca Production International, Inc. of $2,127,652. The note is receivable in monthly installments over thirty-one months beginning March 1, 2006 and the payments currently range from $133,000 - $267,000 per month until paid in full. Accounts receivable at June 30, 2007 includes $219,900 due from Azteca, against which $119,800 in checks from Azteca were being held. At August 1, 2007 $47,900 of these checks had been collected. On April 11, 2007 a favorable verdict was awarded to the plaintiff in a trademark infringement lawsuit in which Azteca is a defendant and is now appealing. This adverse ruling against Azteca may impact their ability to repay our note receivable. On July 1, 2007 we did not receive the July 1st note payment on our note receivable from Azteca and we submitted a notice of default. On July 23, 2007 we received an election from Azteca to defer the July 1st payment for an additional 30 days from our default notice in accordance with terms allowing this deferral in the note agreement. Accordingly, the July 1st note payment is now due September 14, 2007. On August 1, 2007 we did not receive the August 1st note payment and accordingly submitted a notice of default to Azteca Production International, Inc. In accordance with the terms of the note agreement, Azteca has a 30 day cure period to correct the existing default. The outcome of these events or an estimate of the potential impact if any, on the collectibility of our note receivable cannot be reasonably predicted at this time. The failure to collect payments under this note could have a material adverse effect on our financial position and results of operations. On July 20, 2007 the Company changed its name from Tag-It Pacific, Inc. to Talon International, Inc. and changed its AMEX trading symbol from TAG to TLN. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FORWARD LOOKING STATEMENTS This report and other documents we file with the SEC contain forward looking statements that are based on current expectations, estimates, forecasts and projections about us, our future performance, our business or others on our behalf, our beliefs and our management's assumptions. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. We describe our respective risks, uncertainties, and assumptions that could affect the outcome or results of operations below. We have based our forward looking statements on our management's beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that actual outcomes and results may differ materially from what is expressed, implied, or forecast by our forward looking statements. Reference is made in particular to forward looking statements regarding projections or estimates concerning our business, including demand for our products and services, mix of revenue streams, ability to control and/or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, international businesses, competitive position, adequate liquidity to fund our operations and meet our other cash requirements. OVERVIEW The following management's discussion and analysis is intended to assist the reader in understanding our consolidated financial statements. This management's discussion and analysis is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and accompanying notes. On July 20, 2007, we changed our corporate name from Tag-It Pacific, Inc. to Talon International, Inc. in order to reflect our core marketing strategy of focusing on growth opportunities in the global zipper market with our Talon(R) brand zippers. Talon International, Inc. designs, sells and distributes apparel zippers, specialty waistbands and various apparel trim products to manufacturers of fashion apparel, specialty retailers and mass merchandisers. We sell and market these products under various branded names including Talon and Tekfit. We operate the business globally under three product groups. We plan to increase our global expansion of Talon zippers through the establishment of a network of Talon locations, distribution relationships, and joint ventures. The network of global manufacturing and distribution locations are expected to improve our global footprint and allow us to more effectively serve apparel brands and manufacturers globally. Our trim business focus is as an outsourced product development, sourcing and sampling department for the most demanding brands and retailers. We believe that trim design differentiation among brands and retailers has become a critical marketing tool for our customers. By assisting our customers in the development, design and sourcing of trim, we expect to achieve higher margins for our trim products, create long-term relationships with our customers, grow our sales to a particular customer by supplying trim for a larger proportion of their brands, and better differentiate our trim sales and services from those of our competitors. Our Tekfit services provide manufacturers with the patented technology, manufacturing know-how and materials required to produce garments incorporating an expandable waistband. These products historically have been produced by several manufacturers for one single brand under an exclusive supply contract. This contract expired in October 2006 and we now intend to expand this product to other brands. Our expansion has been limited to date due to the exclusive contract as well as licensing dispute. As 15 described more fully in this report under Contingencies and Guarantees (see Note 6 to our unaudited consolidated financial statements), we are presently in litigation with Pro-Fit Holdings Limited regarding our exclusively licensed rights to sell or sublicense stretch waistbands manufactured under Pro-Fit's patented technology. As we have derived a significant amount of revenue from the sale of products incorporating the stretch waistband technology, our business, results of operations and financial condition could be materially adversely affected if our dispute with Pro-Fit is not resolved in a manner favorable to us. RESULTS OF OPERATIONS The following table sets forth selected statements of operations data shown as a percentage of net sales for the periods indicated: THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ---------------- ----------------- 2007 2006 2007 2006 ------ ------ ------ ------ Net sales ............................ 100.0% 100.0% 100.0% 100.0% Cost of goods sold ................... 69.9 71.0 69.9 72.0 ------ ------ ------ ------ Gross profit ......................... 30.1 29.0 30.1 28.0 Selling expenses ..................... 6.2 4.7 6.8 4.9 General and administrative expenses .. 17.7 18.5 22.1 21.9 Interest & taxes ..................... 2.5 1.1 2.5 1.5 ------ ------ ------ ------ Net income (loss) .................... 3.7% 4.7% (1.3)% (0.3)% ====== ====== ====== ====== SALES For the three months and six months ended June 30, 2007 and 2006, sales by geographic region based on the location of the customer as a percentage of sales were: THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ----------------- ----------------- 2007 2006 2007 2006 ------ ------ ------ ------ United States ...................... 7.7% 7.2% 8.3% 7.8% Asia ............................... 85.0% 59.1% 81.9% 59.2% Mexico ............................. 2.4% 10.1% 2.6% 10.4% Dominican Republic ................. 2.0% 18.5% 2.9% 17.2% Other .............................. 2.9% 5.1% 4.3% 5.4% ------ ------ ------ ------ 100.0% 100.0% 100.0% 100.0% ====== ====== ====== ====== Sales for the three months ended June 30, 2007 were $13.6 million or $0.7 million (4.8%) less than sales for the three months ended June 30, 2006. Sales for the six months ended June 30, 2007 were $22.7 million or $2.2 million (8.9%) less than sales for the same period in 2006. The reduction in sales for the three and six months ended June 30, 2007 as compared to the same period in 2006 is primarily attributable to lower sales of waistband products as a result of the termination in October of 2006 of our exclusive sales contract for these products. For the three and six months ended June 30, 2007 sales included $0.2 million and $0.6 million, respectively of waistband product sales, as compared to sales of $2.5 million and $4.4 million, respectively of these products for comparable periods in 2006. Sales within Asia increased $3.1 million, or 37% for the three months ended June 30, 2007 and $3.8 million, or 26% for the six months ended June 30, 2007 as compared to the same periods in 2006. The 16 increase in sales within Asia is principally the result of increased sales of Talon zippers and our continued expansion in China. Sales of trim products for the three months and six months ended June 30, 2007 declined $1.4 million and $2.3 million, respectively as compared to the same periods in 2006 principally as a result of lower sales of trim products to our customers in Mexico and the U.S. as production shifted from these areas to Asia and other worldwide markets, and as a result of sales of $0.8 million recognized in the second quarter of 2006 associated with a revenue restatement from a 2005 agreement. GROSS MARGIN Gross margin for the three months ended June 30, 2007 was $4.1 million, essentially comparable to the gross margin of $4.1 million for the same period in 2006. Gross margin for the six months ended June 30, 2007 was $6.8 million or $0.1 million (2%) less than gross margin for the same period in 2006. The change in gross margin for the three and six months ended June 30, 2007 as compared to the same periods in 2006 was principally attributable to reduced costs associated with lower overall sales volumes, lower direct margin resulting from a change in the mix in product sales, reduced distribution charges since more products are now sourced and delivered within the same marketplace, reduced manufacturing and assembly overhead costs and lower inventory obsolescence and management charges as inventory levels have been reduced and turns accelerated. A brief recap of the change in gross margin for the three and six months ended June 30, 2007 as compared with the same periods in 2006 is as follows:
(Amounts in thousands) THREE MONTHS SIX MONTHS ---------------------------- ---------------------------- AMOUNT %(1) AMOUNT %(1) ------------ ------------ ------------ ------------ Gross margin (decrease) increase as a result of: Lower volumes ................................ $ (234) (5.6) $ (791) (11.3) Product margin mix ........................... (20) (0.5) (319) (4.6) Vendor cost reductions negotiated in 2006 .... (261) (6.3) (261) (3.7) Reduced freight and duty costs ............... 151 3.7 316 4.5 Lower manufacturing & assembly costs ......... 163 3.9 130 1.9 Reduced obsolescence & inventory costs ....... 109 2.7 639 9.2 Other cost of sales charges .................. 47 1.1 146 2.0 ------------ ------------ ------------ ------------ Gross margin (decrease) ...................... $ (45) (1.0)% $ (140) (2.0)% ============ ============ ============ ============
(1) Represents the percentage change in the 2007 period, as compared to the same period in 2006. SELLING EXPENSES Selling expenses for the three months ended June 30, 2007 were $0.8 million, or 6.2% of sales compared to $0.7 million or 4.7% of sales for the same period in 2006. The increase in selling expense is principally due to the increased number of sales offices and salespersons within China and their associated compensation and travel costs, offset in part by lower royalty fees on waistband products. Selling expenses for the six months ended June 30, 2007 were $1.5 million or 6.8% of sales compared to $1.2 million or 4.9% of sales for the same period in 2006. The increase in selling expense is principally due to the increased number of sales offices and salesmen within China and their associated compensation and travel costs and increased marketing cost associated with the Talon brand offset in part by lower royalty fees on waistband products. 17 GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses for the three months ended June 30, 2007 were $2.4 million or $0.2 million less than for the same period in 2006. General and administrative expenses for the six months ended June 30, 2007 were $5.0 million or $0.3 million less than for the same period in 2006. General and administrative expense for the three month period ended June 30, 2007 increased by approximately $217,000 as a result of $53,000 in bad debt provisions in 2007 compared to bad debt recoveries of $164,000 in 2006; by $133,000 due to additional consulting fees on contracts with former employees; and general and administrative expense decreased by approximately $156,000 as a result of lower facility costs; by $275,000 in lower legal, audit and investor costs; and by approximately $64,000 in other lower overall general and administrative expenses. For the six month period ended June 30, 2007 general and administrative expenses as compared to the same period of 2006 declined by approximately $0.3 million. The net reduction reflected an increase of $439,000 as a result of $42,000 in bad debt provisions in 2007 compared to bad debt recoveries of $397,000 in 2006; offset by decreases in general and administrative expenses by $164,000 resulting from lower facility costs; by $459,000 in lower legal, audit and investor costs, and by approximately $95,000 in other lower general and administrative costs. INTEREST EXPENSE Interest expense increased by approximately $37,000 to $266,000 for the three months ended June 30, 2007, as compared to the same period in 2006. The increase principally reflects lower interest earnings on cash and the note receivable, in addition to higher debt amortization costs. Interest expense for the six months ended June 30, 2007 decreased by approximately $25,000 to $491,000, as compared to the same period in 2006. The change for the period from 2006 is due mainly to lower borrowings under a bank line of credit and certain notes. Interest expense for the remaining term of the new debt facility entered into in June 2007 will include approximately $0.2 million per quarter in non-cash charges for debt accretion and deferred financing costs amortization. INCOME TAXES Income tax expense for the three and six months ended June 30 2007 was $78,624 and for the three and six months ended June 30, 2006 the income tax expense was $11,500. The tax expense in both 2007 and 2006 is associated with foreign income taxes from earnings within our Asian facilities. Due to prior operating losses incurred within the year no benefit for domestic income taxes has been recorded since there is not sufficient evidence to determine that we will be able to utilize our net operating loss carryforwards to offset future taxable income. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes selected financial data (amounts in thousands) at: JUNE 30, 2007 DECEMBER 31, 2006 ----------------- ----------------- Cash and cash equivalents ............... $ 3,822 $ 2,935 Total assets ............................ $ 28,358 $ 25,693 Current debt ............................ $ 11,835 $ 22,471 Non-current debt ........................ $ 12,838 $ 1,536 Stockholders' equity .................... $ 3,686 $ 1,686 18 CASH AND CASH EQUIVALENTS Cash and cash equivalents for the six months ended June 30, 2007 increased $887,000 from December 31, 2006 principally arising from cash generated by operating activities, and Restricted cash increased by $9.5 million from borrowings under a term loan agreement. Cash provided by operating activities is our primary recurring source of funds, and was approximately $1.8 million for the six months ended June 30, 2007. The cash provided by operating activities during the six months resulted principally from net earnings before non-cash charges of $576,000; an increase in trade accounts payable of $2,560,000; a net reduction of $496,000 in inventory (a $661,000 reduction in inventory levels, net of established reserves of $165,000); offset by an increase in current receivables of $1,424,000; an increase in net recoverable legal fees of $304,000; and an increase in prepaid expenses and other of $128,000. During the six months ended June 30, 2006 established reserves for uncollectible accounts receivable were applied to approximately $0.6 million of accounts written-off, and approximately $0.3 million in reserves were eliminated following the collection of previously reserved accounts. Cash used by operating activities for the six months ended June 30, 2005 was $148,000. Net cash used in investing activities for the six months ended June 30, 2007 was $515,000 as compared to $26,000 for the six months ended June 30, 2006. These expenditures were principally associated with leasehold improvements in new facilities, office equipment for new employees, improvements in our technology systems and a marketing website acquisition. In 2006 the cash used for investing activities consisted primarily of capital expenditures for replacing computer equipment. Net cash of $9,126,000 was generated from financing activities for the six months ended June 30, 2007. $10,507,000 (net of issuance costs) was provided by the issuance of common stock and warrants, and by borrowings under a new debt facility (see Note 9) designated to payoff our existing convertible promissory notes and to provide funds for future growth. The proceeds from this debt facility initially included $9,500,000 that was funded to a restricted escrow account to partially pay the $12,500,000 of outstanding convertible promissory notes, and $1,004,000 was used to pay a related party note and associated accrued interest. Approximately $374,000 was used primarily for the repayment of borrowings under capital leases and notes payable partially offset by collections on the note receivable and the proceeds of the exercise of stock options. Additionally, net cash used by financing activities for the six months ended June 30, 2006 was $467,000 and represented the repayment of notes payable and capital leases, partially offset by funds collected from the note receivable. We currently satisfy our working capital requirements primarily through cash flows generated from operations. As we continue to expand globally in response to the industry trend to outsource apparel manufacturing to offshore locations, our foreign customers, some of which are backed by U.S. brands and retailers, are increasing. Our revolving debt facility provides limited financing secured by our accounts receivable, and our current borrowing capability may not provide the level of financing we need to expand into additional foreign markets. As a result, we are continuing to evaluate non-traditional financing of our foreign assets and equity transactions to provide capital needed to fund our expansion and operations. We have incurred significant legal fees in our litigation with Pro-Fit Holdings Limited. Unless the case is settled, we will continue to incur additional legal fees in increasing amounts as the case accelerates to trial. We believe that our existing cash and cash equivalents and anticipated cash flows from our operating activities and available financing will be sufficient to fund our minimum working capital and capital expenditure needs for at least the next twelve months. This conclusion is based on the belief that our 19 strategic plan and the company's current structure will allow for continued profitability; and that we will collect our note and accounts receivable in accordance with existing terms. If we are unable to collect our note and accounts receivable, or experience greater than anticipated reductions in sales, we may need to raise additional capital, or further reduce the scope of our business in order to fully satisfy our future short-term liquidity requirements. If we cannot raise additional capital or reduce the scope of our business in response to a substantial decline in sales, we may default on our debt agreement. The event of a default on the debt agreements will materially affect the business operations in the long-term, however the on-going operations for 2007 are nevertheless anticipated to substantially continue throughout the 2007 year-end. The extent of our future long-term capital requirements will depend on many factors, including our results of operations, future demand for our products, the size and timing of future acquisitions, our borrowing base availability limitations related to eligible accounts receivable and inventories and our expansion into foreign markets. Our need for additional long-term financing includes the integration and expansion of our operations to exploit our rights under our Talon trade name, the expansion of our operations in the Asian, Central and South American and Caribbean markets and the further development of our waistband technology. If our cash from operations is less than anticipated or our working capital requirements and capital expenditures are greater than we expect, we may need to raise additional debt or equity financing in order to provide for our operations. We are continually evaluating various financing strategies to be used to expand our business and fund future growth or acquisitions. There can be no assurance that additional debt or equity financing will be available on acceptable terms or at all. If we are unable to secure additional financing, we may not be able to execute our plans for expansion, including expansion into foreign markets to promote our Talon brand trade name, and we may need to implement additional cost savings initiatives. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS The following summarizes our contractual obligations at June 30, 2007 and the effects such obligations are expected to have on liquidity and cash flow in future periods:
PAYMENTS DUE BY PERIOD ------------------------------------------------------------------- LESS THAN 1 TO 3 4 TO 5 AFTER CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS ----------- ----------- ----------- ----------- ----------- Demand notes payable to related parties (1) ................. $ 209,500 $ 209,500 $ 0 $ 0 $ 0 Capital lease obligations ..... $ 831,600 $ 474,000 $ 357,600 $ 0 $ 0 Operating leases .............. $ 1,282,500 $ 492,100 $ 782,700 $ 7,700 $ 0 Notes payable ................. $15,421,500 $ 1,590,300 $13,236,100 $ 595,100 $ 0 Convertible notes payable (2) . $ 3,051,700 $ 3,051,700 $ 0 $ 0 $ 0 ----------- ----------- ----------- ----------- ----------- Total Obligations ...... $20,796,800 $ 5,817,600 $14,376,400 $ 602,800 $ 0 =========== =========== =========== =========== ===========
(1) The majority of notes payable to related parties is due on demand with the remainder due and payable on the fifteenth day following the date of delivery of written demand for payment, and includes accrued interest payable through June 30, 2007. (2) Net of $9,500,000 held in escrow for payment of these notes. 20 At June 30, 2007 and 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. RELATED PARTY TRANSACTIONS A director and significant shareholder of Tarrant Apparel Group is also a significant shareholder of the Company. Sales to Tarrant for the three months and six months ended June 30, 2007 were $139,900, and $140,000, respectively. Sales to Tarrant for the three and six months ended June 30, 2006 were zero and $1,000 respectively. As of June 30, 2007 there were accounts receivable of $140,000 due from Tarrant, and at December 31, 2006 there were no amounts due from Tarrant. Colin Dyne, a director and stockholder of the Company is also a director, officer and significant stockholder in People's Liberation, Inc. During the three and six months ended June 30, 2007 we had sales of $65,600 and $349,200, respectively, to subsidiaries of People's Liberation, Inc. For the three and six months ended June 30, 2006 we had no sales to Peoples Liberation, Inc. At June 30, 2007, accounts receivable included $56,500 outstanding from People's Liberation subsidiaries. At December 31, 2006, accounts receivable of $83,400 was outstanding from subsidiaries of People's Liberation, Inc. Jonathan Burstein, a director of the Company, purchases products from the Company through an entity operated by his spouse. For the three and six months ended June 30, 2007 sales to this entity were $30,000 and $33,600, respectively. Sales to this entity for the three and six months ended June 30, 2006 were $800 and $10,600, respectively. At June 30, 2007, $19,500 was included in accounts receivable from this entity and at December 31, 2006 accounts receivable included $18,400 due from this entity. Due from related parties at June 30, 2007 includes $722,900 and at December 31, 2006 includes $675,100 of unsecured notes, advances and accrued interest receivable from Colin Dyne. The notes and advances bear interest at 7.5% and are due on demand. Demand notes payable to related parties includes notes and advances to parties related to or affiliated with Mark Dyne, Chairman of the Board of the Company. The principal balance of Demand notes payable to related parties at June 30, 2007 was $85,200 and at December 31, 2006 was $665,000. On June 27, 2007 a note payable to Mark Dyne in the principal amount of $665,000, plus accrued interest of $339,000, was paid in full. Consulting fees paid to Diversified Investments, a company owned by Mark Dyne, amounted to $37,500 for the three months ended June 30, 2007 and 2006. Consulting fees paid for the six months ended June 30, 2007 and 2006 were $75,000. Consulting fees of $75,000 and $ 125,200 were paid for services provided by Colin Dyne for the three months and six months ended June 30, 2007, respectively. For the three and six months ended June 30, 2006 consulting fees of $72,000 were paid to Colin Dyne. Consulting fees of $73,800 and $147,200 were paid for services provided by Jonathan Burstein, for the three months and six months ended June 30, 2007. No consulting fees were paid to Jonathan Burstein in 2006. APPLICATION OF CRITICAL ACCOUNTING POLICIES AND 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 for the reporting period and as of the financial statement date. We base our estimates on historical experience and on various other 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. These estimates and assumptions affect the reported amounts of assets and liabilities, the 21 disclosure of contingent liabilities and the reported amounts of revenue and expense. Actual results could differ from those estimates. Critical accounting policies are those that are important to the portrayal of our financial condition and results, and which require us to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: o Accounts receivable balances are evaluated on a continual basis and allowances are provided for potentially uncollectible accounts based on management's estimate of the collectibility of customer accounts. If the financial condition of a customer were to deteriorate, resulting in an impairment of its ability to make payments, an additional allowance may be required. Allowance adjustments are charged to operations in the period in which the facts that give rise to the adjustments become known. o Inventories are stated at the lower of cost or market value. Inventory is evaluated on a continual basis and reserve adjustments are made based on management's estimate of future sales value, if any, of specific inventory items. Inventory reserves are recorded for damaged, obsolete, excess and slow-moving inventory. We use estimates to record these reserves. Slow-moving inventory is reviewed by category and may be partially or fully reserved for depending on the type of product and the length of time the product has been included in inventory. Reserve adjustments are made for the difference between the cost of the inventory and the estimated market value, if lower, and charged to operations in the period in which the facts that give rise to these adjustments become known. Market value of inventory is estimated based on the impact of market trends, an evaluation of economic conditions and the value of current orders relating to the future sales of this type of inventory. o We record deferred tax assets arising from temporary timing differences between recorded net income and taxable net income when and if we believe that future earnings will be sufficient to realize the tax benefit. For those jurisdictions where the expiration date of tax benefit carry-forwards or the projected taxable earnings indicate that realization is not likely, a valuation allowance is provided. If we determine that we may not realize all of our deferred tax assets in the future, we will make an adjustment to the carrying value of the deferred tax asset, which would be reflected as an income tax expense. Conversely, if we determine that we will realize a deferred tax asset, which currently has a valuation allowance, we would be required to reverse the valuation allowance, which would be reflected as an income tax benefit. We believe that our estimate of deferred tax assets and determination to record a valuation allowance against such assets are critical accounting estimates because they are subject to, among other things, an estimate of future taxable income, which is susceptible to change and dependent upon events that may or may not occur, and because the impact of recording a valuation allowance may be material to the assets reported on the balance sheet and results of operations. o We record impairment charges when the carrying amounts of long-lived assets are determined not to be recoverable. Impairment is measured by assessing the usefulness of an asset or by comparing the carrying value of an asset to its fair value. Fair value is typically determined using quoted market prices, if available, or an estimate of undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. The amount of impairment loss is calculated as the excess of the carrying value over the fair value. Changes in market conditions and management strategy have historically caused us to 22 reassess the carrying amount of our long-lived assets. Long-lived assets are evaluated on a continual basis and impairment adjustments are made based upon management's valuations. o Sales are recognized when persuasive evidence of an arrangement exists, product delivery has occurred, pricing is fixed or determinable, and collection is reasonably assured. Sales resulting from customer buy-back agreements, or associated inventory storage arrangements are recognized upon delivery of the products to the customer, the customer's designated manufacturer, or upon notice from the customer to destroy or dispose of the goods. Sales, provisions for estimated sales returns, and the cost of products sold are recorded at the time title transfers to customers. Actual product returns are charged against estimated sales return allowances. o Upon approval of a restructuring plan by management, we record restructuring reserves for certain costs associated with facility closures and business reorganization activities as they are incurred or when they become probable and estimable. Such costs are recorded as a current liability. We record restructuring reserves in compliance with SFAS 146 "Accounting for Costs Associated with Exit or Disposal Activities", resulting in the recognition of employee severance and related termination benefits for recurring arrangements when they became probable and estimable and on the accrual basis for one-time benefit arrangements. We record other costs associated with exit activities as they are incurred. Employee severance and termination benefits are estimates based on agreements with the relevant union representatives or plans adopted by us that are applicable to employees not affiliated with unions. These costs are not associated with nor do they benefit continuing activities. Inherent in the estimation of these costs are assessments related to the most likely expected outcome of the significant actions to accomplish the restructuring. Changing business conditions may affect the assumptions related to the timing and extent of facility closure activities. We review the status of restructuring activities on a quarterly basis and, if appropriate, record changes based on updated estimates. o We are currently involved in various lawsuits, claims and inquiries, most of which are routine to the nature of the business, and in accordance with SFAS No. 5, "Accounting for Contingencies." We accrue estimates of the probable and estimable losses for the resolution of these claims. The ultimate resolution of these claims could affect our future results of operations for any particular quarterly or annual period should our exposure be materially different from our earlier estimates or should liabilities be incurred that were not previously accrued. NEW ACCOUNTING PRONOUNCEMENTS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, and does not require any new fair value measurements. The application of SFAS No. 157 however may change current practice within an organization. SFAS No. 157 is effective for all fiscal years beginning after November 15, 2007, with earlier application encouraged. We do not believe that SFAS No. 157 will have a material impact on our financial position, results of operations or cash flows. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115," ("SFAS No. 159") which expands the use of fair value. Under SFAS No. 159 a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, 23 accounts payable, guarantees, issued debt and other eligible financial instruments. SFAS No. 159 is effective for years beginning after November 15, 2007. We do not believe that SFAS No. 159 will have a material impact on our financial position, results of operations or cash flows. CAUTIONARY STATEMENTS AND RISK FACTORS Several of the matters discussed in this document contain forward-looking statements that involve risks and uncertainties. Factors associated with the forward-looking statements that could cause actual results to differ from those projected or forecast are included in the statements below. In addition to other information contained in this report, readers should carefully consider the following cautionary statements and risk factors. OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY AFFECTED IF WE ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING OUR RIGHTS UNDER OUR EXCLUSIVE LICENSE AND INTELLECTUAL PROPERTY AGREEMENT WITH PRO-FIT. Pursuant to our agreement with Pro-Fit Holdings, Limited, we have exclusive rights in certain geographic areas to Pro-Fit's stretch and rigid waistband technology. We are in litigation with Pro-Fit regarding our rights. See Part II, Item 1, "Legal Proceedings" for discussion of this litigation. We have derived a significant amount of revenues from the sale of products incorporating the stretch waistband technology. Our business, results of operations and financial condition could be materially adversely affected if we are unable to reach a settlement in a manner acceptable to us and ensuing litigation is not resolved in a manner favorable to us. Additionally, we have incurred significant legal fees in this litigation, and unless the case is settled, we will continue to incur additional legal fees in increasing amounts as the case accelerates to trial. IF WE LOSE OUR LARGER CUSTOMERS OR THEY FAIL TO PURCHASE AT ANTICIPATED LEVELS, OUR SALES AND OPERATING RESULTS WILL BE ADVERSELY AFFECTED. Our results of operations will depend to a significant extent upon the commercial success of our larger customers. If these customers fail to purchase our products at anticipated levels, or our relationship with these customers terminates, it may have an adverse effect on our results because: o We will lose a primary source of revenue if these customers choose not to purchase our products or services; o We may not be able to reduce fixed costs incurred in developing the relationship with these customers in a timely manner; o We may not be able to recoup setup and inventory costs; o We may be left holding inventory that cannot be sold to other customers; and o We may not be able to collect our receivables from them. In October 2006, our exclusive supply agreement with Levi Strauss & Co., pursuant to which we supplied Levi with TEKFIT waistbands for their Dockers programs, expired. With the expiration of this contract we now have broader access to other customers and we intend to actively expand this product offering to other brands. Sales of this product to Levi are expected to end during the second quarter of 2007 and to be significantly lower than in the previous year, and orders from new brands are not expected to fully offset these declines for several quarters, if at all. The revenues we derived from the sale of products incorporating the stretch waistband technology represented approximately 19% of our consolidated revenues for the years ended December 31, 2005 and 2006. A failure to attract new customers for our TEKFIT waistbands could have a material adverse effect on our sales and results of operations. IF WE ARE NOT ABLE TO REGAIN COMPLIANCE WITH LISTING REQUIREMENTS, OUR SHARES MAY BE REMOVED FROM LISTING ON AMEX. In May 2006 we were advised by AMEX that we were non-compliant with the minimum net equity listing requirements and we were afforded an opportunity to submit a plan to AMEX that provided for increases in our equity beyond the minimum $4.0 million equity requirement within an eighteen-month timeframe from 24 the date of the notice from AMEX. On August 3, 2006 AMEX accepted our plan to regain compliance and has given us an extension until November 16, 2007 to become compliant with the AMEX continued listing standards. During this period, we will be subject to periodic review by the AMEX staff and failure to make progress consistent with the plan or to regain compliance with continued listing standards by the end of the extension period could result in being delisted from the American Stock Exchange. In addition we have suffered substantial recurring losses and may fail to comply with other listing requirements of AMEX. We may not be able to regain compliance with these matters within the time allowed by the exchange, and our shares of common stock may be removed from the listing on AMEX. WE MAY NOT BE ABLE TO COLLECT OUR NOTE RECEIVABLE. On April 11, 2007 a favorable verdict was awarded to the plaintiff in a trademark infringement lawsuit in which Azteca Production International, Inc. is a defendant. We have an outstanding note from Azteca at June 30, 2007 of $2.1 million and this adverse ruling against them may impact their ability to repay our note receivable. The outcome of this event or an estimate of the potential impact if any, on the collectibility of our note receivable cannot be predicted at this time. The failure to collect payments under this note as scheduled could have a material adverse effect on our financial position, results of operations and cash flow. At August 1, 2007 Azteca had deferred its July 1, 2007 payment under the terms of the agreement and was in default under its August payment requirements (See note 10). IF CUSTOMERS DEFAULT ON INVENTORY PURCHASE COMMITMENTS WITH US, WE WILL BE LEFT HOLDING NON-SALABLE INVENTORY. We hold significant inventories for specific customer programs, which the customers have committed to purchase. If any customer defaults on these commitments, or insists on markdowns, we may incur a charge in connection with our holding significant amounts of non-salable inventory and this would have a negative impact on our operations and cash flow. OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS WORSEN. Our revenues depend on the health of the economy and the growth of our customers and potential future customers. When economic conditions weaken, certain apparel manufacturers and retailers, including some of our customers may experience financial difficulties that increase the risk of extending credit to such customers. Customers adversely affected by economic conditions have also attempted to improve their own operating efficiencies by concentrating their purchasing power among a narrowing group of vendors. There can be no assurance that we will remain a preferred vendor to our existing customers. A decrease in business from or loss of a major customer could have a material adverse effect on our results of operations. Further, if the economic conditions in the United States worsen or if a wider or global economic slowdown occurs, we may experience a material adverse impact on our business, operating results, and financial condition. BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, WE MAY NOT BE ABLE TO ALWAYS OBTAIN MATERIALS WHEN WE NEED THEM AND WE MAY LOSE SALES AND CUSTOMERS. Lead times for materials we order can vary significantly and depend on many factors, including the specific supplier, the contract terms and the demand for particular materials at a given time. From time to time, we may experience fluctuations in the prices, and disruptions in the supply, of materials. Shortages or disruptions in the supply of materials, or our inability to procure materials from alternate sources at acceptable prices in a timely manner, could lead us to miss deadlines for orders and lose sales and customers. WE OPERATE IN AN INDUSTRY THAT IS SUBJECT TO SIGNIFICANT FLUCTUATIONS IN OPERATING RESULTS THAT MAY RESULT IN UNEXPECTED REDUCTIONS IN REVENUE AND STOCK PRICE VOLATILITY. We operate in an industry that is subject to significant fluctuations in operating results from quarter to quarter, which may lead to unexpected reductions in revenues and stock price volatility. Factors that may influence our quarterly operating results include: o The volume and timing of customer orders received during the quarter; o The timing and magnitude of customers' marketing campaigns; o The loss or addition of a major customer; o The availability and pricing of materials for our products; o The increased expenses incurred in connection with the introduction of new products; 25 o Currency fluctuations; o Delays caused by third parties; and o Changes in our product mix or in the relative contribution to sales of our subsidiaries. Due to these factors, it is possible that in some quarters our operating results may be below our stockholders' expectations and those of public market analysts. If this occurs, the price of our common stock could be adversely affected. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. In October 2005, a securities class action lawsuit was filed against us. See Part II, Item 1, "Legal Proceedings" for a detailed description of this lawsuit. THE OUTCOME OF LITIGATION IN WHICH WE HAVE BEEN NAMED AS A DEFENDANT IS UNPREDICTABLE AND AN ADVERSE DECISION IN ANY SUCH MATTER COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS. We are defendants in a number of litigation matters. These claims may divert financial and management resources that would otherwise be used to benefit our operations. Although we believe that we have meritorious defenses to the claims made in each and all of the litigation matters to which we have been named a party, and intend to contest each lawsuit vigorously, no assurances can be given that the results of these matters will be favorable to us. An adverse resolution of any of these lawsuits could have a material adverse effect on our financial position and results of operations. We maintain product liability and director and officer insurance that we regard as reasonably adequate to protect us from potential claims; however we cannot assure you that it will be adequate to cover any losses. Further, the costs of insurance have increased dramatically in recent years, and the availability of coverage has decreased. As a result, we cannot assure you that we will be able to maintain our current levels of insurance at a reasonable cost, or at all. OUR CUSTOMERS HAVE CYCLICAL BUYING PATTERNS WHICH MAY CAUSE US TO HAVE PERIODS OF LOW SALES VOLUME. Most of our customers are in the apparel industry. The apparel industry historically has been subject to substantial cyclical variations. Our business has experienced, and we expect our business to continue to experience, significant cyclical fluctuations due, in part, to customer buying patterns, which may result in periods of low sales usually in the first and fourth quarters of our financial year. OUR BUSINESS MODEL IS DEPENDENT ON INTEGRATION OF INFORMATION SYSTEMS ON A GLOBAL BASIS AND, TO THE EXTENT THAT WE FAIL TO MAINTAIN AND SUPPORT OUR INFORMATION SYSTEMS, IT CAN RESULT IN LOST REVENUES. We must consolidate and centralize the management of our subsidiaries and significantly expand and improve our financial and operating controls. Additionally, we must effectively integrate the information systems of our worldwide operations with the information systems of our principal offices in California. Our failure to do so could result in lost revenues, delay financial reporting or adverse effects on the information reported. THE LOSS OF KEY MANAGEMENT AND SALES PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS, INCLUDING OUR ABILITY TO OBTAIN AND SECURE ACCOUNTS AND GENERATE SALES. Our success has and will continue to depend to a significant extent upon key management and sales personnel, many of whom would be difficult to replace. The loss of the services of key employees could have a material adverse effect on our business, including our ability to establish and maintain client relationships. Our future success will depend in large part upon our ability to attract and retain personnel with a variety of sales, operating and managerial skills. IF WE EXPERIENCE DISRUPTIONS AT ANY OF OUR FOREIGN FACILITIES, WE WILL NOT BE ABLE TO MEET OUR OBLIGATIONS AND MAY LOSE SALES AND CUSTOMERS. Currently, we do not operate duplicate facilities in different geographic areas. Therefore, in the event of a regional disruption where we maintain one or more of our facilities, it is unlikely that we could shift our operations to a different geographic region and we may have to cease or curtail our operations. This may cause us to lose sales and customers. The types of disruptions that may occur include: 26 o Foreign trade disruptions; o Import restrictions; o Labor disruptions; o Embargoes; o Government intervention; o Natural disasters; or o Regional pandemics. INTERNET-BASED SYSTEMS THAT WE RELY UPON FOR OUR ORDER TRACKING AND MANAGEMENT SYSTEMS MAY EXPERIENCE DISRUPTIONS AND AS A RESULT WE MAY LOSE REVENUES AND CUSTOMERS. To the extent that we fail to adequately update and maintain the hardware and software implementing our integrated systems, our customers may be delayed or interrupted due to defects in our hardware or our source code. In addition, since our software is Internet-based, interruptions in Internet service generally can negatively impact our ability to use our systems to monitor and manage various aspects of our customer's trim needs. Such defects or interruptions could result in lost revenues and lost customers. THE REQUIREMENTS OF THE SARBANES-OXLEY ACT, INCLUDING SECTION 404, ARE BURDENSOME, AND OUR FAILURE TO COMPLY WITH THEM COULD HAVE A MATERIAL ADVERSE AFFECT ON OUR BUSINESS AND STOCK PRICE. Effective internal control over financial reporting is necessary for us to provide reliable financial reports and effectively prevent fraud. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal control over financial reporting beginning with our annual report on Form 10-K for the fiscal year ending December 31, 2007. Our independent registered public accounting firm will need to annually attest to our evaluation, and issue their own opinion on our internal control over financial reporting beginning with our annual report on Form 10-K for the fiscal year ending December 31, 2008. We are preparing for compliance with Section 404 by strengthening, assessing and testing our system of internal control over financial reporting to provide the basis for our report. The process of strengthening our internal control over financial reporting and complying with Section 404 is expensive and time consuming, and requires significant management attention. Failure to implement required controls, or difficulties encountered in their implementation, could cause us to fail to meet our reporting obligations. If we or our auditors discover a material weakness in our internal control over financial reporting, the disclosure of that fact, even if the weakness is quickly remedied, could diminish investors' confidence in our financial statements and harm our stock price. In addition, non-compliance with Section 404 could subject us to a variety of administrative sanctions, including the suspension of trading, ineligibility for listing on one of the national securities exchanges, and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price. THERE ARE MANY COMPANIES THAT OFFER SOME OR ALL OF THE PRODUCTS AND SERVICES WE SELL AND IF WE ARE UNABLE TO SUCCESSFULLY COMPETE OUR BUSINESS WILL BE ADVERSELY AFFECTED. We compete in highly competitive and fragmented industries with numerous local and regional companies that provide some or all of the products and services we offer. We compete with national and international design companies, distributors and manufacturers of tags, packaging products, zippers and other trim items. Some of our competitors have greater name recognition, longer operating histories and greater financial and other resources than we do. UNAUTHORIZED USE OF OUR PROPRIETARY TECHNOLOGY MAY INCREASE OUR LITIGATION COSTS AND ADVERSELY AFFECT OUR SALES. We rely on trademark, trade secret and copyright laws to protect our designs and other proprietary property worldwide. We cannot be certain that these laws will be sufficient to protect our property. In particular, the laws of some countries in which our products are distributed or may be distributed in the future may not protect our products and intellectual rights to the same extent as the laws of the United States. If litigation is necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others, such litigation could result in substantial costs and diversion of resources. This could have a material adverse effect on our operating results and financial 27 condition. Ultimately, we may be unable, for financial or other reasons, to enforce our rights under intellectual property laws, which could result in lost sales. IF OUR PRODUCTS INFRINGE ANY OTHER PERSON'S PROPRIETARY RIGHTS, WE MAY BE SUED AND HAVE TO PAY LEGAL EXPENSES AND JUDGMENTS AND REDESIGN OR DISCONTINUE SELLING OUR PRODUCTS. From time to time in our industry, third parties allege infringement of their proprietary rights. Any infringement claims, whether or not meritorious, could result in costly litigation or require us to enter into royalty or licensing agreements as a means of settlement. If we are found to have infringed the proprietary rights of others, we could be required to pay damages, cease sales of the infringing products and redesign the products or discontinue their sale. Any of these outcomes, individually or collectively, could have a material adverse effect on our operating results and financial condition. COUNTERFEIT PRODUCTS ARE NOT UNCOMMON IN THE APPAREL INDUSTRY AND OUR CUSTOMERS MAY MAKE CLAIMS AGAINST US FOR PRODUCTS WE HAVE NOT PRODUCED AND WE MAY BE ADVERSELY IMPACTED BY THESE FALSE CLAIMS. Counterfeiting of valuable trade names is commonplace in the apparel industry and while there are industry organizations and federal laws designed to protect the brand owner, these counterfeit products are not always detected and it can be difficult to prove the manufacturing source of these products. Accordingly, we may be adversely affected if counterfeit products damage our relationships with customers, and we incur costs to prove these products are counterfeit, to defend ourselves against false claims, or we may have to pay for false claims. OUR STOCK PRICE MAY DECREASE, WHICH COULD ADVERSELY AFFECT OUR BUSINESS AND CAUSE OUR STOCKHOLDERS TO SUFFER SIGNIFICANT LOSSES. The following factors could cause the market price of our common stock to decrease, perhaps substantially: o The failure of our quarterly operating results to meet expectations of investors or securities analysts; o Adverse developments in the financial markets, the apparel industry and the worldwide or regional economies; o Interest rates; o Changes in accounting principles; o Intellectual property and legal matters; o Sales of common stock by existing shareholders or holders of options; o Announcements of key developments by our competitors; and o The reaction of markets and securities analysts to announcements and developments involving our company. IF WE NEED TO SELL OR ISSUE ADDITIONAL SHARES OF COMMON STOCK OR ASSUME ADDITIONAL DEBT TO FINANCE FUTURE GROWTH, OUR STOCKHOLDERS' OWNERSHIP COULD BE DILUTED OR OUR EARNINGS COULD BE ADVERSELY IMPACTED. Our business strategy may include expansion through internal growth, by acquiring complementary businesses or by establishing strategic relationships with targeted customers and suppliers. In order to do so or to fund our other activities, we may issue additional equity securities that could dilute our stockholders' value. We may also assume additional debt and incur impairment losses to our intangible assets if we acquire another company. WE MAY NOT BE ABLE TO REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS. We may consider strategic acquisitions as opportunities arise, subject to the obtaining of any necessary financing. Acquisitions involve numerous risks, including diversion of our management's attention away from our operating activities. We cannot assure you that we will not encounter unanticipated problems or liabilities relating to the integration of an acquired company's operations, nor can we assure you that we will realize the anticipated benefits of any future acquisitions. OUR ACTUAL TAX LIABILITIES MAY DIFFER FROM ESTIMATED TAX RESULTING IN UNFAVORABLE ADJUSTMENTS TO OUR FUTURE RESULTS. The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities. Our 28 estimate of the potential outcome of uncertain tax issues is subject to our assessment of relevant risks, facts, and circumstances existing at that time. Our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, which may impact our effective tax rate and our financial results. WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF OUR COMMON STOCK. Our stockholders' rights plan, our ability to issue additional shares of preferred stock and some provisions of our certificate of incorporation and bylaws and of Delaware law could make it more difficult for a third party to make an unsolicited takeover attempt of us. These anti-takeover measures may depress the price of our common stock by making it more difficult for third parties to acquire us by offering to purchase shares of our stock at a premium to its market price. INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS. As of August 1, 2007, our officers and directors and their affiliates beneficially owned approximately 19% of the outstanding shares of our common stock. The Dyne family, which includes Mark Dyne, Colin Dyne, and Jonathan Burstein, who are also our directors; Larry Dyne and the estate of Harold Dyne; beneficially owned approximately 13% of the outstanding shares of our common stock at August 1, 2007. As a result, our officers and directors and the Dyne family are able to exert considerable influence over the outcome of any matters submitted to a vote of the holders of our common stock, including the election of our Board of Directors. The voting power of these stockholders could also discourage others from seeking to acquire control of us through the purchase of our common stock, which might depress the price of our common stock. WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED SECURITY MEASURES IN RESPONSE TO TERRORISM. Our business depends on the free flow of products and services through the channels of commerce. In response to terrorists' activities and threats aimed at the United States, transportation, mail, financial and other services may be slowed or stopped altogether. Extensive delays or stoppages in transportation, mail, financial or other services could have a material adverse effect on our business, results of operations and financial condition. Furthermore, we may experience an increase in operating costs, such as costs for transportation, insurance and security as a result of the activities and potential delays. We may also experience delays in receiving payments from payers that have been affected by the terrorist activities. The United States economy in general may be adversely affected by the terrorist activities and any economic downturn could adversely impact our results of operations, impair our ability to raise capital or otherwise adversely affect our ability to grow our business. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. All of our sales are denominated in United States dollars or the currency of the country in which our products originate. We are exposed to market risk for fluctuations in the foreign currency exchange rates for certain product purchases that are denominated in Hong Kong dollars, Chinese yuans and British pounds. There were no hedging contracts outstanding as of June 30, 2007 or December 31, 2006. Currency fluctuations can increase the price of our products to foreign customers which can adversely impact the level of our export sales from time to time. The majority of our cash equivalents are held in United States dollars in various bank accounts and we do not believe we have significant market risk exposure with regard to our investments. At June 30, 2007 the Revolving Credit Note of $1.3 million was subject to interest rate fluctuations. 29 ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities Exchange Commission's rules and forms, including to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, rather than absolute, assurance of achieving the desired control objectives. As of June 30, 2007, we conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of June 30, 2007, our disclosure controls and procedures were effective at a reasonable assurance level. CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING There were no significant changes in our internal controls over financial reporting that occurred during the second quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 30 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On October 12, 2005, a shareholder class action complaint -- HUBERMAN V.TAG-IT PACIFIC, INC., ET AL., Case No. CV05-7352 R(Ex) -- was filed against us and certain of our current and former officers and directors in the United States District Court for the Central District of California, alleging claims under Section 10(b) and Section 20 of the Securities Exchange Act of 1934. A lead plaintiff was appointed, and his amended complaint alleged that defendants made false and misleading statements about our financial situation and our relationship with certain of our large customers. The action was brought on behalf of all purchasers of our publicly-traded securities during the period from November 13, 2003 to August 12, 2005. On February 20, 2007, the Court denied class certification. Plaintiff moved the court to reconsider the ruling, and also to intervene a new plaintiff to pursue class certification. Both of those motions were denied on April 2, 2007. In addition, the same day the Court granted defendants' motion for summary judgment, and on or about April 5, 2007, the Court entered judgment in favor of all defendants. On or about April 30, 2007, plaintiff filed a notice of appeal, and his opening appellate brief is due on October 15, 2007. We believe that this matter will be resolved in trial or in settlement within the limits of its insurance coverage. However, the outcomes of this action or an estimate of the potential losses, if any, related to the lawsuit cannot be reasonably predicted, and an adverse resolution of the lawsuit could potentially have a material adverse effect on our financial position and results of operations. On April 16, 2004 we filed suit against Pro-Fit Holdings, Limited ("Pro-Fit") in the U.S. District Court for the Central District of California - TAG-IT PACIFIC, INC. V. PRO-FIT HOLDINGS, LIMITED, CV 04-2694 LGB (RCx) -- asserting various contractual and tort claims relating to our exclusive license and intellectual property agreement with Pro-Fit, seeking declaratory relief, injunctive relief and damages. It is our position that the agreement with Pro-Fit gives us the exclusive rights in certain geographic areas to Pro-Fit's stretch and rigid waistband technology. On June 5, 2006 the Court denied our motion for partial summary judgment, but did not find that we breached our agreement with Pro-Fit and a trial is required to determine issues concerning our activities in Columbia and whether other actions by Pro-Fit constituted an unwillingness or inability to fill orders. The Court also held that Pro-Fit was not "unwilling or unable" to fulfill orders by refusing to fill orders with goods produced in the United States. The Court has not yet set a date for trial of this matter. We have historically derived a significant amount of revenue from the sale of products incorporating the stretch waistband technology and our business, results of operations and financial condition could be materially adversely affected if the dispute with Pro-Fit is not resolved in a manner favorable to us. Additionally, we have incurred significant legal fees in this litigation, and unless the case is settled, we will continue to incur additional legal fees in increasing amounts as the case accelerates to trial. We currently have pending a number of other claims, suits and complaints that arise in the ordinary course of its business. We believe that we has meritorious defenses to these claims and that the claims are either covered by insurance or, after taking into account the insurance in place, would not have a material effect on our consolidated financial condition if adversely determined against us. ITEM 1A. RISK FACTORS A restated description of the risk factors associated with the Company is included under "Cautionary Statements and Risk Factors" in Management's Discussion and Analysis of Financial Condition and Results of Operations," contained in Item 2 of Part I of this report. This description includes any material changes to and supersedes the description of the risk factors associated with an investment in the Company previously disclosed in our Annual Report on Form 10-K for 2006 and is incorporated herein by reference. 31 ITEM 6. EXHIBITS 10.31.2(1) Amendment, dated May 25, 2007, to employment offer letter between Tag-It Pacific, Inc. and Lonnie Schnell. 10.35 Revolving Credit and Tern Loan Agreement dated June 27, 2007, by and between Tag-It Pacific, Inc. and Bluefin Capital, LLC. 10.36 Guaranty Agreement, dated June 27, 2007, by Talon International, Inc., Tag-It, Inc., A.G.S. Stationary, Inc., Tag-It Pacific Limited, Tag-It Pacific (HK) Ltd., Tagit de Mexico, S.A. de C. V., Talon Zipper (Shenzhen) Company, Ltd., and Talon International, Pvt. Ltd. in favor of Bluefin Capital, LLC. 10.37 Collateral Agreement, dated June 27, 2007, by and among Tag-It Pacific, Inc., Talon International, Inc., Tag-It, Inc., A.G.S. Stationary, Inc., Tag-It Pacific Limited, Tag-It Pacific (HK) Ltd., Tagit de Mexico, S.A. de C. V., Talon Zipper (Shenzhen) Company, Ltd., and Talon International, Pvt. Ltd. in favor of Bluefin Capital, LLC. 10.38 Registration Rights Agreement, dated June 27, 2007, by Talon International, Inc., for the benefit of holders. Incorporated by reference to Exhibit 4.10 to Registration Statement on Form S-3 filed on August 10, 2007. 10.39 Form of Warrant issued to Bluefin Capital, LLC. Incorporated by reference to Exhibit 4.10 to Registration Statement on Form S-3 filed on August 10, 2007. 10.40 Promissory Note, dated June 27, 2007, executed by Colin Dyne in favor of Tag-It Pacific, Inc. 31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities and Exchange Act of 1934, as amended. 32.1 Certificate of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities and Exchange Act of 1934, as amended. (1) Indicates a management contract or compensatory plan. 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: August 14, 2007 TALON INTERNATIONAL, INC. ` /S/ LONNIE D. SCHNELL --------------------------------------- By: Lonnie D. Schnell Its: Chief Financial Officer 33 EX-10 2 ex10-31_1.txt EX-10.31.1 EXHIBIT 10.31.1 May 21, 2007 Lonnie D. Schnell 1721 Cannes Drive Thousand Oaks, CA 91362 Dear Lonnie: In accordance with the actions approved by the Compensation Committee on April 26, 2007 and effective as of that date, your employment terms and conditions as defined in your employment agreement of March 16, 2006 are modified as follows: Page 2, TERMINATION WITHOUT CAUSE: is replaced in its entirety as follows: TERMINATION Subject to the provisions below, if terminated by the Company WITHOUT CAUSE: without cause or due to your death or permanent and total disability, conditioned upon your (or your estate's) execution and non-revocation of a full release and waiver of claims agreement in a form prescribed by the Company, you (or your estate) will receive (i) 12 months of your then-current base salary, payable in 12 equal monthly installments commencing on the first day of the calendar month immediately following such termination and thereafter on the first day of each subsequent calendar month; (ii) 12 months of continued coverage under the company's group health plan at the same cost to you (and/or your dependents) as immediately prior to your termination, subject to your (and/or your dependents') making a valid "COBRA" election and to any cost increases affecting plan participants generally; and (iii) accelerated stock option vesting deemed to occur immediately prior to your termination with respect to that portion of any and all outstanding options then held by you that would have vested during the 12 months immediately following your termination absent such termination (the "SEVERANCE"). Notwithstanding the foregoing, the payments and benefits described in clauses (i) and (ii) of the preceding sentence shall, to the extent not already paid or provided, cease immediately if you become employed or take a position as a consultant prior to their expiration. To indicate your acceptance of the Addendum to your employment terms, please sign this letter. Yours very truly, /s/ Stephen Forte - -------------------------------------- Stephen Forte, Chief Executive Officer Agreed to and accepted: /S/ LONNIE D. SCHNELL - -------------------------------------- Lonnie D. Schnell Date: May 25, 2007 2 EX-10 3 ex10-35.txt EX-10.35 EXHIBIT 10.35 REVOLVING CREDIT AND TERM LOAN AGREEMENT AGREEMENT (this "AGREEMENT") is made and entered into as of the 27th day of June, 2007, by and between BLUEFIN CAPITAL, LLC, a Delaware limited liability company (the "LENDER"), and TAG-IT PACIFIC, INC., a Delaware corporation (the "BORROWER"). W I T N E S S E T H : WHEREAS, the Borrower is engaged in the business of distributing a full range of apparel, zipper and trim products to manufacturers of fashion apparel, specialty retailers and mass merchandisers (collectively, the "BUSINESS OPERATIONS"); and WHEREAS, in order to provide funds for (a) the repayment and retirement of the Convertible Debentures (as such term is hereinafter defined), and (b) the Borrower's working capital and other general corporate purposes, the Borrower has requested the Lender to extend to the Borrower a revolving credit facility and a term loan on the terms and conditions of this Agreement; and WHEREAS, the Lender is willing and able to provide such revolving credit facility and make such term loan to the Borrower on the terms and conditions of this Agreement; NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereby agree as follows: I. DEFINITIONS SECTION 1.01. DEFINED TERMS. In addition to the other terms defined elsewhere in this Agreement, as used herein, the following terms shall have the following meanings: "ACCOUNTS" shall mean "accounts" (as defined in the UCC) of the Borrower and its Subsidiaries from time to time. "ACCOUNT DEBTOR" shall mean any Person who is obligated on an Account. "ACT" shall mean the Securities Act of 1933, as amended, and the rules and regulations thereunder. "ADVANCES" shall mean the principal amounts loaned to the Borrower from time to time pursuant to Section 2.01 below. "AFFILIATE" shall mean, with respect to any Person, any other Person in Control of, Controlled by, or under common Control with the first Person, and any other Person who has a substantial interest, direct or indirect, in the first Person or any of its Affiliates, including, without limitation, any officer or director of the first Person or any of its Affiliates; PROVIDED, HOWEVER, that neither the Lender nor any of its Affiliates shall be deemed an "Affiliate" of the Borrower for any purposes of this Agreement. For the purpose of this definition, a "substantial interest" shall mean the direct or indirect legal or beneficial ownership of more than ten (10%) percent of any class of stock or similar interest. "AGREEMENT" shall mean this Revolving Credit and Term Loan Agreement as it may from time to time be amended, modified, supplemented and/or restated. "APPLICABLE LAW" shall mean all applicable provisions of all (a) constitutions, statutes, ordinances, rules, regulations and orders of all governmental and/or quasi-governmental bodies, (b) Government Approvals, and (c) order, judgments and decrees of all courts and arbitrators. "AVAILABILITY" shall mean the amount (if any) by which, at the time of determination, (a) the Revolving Credit Commitment exceeds (b) the outstanding principal amount of Advances. "BORROWING BASE" shall mean an amount, determined in accordance with the most recent borrowing base report theretofore provided to the Lender under Section 5.04(d) below, equal to (a) 75% of Eligible Accounts, PLUS (b) 55% of Eligible Inventory, PLUS (c)(i) $1,200,000 at all times from the Closing Date through and including June 30, 2007, (ii) $750,000 at all times from July 1, 2007 through and including September 30, 2007, and (iii) $500,000 at all times from October 1, 2007 through and including March 31, 2008, MINUS (d) the amount (if any) of the Debenture Reserve at the date of determination, MINUS (e) such other reserves as the Lender may establish from time to time in its Permitted Discretion (including, without limitation, to account for Account concentration and other risks of collection, and for obsolete, slow-moving or otherwise problematic inventory). In the event that the Borrower has not timely delivered a current Borrowing Base report in accordance with Section 5.04(d) below, then the applicable Borrowing Base shall be such amount as is established by the Lender, until such time as the Borrower has delivered a current Borrowing Base report. "BORROWING DATE" means the Business Day on which the Lender makes a Loan hereunder. "BUSINESS DAY" shall mean a day other than (a) a Saturday, (b) a Sunday, or (c) a day on which banking institutions in either the State of Florida or the State of California are authorized or required by law or executive order to close. "CAPITAL EXPENDITURES" shall mean with respect to any Person, all expenditures of such Person for tangible assets which are capitalized, and the fair value of any tangible assets leased by such Person under any lease which would be a Capitalized Lease, determined in accordance with GAAP, including all amounts paid or accrued by such Person in connection with the purchase (whether on a cash or deferred payment basis) or lease (including Capitalized Lease Obligations) of any machinery, equipment, real property, improvements to real property (including leasehold improvements), or any other tangible asset of such Person which is required, in accordance with GAAP, to be treated as a fixed asset on the consolidated balance sheet of such Person. 2 "CAPITALIZED LEASE" shall mean any lease which is or should be capitalized on the balance sheet of the lessee thereunder in accordance with GAAP. "CAPITALIZED LEASE OBLIGATION" shall mean with respect to any Person, the amount of the liability which reflects the amount of future payments under all Capitalized Leases of such Person as at any date, determined in accordance with GAAP. "CASH EQUIVALENTS" shall mean (a) marketable securities issued, or directly and fully guaranteed or insured, by the United States of America or any agency or instrumentality thereof (provided that the full faith and credit of the United States of America is pledged in support thereof) having maturities of not more than twelve (12) months from the date of acquisition; (b) time deposits, demand deposits, certificates of deposit, acceptances or prime commercial paper issued by, or repurchase obligations for underlying securities of the types described in clause (a) entered into with any commercial bank having a short-term deposit rating of at least A-2 or the equivalent thereof by Standard & Poor's Corporation or at least P-2 or the equivalent thereof by Moody's Investors Service, Inc.; (c) commercial paper with a rating of A-I or A-2 or the equivalent thereof by Standard & Poor's Corporation or P-1 or P-2 or the equivalent thereof by Moody's Investors Service, Inc. and in each case maturing within twelve (12) months after the date of acquisition; (d) marketable direct obligations issued by any state in the United States or any agency or instrumentality thereof maturing within twelve (12) months from the date of acquisition thereof and, at the time of acquisition, have one of the two highest ratings generally obtainable from either Standard & Poor's Corporation or Moody's Investors Services, Inc.; (e) tax-exempt commercial paper of United States municipal, state or local governments rated at least A-2 or the equivalent thereof by Standard & Poor's Corporation or at least P-2 or the equivalent thereof by Moody's Investors Services, Inc. and maturing within twelve (12) months after the date of acquisition thereof; (f) any other items selected by the Borrower and approved by the Lender (which approval shall not be unreasonably withheld or delayed); or (g) any mutual fund or other pooled investment vehicle which invests principally in the foregoing obligations. "CLOSING DATE" shall mean the date on which the Term Loan is funded. "CLOSING FEE" shall mean the sum of $250,000 with respect to the Term Loan, which shall be payable in accordance with Section 2.03(a) below. "CODE" shall mean the Internal Revenue Code of 1986, and the rules and regulations promulgated thereunder, as in effect from time to time. "COLLATERAL" shall mean all collateral pledged by the Borrower and/or any of the Subsidiaries as security for the payment and performance of the Obligations, whether pursuant to the Collateral Agreement or any other Security Document. "COLLATERAL AGREEMENT" shall mean the Collateral Agreement, dated as of the Closing Date, by and between the Borrower and the Lender, as same may be amended, modified, supplemented and/or restated from time to time. "COMMITMENT FEES" shall mean the annual fees payable to the Lender pursuant to Section 2.03(b)(ii) below. 3 "COMMON STOCK" shall mean the authorized common stock of the Company, $.001 par value per share. "CONFIDENTIAL INFORMATION" shall mean information that the Borrower furnishes to the Lender which is not generally available to the public or available to the Lender from a source other than the Borrower which is not, to the Lender's knowledge, bound by any confidentiality agreement in respect thereof. "CONTRACT" shall mean any indenture, agreement (other than this Agreement), other contractual restriction, lease in which the Borrower or any Subsidiary is a lessor or lessee, license or instrument. "CONTROL" shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a Person, whether through the ownership of voting securities, by contract or otherwise, and the terms "CONTROLLING" and "CONTROLLED" shall have meanings correlative thereto. "CONTROL AGREEMENT" shall mean, with respect to each bank account (including, without limitation, the Escrow Account) and/or securities account maintained by or in the name of the Borrower or any Subsidiary from time to time, an agreement executed and delivered by the Borrower (or the subject Subsidiary, as applicable) and the account intermediary, whereby the account intermediary acknowledges the Lender's Lien on such account and all funds or property therein, and "control" (within the meaning of the UCC) over such account is established in favor of the Lender. "CONVERTIBLE DEBENTURES" shall mean the Convertible Promissory Notes of the Borrower dated November 9, 2004 in the aggregate principal amount of $12,500,000, which by their terms mature on November 9, 2007. "DEBENTURE RESERVE" shall mean, at any time, an amount equal to the positive difference (if any) of (a) the aggregate outstanding principal amount and unpaid accrued interest of the Convertible Debentures at such time, MINUS (b) the amount of funds then on deposit in the Escrow Account. "DEFAULT" shall mean any of the events specified in Article VII hereof, whether or not any requirement for the giving of notice, the lapse of time, or both, or any other condition, has been satisfied. "DISCLOSURE SCHEDULE" shall mean the disclosure schedule, dated as of the Closing Date, executed and delivered by the Borrower to the Lender, the section numbers of which correspond to the Section numbers of this Agreement. "DOLLARS" or "$" shall mean United States Dollars, lawful currency for the payment of public and private debts. "DOMESTIC SUBSIDIARY" shall mean any Subsidiary which is incorporated or formed under the laws of the United States, any State or Commonwealth in the United States, or the District of Columbia. 4 "EBITDA" shall mean, for the subject period, for the Borrower and its Subsidiaries on a consolidated basis, the sum of (a) Net Income, MINUS (b) net income attributable to any Subsidiary to the extent, but only to the extent, that such net income is (A) not available for distribution to the Borrower for more than six (6) months, or (B) required by the Borrower's auditors to be reserved in whole or in part as a result of restrictions on distribution (PROVIDED, HOWEVER, that this clause (B) shall not apply if such reserve(s) is included in Net Income), PLUS (c) Interest Expense deducted in the calculation of such Net Income, PLUS (d) taxes on income, whether payable or accrued, deducted in the calculation of such Net Income (except that taxes actually paid in cash shall not be added back pursuant to this clause (d)), PLUS (e) depreciation expense deducted in the calculation of such Net Income, PLUS (f) amortization expense deducted in the calculation of such Net Income, PLUS (g) all other non-cash charges and expenses (including equity incentive plan expenses) deducted in the calculation of such Net Income, excluding accruals for cash expenses made in the ordinary course of business, MINUS (h) any non-cash gains included in the calculation of such Net Income, PLUS (i) losses deducted in the calculation of such Net Income from any sales of assets, other than sales in the ordinary course of business, MINUS (j) gains added in the calculation of such Net Income from any sales of assets, other than sales in the ordinary course of business, PLUS (k) other extraordinary or non-recurring non-cash losses deducted in the calculation of such Net Income, MINUS (l) other extraordinary or non-recurring non-cash gains added in the calculation of such Net Income, all determined in accordance with GAAP. "ELIGIBLE ACCOUNT" shall mean the face amount of each trade Account of the Borrower or a Subsidiary (if same has executed a Guaranty Agreement and become a party to the Collateral Agreement) for services rendered or goods and products sold in the ordinary course of the Business Operations which the Lender, in its Permitted Discretion, deems to be an Eligible Account; PROVIDED, HOWEVER, that an Account shall not be deemed an Eligible Account unless it meets all of the following conditions: (a) the subject services or products and goods have been rendered, shipped or delivered on an absolute sale basis to an Account Debtor which is not an Affiliate, vendor or supplier of the Borrower or a Subsidiary, with an invoice date contemporaneous with or within thirty (30) calendar days after the date of shipment or service, and which does not constitute a consignment sale, bill-and-hold sale, sale-and-return or other such arrangement and is not subject to any other repurchase, return or offset agreement binding upon the Borrower or a Subsidiary; the subject services or products and goods have been rendered, shipped and delivered (or shipped f.o.b.) to such Account Debtor on an open account basis (or with payment guaranteed by a letter of credit, drawn on or by a domestic financial institution, acceptable to the Lender in all respects), and no part of the subject services, products or goods has been returned, rejected, lost or damaged; the Account is not evidenced by chattel paper or an instrument of any kind; and such Account Debtor, unless pre-approved in writing by the Lender, is not insolvent or the subject of any bankruptcy or insolvency proceeding of any kind in any jurisdiction; (b) if the Account Debtor is located outside the continental United States, either (i) payment for the subject services or goods shall be secured by an irrevocable letter of credit, which letter of credit shall have been confirmed by a financial institutional reasonably acceptable to the Lender payable in the full amount of the face value of the Account in Dollars or 5 other currency reasonably acceptable to the Lender, or (ii) such Account and Account Debtor are reasonably satisfactory to the Lender in its Permitted Discretion; (c) it is a valid, legally enforceable obligation of the Account Debtor thereunder payable in Dollars or other currency reasonably satisfactory to the Lender, and is not subject to any recoupment, offset or other defense or any discount or chargeback on the part of such Account Debtor (provided that prompt payment discounts granted in the ordinary course of business shall not cause an Account to be disqualified hereunder, so long as only the discounted amount of such Account, if not otherwise disqualified, is included in the calculation of the Borrowing Base) or to any claim on the part of such Account Debtor denying liability thereunder (provided that the undisputed portion may be considered to be an Eligible Account); (d) it is subject to no Lien whatsoever, except for the Lien of the Lender; (e) it has not remained unpaid in whole or in part for a period exceeding ninety (90) days after the original invoice date; (f) it does not arise out of a transaction (whether direct or indirect) with an employee, officer, agent, director or Affiliate of the Borrower or any Subsidiary or with any entity controlled by any employee, officer, agent or director of the Borrower or any Subsidiary (unless, in any such case, a majority of the disinterested members of the Board of Directors of the Borrower has approved the subject transaction and such transaction is on an arms'-length basis); (g) it is not subject to any contract retainage or other withholding of any portion of payments on amounts invoiced, whether to secure the Borrower's or any Subsidiary's performance or otherwise; (h) it does not represent the unpaid portion of an Account any portion of which was previously paid or agreed to be paid through the issuance or delivery of equity securities or other non-cash consideration; (i) if the Account Debtor is the United States, any State or Commonwealth therein, or any department, agency or instrumentality thereof, or any foreign government or agency of a foreign government, the Borrower or the applicable Domestic Subsidiary has duly assigned its rights to payment of such Account to the Lender pursuant to the federal Assignment of Claims Act, any comparable state statutes or any comparable foreign statutes (as applicable); (j) the Lender has a perfected first priority Lien in such Account; (k) such Account is not payable by any person other than the Account Debtor (such as a beneficiary, recipient or subscriber individually), provided that the portion thereof which is payable by the Account Debtor may be considered to be an Eligible Account; (l) at least sixty (60%) percent in dollar amount of the total Accounts owed by such Account Debtor and/or its Affiliates constitute Eligible Accounts; 6 (m) the total Accounts owed by the subject Account Debtor and/or its Affiliates constitute less than ten (10%) percent of the net collectible dollar value of all Eligible Accounts (provided that only the excess over ten (10%) percent shall be disqualified under this clause (m), unless the Lender has otherwise consented in writing to the inclusion of all or any portion of such excess); (n) such Account is payable solely to the Borrower or a Subsidiary, and the Borrower or such Subsidiary is not aware of any dispute by the Account Debtor with respect to such Account; and (o) it is not otherwise determined by the Lender, in the Lender's Permitted Discretion, to be difficult to collect, uncollectible or otherwise unacceptable for any reason. "ELIGIBLE INVENTORY" shall mean the lower of the cost (on a [first in-first out] basis) or fair market value of that inventory consisting of raw materials or finished goods (but excluding work in process and product models or samples) of Borrower or any Subsidiary which is party to the Collateral Agreement which (a) is in good and merchantable condition, (b) was manufactured in accordance with and meets all standards imposed by any governmental agency having regulatory authority over such goods and/or their use, manufacture and/or sale, (c) is in the physical possession of the Borrower or the subject Subsidiary, or has been shipped to the Borrower or the subject Subsidiary with title thereto having passed to the Borrower or such Subsidiary (provided that up to $100,000 in value of inventory held by a vendor/supplier for drop shipment to a customer for the benefit of the Borrower or the subject Subsidiary may be considered to be Eligible Inventory if it otherwise meets all other criteria set forth in this definition), (d) is currently usable or currently saleable in the normal course of the Business Operations, (e) is not on consignment to or from any Person, (f) is not subject to any Lien whatsoever, except for the Lien of the Lender, which shall be perfected with respect to such inventory, (g) has not been sold to any Person, and (h) is otherwise satisfactory to the Lender in its Permitted Discretion. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as in effect from time to time. "ERISA AFFILIATE" shall mean, with respect to any Person, any other Person which is under common control with the first Person within the meaning of Section 414(b) or 414(c) of the Code; PROVIDED, HOWEVER, that with respect to the Borrower, no Person which is an Affiliate of the Lender (other than the Borrower and its Subsidiaries) shall be deemed an ERISA Affiliate for purposes of this Agreement "ESCROW ACCOUNT" shall mean the bank account contemplated by Section 2.04(b)(i) below. "EVENT OF DEFAULT" has the meaning set forth in Article VII below. "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended. "FACTORING AGREEMENT" shall mean the factoring agreement dated July 19, 2004 by and between the Borrower and East Asia GE Commercial Finance Limited, as amended. 7 "FINANCIAL STATEMENTS" has the meaning set forth in Section 3.01(a) below. "FISCAL YEAR" shall mean the fiscal year of the Borrower which ends on December 31 of each year. "FOREIGN INVESTMENT LIMITATION" has the meaning set forth in Section 6.01(g) below. "FOREIGN SUBSIDIARY" shall mean any Subsidiary which is not a Domestic Subsidiary. "FREE CASH FLOW" shall mean, for any Fiscal Year in question, an amount equal to (a) EBITDA for the immediately preceding Fiscal Year, MINUS (b) taxes paid or payable in cash by or in respect of the Borrower and its Subsidiaries during or in respect of such immediately preceding Fiscal Year, MINUS (c) principal and interest payments made or required to be made by the Borrower and its Subsidiaries during such immediately preceding Fiscal Year, MINUS (d) Capital Expenditures paid by the Borrower and its Subsidiaries in cash during such immediately preceding Fiscal Year, MINUS (e) scheduled principal and interest payments made or required to be made by the Borrower and its Subsidiaries during the subject Fiscal Year. "GAAP" shall mean generally accepted accounting principles in the United States of America, consistently applied, unless the context otherwise requires, with respect to any financial terms contained herein, as then in effect with respect to the preparation of financial statements. "GOVERNMENT APPROVAL" shall mean an authorization, consent, non-action, approval, license or exemption of, registration or filing with, or report to, any governmental or quasi-governmental department, agency, body or other unit. "GUARANTY", "GUARANTEED" or to "GUARANTEE", as applied to any Indebtedness, liability or other obligation, shall mean (a) a guaranty, directly or indirectly, in any manner, including by way of endorsement (other than endorsements of negotiable instruments for collection in the ordinary course of business), of any part or all of such obligation, and (b) an agreement, contingent or otherwise, and whether or not constituting a guaranty, assuring, or intended to assure, the payment or performance (or payment of damages in the event of non-performance) of any part or all of such obligation by any means (including, without limitation, the purchase of securities or obligations, the purchase or sale of property or services, or the supplying of funds). "GUARANTY AGREEMENT" shall mean a guaranty agreement, in form and substance satisfactory to the Lender, to be executed by each Subsidiary in favor of the Lender, pursuant to which such Subsidiary will guaranty the full and timely payment and performance of all of the Obligations. "INDEBTEDNESS" shall mean (without duplication), with respect to any Person, (a) all obligations or liabilities, contingent or otherwise, for borrowed money, (b) any and all obligations represented by promissory notes, bonds, debentures or the like, or on which interest charges are customarily paid, (c) any liability secured by any mortgage, pledge, lien or security 8 interest on property owned or acquired, whether or not such liability shall have been assumed, (d) obligations of such Person under conditional sale or other title retention agreements relating to property or assets purchased by such Person, (e) all obligations of such Person issued or assumed as the deferred purchase price of property or services (excluding trade payables and accrued obligations incurred in the ordinary course of business), (f) any obligations (contingent or otherwise) of such Person as an account party or applicant in respect of letters of credit and/or bankers' acceptances, or in respect of interest rate swaps, interest rate caps, hedging agreements or other financial or hedging obligations, and (g) Guarantees, endorsements (other than for collection in the ordinary course of business) and other contingent obligations in respect of the obligations of others. "INTELLECTUAL PROPERTY" shall have the meaning ascribed thereto in the Collateral Agreement. "INTEREST EXPENSE" shall mean, for the relevant period, total interest expense (including interest attributable to Capitalized Leases in accordance with GAAP) and fees with respect to outstanding Indebtedness. "INVESTMENT", as applied to the Borrower or any Subsidiary, shall mean: (a) any shares of capital stock, evidence of Indebtedness or other security issued by any other Person to the Borrower or any Subsidiary, (b) any loan, advance or extension of credit to, or contribution to the capital of, any other Person, other than credit terms extended to customers in the ordinary course of business, (c) any other investment by the Borrower or any Subsidiary in any assets or securities of any other Person, and (d) any commitment to make any Investment. "KNOWLEDGE" OR "KNOWN" or words of similar import shall mean, with respect to the Borrower and/or any Subsidiary, the actual knowledge of Steve Forte, Lonnie Schnell and/or Wouter van Biene (and/or their respective successors as officers of the Borrower) after reasonable inquiry of the appropriate employees of the Borrower and the Subsidiaries. "LANDLORD WAIVER" shall mean a landlord waiver, subordination and/or access agreement, in form and substance reasonably satisfactory to the Lender, executed in favor of the Lender by the landlord of a Leased Real Property. "LEASED REAL PROPERTY" shall mean any and all Real Properties leased or occupied by the Borrower or any Subsidiary from time to time. "LENDER SHARES" shall mean the shares of Common Stock to be purchased by and issued to the Lender as contemplated by Section 2.03(d) below. "LIABILITIES AND CONTINGENCIES" has the meaning set forth in Section 3.01(c) below. "LIEN", as applied to the property or assets (or the income or profits therefrom) of the Borrower or any Subsidiary, shall mean (in each case, whether the same is consensual or non-consensual or arises by contract, operation of law, legal process or otherwise): (a) any mortgage, lien, pledge, hypothecation, attachment, assignment, deposit arrangement, encumbrance, charge, lease constituting a Capitalized Lease Obligation, conditional sale or other 9 title retention agreement, or other security interest or encumbrance of any kind in respect of any property (including, without limitation, stock of any Subsidiary) of the Borrower or any Subsidiary, or upon the income or profits therefrom; (b) any arrangement under which any property of the Borrower or any Subsidiary is transferred, sequestered or otherwise identified for the purpose of subjecting or making available the same for the payment of Indebtedness or the performance of any other liability in priority to the payment of the general, unsecured creditors of the Borrower or any Subsidiary; (c) any Indebtedness or liability which remains unpaid after the same shall become due and payable and which, if unpaid, by law or otherwise is given any priority whatsoever over the general unsecured creditors of the Borrower or any Subsidiary; and (d) any agreement (other than this Agreement) or other arrangement which, directly or indirectly, prohibits the Borrower or any Subsidiary from creating or incurring any lien on any of its properties or assets or which conditions the ability to do so on the security, on a PRO RATA or other basis, of Indebtedness other than Indebtedness outstanding under this Agreement. "LOAN DOCUMENTS" shall mean the collective reference to this Agreement, the Notes, the Security Documents, the Warrants, the Registration Rights Agreement, and any and all other agreements, instruments, certificates and other documents as may be executed and delivered by the Borrower and/or any of the Subsidiaries pursuant hereto or thereto. "LOANS" shall mean, collectively, the Advances and the Term Loan. "MATERIAL ADVERSE EFFECT" shall mean any event, act, omission, condition or circumstance which has or would reasonably be expected to have a material adverse effect on (a) the business, operations, properties, assets or condition, financial or otherwise, of the Borrower and the Subsidiaries, taken as a whole, (b) the ability of the Borrower or any Subsidiary to perform any of its obligations under any of the Loan Documents, or (c) the validity or enforceability of, or the Lender's rights and remedies under, any of the Loan Documents, other than due to the acts or omissions of the Lender or any of its Affiliates. "MATURITY DATE" shall mean June 30, 2010. "MAXIMUM REVOLVER AMOUNT" shall mean, at any date, (a) $5,000,000 MINUS (b) the amount of the Debenture Reserve (if any) at the date of determination, MINUS (c) an amount equal to 50% of all Qualified Proceeds received by the Borrower from and after the repayment (or required repayment) in full of the Term Loan. "MONITORING FEE" shall mean the fees payable to the Lender pursuant to Section 2.03(b)(i) below. "NET INCOME" shall mean the consolidated net income (or loss) of the Borrower and its Subsidiaries for the period in question, after giving effect to deduction of or provision for all operating expenses, all taxes and reserves (including reserves for deferred taxes) and all other proper deductions, all determined in accordance with GAAP and (for so long as the Borrower is subject thereto) Regulation S-X promulgated under the Act. "NOTES" shall mean, collectively, the Revolving Credit Note and the Term Note. 10 "OBLIGATIONS" shall mean the collective reference to all Indebtedness and other liabilities and obligations of every kind and description owed by the Borrower to the Lender from time to time under or pursuant to this Agreement, the Notes, the Security Documents and the other Loan Documents (excluding the Warrant and Registration Rights Agreement, other than amounts payable from time to time pursuant to Section 2(c) of the Registration Rights Agreement), and/or otherwise in respect of the Loans, however evidenced, created or incurred, fixed or contingent, now or hereafter existing, due or to become due. "ORGANIC DOCUMENTS" shall mean, with respect to any Person, the certificate of incorporation, articles of incorporation, certificate of formation, certificate of limited partnership, by-laws, operating agreement, limited partnership agreement or other such document of such Person. "OWNED REAL PROPERTY" shall mean each Real Property in which the Borrower or any Subsidiary holds an ownership or fee interest from time to time. "PERMITTED DISCRETION" shall mean a determination or judgment made by the Lender in good faith in the exercise of reasonable business judgment from the perspective of a secured lender. "PERMITTED INDEBTEDNESS" shall mean any and all Indebtedness expressly permitted pursuant to Section 6.01 below. "PERMITTED LIENS" shall mean those Liens expressly permitted pursuant to Section 6.02 below. "PERSON" shall mean any individual, partnership, corporation, limited liability company, banking association, business trust, joint stock company, trust, unincorporated association, joint venture, governmental authority or other entity of whatever nature. "QUALIFIED PROCEEDS" shall mean any and all net proceeds received by the Borrower from time to time after the date of this Agreement from the issuance and/or sale of any capital stock of the Borrower or any security (including any Indebtedness incurred subsequent to the Closing Date) convertible into or exchangeable for capital stock of the Borrower, except to the extent that (a) such proceeds are received from the exercise of warrants or options that are outstanding on the date of this Agreement, or (b) such proceeds are, within thirty (30) days after the receipt thereof, applied to pay the purchase price and/or directly associated expenses of the Borrower's acquisition (directly or through a Wholly-Owned Subsidiary which is a Domestic Subsidiary) of another business (whether through merger, consolidation, share exchange, stock purchase, or purchase of all or substantially all of the assets of the target company or an operating division or unit thereof), in each case effected subject to and in accordance with the requirements of this Agreement and the Collateral Agreement (including, without limitation the pledge to the Lender of the capital stock and/or assets (as applicable) of the acquired business). In determining the amount of net proceeds for purposes of this definition, there shall be deducted from gross proceeds only those reasonable expenses incurred by the Borrower directly related to the subject issuance or sale, exclusive of any fees or commissions paid to any officer, director or other Affiliate of the Borrower or any Affiliate of any of the foregoing. 11 "REAL PROPERTIES" shall mean, collectively, any real properties (land, buildings and/or improvements) now owned or leased or occupied by the Borrower or any of the Subsidiaries, and, during the period of the Borrower's and/or Subsidiary's occupancy thereof, any other real properties heretofore owned or leased by the Borrower or any Subsidiary (provided that, with respect to leased properties, the "Real Property" shall refer only to the portion of the subject property (excluding common areas) leased by the Borrower or a Subsidiary). "REGISTRATION RIGHTS AGREEMENT" shall mean the Registration Rights Agreement, to be dated as of the Closing Date, made by the Borrower for the benefit of the Lender and any subsequent Holders (as such term is defined in the Registration Rights Agreement), as same may be amended, modified, supplemented and/or restated from time to time. "REVOLVING CREDIT COMMITMENT" shall mean the Lender's agreement to make Advances to the Borrower within the limitations set forth in Section 2.01 below. "REVOLVING CREDIT NOTE" shall mean the promissory note of the Borrower issued to the Lender to represent the Advances and interest thereon, as described in Section 2.01(f) below. "SALE" shall mean any transaction or series of related transactions (a) whereby Control of the Borrower is held by a Person (or group of Persons acting in concert) other than the management of the Borrower on the date of this Agreement (or Affiliates of such management), provided that a "Sale" shall not be deemed to have occurred solely by reason of normal market trading in the Common Stock which does not result in the acquisition by a single Person or "group" (within the meaning of Section 13(d)(3) of the Exchange Act) of a majority of the outstanding voting stock of the Borrower, (b) in which the Borrower is a constituent party to any merger, consolidation or share exchange and as a result thereof (i) the holders of the outstanding capital stock of the Borrower which ordinarily has voting power for the election of directors (including preferred stock counted on an "as converted" basis into common stock) immediately prior to such merger or consolidation cease to own a majority of the outstanding capital stock of the Borrower which ordinarily has voting power for the election of directors (including preferred stock counted on an "as converted" basis into common stock), or (ii) the Borrower is not the surviving corporation, or (c) whereby all or any material portion of the assets of the Borrower or any Subsidiary are sold, assigned or transferred. "SEC" shall mean the United States Securities and Exchange Commission, and any successor agency performing the functions thereof. "SEC REPORTS" shall mean the periodic and current reports, registration statements, proxy statements and other reports filed or required to be filed by the Borrower with the SEC pursuant to the Act and/or the Exchange Act, and any amendments or supplements thereto filed with the SEC. "SECURITY DOCUMENTS" shall mean the Guaranty Agreement, the Collateral Agreement, any Collateral Assignments, Landlord Waivers, Control Agreements, financing 12 statements or other such agreements or documents pursuant thereto, and any other agreements or instruments securing or creating or evidencing Liens securing the Obligations. "SUBORDINATED DEBT" shall mean all Indebtedness for money borrowed and other liabilities of the Borrower or any Subsidiary, whether or not evidenced by promissory notes, which is contractually subordinated in right of payment, in a manner satisfactory to the Lender (as evidenced by the Lender's prior written approval thereof), to all Obligations of the Borrower and/or the subject Subsidiary to the Lender. "SUBSCRIPTION AGREEMENTS" shall mean those Subscription Agreements dated November 9, 2004, by and between the Borrower and the original purchasers of the Convertible Debentures. "SUBSIDIARY" or "SUBSIDIARIES" shall mean the individual or collective reference to any corporation, limited liability company or other entity of which 50% or more of the outstanding shares of stock or other equity interests of each class having ordinary voting power and/or rights to profits (other than stock having such power only by reason of the happening of a contingency) is at the time owned by the Borrower, directly or indirectly through one or more Subsidiaries of the Borrower. "TERM LOAN" shall mean the term loan in the principal amount of $9,500,000 to be made pursuant to Section 2.02(a) below. "TERM NOTE" shall mean the promissory note of the Borrower issued to the Lender as described in Section 2.02(d) below. "UCC" means the Uniform Commercial Code as in effect in the State of New York on the date hereof and hereafter from time to time. "WARRANTS" shall mean the warrants to purchase shares of Common Stock (such warrants covering an aggregate of 2,100,000 shares of Common Stock, subject to adjustment) to be issued by the Borrower to the Lender on the Closing Date. "WHOLLY-OWNED SUBSIDIARY" shall mean each Subsidiary of which all of the outstanding equity securities (other than directors' qualifying shares) are owned by the Borrower or another such Wholly-Owned Subsidiary. "WHOLLY-OWNED DOMESTIC SUBSIDIARY" shall mean each Wholly-Owned Subsidiary which is a Domestic Subsidiary. SECTION 1.02. USE OF DEFINED TERMS. All terms defined in this Agreement shall have their defined meanings when used in the Notes, the Security Documents, the other Loan Documents, and all certificates, reports or other documents made or delivered pursuant to this Agreement, unless otherwise defined therein or unless the specific context shall otherwise require. SECTION 1.03. ACCOUNTING TERMS. All accounting terms not specifically defined herein shall be construed in accordance with GAAP. 13 SECTION 1.04. OTHER DEFINITIONAL PROVISIONS. The words "hereof," "herein", "hereto" and "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement, and Section references are to this Agreement unless otherwise specified. The meanings given to terms defined herein shall be equally applicable to both the singular and plural forms of such terms. The word "including" and words of similar import when used in this Agreement shall mean "including, without limitation," unless otherwise specified. II. GENERAL TERMS SECTION 2.01. REVOLVING CREDIT LOANS. (a) Subject at all times to all of the terms and conditions of this Agreement, the Lender hereby agrees to extend to the Borrower a secured revolving credit facility, from the Closing Date to the Maturity Date, in an aggregate principal amount not to exceed, at any time outstanding, the lesser of (i) the Borrowing Base at the subject time, or (ii) the Maximum Revolver Amount (the "REVOLVING CREDIT COMMITMENT"); PROVIDED, HOWEVER, that following the application of all funds in the Escrow Account to the repayment of Convertible Debentures, accrued interest thereon and/or accrued interest on the Term Loan, the amount of the Debenture Reserve shall be disregarded in the calculation of the Borrowing Base and the Maximum Revolver Amount to the extent that Advances then being borrowed hereunder shall immediately be applied to repayment of remaining Convertible Debentures. (b) Such revolving credit loans are herein sometimes referred to individually as an "ADVANCE" and collectively as the "ADVANCES." Subject at all times to all of the terms and conditions of this Agreement, from the Closing Date to the Maturity Date and within the limits of the Revolving Credit Commitment, the Lender shall lend, and the Borrower may borrow, prepay (without premium or penalty) and reborrow under this Section 2.01. Each request for an Advance (i) shall be irrevocable, (ii) shall be deemed to constitute an express affirmation that all conditions precedent set forth in part B of Article IV hereof are satisfied on the date of such request and will be satisfied on the requested Borrowing Date, and (iii) shall be made to the Lender in writing, not later than three (3) Business Days prior to the requested Borrowing Date, by an authorized officer of the Borrower or by telephonic communication by such authorized officer to the Lender, which shall be confirmed by written notice to the Lender to be delivered to the Lender by the Business Day next following the subject request. In no event shall the Borrower request, or shall the Lender be required to honor, (A) any request for an Advance in an amount greater than the Availability at such time, (B) any request for an Advance in an amount less than $100,000, or (C) more than one request for the borrowing of Advances in any seven (7) calendar day period. (c) The Borrower shall pay the Lender interest on all Advances at the rate(s) per annum as in effect from time to time in accordance with the Revolving Credit Note. Such interest shall be payable monthly in arrears on the last day of each calendar month commencing June 30, 2007 and on the Maturity Date, and shall be computed on the daily unpaid balance of all Advances made under the Borrower's revolving credit loan accounts with the Lender, based on a three hundred sixty (360) day year, counting the actual number of days elapsed. The Borrower hereby authorizes the Lender to charge the Borrower's revolving credit loan accounts for all such 14 interest; PROVIDED, HOWEVER, that the Lender shall be under no obligation to make any such charge to the Borrower's revolving credit loan accounts (including, without limitation, if there is insufficient Availability at the time such interest is due and payable). (d) In the event and to the extent that, at any time, the outstanding principal amount of Advances exceeds the Revolving Credit Commitment then in effect, then the Borrower shall immediately, without notice or demand, make a payment to the Lender in respect of the Advances in an amount sufficient to cause the outstanding principal amount of Advances to be equal to or less than the Revolving Credit Commitment then in effect. (e) Unless sooner due and payable by reason of an Event of Default or Sale having occurred, the Borrower shall pay in full all of the Obligations to the Lender in respect of all Advances on or prior to the Maturity Date. (f) All Advances shall be evidenced by a secured Revolving Credit Note of the Borrower payable to the order of the Lender. (g) The Borrower may, at its option, terminate the Revolving Credit Commitment at any time upon ten (10) Business Days' prior written notice, and paying to the Lender, on the date fixed for termination, an amount equal to the sum of (i) all outstanding principal and accrued interest of the Advances, and (ii) prorated accrued Commitment Fees. In the event that, simultaneously with such termination and payment, the Borrower enters into a replacement revolving credit facility, the Lender shall, upon request of the Borrower, subordinate its liens and security interests in the Borrower's and the Subsidiaries' Accounts and inventory pursuant to a subordination agreement in form and substance reasonably satisfactory to the Lender. SECTION 2.02. TERM LOAN. (a) Subject at all times to all of the terms and conditions of this Agreement, the Lender hereby agrees to extend to the Borrower a Term Loan in the principal amount of $9,500,000. The Term Loan shall be borrowed in a single borrowing on the Closing Date, and any principal amounts repaid in respect of the Term Loan may not be reborrowed. (b) The Term Loan shall be repayable in full on the Maturity Date. The Borrower shall be required to prepay the Term Loan (i) in full simultaneously with the consummation of any Sale, and (ii) in whole or in part from time to time (A) in the event and to the extent of 50% of any and all Qualified Proceeds received by the Borrower from time to time, and (B) as provided in Section 2.04 below. Any prepayment required under the foregoing clause (A) shall be due and payable as and when the amount of Qualified Proceeds is determined (i.e., upon receipt of such Qualified Proceeds in the event that no acquisition transaction is then pending, or thirty (30) days after receipt of such Qualified Proceeds to the extent that such Qualified Proceeds have not been applied to the purchase price and/or related expenses of a consummated business acquisition). (c) The Borrower shall pay the Lender interest on the principal balance of the Term Loan at the rate(s) per annum as in effect from time to time in accordance with the Term Note. Such interest shall be payable quarterly in arrears commencing June 30, 2007, on the last 15 day of each calendar quarter thereafter, and on the Maturity Date, and shall be computed on the daily unpaid balance of the Term Loan, based on a three hundred sixty (360) day year, counting the actual number of days elapsed. The Borrower hereby authorizes the Lender to charge the Borrower's revolving credit loan accounts for all such interest and/or for any or all principal amounts due and payable in respect of the Term Loans; PROVIDED, HOWEVER, that the Lender shall be under no obligation to make any such charge to the Borrower's revolving credit loan accounts (including, without limitation, if there is insufficient Availability at the time such interest and/or principal is due and payable). (d) The Term Loan shall be evidenced by a secured Term Note of the Borrower payable to the order of the Lender. SECTION 2.03. FEES AND PREMIUMS; LENDER SHARES. (a) The Borrower shall pay the Closing Fee to the Lender on the Closing Date. The Closing Fee shall be deemed fully earned on the Closing Date and shall not be refundable in whole or in part and shall not be subject to reduction or set-off under any circumstances. (b) The Borrower shall further pay to the Lender, in respect of the Revolving Credit Commitment: (i) in advance on the Closing Date and on the first (1st) Business Day of each calendar month prior to (A) the Maturity Date, or (B) the earlier termination of the Revolving Credit Commitment and payment of the Obligations thereon in accordance with this Agreement, a collateral monitoring and unused commitment/administrative fee in the amount of $5,000 per month or portion thereof; and (ii) on May 31 of each year commencing May 31, 2008, and upon any early termination of the Revolving Credit Commitment (appropriately prorated in such latter case), an annual Commitment Fee in the amount of $50,000. (c) In the event of any prepayment of all or any portion of the Term Loan other than pursuant to Sections 2.04(b)(i) or 2.04(b)(iii) below, in addition to the payment of the subject principal amount and all unpaid accrued interest thereon, the Borrower shall be required to pay to the Lender a prepayment premium in an amount equal to one (1%) percent of the principal amount being prepaid. (d) On the Closing Date, the Lender shall purchase, and the Borrower shall sell and issue to the Lender, an aggregate of 1,500,000 fully paid and nonassessable shares of Common Stock for aggregate purchase price of $1,500. The Lender hereby acknowledges that such Lender Shares constitute "restricted securities" under the Act, and represents and warrants that it is acquiring such Lender Shares for its own account for investment, and not with a view to the resale or distribution thereof in violation of any applicable securities laws. (e) Payments received in respect of the Obligations after 12:00 Noon on any day shall be deemed to be received on the next succeeding Business Day, and if any payment is received other than by wire transfer of immediately available funds, such payment shall be 16 subject to three (3) Business Days' clearance prior to being credited to the Obligations for interest calculation purposes. (f) In the event that the Lender notifies the Borrower that the Lender is ready, willing and able to fund the Loans on substantially the terms of this Agreement and the Closing Date has not occurred within fifteen (15) days thereafter other than due to the fault of the Lender, then the Lender may, at any time thereafter until the Closing Date, terminate this Agreement by written notice to the Borrower, in which event the Borrower shall immediately pay to the Lender (i) an amount equal to all out-of-pocket costs, charges and expenses (up to an aggregate maximum of $75,000) incurred by the Lender in respect of the transactions contemplated by this Agreement, and (ii) an additional fee in the amount of $250,000. This Section 2.03(f) shall survive any termination of this Agreement. SECTION 2.04. USE OF PROCEEDS. (a) The Borrower shall utilize the proceeds of the Advances solely for (i) repaying outstanding principal and accrued interest on Indebtedness currently owed by the Borrower to Mark Dyne in the aggregate amount of approximately $1,000,000, (ii) repaying up to $3,000,000 in principal amount of Convertible Debentures, (iii) paying accrued interest on the Convertible Debentures, and (iv) working capital and other general corporate purposes of the Borrower. (b) The Borrower shall utilize the proceeds of the Term Loan solely for the purpose of repaying the Convertible Debentures, provided that, if all holders of the Convertible Debentures have not agreed, prior to and effective on the Closing Date, to waive the prepayment penalties provided in the Convertible Debentures, then: (i) On the Closing Date, the proceeds of the Term Loan shall be placed in a segregated bank account (the "ESCROW ACCOUNT") at a commercial bank reasonably satisfactory to the Lender, which shall have entered into a Control Agreement pursuant to which no transactions in or withdrawals or other dispositions of funds in the Escrow Account may be made without the written consent of the Lender. The funds in the Escrow Account (including any interest earned thereon) may be withdrawn (and the Lender shall give its written authorization for such withdrawal) and applied to the payment of interest on the Term Loan from time to time as and when same becomes due and payable and to the payment of the Convertible Debentures at the earlier of (A) the maturity date of the Convertible Debentures, or (B) such time as the holders of the Convertible Debentures will accept prepayment thereof in full without any prepayment penalty. To the extent that, on the maturity date of the Convertible Debentures, the funds in the Escrow Account are not utilized to pay the Convertible Debentures, or sooner in the event and to the extent that, at any time or from time to time, the funds in the Escrow Account shall be greater than the outstanding principal and unpaid accrued interest of the Convertible Debentures, funds shall be withdrawn from the Escrow Account and applied to the prepayment of the Term Loan. (ii) Anything contained in the Term Note to the contrary notwithstanding, the interest rate applicable to the portion of the proceeds of the Term 17 Loan held in the Escrow Account from time to time shall be equal to the interest income earned on the funds on deposit in the Escrow Account (and, for purposes of this Section 2.04(b)(ii), any withdrawals from the Escrow Account shall be deemed made from the principal originally deposited in the Escrow Account, until all such principal has been withdrawn from the Escrow Account). (iii) In the event and to the extent that the holders of the Convertible Debentures hereafter elect to and do convert the Convertible Debentures (or any portion or portions thereof) into Common Stock, then (A) an amount equal to the principal amount of Convertible Debentures that are converted shall, simultaneously with such conversion, be withdrawn from the Escrow Account and used to prepay a like portion of the Term Loan, and (B) upon each such prepayment, the Lender shall return to the Borrower a ratable portion of the Lender Shares and Warrants based on the principal amount prepaid as a portion of the aggregate $14,000,000 of maximum lending commitments hereunder. By way of example, if an aggregate of $4,000,000 in principal amount of Convertible Debentures were converted, $4,000,000 of the principal of the Term Loan would thereupon be prepaid out of funds in the Escrow Account, and simultaneously with such prepayment, four fourteenths ((4)/14th) of the Lender Shares (428,571 Lender Shares) and four fourteenths ((4)/14th) of each Warrant would be cancelled (and the Borrower shall promptly (x) if required, issue replacement stock certificates for the uncancelled portion of any stock certificate theretofore representing any cancelled Lender Shares, and (y) issue replacement Warrants for the unexercised and uncancelled portions of the original Warrants). The Lender hereby agrees that it will not sell, transfer or dispose of Lender Shares or Warrants, or exercise Warrants, to such an extent that the Lender ceases to hold a sufficient number of Lender Shares and Warrants to satisfy any potential future surrender obligation under this Section 2.04(b)(iii). (iv) Nothing herein contained shall be deemed to abrogate or impair the Lender's right to withdraw funds from the Escrow Account for application to the Obligations upon the occurrence and during the continuance of any Event of Default. SECTION 2.05. FURTHER OBLIGATIONS. With respect to all Obligations for which the interest rate is not otherwise specified herein (whether such Obligations arise hereunder, pursuant to the Notes or Security Documents, or otherwise), such Obligations shall bear interest at the rate(s) in effect from time to time pursuant to the Revolving Credit Note. SECTION 2.06. APPLICATION OF PAYMENTS. All amounts paid to or received by the Lender in respect of the Loans from whatever source (whether from the Borrower, any Subsidiary pursuant to the Guaranty Agreement, any realization upon any Collateral, or otherwise) shall, unless otherwise directed by the Borrower with respect to any particular payment (unless an Event of Default shall then be continuing, in which event the Lender may disregard the Borrower's direction), be applied (a) first, to reimburse the Lender for all out-of-pocket costs and expenses incurred by the Lender which are reimbursable to the Lender in accordance with this Agreement, the Notes and/or any of the other Loan Documents, (b) next, to any accrued but unpaid fees or prepayment premiums, and amounts payable under Section 2.2(c) of the Registration Rights Agreement, (c) next, to unpaid accrued interest on the Term Loan, (d) next, to unpaid accrued interest on the Advances, (e) next, to the outstanding principal of the Term Loan, to the extent 18 then due and payable, (f) next, to the outstanding principal of the Advances, and (g) finally, to the payment of any other outstanding Obligations; and after payment in full of the Obligations, any further amounts paid to or received by the Lender in respect of the Loans shall be paid over to the Borrower or such other Person(s) as may be legally entitled thereto. SECTION 2.07. SALE. Anything elsewhere contained in this Agreement and/or the Notes to the contrary notwithstanding, the Revolving Credit Commitment shall terminate and all Obligations shall become immediately due and payable, without requirement of any notice or demand, upon the consummation of any Sale. SECTION 2.08. OBLIGATIONS UNCONDITIONAL. (a) The payment and performance of all Obligations shall constitute the absolute and unconditional obligations of the Borrower, and shall be independent of any defense or rights of set-off, recoupment or counterclaim which the Borrower might otherwise have against the Lender. All payments required by this Agreement and/or the Notes shall be paid free of any deductions or withholdings for any taxes (but only for the original Lender and any investment funds under common management with such Lender) or other amounts and without abatement, diminution or set-off. If the Borrower is required by law to make such a deduction or withholding from a payment hereunder, the Borrower shall pay to the Lender such additional amount as is necessary to ensure that, after the making of such deduction or withholding, the Lender receives (free from any liability in respect of any such deduction or withholding) a net sum equal to the sum which it would have received and so retained had no such deduction or withholding been made or required to be made. The Borrower shall (i) pay the full amount of any deduction or withholding, which it is required to make by-law, to the relevant authority within the payment period set by the relevant law, and (ii) promptly after any such payment, deliver to the Lender an original (or certified copy) official receipt issued by the relevant authority in respect of the amount withheld or deducted or, if the relevant authority does not issue such official receipts, such other evidence of payment of the amount withheld or deducted as is reasonably acceptable to the Lender. (b) If, at any time and from time to time after the Closing Date, (i) any change in any existing law, regulation, treaty or directive or in the interpretation or application thereof, (ii) any new law, regulation, treaty or directive enacted or application thereof, or (iii) compliance by the Lender with any request or directive (whether or not having the force of law) from any governmental authority (A) subjects the Lender to any tax, levy, impost, deduction, assessment, charge or withholding of any kind whatsoever with respect to any Loan Document, or changes the basis of taxation of payments to the Lender of any amount payable thereunder (except for net income taxes, or franchise taxes imposed in lieu of net income taxes, imposed generally by federal, state or local taxing authorities with respect to interest or commitment fees or other fees payable hereunder or changes in the rate of tax on the overall net income of the Lender or its members), or (B) imposes on the Lender any other condition or increased cost in connection with the transactions contemplated thereby or participations therein, and the result of any of the foregoing is to increase the cost to the Lender of making or continuing any Loan or to reduce any amount receivable hereunder, then, in any such case, the Borrower shall promptly pay to the Lender any additional amounts necessary to compensate the Lender, on an after-tax basis, for such additional cost or reduced amount as determined by the Lender. If the Lender becomes 19 entitled to claim any additional amounts pursuant to this Section 2.08(b), the Lender shall promptly notify the Borrower of the event by reason of which the Lender has become so entitled, and each such notice of additional amounts payable pursuant to this Section 2.08(b) submitted by the Lender to the Borrower shall, absent manifest error, be final, conclusive and binding for all purposes. SECTION 2.09. REVERSAL OF PAYMENTS. To the extent that any payment or payments made to or received by the Lender pursuant to this Agreement or any other Loan Document are subsequently invalidated, declared to be fraudulent or preferential, set aside, or required to be repaid to any trustee, receiver or other person under any state or federal bankruptcy or other such law, then, to the extent thereof, such amounts shall be revived as Obligations and continue in full force and effect hereunder as if such payment or payments had not been received by the Lender. SECTION 2.10. OFFERING TO HOLDERS OF CONVERTIBLE DEBENTURES. Within the time periods provided in Section 8 of the Subscription Agreements, the Borrower shall offer to the holders of the Convertible Debentures the opportunity to purchase participations in the Loans, the Lender Shares and the Warrants, pursuant to participation agreements in form and substance satisfactory to the Lender; PROVIDED, however, that in no event shall such participations offered to the holders of the Convertible Debentures exceed 49% of the Loans, the Lender Shares or the Warrants. If any of such holders accepts such offer, the Borrower shall, upon tender of the certificates representing the Lender Shares and the Warrants, reissue such Lender Shares and Warrants to the Lender and the subject participants in the amounts designated by the Lender based upon such participations. Thereafter, in the event that any of the Lender Shares or the Warrants are required to be surrendered pursuant to Section 2.04(b)(iii) above, the Borrower shall look solely to the participants for the return of their proportionate shares of such to-be-surrendered Lender Shares and Warrants. III. REPRESENTATIONS AND WARRANTIES As of the Closing Date and on each Borrowing Date (unless the representation and warranty refers to a specific date), the Borrower hereby makes the following representations and warranties to the Lender, all of which representations and warranties shall survive the Closing Date, the delivery of the Notes and the making of the Loans, shall be continuing in nature so long as any Obligations are outstanding or the Revolving Credit Commitment remains in effect, and are as follows: SECTION 3.01. FINANCIAL MATTERS. (a) The Borrower has heretofore furnished to the Lender (i) the audited consolidated financial statements (including balance sheets, statements of income and statements of cash flows) of the Borrower and its Subsidiaries as at December 31, 2005 and 2006, and for the Fiscal Years then ended, and (ii) the unaudited consolidated financial statements of the Borrower and its Subsidiaries as of March 31, 2007 and for the three (3) months then ended (collectively, the "FINANCIAL STATEMENTS"). (b) The Financial Statements (i) have been prepared in accordance with GAAP and Regulation S-X promulgated under the Act on a consistent basis for all periods 20 (subject, in the case of unaudited statements, to the absence of full footnote disclosures, and to normal non-material audit adjustments), (ii) are complete and correct in all material respects, (iii) fairly present the consolidated financial condition of the Borrower and its Subsidiaries as of said dates, and the results of their operations for the periods stated, (iv) contain and reflect all necessary adjustments and accruals for a fair presentation of the Borrower's and its Subsidiaries' consolidated financial condition and results of operations as of the dates of and for the periods covered by such Financial Statements, and (v) make full and adequate provision, subject to and in accordance with GAAP, for the various assets and liabilities (including, without limitation, deferred revenues) of the Borrower, fixed or contingent, and the results of their operations and transactions in their accounts, as of the dates and for the periods referred to therein. (c) Except as set forth in SCHEDULE 3.01 of the Disclosure Schedule, neither the Borrower nor any of its Subsidiaries have any liabilities, obligations or commitments of any kind or nature whatsoever, whether absolute, accrued, contingent or otherwise (collectively "LIABILITIES AND CONTINGENCIES"), including, without limitation, Liabilities and Contingencies under employment agreements and with respect to any "earn-outs", stock appreciation rights, or related compensation obligations, except: (i) Liabilities and Contingencies disclosed in the Financial Statements or footnotes thereto, (ii) Liabilities and Contingencies incurred in the ordinary course of business and consistent with past practice since the date of the most recent Financial Statements, or (iii) those Liabilities and Contingencies which are not required to be disclosed under GAAP. The reserves, if any, reflected on the balance sheet included in the most recent Financial Statements are appropriate and reasonable. Neither the Borrower nor any of its Subsidiaries have any Indebtedness for money borrowed, outstanding obligations for the purchase price of property, contingent obligations or liabilities for taxes, or any unusual forward or long-term commitments, except as specifically set forth in SCHEDULE 3.01 of the Disclosure Schedule. (d) Since the date of the most recent Financial Statements, except as set forth in SCHEDULE 3.01 of the Disclosure Schedule, there has been no material adverse change in the working capital, condition (financial or otherwise), assets, liabilities, reserves, business, management, operations or prospects of the Borrower or any of its Subsidiaries, including, without limitation, the following: (i) there has been no material change in any assumptions underlying, or in any methods of calculating, any bad debt, contingency or other reserve relating to the Borrower or any Subsidiary; (ii) there have been (A) no material write-downs in the value of any inventory of, and there have been no write-offs as uncollectible of any notes, accounts receivable or other receivables of, the Borrower or any Subsidiary other than write-offs of accounts receivable reserved in full as of the date of the most recent financial statements delivered to the Lender, and (B) no reserves established for the uncollectibility of any notes, Accounts or other receivables of the Borrower or any Subsidiary except to the extent that same have been disclosed to the Lender in writing and would not, individually or in the aggregate, cause the outstanding Advances to exceed the Revolving Credit Commitment; 21 (iii) no debts have been cancelled, no claims or rights of substantial value have been waived and no properties or assets (real, personal or mixed, tangible or intangible) have been sold, transferred, or otherwise disposed of by the Borrower or any Subsidiary except in the ordinary course of business and consistent with past practice; (iv) there has been no change in any method of accounting or accounting practice utilized by the Borrower or any Subsidiary; (v) no material casualty, loss or damage has been suffered by the Borrower or any Subsidiary, regardless of whether such casualty, loss or damage is or was covered by insurance; (vi) Any announced changes in the policies or practices of any customer, supplier or referral source which would reasonably be expected to have a Material Adverse Effect; (vii) Any incurrence of (A) any liability or obligation outside of the ordinary course of business, or (B) any Indebtedness other than Permitted Indebtedness; (viii) Any declaration, setting aside or payment of any dividend or distribution or any other payment of any kind by the Borrower to or in respect of any equity securities of the Borrower; and (ix) No action described in this Section 3.01(d) has been agreed to be taken by the Borrower or any Subsidiary. (e) Subsequent to January 1, 2007, neither the Borrower nor any of the Subsidiaries has effected any borrowing or sale transaction under the Factoring Agreement. (f) The Borrower and its Subsidiaries have in place adequate systems of internal controls and disclosure controls and procedures sufficient to provide reasonable assurance that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and to maintain asset accountability, (iii) access to assets is permitted only in accordance with management's general or specific authorization, (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences, and (v) the Borrower and its management are able to obtain timely and accurate information regarding the Business Operations and all material transactions relating to the Borrower and the Subsidiaries; and no material deficiency exists with respect to the Borrower's or any Subsidiary's systems of internal controls. (g) All of the SEC Reports, as of the respective dates thereof, complied in all material respects, as applicable, with the Act and the Exchange Act. 22 SECTION 3.02. ORGANIZATION; CORPORATE EXISTENCE. (a) The Borrower (i) is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, (ii) has all requisite corporate power and authority to own its properties and to carry on its business as now conducted and as proposed hereafter to be conducted, (iii) is qualified to do business as a foreign corporation in each jurisdiction in which the failure of the Borrower to be so qualified would have a Material Adverse Effect, and (iv) has all requisite corporate power and authority to execute and deliver, and perform all of its obligations under, the Loan Documents. True and complete copies of the Organic Documents of the Borrower, together with all amendments thereto to the date hereof, have been furnished to the Lender. (b) On the date of this Agreement, the outstanding capital stock of the Borrower, the number and amount of all outstanding options, warrants, convertible securities, subscriptions and other rights to acquire capital stock of the Borrower, and the number of shares reserved under outstanding option plans or the like, are as set forth in SCHEDULE 3.02 of the Disclosure Schedule. All of such outstanding capital stock is validly issued, fully paid and nonassessable. Except as set forth in such SCHEDULE 3.02, no holders of any such securities have any registration rights in respect thereof. (c) SCHEDULE 3.02 of the Disclosure Schedule further sets forth, with respect to each Subsidiary on the date of this Agreement, (i) its proper legal name, (ii) its jurisdiction of incorporation or formation, (iii) the jurisdictions in which it is qualified to do business as a foreign entity, (iv) the number of shares of capital stock, equity securities or ownership interests outstanding (all of which are validly issued, fully paid and nonassessable), and (v) the owner(s) of such outstanding capital stock, equity securities or other ownership interests. Each of the Subsidiaries (A) is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or formation, (B) has all requisite power and authority to own its properties and to carry on its business as now conducted and as proposed hereafter to be conducted, and to execute and deliver, and perform all of its obligations under, the Loan Documents to which it is a party, and (C) is not required to be qualified to do business as a foreign entity in any jurisdiction in which it is not so qualified and the failure to be so qualified would reasonably be expected to have a Material Adverse Effect. True and complete copies of the Organic Documents of each Subsidiary, together with all amendments thereto to the date hereof, have been furnished to the Lender. SECTION 3.03. AUTHORIZATION. (a) The execution, delivery and performance by the Borrower and the Subsidiaries of their respective obligations under the Loan Documents have been duly authorized by all requisite corporate and other action and will not, either prior to or as a result of the consummation of the transactions contemplated by this Agreement: (i) violate any provision of Applicable Law, any order of any court or other agency of government, any provision of the Organic Documents of the Borrower or any Subsidiary, or any Contract, indenture, agreement or other instrument to which the Borrower or any of the Subsidiaries is a party, or by which the Borrower or any of the Subsidiaries or any of its assets or properties are bound, or (ii) be in conflict with, result in a breach of, or constitute (after the giving of notice or lapse of time or both) a default under, or, except as may be provided in the Loan Documents, result in the creation or imposition of any Lien of any nature whatsoever upon any of the property or assets of 23 the Borrower or any of the Subsidiaries pursuant to, any such Contract, indenture, agreement or other instrument. (b) This Agreement and the other Loan Documents have been duly executed and delivered by the Borrower and its Subsidiaries party thereto, and constitute the valid and binding obligations of the Borrower and its Subsidiaries party thereto, enforceable against the Borrower and such Subsidiaries in accordance with their respective terms, except to the extent that enforceability may be limited by bankruptcy, insolvency, reorganization, moretorium, fraudulent transfer or other similar laws now or hereafter in effect relating to creditors' rights generally, and by general principles of equity. (c) Neither the Borrower nor any of the Subsidiaries is required to obtain any Government Approval, consent or authorization from, or to file any declaration or statement with, any governmental instrumentality or agency in connection with or as a condition to the execution, delivery or performance of any of the Loan Documents. (d) Without limitation of Sections 3.03(a) through 3.03(c) above, the issuance of the Warrants has been authorized by all requisite corporate action of the Borrower, and such issuance does not conflict with any shareholders' agreement, preemptive rights, limitation under or requirement of Organic Documents, or other agreement or commitment of the Borrower. Upon exercise of the Warrants in accordance with the terms thereof, the Warrant Shares (as such term is defined in the Warrants) will be validly issued, fully paid and nonassessable. SECTION 3.04. LITIGATION. Except as disclosed on SCHEDULE 3.04 of the Disclosure Schedule, there is no action, suit or proceeding at law or in equity or by or before any governmental instrumentality or other agency now pending or, to the knowledge of the Borrower, threatened against or affecting the Borrower or any of the Subsidiaries or any of their respective assets, which, if adversely determined, would have a Material Adverse Effect. The Borrower has no Knowledge of any state of facts, events, conditions or circumstances which are reasonably likely to give rise to, or would properly constitute grounds for or the basis of, any suit, action, arbitration, proceeding or investigation (including, without limitation, any unfair labor practice charges, interference with union organizing activities, or other labor or employment claims) against or with respect to the Borrower or any Subsidiary. SECTION 3.05. MATERIAL CONTRACTS. Except as disclosed on SCHEDULE 3.05 of the Disclosure Schedule, neither the Borrower nor any of the Subsidiaries is (a) a party to any Contract, agreement or instrument or subject to any charter or other corporate or organizational restriction which has had or could reasonably be expected to have a Material Adverse Effect, (b) subject to any liability or obligation under or relating to any collective bargaining agreement, or (c) in default in the performance, observance or fulfillment of any of the obligations, covenants or conditions contained in any Contract, agreement or instrument to which it is a party or by which any of its assets or properties is bound, which default, individually or in the aggregate, would have or could reasonably be expected to have a Material Adverse Effect. SECTION 3.06. TITLE TO PROPERTIES. The Borrower and each of the Subsidiaries has good title to all of its properties and assets, free and clear of all mortgages, security interests, restrictions, encumbrances or other Liens of any kind, except for restrictions on the nature of use 24 thereof imposed by Applicable Law, and except for Permitted Liens, none of which materially interfere with the use and enjoyment of such properties and assets in the normal course of the Business Operations as presently conducted, or materially impair the value of such properties and assets for the purpose of such business. SECTION 3.07. REAL PROPERTY. SCHEDULE 3.07 of the Disclosure Schedule sets forth a correct and complete lists of all (i) Owned Real Properties, and (ii) Leased Real Properties. The Borrower owns good and marketable title to all Owned Real Properties. The Borrower has a valid lessee's interest in each Leased Real Property currently leased or occupied by the Borrower and neither the Borrower nor, to the Borrower's Knowledge, any other party thereto, is in material breach or violation of any requirements of any such lease. All Real Properties currently owned or occupied by the Borrower or any Subsidiary are in good condition (reasonable wear and tear excepted) and are adequate for the current and proposed businesses of the Borrower and its Subsidiaries. To the Borrower's Knowledge, its use of the Real Properties in the normal conduct of the Business Operations does not violate any applicable building, zoning or other law, ordinance or regulation affecting such Real Properties, and no covenants, easements, rights-of-way or other such conditions of record impair the Borrower's use of the Real Properties in the normal conduct of the Business Operations. SECTION 3.08. MACHINERY AND EQUIPMENT. The machinery and equipment owned and/or used by the Borrower and the Subsidiaries is, as to each individual material item of machinery and equipment, and in the aggregate as to all such equipment, in good and usable condition and in a state of good maintenance and repair (reasonable wear and tear excepted), and adequate for its use in the Business Operations. SECTION 3.09. CAPITALIZATION. Except as set forth in SCHEDULE 3.02 of the Disclosure Schedule and for new Subsidiaries which may hereafter be formed or acquired in compliance with this Agreement, the Borrower does not, directly or indirectly, own any capital stock of or any form of equity interest in any other Person. SECTION 3.10. SOLVENCY. After giving effect to the Loans and the other transactions contemplated hereby, the borrowings made and/or to be made by the Borrower under this Agreement do not and will not render the Borrower insolvent or with unreasonably small capital for its business; the fair saleable value of all of the assets and properties of the Borrower does now, and will, upon the funding of the Loans contemplated hereby, exceed the aggregate liabilities and Indebtedness of the Borrower (including contingent liabilities); the Borrower is not contemplating either the filing of a petition under any state or federal bankruptcy or insolvency law, or the liquidation of all or any substantial portion of its assets or property; the Borrower has no knowledge of any Person contemplating the filing of any such petition against the Borrower; and the Borrower reasonably anticipates that it will be able to pay its debts as they mature. SECTION 3.11. NO INVESTMENT COMPANY. The Borrower is not an "investment company" or a company "controlled" by an "investment company" as such terms are defined in the Investment Company Act of 1940, as amended. SECTION 3.12. MARGIN SECURITIES. The Borrower does not own or have any present intention of acquiring any "margin security" or any "margin stock" within the meaning of 25 Regulations G, T, U or X of the Board of Governors of the Federal Reserve System (herein called "margin security" and "margin stock"). None of the proceeds of the Loans will be used, directly or indirectly, for the purpose of purchasing or carrying, or for the purpose of reducing or retiring any Indebtedness which was originally incurred to purchase or carry, any margin security or margin stock or for any other purpose which might constitute the transactions contemplated hereby a "purpose credit" within the meaning of said Regulations G, T, U or X, or cause this Agreement to violate any other regulation of the Board of Governors of the Federal Reserve System or the Exchange Act, or any rules or regulations promulgated under such statutes. SECTION 3.13. TAXES. (a) All federal, state and local tax returns and tax reports required to be filed by the Borrower and/or any Subsidiary have been timely filed with the appropriate governmental agencies in all jurisdictions in which such returns and reports are required to be filed, and all of such tax returns, tax reports and other filings are correct and complete in all material respects. All federal, state and local income, franchise, sales, use, property, excise, ad valorem, value-added, payroll and other taxes (including interest, penalties and additions to tax and including estimated tax installments where required to be filed and paid) due from or with respect to the Borrower and the Subsidiaries have been fully paid, and appropriate accruals have been made on the Borrower's books for taxes not yet due and payable. All taxes and other assessments and levies which the Borrower and/or any Subsidiary is required by law to withhold or to collect have been duly withheld and collected, and have been paid over to the proper governmental authorities to the extent due and payable. Except as set forth in SCHEDULE 3.13 of the Disclosure Schedule, there are no outstanding or pending claims, deficiencies or assessments for taxes, interest or penalties with respect to any taxable period of the Borrower or any Subsidiary, and no outstanding tax Liens. (b) Except as disclosed in SCHEDULE 3.13 of the Disclosure Schedule, the Borrower has no Knowledge and has not received notice of any pending audit with respect to any federal, state or local tax returns of the Borrower or any Subsidiary, and no waivers of statutes of limitations have been given or requested with respect to any tax years or tax filings of the Borrower or any Subsidiary. SECTION 3.14. ERISA. Except as set forth in SCHEDULE 3.14 of the Disclosure Schedule, neither the Borrower nor any ERISA Affiliate of the Borrower maintains or has any obligation to make any contributions to any pension, profit sharing or other similar plan providing for deferred compensation to any employee. With respect to any such plan(s) as may now exist or may hereafter be established by the Borrower or any ERISA Affiliate of the Borrower, and which constitutes an "employee pension benefit plan" within the meaning of Section 3(2) of ERISA, except as set forth on SCHEDULE 3.14 of the Disclosure Schedule: (a) the Borrower or the subject ERISA Affiliate has paid and shall cause to be paid when due all amounts necessary to fund such plan(s) in accordance with its terms, (b) except for normal premiums payable by the Borrower to the Pension Benefit Guaranty Corporation ("PBGC"), the Borrower or the subject ERISA Affiliate has not taken and shall not take any action which could result in any liability to the PBGC, or any of its successors or assigns, (c) the present value of all accrued benefits thereunder shall not at any time exceed the value of the assets of such plan(s) allocable to such accrued benefits, (d) there have not been and there shall not be any transactions such as would cause the 26 imposition of any tax or penalty under Section 4975 of the Code or under Section 502 of ERISA, which would adversely affect the funded benefits attributable to the Borrower or the subject ERISA Affiliate, (e) there has not been and there shall not be any termination or partial termination thereof (other than a partial termination resulting solely from a reduction in the number of employees of the Borrower or an ERISA Affiliate of the Borrower, which reduction is not anticipated by the Borrower), and there has not been and there shall not be any "reportable event" (as such term is defined in Section 4043(b) of ERISA) on or after the effective date of Section 4043(b) of ERISA with respect to any such plan(s) subject to Title IV of ERISA, (f) no "accumulated funding deficiency" (as defined in Section 412 of the Code) has been or shall be incurred on or after the effective date of Section 412 of the Code, (g) such plan(s) have been and shall be determined to be "qualified" within the meaning of Section 401(a) of the Code, and have been and shall be duly administered in compliance with ERISA and the Code, and (h) the Borrower is not aware of any fact, event, condition or cause which might adversely affect the qualified status thereof. As respects any "multi-employer plan" (as such term is defined in Section 3(37) of ERISA) to which the Borrower or any ERISA Affiliate thereof has heretofore been, is now, or may hereafter be required to make contributions, the Borrower or such ERISA Affiliate has made and shall make all required contributions thereto, and there has not been and shall not be any "complete withdrawal" or "partial withdrawal" (as such terms are respectively defined in Sections 4203 and 4205 of ERISA) therefrom on the part of the Borrower or such ERISA Affiliate. SECTION 3.15. INTELLECTUAL PROPERTY. (a) The Borrower and the Subsidiaries own or have the valid right to use all material patents, trademarks, copyrights, software, computer programs, equipment designs, network designs, equipment configurations, technology and other intellectual property used, marketed and sold in the Business Operations, and the Borrower and the Subsidiaries are in compliance in all material respects with all licenses, user agreements and other such agreements regarding the use of intellectual property used in the Business Operations; and the Borrower has no Knowledge of or received notice claiming that any such intellectual property infringes upon or violates the rights of any other Person. (b) SCHEDULE 3.15(B) of the Disclosure Schedule sets forth all material Intellectual Property owned by the Borrower and its Subsidiaries ("OWNED INTELLECTUAL PROPERTY"), including the name, if any, and a brief description thereof. Except as set forth in such SCHEDULE 3.15(B), to the Knowledge fo the Borrower, either the Borrower or one of its Subsidiaries holds, good, valid and indefeasible title to all Owned Intellectual Property, free and clear of any liens or encumbrances of any kind, except for: (i) any lien for current taxes not yet due and payable, and (ii) liens that have arisen in the ordinary course of business and that do not (individually or in the aggregate) materially detract from the value of the assets subject thereto or materially impair the operations of the Borrower and its Subsidiaries. (c) SCHEDULE 3.15(C) of the Disclosure Schedule sets forth: (i) all material Intellectual Property licensed by the Borrowers or any of its Subsidiaries from third parties and used in the conduct of the business of the Borrower and its Subsidiaries ("LICENSED INTELLECTUAL 27 PROPERTY"), including a brief description thereof; (ii) with respect to any Owned Intellectual Property that is the subject of any registration or pending application in any jurisdiction, the names of the jurisdictions, any registration and/or application serial numbers, and the current status thereof; (iii) a brief description of all material licenses, sublicenses, and other agreements pursuant to which the Borrower (or any of its Subsidiaries) or any sublicensee of the Borrower (or any of its Subsidiaries) has granted to any third party the right to use any of the Owned Intellectual Property; (iv) all other material consents, indemnifications, forbearances to sue, settlement agreements and licensing or cross-licensing arrangements to which the Borrower or any of its Subsidiaries is a party relating to the Owned Intellectual Property; and (v) any ongoing royalty or payment obligations with respect to the Licensed Intellectual Property. (d) To the Knowledge of the Borrower, the Borrower and its Subsidiaries have a valid right to use, license, and otherwise exploit all Licensed Intellectual Property, and any rights thereunder will not be affected by the Borrower and its Subsidiaries entering into this Agreement, the other Loan Documents and the agreements and transactions contemplated hereby and thereby. Except as set forth in SCHEDULE 3.15(D) of the Disclosure Schedule, neither the Borrower nor any of its Subsidiaries is under any obligation to pay royalties or other payments in connection with any license, sublicense, or other agreement, nor restricted from assigning its right under any sublicense or agreement respecting the Licensed Intellectual Property, nor will the Borrower or any of its Subsidiaries otherwise be, as a result of the execution and delivery of this Agreement, the other Loan Documents or the performance of their obligations hereunder and thereunder, in breach of any license, sublicense or other agreement relating to the Licensed Intellectual Property. (e) To the Knowledge of the Borrower, each of the Borrower's and its Subsidiaries' rights in all of the Owned Intellectual Property are valid, subsisting, and enforceable. None of the Owned Intellectual Property or any registrations therefor have been cancelled or adjudicated invalid or unenforceable, or are subject any outstanding order, judgment, or decree restricting its use or adversely affecting or reflecting the Borrower's or any of its Subsidiaries' rights thereto. To the knowledge of the Borrower, all Owned Intellectual Property that is the subject of a registration or pending application is valid, subsisting, unexpired, and in proper form, and all renewal fees and other maintenance fees that have fallen due on or prior to the Closing Date have been paid. Either the Borrower or its applicable Subsidiary has timely made all filings and payments with the appropriate intellectual property offices required to maintain in subsistence all Owned Intellectual Property. All documentation necessary to confirm and effect the Borrower's and its Subsidiaries' ownership of and rights in any Owned Intellectual Property that is the subject of a registration or pending application acquired by the Borrower or any of its Subsidiaries from third parties has been filed in the United States Patent and Trademark Office and the United States Copyright Office, and any and all other relevant intellectual property offices and agencies in other jurisdictions. No Owned Intellectual Property is the subject of any legal or governmental proceeding before any governmental, registration or other authority in any jurisdiction, including any office action or other form of preliminary or final refusal of registration. 28 (f) The consummation of the transactions contemplated hereby will not materially alter or impair any Owned Intellectual Property. To the Knowledge of the Borrower, no Owned Intellectual Property has been used, divulged, disclosed or appropriated to the detriment of the Borrower or any of its Subsidiaries for the benefit of any third party; and, to the Knowledge of the Borrower, no employee or agent of the Company or any of its Subsidiaries has misappropriated any material trade secrets or other material confidential information of any third party in the course of the performance of his or her duties as an employee of the Borrower or any of its Subsidiaries. To the Knowledge of the Borrower, (i) none of the Owned Intellectual Property infringes on any Intellectual Property owned or used by any other Person; (ii) none of the products that are or have been designed, created, developed, assembled, manufactured or sold by the Borrower or any of its Subsidiaries is infringing, misappropriating, or making any unlawful use of any Intellectual Property owned by any other Person, and the Borrower and its Subsidiaries have all rights and licenses reasonably necessary in order to make, have made, use or sell such products, (iii) no other Person is infringing, misappropriating or making any unlawful use of, and no Intellectual Property owned or used by any other Person infringes on any Owned Intellectual Property, and (iv) there is no claim, suit, action or proceeding pending or threatened or asserted against the Borrower or any of its Subsidiaries: (A) alleging any conflict or infringement by the Borrower or any of its Subsidiaries of any other Person's intellectual property or proprietary rights; or (B) challenging the Borrower's or any of its Subsidiaries' ownership or use of, or the validity or enforceability of, any of the Owned Intellectual Property or the Licensed Intellectual Property. SECTION 3.16. COMPLIANCE WITH LAWS. The Borrower and the Subsidiaries are in compliance with all occupational safety, health, wage and hour, employment discrimination, environmental, flammability, labeling and other Applicable Law which are material to the Business Operations, except where such non-compliance would not, individually or in the aggregate, have a Material Adverse Effect. Neither the Borrower nor any Subsidiary is aware of any state or facts, events, conditions or occurrences which may now or hereafter constitute or result in a violation of any Applicable Law, or which may give rise to the assertion of any such violation, which could have a Material Adverse Effect. Neither the Borrower nor any Subsidiary has received written notice of default or violation, nor is the Borrower or any Subsidiary in default or violation, with respect to any judgment, order, writ, injunction, decree, demand or assessment issued by any court or any federal, state, local, municipal or other governmental agency, board, commission, bureau, instrumentality or department, domestic or foreign, relating to any aspect of the Borrower's or any Subsidiaries' business, affairs, properties or assets. Neither the Borrower nor any Subsidiary has received written notice of or been charged with, or is, to the Borrower's Knowledge, under investigation with respect to, any violation of any provision of any Applicable Law, which violation would have a Material Adverse Effect. SECTION 3.17. LICENSES AND PERMITS. The Borrower and each Subsidiary has all federal, state and local licenses and permits required to be maintained in connection with and material to the Business Operations, and all such licenses and permits are valid and in full force and effect. The Borrower and each Subsidiary has complied with the requirements of such licenses and permits in all material respects, and has received no notice of any pending or threatened proceedings for the suspension, termination, revocation or limitation thereof. There is no circumstance or condition Known to the Borrower that would cause or permit any of such licenses or permits to be voided, revoked or withdrawn. 29 SECTION 3.18. INSURANCE. SCHEDULE 3.18 of the Disclosure Schedule lists all insurance coverages maintained by the Borrower on the date of this Agreement, including the names of insurers, policy limits and deductibles. The Borrower has not received written notice of cancellation or intent not to renew any of such policies, and there has not occurred, and there does not exist, any condition (other than general industry-wide conditions) such as would cause any of such insurers to cancel any of such insurance coverages, or would be reasonably likely to materially increase the premiums charged to the Borrower for coverages consistent with the scope and amounts of coverages as in effect on the date hereof. SECTION 3.19. ENVIRONMENTAL LAWS. (a) The Borrower and each Subsidiary has complied in all material respects with all Environmental Laws relating to its business and properties, and to the Knowledge of the Borrower there exist no Hazardous Substances in amounts in violation of applicable Environmental Laws or underground storage tanks on any of the Real Properties the existence of which would have a Material Adverse Effect, except those that are stored and used in compliance with Applicable Laws. (b) Neither the Borrower nor any Subsidiary has received notice of any pending or threatened litigation or administrative proceeding which in any instance (i) asserts or alleges any violation of applicable Environmental Laws on the part of the Borrower or any Subsidiary, (ii) asserts or alleges that the Borrower or any Subsidiary is required to clean up, remove or otherwise take remedial or other response action due to the disposal, depositing, discharge, leaking or other release of any Hazardous Substances or materials, or (iii) asserts or alleges that the Borrower or any Subsidiary is required to pay all or any portion of the costs of any past, present or future cleanup, removal or remedial or other response action which arises out of or is related to the disposal, depositing, discharge, leaking or other release of any hazardous substances or materials by the Borrower or any Subsidiary. To the Borrower's Knowledge, neither the Borrower nor any Subsidiary is subject to any judgment, decree, order or citation related to or arising out of any Environmental Laws. To the Borrower's Knowledge, neither the Borrower nor any Subsidiary has been named or listed as a potentially responsible party by any governmental body or agency in any matter arising under any Environmental Laws. Neither the Borrower nor any Subsidiary is a participant in, nor does the Borrower have Knowledge of, any governmental investigation involving any of the Real Properties. (c) Neither the Borrower or any Subsidiary nor, to the Borrower's Knowledge, any other person, firm, corporation or governmental entity has caused or permitted any Hazardous Substances or other materials to be stored, deposited, treated, recycled or disposed of on, under or at any of the Real Properties which materials, if known to be present, would reasonably be expected to require or authorize cleanup, removal or other remedial action under any applicable Environmental Laws. (d) As used in this Section 3.19 and in Section 5.08 below, the following terms have the following meanings: "ENVIRONMENTAL LAWS" include all federal, state, and local laws, rules, regulations, ordinances, permits, orders, and consent decrees agreed to by the Borrower or any Subsidiary 30 relating to health, safety, and environmental matters applicable to the business and property of the Borrower or any Subsidiary. Such laws and regulations include but are not limited to the Resource Conservation and Recovery Act ("RCRA"), 42 U.S.C. ss.6901 et seq., as amended; the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), 42 U.S.C. ss.9601 et seq., as amended; the Toxic Substances Control Act ("TSCA"), 15 U.S.C. ss.2601 et seq., as amended; and the Clean Water Act, 33 U.S.C. ss.1331 et seq., as amended. "HAZARDOUS SUBSTANCES", "RELEASE", "RESPOND" and "RESPONSE" shall have the meanings assigned to them in CERCLA, 42 U.S.C. ss.9601, as amended. "NOTICE" means any actual summons, citation, directive, information request, notice of potential responsibility, notice of violation or deficiency, order, claim, complaint, investigation, proceeding, judgment, letter, or other communication, written or oral, from the United States Environmental Protection Agency or other federal, state, or local agency or authority, or any other entity or individual, public or private, concerning any intentional or unintentional act or omission which involves management of Hazardous Substances in amounts in violation of Environmental Laws on or off any Real Properties; the imposition of any lien on any Real Properties, including but not limited to liens asserted by government entities in connection with any Borrower's or Subsidiary's response to the presence or Release of Hazardous Substances in amounts in violation of Environmental Laws; and any alleged violation of or responsibility under any Environmental Laws. SECTION 3.20. SENSITIVE PAYMENTS. Neither the Borrower nor any Subsidiary has (a) made any contributions, payments or gifts to or for the private use of any governmental official, employee or agent where either the payment or the purpose of such contribution, payment or gift is illegal under the laws of the United States or the jurisdiction in which made, (b) established or maintained any unrecorded fund or asset for any purpose or made any false or artificial entries on its books, (c) made any payments to any person with the intention that any part of such payment was to be used for any purpose other than that described in the documents supporting the payment, or (d) engaged in any "trading with the enemy" or other transactions violating any rules or regulations of the Office of Foreign Assets Control or any similar laws, rules or regulations. SECTION 3.21. FULL DISCLOSURE. No statement of fact made by the Borrower in this Agreement or any other Loan Document, in any SEC Report, or in any information memorandum, business summary, agreement, certificate, schedule or other written statement furnished by the Borrower or any Subsidiary to the Lender pursuant hereto, contains or will contain any untrue statement of a material fact, or omits or will omit to state any material fact necessary to make any statements contained herein or therein not misleading. Except for matters of a general economic or political nature which do not affect the Borrower or any Subsidiary uniquely, there is no fact presently known to the Borrower which has not been disclosed to the Lender, which has had or would reasonably be expected to have a Material Adverse Effect. SECTION 3.22. REAFFIRMATION. Each and every request by the Borrower for an Advance shall constitute a reaffirmation of the truth and accuracy of the Borrowers' and each Subsidiary's representations and warranties made in this Agreement and the Security Documents on and as of the date of such request. 31 IV. CONDITIONS OF MAKING THE LOANS A. The obligation of the Lender to make the initial Loan hereunder and to consummate the other transactions contemplated hereby are subject to the following conditions precedent: SECTION 4.01. REPRESENTATIONS AND WARRANTIES. The representations and warranties set forth in Article III hereof and in the other Loan Documents shall be true and correct on and as of the Closing Date. SECTION 4.02. LOAN DOCUMENTS. The Borrower and its Subsidiaries (as applicable) shall have duly executed and/or delivered to the Lender all of the following: (a) The Notes; (b) The Guaranty Agreement, the Collateral Agreement and any and all other Security Documents required by the Lender at the Closing Date (including, without limitation, a Control Agreement or escrow agreement (in form satisfactory to the Lender) in respect of the Escrow Account, and any Landlord Waivers, warehousemen's waivers, bailee letters or consents required by the Lender); (c) The Warrants; (d) The Registration Rights Agreement; (e) A certificate or certificates of insurance, with loss payable endorsements, evidencing the insurance required by Section 5.01(d) below; PROVIDED, HOWEVER, that this condition precedent shall be deemed to be satisfied with respect to foreign insurance coverages if the Borrower provides reasonable evidence to the Lender of the existence and amounts of such insurance on the Closing Date; (f) A current Borrowing Base report in conformity with Section 5.04(d) below, and a written request for the borrowing of the Term Loan and the initial Advance; (g) A certificate of the Secretary or an Assistant Secretary of the Borrower and each Subsidiary, certifying the vote of the Boards of Directors or other governing body of the Borrower and each Subsidiary, authorizing and directing the execution and delivery of the Loan Documents and all further agreements, instruments, certificates and other documents pursuant hereto and thereto; (h) A certificate of the Secretary or an Assistant Secretary of the Borrower and each Subsidiary, certifying the names of the officers of the Borrower and each Subsidiary who are authorized to execute and deliver the Loan Documents and all other agreements, instruments, certificates and other documents to be delivered pursuant hereto and thereto, together with the true signatures of such officers. The Lender may conclusively rely on such certificate until the Lender shall receive any further such certificate canceling or amending the prior certificate and submitting the signatures of the officers named in such further certificate; 32 (i) Certified copies of the Organic Documents of the Borrower and each Subsidiary, and a certificate of the Secretary of State or other appropriate official of the jurisdiction of incorporation of the Borrower and each Subsidiary and of each jurisdiction in which the Borrower and each Subsidiary is qualified to do business as a foreign corporation, dated reasonably prior to the Closing Date, stating that the Borrower and each Subsidiary is duly formed or qualified and in good standing in such jurisdiction; PROVIDED, HOWEVER, that with respect to any Foreign Subsidiary, (i) the delivery of uncertified copies of its Organic Documents shall be satisfactory, and (ii) no certificate of good standing need be delivered if the subject jurisdiction does not issue such certificates or comparable documents; (j) Such other agreements, instruments, documents and certificates (including, without limitation, satisfactory lien and judgment searches respecting the Borrower) as the Lender or its counsel may reasonably request. SECTION 4.03. LENDER SHARES. The Borrower shall have delivered to the Lender one or more stock certificates representing, in the aggregate, the 1,500,000 Lender Shares. SECTION 4.04. TERMINATION OF FACTORING AGREEMENT; DYNE REPAYMENT. (a) The Borrower shall have delivered to the Lender a written agreement, in form and substance reasonably satisfactory to the Lender, evidencing the termination of the Factoring Agreement and the absence of any continuing obligations thereunder. (b) The Borrower shall have delivered to the Lender a written agreement, executed by Mark Dyne in favor of the Borrower and in form and substance reasonably satisfactory to the Lender, confirming the amounts payable to Mark Dyne on the Closing Date in respect of the Borrower's outstanding Indebtedness owed to Mark Dyne, and confirming that, upon receipt of such amount (plus any applicable per diem interest) by Mark Dyne on the Closing Date, all liens and security interests held by Mark Dyne in or upon any assets or properties of the Borrower and its Subsidiaries shall be released and may be terminated of record. SECTION 4.05. LEGAL OPINION. The Lender shall have received a written opinion of Stubbs Alderton & Markiles, LLP, counsel for the Borrower and the Subsidiaries, dated the Closing Date, satisfactory to the Lender and its counsel in scope and substance. SECTION 4.06. FEES AND REIMBURSEMENTS. The Borrower shall have paid to the Lender the Closing Fee and the initial Monitoring Fee, and shall have paid or reimbursed the Lender for its reasonable out-of-pocket costs, charges and expenses incurred to the Closing Date (up to a maximum of $75,000); and in connection herewith, the Borrower hereby irrevocably authorizes the Lender to charge such amounts as Advances to the Borrower's revolving credit loan account. Failure of the Lender to effect any such charge shall not excuse the Borrower from its obligation to pay such amounts. SECTION 4.07. FURTHER MATTERS. All legal matters, and the form and substance of all documents, incident to the transactions contemplated hereby shall be satisfactory to the Lender and its counsel. 33 SECTION 4.08. NO DEFAULT. No Default or Event of Default shall have occurred and be continuing. B. The obligation of the Lender to make any Advances subsequent to the Closing Date is subject to (a) the representations and warranties set forth in Article III and in the other Loan Documents being true and correct in all material respects (except that, to the extent that any representation or warranty is already qualified by concepts of materiality and/or Material Adverse Effect, then such representations and warranties shall be true and correct in all respects) on and as of the subject Borrowing Date, (b) the Lender's receipt of a current Borrowing Base report in conformity with Section 5.04(d) below, (c) the execution and delivery of such further Security Documents as the Lender may have reasonably requested pursuant to the Security Documents theretofore executed and delivered, and (d) there being no continuing Default or Event of Default. V. AFFIRMATIVE COVENANTS The Borrower hereby covenants and agrees that, from the date hereof and until all Obligations (whether now existing or hereafter arising) have been paid in full and the Revolving Credit Commitment has been terminated, unless the Lender shall otherwise consent in writing, the Borrower shall, and shall cause each of its Subsidiaries to: SECTION 5.01. CORPORATE AND INSURANCE. Do or cause to be done all things necessary to at all times (a) preserve, renew and keep in full force and effect its corporate or other legal existence, rights, licenses, permits and franchises, (b) comply with the Loan Documents and any other agreements and instruments executed and delivered hereunder and thereunder (to the extent a party thereto), (c) maintain, preserve and protect all of its franchises and material trade names, and preserve all of its material property used or useful in the conduct of its business and keep the same in good repair, working order and condition (reasonable wear and tear excepted), and from time to time make, or cause to be made, all needed and proper repairs, renewals, replacements, betterments and improvements thereto, so that the Business Operations carried on in connection therewith may be properly and advantageously conducted at all times, (d) maintain insurance in amounts, on such terms and against such risks (including fire and other hazards insured against by extended coverage, and public liability insurance covering claims for personal injury, death or property damage) as are customary for companies of similar size in the same or similar businesses and operating in the same or similar locations, as well as all such other insurance as is required by the Collateral Agreement, each of which policies (other than workers compensation) shall be issued by a financially sound and reputable insurer reasonably satisfactory to the Lender and shall name the Lender as loss payee and additional insured as its interest appears and provide for the Lender to receive written notice thereof at least thirty (30) days prior to any cancellation of the subject policy, and (e) comply with all material Contracts and material obligations to which it is a party or by which it is bound, all benefit plans which it maintains or is required to contribute to, and all Applicable Law (including, without limitation, Environmental Laws) material to its Business Operations, and all requirements of its insurers, whether now in effect or hereafter enacted, promulgated or issued. The Borrower will provide to the Lender a certificate of the foregoing insurance, promptly upon request; and, without limitation of the foregoing, to the extent that certificates of foreign insurance were not delivered to the Lender on the Closin 34 Date in accordance with Section 4.02(e) above, such certificates shall be delivered to the Lender within sixty (60) days after the Closing Date. SECTION 5.02. PAYMENT OF TAXES. File, pay and discharge, or cause to be paid and discharged, all material taxes, assessments and governmental charges or levies imposed upon the Borrower and/or any Subsidiary or upon its income and profits or upon any of its property (real, personal or mixed) or upon any part thereof, before the same shall become in default, as well as all lawful claims for labor, materials, supplies and otherwise, which, if unpaid when due, might become a Lien or charge upon such property or any part thereof; PROVIDED, HOWEVER, that neither the Borrower nor any Subsidiary shall be required to pay and discharge or cause to be paid and discharged any such tax, assessment, charge, levy or claim so long as (a) the validity thereof shall be contested in good faith by appropriate proceedings and the Borrower or such Subsidiary shall have set aside on its books adequate reserves (to the extent required by GAAP) with respect to any such tax, assessment, charge, levy or claim so contested, and (b) payment with respect to any such tax, assessment, charge, levy or claim shall be made before any of the Borrower's or such Subsidiary's property shall be seized or sold in satisfaction thereof. SECTION 5.03. NOTICES. Give prompt written notice to the Lender of (a) the filing by the Borrower of any SEC Reports, (b) any proceedings instituted against the Borrower or any Subsidiary in any federal or state court or before any commission or other regulatory body, whether federal, state or local, which, if adversely determined, could reasonably be expected to have a Material Adverse Effect (c) occupancy of any new or additional Real Property, and (d) the occurrence of any material casualty to any Collateral, any Material Adverse Effect, or any Default or Event of Default, and the action that the Borrower has taken, is taking, or proposes to take with respect thereto. SECTION 5.04. PERIODIC REPORTS. Furnish to the Lender: (a) Within ninety (90) calendar days after the end of each Fiscal Year, consolidated balance sheets, and consolidated and consolidating statements of income, statements of stockholders' equity, and statements of cash flows of the Borrower and its Subsidiaries, together with footnotes and supporting schedules thereto, certified (as to the consolidated statements) by independent certified public accountants selected by the Borrower and reasonably satisfactory to the Lender, showing the financial condition of the Borrower and its Subsidiaries at the close of such Fiscal Year and the results of operations of the Borrower and its Subsidiaries during such Fiscal Year; (b) Within thirty (30) calendar days after the end of each calendar month (forty-five (45) calendar days in the case of the end of a fiscal quarter), consolidated (and, if specifically requested by the Lender reasonably in advance, consolidating) unaudited balance sheets, statements of income and statements of cash flows of the Borrower and its Subsidiaries, in each case with supporting schedules thereto, prepared by the Borrower and certified by the Borrower's Chairman, President, Chief Executive Officer, Chief Financial Officer or Chief Accounting Officer, such balance sheets to be as of the close of such calendar month and such statements of income and statements of cash flows to be for the period from the beginning of the then-current Fiscal Year to the end of such calendar month, together with comparative statements 35 of income and cash flows for the corresponding period in the immediately preceding Fiscal Year, in each case subject to normal audit and year-end adjustments; (c) Concurrently with the delivery of each of the financial statements required by Sections 5.04(a) and 5.04(b) above, a certificate on behalf of the Borrower (signed by the Chairman, President, Chief Executive Officer, Chief Financial Officer or Chief Accounting Officer of the Borrower), certifying that he has examined the provisions of this Agreement and that, to the best of his knowledge, no Default or Event of Default (including, without limitation, under Sections 6.16 and 6.17 below, as demonstrated by detailed calculations included in such certificate) has occurred and/or is continuing; (d) On or prior to the fifth (5th) calendar day of each calendar month, a detailed calculation of the Borrowing Base as of the end of the immediately preceding calendar month, in form and substance, and with supporting documentation (including, without limitation, receivables and payables agings as of the close of the immediately preceding calendar month) as may reasonably be required by the Lender; and, on or prior to the twentieth (20th) calendar day of each calendar month, a report on accounts receivable balances of the Borrower and its Subsidiaries as of the fifteenth (15th) calendar day of such calendar month; (e) As soon as approved by the Borrower's Board of Directors (but in any event not later than thirty (30) days after the beginning of each Fiscal Year), a budget and operating plan (on a quarter-by-quarter basis) for such Fiscal Year, in such detail as may reasonably be required by the Lender; (f) As and when distributed to the Borrower's shareholders, copies of all proxy materials, reports and other information which the Borrower provides to its shareholders; and as and when distributed to any other holders of Indebtedness of the Borrower or the Subsidiaries, copies of all reports, statements and other information provided to such lenders; and (g) Promptly, from time to time, such other information (including, without limitation, receivables and payables agings, and sales reports) regarding the Borrower's or any Subsidiary's operations, assets, business, affairs and financial condition, as the Lender may reasonably request. To the extent that the financial statements required by Sections 5.04(a) and 5.04(b) are contained in any SEC Reports filed by the Borrower within the required time period hereunder for the delivery of such financial statements, then the Borrower shall be deemed to have complied with the subject financial statement delivery by notifying the Lender of the filing of the subject SEC Report. To the extent that any report or other delivery required under this Section 5.04 or elsewhere in this Agreement will, at the time of anticipated delivery to the Lender, contain any material non-public information, the Borrower will notify the Lender thereof as promptly as practicable prior to the delivery of such report (but without disclosing the specific items of material non-public information or the nature thereof), and if so requested by the Lender prior to the required date of the information delivery hereunder, the Borrower shall (x) if reasonably practicable, redact such 36 material non-public information from the subject report prior to the delivery thereof to the Lender, or (y) defer delivery of such report until such time as the Borrower has made public disclosure of the subject material information or the Lender has affirmatively requested delivery of such report. Absent timely request by the Lender as aforesaid, the Borrower shall make the required delivery to the Lender on a timely basis. SECTION 5.05. BOOKS AND RECORDS; INSPECTION. Maintain centralized books and records regarding all of the Business Operations at the Borrower's principal place of business, and permit agents or representatives of the Lender to inspect, at any time during normal business hours, upon reasonable notice, and without undue material disruption of the Business Operations, all of the Borrower's and its Subsidiaries' various books and records, to make copies, abstracts and/or reproductions thereof, and to discuss the business and affairs of the Borrower and the Subsidiaries with the management of the Borrower; and the Lender shall maintain the confidentiality of any Confidential Information so obtained, as and to the extent required under Section 9.13 below, and shall not trade in any securities of the Borrower utilizing any of such Confidential Information. SECTION 5.06. ACCOUNTING. Maintain a standard system of accounting in order to permit the preparation of financial statements in accordance with GAAP and Regulation S-X promulgated under the Act. SECTION 5.07. REIMBURSEMENTS. Pay or reimburse the Lender or other appropriate Persons on demand for all reasonable costs, expenses and other charges incurred or payable from time to time in connection with the transactions contemplated by this Agreement, any waivers or amendments in respect of any Loan Documents (whether or not completed or executed), and any "workout" or enforcement action (whether or not consummated or completed, and regardless of the outcome thereof), including but not limited to any and all search fees, recording fees, costs of inspections, reasonable legal and accounting fees, and costs related to routine Exchange Act filings in respect of the Lender's and its Affiliates' position in securities of the Borrower. SECTION 5.08. ENVIRONMENTAL RESPONSE. In the event of any material discharge, spill, injection, escape, emission, disposal, leak or other Release of Hazardous Substances in amounts in violation of applicable Environmental Laws by the Borrower or any Subsidiary on any Real Property owned or leased by the Borrower or any Subsidiary, which is not authorized by a permit or other approval issued by the appropriate governmental agencies and which requires notification to or the filing of any report with any federal or state governmental agency, the Borrower shall promptly: (a) notify the Lender; and (b) comply with the notice requirements of the Environmental Protection Agency and applicable state agencies, and take all steps necessary to promptly clean up such discharge, spill, injection, escape, emission, disposal, leak or other Release in accordance with all applicable Environmental Laws and the Federal National Contingency Plan, and, if required, receive a certification from all applicable state agencies or the Environmental Protection Agency, that such Real Property has been cleaned up to the satisfaction of such agency(ies). SECTION 5.09. MANAGEMENT. Cause Stephen Forte to continue to be employed or to function as the Chief Executive Officer of the Borrower, unless a successor is appointed within 37 sixty (60) days after the termination of Mr. Forte's employment and such successor is reasonably satisfactory to the Lender. SECTION 5.10. USE OF PROCEEDS. Cause all proceeds of the Loans to be utilized solely in the manner and for the purposes set forth in Section 2.04 above. SECTION 5.11. FUTURE SUBSIDIARIES. At any time and from time to time when the Borrower or any of its Subsidiaries proposes to form or acquire any Subsidiary subsequent to the Closing Date, the Borrower shall give written notice thereof to the Lender reasonably in advance of (and in no event less than fifteen (15) days prior to) the formation or acquisition of such Subsidiary, accompanied by true and complete copies of the Organic Documents of such Subsidiary and stating, with respect to such Subsidiary, (a) its proper legal name, (b) its jurisdiction of incorporation or formation, (c) the jurisdictions (if any) in which it is qualified or is required to be qualified to do business as a foreign entity, (d) the number of shares of capital stock, equity securities or ownership interests outstanding, and (e) the record owners of such outstanding capital stock, equity securities or other ownership interests; and contemporaneously with the formation or acquisition of such new Subsidiary, such new Subsidiary shall be deemed to have made and joined in all of the representations and warranties made by the Borrower in this Agreement and the other Loan Documents (all of which shall be applicable to such new Subsidiary as if named therein), and the Borrower shall cause such new Subsidiary to execute and deliver to the Lender (i) a Guaranty Agreement in substantially the form of the Guaranty Agreement as then in effect (or a joinder agreement with respect to the existing Guaranty Agreement in form and substance reasonably satisfactory to the Lender), and (ii) a Collateral Agreement (with completed perfection certificate and other appropriate Security Documents) in substantially the form of the Collateral Agreement as then in effect (or a joinder agreement with respect to the existing Collateral Agreement in form and substance reasonably satisfactory to the Lender) and other Security Documents as reasonably requested by the Lender. SECTION 5.12. LANDLORD WAIVERS. To the extent requested by the Lender from time to time subsequent to the Closing Date, use their commercially reasonable efforts to obtain, within thirty (30) days after the Lender's request therefor, in form and substance reasonably satisfactory to the Lender, any and all bailee waivers, warehousemen's waivers, Landlord Waivers and/or access agreements requested by the Lender in respect of locations where there is stored or held Collateral having an aggregate fair market value in excess of $100,000. This Section 5.12 shall not require the Borrower or any Subsidiary to obtain waivers or access agreements from vendors or suppliers holding Collateral only for drop shipment to the Borrower's or any Subsidiary's customers on behalf of the Borrower or any Subsidiary. SECTION 5.13. DEPOSIT ACCOUNTS. Notify the Lender upon opening any new bank account, and cause the subject bank or securities intermediary promptly to execute and deliver to the Lender a Control Agreement in respect of such bank account or securities account; and this Section 5.13 shall also be applicable to any and all bank accounts for which Control Agreements have not been entered into on the Closing Date if (a) the funds in such bank account exceed $75,000 (or the Dollar equivalent), or (ii) the funds held in the Bank Accounts for which Control Agreements are not in place exceed $300,000 (or the Dollar equivalent) in the aggregate; and to the extent that a required Control Agreement is not entered into within sixty (60) days after the Closing Date, then the subject bank account(s) shall be promptly closed and the funds held 38 therein shall be transferred to one or more accounts at another banking institution which has executed and delivered a Control Agreement in respect of such account(s) in form and substance satisfactory to the Lender. VI. NEGATIVE COVENANTS The Borrower hereby covenants and agrees that, until all Obligations (whether now existing or hereafter arising) have been paid in full and the Revolving Credit Commitment has been terminated, unless the Lender shall otherwise consent in writing, the Borrower shall not, and shall not permit any Subsidiary to, directly or indirectly: SECTION 6.01. INDEBTEDNESS. Incur, create, assume, become or be liable in any manner with respect to, or permit to exist, any Indebtedness, OTHER THAN: (a) Indebtedness to the Lender pursuant to the Loan Documents; (b) liabilities with respect to trade obligations, accounts payable, advances, royalty or other similar payments, operating leases and other normal accruals incurred in the ordinary course of business, or with respect to which the Borrower or the subject Subsidiary is contesting in good faith the amount or validity thereof by appropriate proceedings, and then only to the extent that the Borrower or the subject Subsidiary has set aside on its books adequate reserves therefor; (c) Indebtedness existing on the date of this Agreement owed to those Persons, in those amounts and having those maturities as set forth in SCHEDULE 3.01 of the Disclosure Schedule; (d) Capitalized Leases reflected in the Financial Statements, and Capitalized Leases hereafter entered into by the Borrower or its Subsidiaries, subject to the limitations of Section 6.16 below; (e) purchase money Indebtedness incurred in connection with the Borrower's or its Subsidiaries' acquisition of capital assets, subject to the limitations of Section 6.16 below; (f) Subordinated Debt in such amounts and upon such terms and conditions as shall be acceptable to the Lender in its sole and absolute discretion; (g) intercompany Indebtedness between the Borrower and any Wholly-Owned Subsidiary or between Wholly-Owned Subsidiaries; PROVIDED, HOWEVER, that the aggregate intercompany Indebtedness owed by Foreign Subsidiaries to the Borrower or any Domestic Subsidiary, when aggregated with the amount of all other Investments in Foreign Subsidiaries (excluding any equipment presently owned by the Borrower or any Domestic Subsidiary which is hereafter transferred to any Foreign Subsidiary) and the face amount of all Guarantees made by the Borrower or its Domestic Subsidiaries in respect of obligations of Foreign Subsidiaries, shall not at any time exceed the sum of the net such intercompany Indebtedness on the Closing Date plus $1,800,000 (or the Dollar equivalent) (the "FOREIGN INVESTMENT LIMITATION"); PROVIDED, HOWEVER, that intercompany Indebtedness between the Borrower or any Domestic Subsidiary and A.S.G. Stationary, Inc. and/or Tag-It de Mexico, S.A. C.V. shall be excluded from intercompany 39 Indebtedness for purposes of this limitation, and no increase in Indebtedness and no further advances to or Investments in either such entity from and after May 1, 2007 shall be permitted. (h) Guarantees to the extent permitted pursuant to Section 6.03 below. SECTION 6.02. LIENS. Create, incur, assume or suffer to exist any Lien or other encumbrance of any nature whatsoever on any of its assets, now or hereafter owned, other than: (a) subject to Section 5.02 above, Liens securing the payment of taxes which are either not yet due or the validity of which is being contested in good faith by appropriate proceedings, and as to which the Borrower or the subject Subsidiary shall have set aside on its books adequate reserves; (b) deposits under workers' compensation, unemployment insurance and social security laws, or to secure the performance of bids, tenders, contracts (other than for the repayment of money borrowed) or leases, or to secure statutory obligations or surety or appeal bonds, or to secure indemnity, performance or other similar bonds in the ordinary course of business; (c) statutory Liens of landlords and Liens imposed by law, such as, carriers', warehousemen's, materialmen's or mechanics' liens, incurred by the Borrower or any Subsidiary in good faith in the ordinary course of business and discharged promptly after same are incurred; fully bonded Liens arising out of a judgment or award against the Borrower or any Subsidiary with respect to which the Borrower or such Subsidiary shall currently be prosecuting an appeal, a stay of execution pending such appeal having been secured; and Liens arising out of a judgment or award against the Borrower or any Subsidiary which are fully covered by insurance (subject to applicable deductibles) and for which the relevant insurer has not denied or disclaimed coverage; (d) other Liens incurred in connection with Indebtedness expressly permitted pursuant to Section 6.01(d) and/or Section 6.01(e) above, provided that such Liens do not extend to any assets or property other than the specific assets or properties acquired pursuant to such permitted Indebtedness; (e) encumbrances consisting of easements, rights-of-way, survey exceptions and other similar restrictions on the use of Real Property, or minor irregularities in title thereto which do not materially impair the use of such property in the operation of the business of the Borrower and its Subsidiaries; (f) Liens in existence on the date of this Agreement, as set forth on SCHEDULE 6.02 of the Disclosure Schedule; (g) Liens arising out of judgments or awards (i) which are fully covered by insurance (subject to applicable deductibles) and for which the relevant insurer has not denied or disclaimed coverage, or (ii) with respect to which the Borrower or the subject Subsidiary shall be prosecuting an appeal in good faith and in respect of which a stay of execution shall have been issued; (h) Liens in favor of the Lender; and 40 (i) extensions, renewals or replacements of any Lien referred to in clauses (a) through (f) above, provided that same shall not extend such Lien to any additional assets or effect any increase in any principal amount secured thereby. SECTION 6.03. GUARANTEES. Guarantee, endorse or otherwise in any manner become or be responsible for obligations of any other Person, except (a) endorsements of negotiable instruments for collection in the ordinary course of business, (b) subject to the Foreign Investment Limitation, Guarantees by the Borrower of obligations of Wholly-Owned Subsidiaries in the ordinary course of business. SECTION 6.04. SALES OF ASSETS AND MANAGEMENT. (a) Sell, lease, transfer, encumber or otherwise dispose of any of the Borrower's or any Subsidiary's properties, assets, rights, licenses or franchises other than (i) sales of inventory in the ordinary course of business, (ii) licenses, joint ventures and related transactions entered into, modified or terminated in the ordinary course of business, (iii) the disposition of surplus or obsolete personal properties in the ordinary course of business, including the disposition of the Owned Real Property located in Kings Mountain, North Carolina for a gross sales price of not less than $800,000, or (b) permit any Affiliate of the Borrower (other than a Subsidiary which is a party to the Collateral Agreement) to own or obtain any patent, patent application, copyright, copyright application, trademark, trademark application, license, or other intangible asset relating to the Business Operations except in the normal course of business on terms and conditions no less favorable to the Borrower or any Subsidiary than those which could be obtained in an arms' length transaction with an unaffiliated third party. SECTION 6.05. SALE-LEASEBACK. Enter into any arrangement, directly or indirectly, with any Person whereby the Borrower or any Subsidiary shall sell or transfer any property (real, personal or mixed) used or useful in the Business Operations, whether now owned or hereafter acquired, and thereafter rent or lease such property. SECTION 6.06. INVESTMENTS; ACQUISITIONS. Make any Investment in, or otherwise acquire or hold securities (including, without limitation, capital stock and evidences of Indebtedness) of, or make loans or advances to, or enter into any arrangement for the purpose of providing funds or credit to, any other Person (including any Affiliate), EXCEPT: (a) Investments in Wholly-Owned Subsidiaries which have complied with the requirements of Section 5.11 hereof (subject, in the case of Foreign Subsidiaries, to the Foreign Investment Limitation); (b) advances (to the extent permitted by Applicable Law, including federal securities laws) to employees of the Borrower or any Wholly-Owned Subsidiaries for normal business expenses not to exceed at any time $10,000 in the aggregate; (c) Investments of excess cash generated in the Business Operations in Cash Equivalents; and (d) Investments of cash in overnight deposits or other customary cash management Investments with commercial banks or in commercial paper satisfying the criteria for such banks or commercial paper as set forth in the definition of Cash Equivalents. 41 SECTION 6.07. CORPORATE FORM; ACQUISITIONS. Purchase or acquire any Real Property or any ownership interest in any Real Property; or dissolve or liquidate, or consolidate or merge with or into, sell all or substantially all of the assets of the Borrower or any Subsidiary to, or acquire all or substantially all of the securities, assets or properties of, any other Person, except for (a) consolidations of a Subsidiary with a Wholly-Owned Subsidiary (provided that no Domestic Subsidiary shall be consolidated with a Foreign Subsidiary); (b) mergers of a Wholly-Owned Subsidiary into the Borrower or into a Wholly-Owned Subsidiary (provided that no Domestic Subsidiary shall be merged into any Foreign Subsidiary); or (c) sales to the Borrower or another Subsidiary for fair value. SECTION 6.08. DIVIDENDS AND REDEMPTIONS. Directly or indirectly declare or pay any dividends, or make any distribution of cash or property, or both, to any Person in respect of any of the shares of the capital stock or other equity securities of the Borrower or any other Person, or directly or indirectly redeem, purchase or otherwise acquire for consideration any securities or shares of the capital stock or other equity securities of the Borrower or any other Person; PROVIDED, that this Section 6.08 shall not be deemed to prohibit the payment of dividends or distributions by any Subsidiary to the Borrower or to any direct or indirect Wholly-Owned Domestic Subsidiary. SECTION 6.09. COMPENSATION. Directly or indirectly pay any cash compensation to any executive officers of the Borrower except in accordance with the compensation levels disclosed in SCHEDULE 6.09 of the Disclosure Schedule or as otherwise approved by the independent members of the Board of Directors of the Borrower but in no case in any amount or amounts which would cause or reasonably be expected to cause a Material Adverse Effect. SECTION 6.10. CHANGE OF BUSINESS. Directly or indirectly: (a) engage in a business materially different from the general nature of the Business Operations (i) as now being conducted, or (ii) as the same may hereafter be reasonably expanded from time to time in like areas of business; (b) wind up the Business Operations or cease substantially all of its normal Business Operations for a period in excess of ten (10) consecutive days; or (c) suffer any material disruption, interruption or discontinuance of a material portion of its normal Business Operations for a period in excess of ten (10) consecutive days. SECTION 6.11. RECEIVABLES. Sell or assign in any way any accounts receivable, promissory notes or trade acceptances held by the Borrower or any Subsidiary with or without recourse, except for collections (including endorsements) in the ordinary course of business. SECTION 6.12. CERTAIN AMENDMENTS. Agree, consent, permit or otherwise undertake to amend any of the terms or provisions of the Borrower's or any Subsidiary's Organic Documents in a manner which may impair in any respect any of the Lender's rights under any of the Loan Documents. SECTION 6.13. AFFILIATE TRANSACTIONS. Enter into any Contract, agreement or transaction with any Affiliate of the Borrower except (a) as disclosed in SCHEDULE 6.13 of the Disclosure Schedule, (b) for intercompany Indebtedness between the Borrower and any Wholly-Owned Subsidiary or between any Wholly-Owned Subsidiaries (subject to the limitations provided in Section 6.06(a) above), or (c) in the normal course of business on terms and conditions no less 42 favorable to the Borrower or any Subsidiary than those which could be obtained in an arms' length transaction with an unaffiliated third party. SECTION 6.14. FISCAL YEAR. Amend its Fiscal Year. SECTION 6.15. SUBORDINATED DEBT; COLIN DYNE INDEBTEDNESS. (a) Prepay any of the Indebtedness listed in SCHEDULE 3.01 of the Disclosure Schedule; or prepay, redeem or purchase any Subordinated Debt, or make any payment on any Subordinated Debt, in each case in violation of the applicable subordination agreement. (b) Make any payment on any Indebtedness owed to Colin Dyne except by means of dollar-for-dollar offset against amounts owed to the Borrower or any Domestic Subsidiary by Colin Dyne. SECTION 6.16. CAPITAL EXPENDITURES. Make aggregate Capital Expenditures (a) in excess of $500,000 during the period from the Closing Date through and including December 31, 2007, (b) in excess of $750,000 during the Fiscal Year ending December 31, 2008, and (c) in excess of fifty (50%) percent of Free Cash Flow in any Fiscal Year thereafter. SECTION 6.17. COVERAGE TEST. Permit, as of the end of any quarter of any Fiscal Year, EBITDA for the four (4) consecutive fiscal quarters then ended to exceed principal and interest payments by the Borrower and its Subsidiaries for such four (4) fiscal quarter period (excluding principal of the Convertible Debentures and principal payments made from a matched source where such matched source makes the payment); PROVIDED, HOWEVER, that the Lender shall not accelerate the Obligations by reason of any non-compliance with this Section 6.17 unless and until non-compliance herewith occurs as of the end of two (2) consecutive fiscal quarters. VII. DEFAULTS SECTION 7.01. EVENTS OF DEFAULT. Each of the following events is herein, and in the Notes, sometimes referred to as an Event of Default: (a) if any representation or warranty made herein or in any other Loan Document, or in any certificate, financial statement, Borrowing Base report, instrument or other written statement furnished by the Borrower or any Subsidiary in connection with this Agreement, any other Loan Document or any of the borrowings hereunder shall be false, inaccurate or misleading in any material respect when made or when deemed made hereunder; (b) any default in the payment of any principal or interest under any of the Notes or any other Obligations when the same shall be due and payable, whether at the due date thereof or at a date required for prepayment or by acceleration or otherwise, and the continuance of any such non-payment (in whole or in part) for a period of three (3) Business Days; (c) any default in the due observance or performance of any covenant, condition or agreement contained in any Section of Article VI hereof, which, if capable of being cured, is not fully cured within thirty (30) days after the occurrence thereof; 43 (d) any default in the due observance or performance of any covenant, condition or agreement to be observed or performed under Article V hereof, or otherwise pursuant to the terms hereof or any other Loan Document and not addressed in Sections 7.01(a), (b) or (c), and the continuance of such default unremedied for a period of thirty (30) days (five (5) Business Days in the case of Section 5.01(d) hereof) after written notice thereof to the Borrower, or such other cure period as may be provided in the applicable Loan Document; (e) any uncured default or event of default with respect to any Indebtedness of the Borrower or any of the Subsidiaries (other than to the Lender) in an amount in excess of $250,000, if the effect of such default or event of default is to permit the holder, with or without notice or lapse of time or both, to accelerate the maturity of any such Indebtedness for money borrowed or to cause such Indebtedness for money borrowed to become due prior to the stated maturity thereof; (f) if the Borrower or any Subsidiary shall: (i) apply for or consent to the appointment of a receiver, trustee, custodian or liquidator of it or any of its properties, (ii) admit in writing its inability to pay its debts as they mature, (iii) make a general assignment for the benefit of creditors, (iv) be adjudicated a bankrupt or insolvent or be the subject of an order for relief under Title 11 of the United States Code or any bankruptcy, reorganization, insolvency, readjustment of debt, dissolution or liquidation law or statute of any other jurisdiction or foreign country, or (v) file a voluntary petition in bankruptcy, or a petition or an answer seeking reorganization or an arrangement with creditors or to take advantage or any bankruptcy, reorganization, insolvency, readjustment of debt, dissolution or liquidation law or statute, or an answer admitting the material allegations of a petition filed against it in any proceeding under any such law, or (vi) take or permit to be taken any action in furtherance of or for the purpose of effecting any of the foregoing; (g) if any order, judgment or decree shall be entered, without the application, approval or consent of the Borrower or any Subsidiary, by any court of competent jurisdiction, approving a petition seeking liquidation or reorganization of the Borrower or any Subsidiary, or appointing a receiver, trustee, custodian or liquidator of the Borrower or any Subsidiary, or of all or any substantial part of its assets, and such order, judgment or decree shall continue unstayed and in effect for any period of sixty (60) days; (h) if final judgment(s) or administrative order for the payment of money in an uninsured amount in excess of $50,000 individually or in the aggregate shall be rendered against the Borrower and/or any Subsidiary, and the same shall remain undischarged or unbonded for a period of thirty (30) consecutive days, during which execution shall not be effectively stayed; (i) the occurrence of any levy upon or seizure or attachment of, or any uninsured loss of or damage to, any property of the Borrower or any Subsidiary having an aggregate fair value or repair cost (as the case may be) in excess of $50,000 individually or in the aggregate, and any such levy, seizure or attachment shall not be set aside, bonded or discharged within thirty (30) days after the date thereof; 44 (j) if any Lien purported to be created by any Security Document shall cease to be a valid perfected first priority Lien (subject only to any priority accorded by law to Permitted Liens) on the assets or properties covered thereby, or the Borrower or any Subsidiary shall assert in writing that any Lien purported to be created by any Security Document is not a valid perfected first priority lien (subject only to any priority accorded by law to Permitted Liens, and any priority granted to a replacement revolving credit lender with respect to Accounts and inventory as contemplated by Section 2.01(g) above) on the assets or properties purported to be covered thereby; or if any Subsidiary which is a Wholly-Owned Subsidiary shall cease to be a Wholly-Owned Subsidiary; (k) if any of the Loan Documents shall, other than by reason of the Lender's default, bankruptcy or insolvency, cease to be in full force and effect (other than as a result of the discharge thereof in accordance with the terms thereof or by written agreement of all parties thereto); (l) if the Common Stock shall not be listed or traded on any national securities exchange or any NASDAQ market, or shall cease to be listed or quoted on the OTC Bulletin Board, for any period in excess of thirty (30) consecutive days; or (m) if the Borrower or any Subsidiary shall be indicted for, convicted of or plead NOLO CONTENDERE to any criminal offense; or (n) the occurrence of a Material Adverse Effect. SECTION 7.02. REMEDIES. Upon the occurrence of any Event of Default, and at all times thereafter during the continuance thereof: (a) the Notes, and any and all other Obligations, shall, at the Lender's option (except in the case of Sections 7.01(f) and 7.01(g) hereof, the occurrence of which shall automatically effect acceleration, regardless of any action or forbearance in respect of any prior or ongoing Default or Event of Default which may be inconsistent with such automatic acceleration), become immediately due and payable, both as to principal, interest and other charges, without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived, anything contained herein or in the Notes or other evidence of such Obligations to the contrary notwithstanding, (b) all outstanding Obligations under the Notes, and all other outstanding Obligations, shall bear interest at the default rates of interest provided in the Notes, (c) the Lender may file suit against the Borrower on the Notes and against the Borrower and the Subsidiaries under the other Loan Documents and/or seek specific performance or injunctive relief thereunder (whether or not a remedy exists at law or is adequate), (d) the Lender shall have the right, in accordance with the Security Documents, to exercise any and all remedies in respect of such or all of the Collateral as the Lender may determine in its discretion (without any requirement of marshalling of assets or other such requirement, all of which are hereby waived by the Borrower), and (e) the Revolving Credit Commitment shall, at the Lender's option (except in the case of Sections 7.01(f) and 7/01(g) hereof, the occurrence of which shall automatically effect termination, regardless of any action or forbearance in respect of any prior or ongoing Default or Event of Default which may be inconsistent with such automatic termination), be immediately terminated or reduced, and the Lender shall be under no further obligation to consider making any further Advances. 45 VIII. PARTICIPATING LENDERS; ASSIGNMENT. SECTION 8.01. PARTICIPATIONS. Anything in this Agreement to the contrary notwithstanding, the Lender may, at any time and from time to time, without in any manner affecting or impairing the validity of any Obligations, transfer, assign or grant participating interests in the Loans as the Lender shall in its sole discretion determine, to such other Persons (the "PARTICIPANTS") as the Lender may determine. Notwithstanding the granting of any such participating interests: (a) the Borrower shall look solely to the Lender for all purposes of this Agreement and the transactions contemplated hereby, (b) the Borrower shall at all times have the right to rely upon any waivers or consents signed by the Lender as being binding upon all of the Participants, and (c) all communications in respect of this Agreement and such transactions shall remain solely between the Borrower and the Lender (exclusive of Participants) hereunder. SECTION 8.02. TRANSFER AND ASSIGNMENT. Anything in this Agreement to the contrary notwithstanding, the Lender may, at any time and from time to time, subject to Section 8.03 below, without in any manner affecting or impairing the validity of any Obligations, transfer and assign all or any portion of its interest in this Agreement, the Notes and the other Loan Documents to any Person (an "ASSIGNEE LENDER") as the Lender may determine. Upon any such transfer or assignment, the Assignee Lender shall be deemed to succeed (to the extent of the interest assigned) to the rights and obligations of the Lender for all purposes of this Agreement. In the event of any transfer and assignment of the Lender's entire interest in this Agreement, the Notes and the Security Documents, the Lender shall be replaced by the Assignee Lender as "Secured Party" under the Collateral Agreement and all other Security Documents. SECTION 8.03. RECORDATION OF ASSIGNMENT. In respect of any negotiation, transfer or assignment of all or any portion of any Lender's interest in this Agreement, any Note and/or any other Loan Documents at any time and from time to time, the following provisions shall be applicable: (a) The Borrower, or any agent appointed by the Borrower, shall maintain a register (the "REGISTER") in which there shall be recorded the name and address of each Person holding any Note(s) hereunder or any commitment to lend hereunder, and the principal amount payable to such Person under such Person's Note(s) or committed by such Person under such Person's lending commitment. The Borrower hereby irrevocably appoints the Lender (and/or any subsequent Lender appointed by the Lender then maintaining the Register) as the Borrower's agent for the purpose of maintaining the Register. (b) In connection with any negotiation, transfer or assignment as aforesaid, the transferor/assignor shall deliver to the Lender then maintaining the Register an assignment and assumption agreement executed by the transferor/assignor and the transferee/assignee, setting forth the specifics of the subject transaction, including but not limited to the amount and nature of Obligations and/or lending commitments being transferred or assigned (and being assumed, as applicable), and the proposed effective date of such transfer or assignment and the related assumption (if applicable). (c) Subject to receipt of completed tax forms (indicating withholding status, or exemption from withholding, as applicable, of the transferee/assignee) reasonably required by 46 the Person then maintaining the Register, and (if required by such Person) surrender of the negotiated, transferred or assigned Note(s) for reissuance by the Borrower, such Person shall record the subject transfer, assignment and assumption in the Register. Anything contained in any Note or other Loan Document to the contrary notwithstanding, no negotiation, transfer or assignment shall be effective until it is recorded in the Register pursuant to this Section 8.03(c). The entries in the Register shall be conclusive and binding for all purposes, absent manifest error; and the Borrower and each Lender shall treat each Person whose name is recorded in the Register as a Lender hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Borrower and each Lender at any reasonable time and from time to time upon reasonable prior notice. IX. MISCELLANEOUS SECTION 9.01. SURVIVAL. This Agreement and all covenants, agreements, representations and warranties made herein and in the certificates delivered pursuant hereto, shall survive the making by the Lender of the Loans and the execution and delivery to the Lender of the Notes, and shall continue in full force and effect for so long as the Notes or any other Obligations are outstanding and unpaid or the Revolving Credit Commitment remains outstanding. Whenever in this Agreement any of the parties hereto is referred to, such reference shall be deemed to include the successors and permitted assigns of such party; and all covenants, promises and agreements in this Agreement contained, by or on behalf of the Borrower shall inure to the benefit of the successors and assigns of the Lender. SECTION 9.02. INDEMNIFICATION. The Borrower shall indemnify the Lender and its directors, officers, employees, attorneys and agents against, and shall hold the Lender and such Persons harmless from, any and all losses, claims, damages and liabilities and related expenses, including reasonable counsel fees and expenses, incurred by the Lender or any such Person arising out of, in any way connected with, or as a result of: (a) the use of any of the proceeds of the Loans made by the Lender to the Borrower; (b) this Agreement, the ownership and operation of the Borrower's and any Subsidiary's assets, including all Real Properties and improvements or any Contract, the performance by the Borrower or any other Person of their respective obligations thereunder, and the consummation of the transactions contemplated by this Agreement; (c) any finder's fee, brokerage commission of other such obligation payable or alleged to be payable in respect of the transactions contemplated by this Agreement which arises or is alleged to arise from any agreement, action or conduct of the Borrower or any of its Affiliates, and/or (d) any claim, litigation, investigation or proceeding relating to any of the foregoing, whether or not the Lender or its directors, officers, managers, employees, attorneys or agents are a party thereto; PROVIDED that such indemnity shall not apply to any such losses, claims, damages, liabilities or related expenses arising from (i) any unexcused breach by the Lender of any of its obligations under this Agreement, (ii) the willful misconduct or gross negligence of the Lender as determined by a final, non-appealable judgment of a court of competent jurisdiction, or (iii) the breach of any commitment or legal obligation of the Lender to any Person other than the Borrower or its Affiliates, PROVIDED that such breach is determined pursuant to a final and nonappealable decision of a court of competent jurisdiction. The foregoing indemnity shall remain operative and in full force and effect regardless of the expiration or any termination of this Agreement, the consummation of the transactions contemplated by this Agreement, the repayment of the Loans, the invalidity or unenforceability 47 of any term or provision of any Loan Document, any investigation made by or on behalf of the Lender, and the content or accuracy of any representation or warranty made by the Borrower or any Subsidiary in any Loan Document. All amounts due under this Section 9.02 shall be payable on written demand therefor. SECTION 9.03. GOVERNING LAW. This Agreement and the other Loan Documents shall (irrespective of where same are executed and delivered) be governed by and construed in accordance with the laws of the State of New York (without giving effect to principles of conflicts of laws). SECTION 9.04. WAIVER AND AMENDMENT. Neither any modification or waiver of any provision of this Agreement, the Notes, or any other Loan Document, nor any consent to any departure by the Borrower or any Subsidiary therefrom, shall in any event be effective unless the same shall be set forth in writing duly signed or acknowledged by the Lender (or, in the event that there are multiple Lenders at any time, Lenders holding a majority of the outstanding principal balance of the Term Loan and the maximum Revolving Credit Commitment) and all parties to such Loan Document, and then such waiver or consent shall be effective only in the specific instance, and for the specific purpose, for which given. No notice to or demand on the Borrower in any instance shall entitle the Borrower to any other or future notice or demand in the same, similar or other circumstances. SECTION 9.05. RESERVATION OF REMEDIES. Neither any failure nor any delay on the part of the Lender in exercising any right, power or privilege hereunder or under the Notes or any other Loan Document shall operate as a waiver thereof, nor shall a single or partial exercise thereof preclude any other or future exercise, or the exercise of any other right, power or privilege. SECTION 9.06. NOTICES. All notices, requests, demands and other communications under or in respect of this Agreement or any transactions hereunder shall be in writing (which may include telegraphic or telecopied communication) and shall be personally delivered or mailed (by prepaid registered or certified mail, return receipt requested), sent by prepaid recognized overnight courier service, or telegraphed or telecopied by facsimile transmission to the applicable party at its address or telecopier number indicated below. If to the Lender: Bluefin Capital, LLC One North Clematis, Suite 300 West Palm Beach, FL 33401 Attention: Chief Financial Officer Telecopier: (212) 829-5986 with a copy to: Greenberg Traurig, LLP 200 Park Avenue New York, New York 10166 Attention: Shahe Sinanian, Esq. Telecopier: (212) 801-6400 48 If to the Borrower: Tag-It Pacific, Inc. 21900 Burbank Blvd., Suite 270 Woodland Hills, California 91367 Attention: Lonnie D. Schell, CFO Telecopier: (818) 844-4110 with a copy to: Stubbs Alderton & Markiles, LLP 15260 Ventura Boulevard, 20th Floor Sherman Oaks, California 91403 Attention: Jonathan R. Hodes, Esq. Telecopier: (818) 474-8608 or, as to each party, at such other address or telecopier number as shall be designated by such party in a written notice to the other party delivered as aforesaid. All such notices, requests, demands and other communications shall be deemed given (a) when personally delivered, (b) three (3) Business Days after being deposited in the mails with postage prepaid (by registered or certified mail, return receipt requested), (c) one (1) Business Day after being delivered to the telegraph company or overnight courier service, if prepaid and sent overnight delivery, addressed as aforesaid and with all charges prepaid or billed to the account of the sender, or (d) when sent by facsimile transmission to a telecopier number designated by such addressee. SECTION 9.07. BINDING EFFECT. This Agreement shall be binding upon and inure to the benefit of the Borrower and the Lender and their respective successors and assigns, except that the Borrower shall not assign any of its rights or obligations hereunder without the prior written consent of the Lender. SECTION 9.08. CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL. The Borrower hereby consents to the jurisdiction of all courts of the State of New York and the United States District Court for the Southern District of New York, as well as to the jurisdiction of all courts from which an appeal may be taken from such courts, for the purpose of any suit, action or other proceeding arising out of or with respect to this Agreement, any other Loan Document, any other agreements, instruments, certificates or other documents executed in connection herewith or therewith, or any of the transactions contemplated hereby or thereby, or any of the Borrower's or any Subsidiary's obligations hereunder or thereunder. The Borrower hereby waives the right to interpose any counterclaims (other than compulsory counterclaims) in any action brought by the Lender hereunder or in respect of any other Loan Document, provided that this waiver shall not preclude the Borrower from pursuing any such claims by means of separate proceedings. THE BORROWER HEREBY EXPRESSLY WAIVES ANY AND ALL OBJECTIONS WHICH IT MAY HAVE AS TO VENUE IN ANY OF SUCH COURTS, AND ALSO WAIVES TRIAL BY JURY IN ANY SUCH SUIT, ACTION OR PROCEEDING. The Lender may file a copy of this Agreement as evidence of the foregoing waiver of right to jury trial. 49 SECTION 9.09. CERTAIN WAIVERS. The Borrower and the Lender each hereby waives any claims for special, consequential or punitive damages in any way arising out of or relating to this Agreement, any of the other Loan Documents, or any breach hereof or thereof. SECTION 9.10. SEVERABILITY. If any provision of this Agreement is held invalid or unenforceable, either in its entirety or by virtue of its scope or application to given circumstances, such provision shall thereupon be deemed modified only to the extent necessary to render same valid, or not applicable to given circumstances, or excised from this Agreement, as the situation may require, and this Agreement shall be construed and enforced as if such provision had been included herein as so modified in scope or application, or had not been included herein, as the case may be. SECTION 9.11. CAPTIONS. The Article and Section headings in this Agreement are included herein for convenience of reference only, and shall not affect the construction or interpretation of any provision of this Agreement. SECTION 9.12. SOLE AND ENTIRE AGREEMENT. This Agreement, the Notes, the other Loan Documents, and the other agreements, instruments, certificates and documents referred to or described herein and therein constitute the sole and entire agreement and understanding between the parties hereto as to the subject matter hereof, and supersede all prior discussions, agreements and understandings of every kind and nature between the parties as to such subject matter. SECTION 9.13. CONFIDENTIALITY. The Lender shall not disclose any Confidential Information to any Person, or use Confidential Information except in connection with the administration of this Agreement and the other Loan Documents, without the prior written consent of the Borrower; PROVIDED, HOWEVER, that nothing herein contained shall limit any disclosure of the tax structure of the transactions contemplated hereby, or the disclosure of any information (a) to the extent required by statute, rule, regulation or judicial process, (b) to counsel for the Lender, (c) to bank examiners, auditors, accountants or, if required by law, any regulatory authority, (d) to the officers, partners, managers, directors, employees, agents and advisors (including independent auditors and counsel) of the Lender, (e) in connection with any litigation which relates to this Agreement to which the Lender is a party, (f) to a subsidiary or Affiliate of the Lender, or (g) to any assignee or participant (or prospective assignee or participant) which agrees to be bound by this Section 9.13, AND FURTHER provided, that in no event shall the Lender be obligated or required to return any materials furnished by the Borrower. The obligations of the Lender under this Section 9.13 shall supersede and replace the obligations of the Lender under any confidentiality letter in respect of this financing previously signed and delivered by the Lender to the Borrower. In no event shall the Lender trade in any securities of the Borrower using non-public information of the Borrower. SECTION 9.14. COUNTERPARTS; FAX SIGNATURES. This Agreement may be executed in any number of counterparts, all of which shall constitute one and the same agreement. This Agreement may be executed by fax signatures, each of which shall be fully binding on the signing party. [The remainder of this page is intentionally blank] 50 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their duly authorized officer as of the day and year first written above. BLUEFIN CAPITAL, LLC By: /S/ LARRY E. LENIG, JR. -------------------------------------------------- Name: Larry E. Lenig, Jr. Title: Senior Partner/Portfolio Manager TAG-IT PACIFIC, INC. By: /S/ LONNIE D. SCHNELL -------------------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer 51 EX-10 4 ex10-35_1.txt EX-10.35.1 EXHIBIT 10.35.1 July 30, 2007 Talon International, Inc. (f/k/a Tag-It Pacific, Inc.) 21900 Burbank Blvd., Suite 270 Woodland Hills, CA 91367 Attention: Mr. Lonnie D. Schnell, CFO Re: AMENDMENT NO. 1 TO LOAN AGREEMENT Dear Sirs: Reference is made to the Revolving Credit and Term Loan Agreement dated June 27, 2007 (the "LOAN AGREEMENT") by and between Bluefin Capital, LLC (the "LENDER") and Talon International, Inc. (f/k/a Tag-It Pacific, Inc.) (the "BORROWER"). All capitalized terms used herein without definition have the respective meanings ascribed to them in the Loan Agreement. This will confirm the agreement of the Lender and the Borrower to make the following correction to the Loan Agreement as follows: 1. CORRECTED COVENANT. Section 6.17 the Loan Agreement is hereby amended, effective as of June 29, 2007, so as to read in full as follows: SECTION 6.17. COVERAGE TEST. Permit, as of the end of any quarter of any Fiscal Year, principal and interest payments by the Borrower and its Subsidiaries for the four (4) consecutive fiscal quarters then ended (excluding principal of the Convertible Debentures and principal payments made from a matched source where such matched source makes the payment) to exceed EBITDA for such four (4) fiscal quarter period; PROVIDED, HOWEVER, that the Lender shall not accelerate the Obligations by reason of any non-compliance with this Section 6.17 unless and until non-compliance herewith occurs as of the end of two (2) consecutive fiscal quarters. 2. ONGOING FORCE AND EFFECT. Except as expressly set forth herein, all of the terms and conditions of the Loan Agreement remain unchanged and in full force and effect. From and after June 29, 2007, all references to the Loan Agreement in any other Loan Documents shall mean and refer to the Loan Agreement as amended by this Amendment No. 1. 3. GOVERNING LAW. This amendment shall be governed by and construed in accordance with the laws of the State of New York, without giving effect to conflicts of laws principles. Kindly confirm your agreement to the foregoing by countersigning a counterpart copy of this Amendment No. 1 in the space provided below. Very truly yours, BLUEFIN CAPITAL, LLC By: /S/ LARRY E. LENIG, JR. ---------------------------------- Larry E. Lenig, Jr., Vice Chairman Acknowledged, Confirmed and Agreed To: TALON INTERNATIONAL, INC. (f/k/a Tag-It Pacific, Inc.) By: /S/ LONNIE D. SCHNELL ------------------------------------------ Lonnie D. Schnell, Chief Financial Officer 2 EX-10 5 ex10-36.txt EX-10.36 EXHIBIT 10.36 GUARANTY AGREEMENT (as amended, restated, supplemented or otherwise modified, this "GUARANTY" or this "AGREEMENT"), dated as of June 27, 2007, is made by TALON INTERNATIONAL, INC., a Delaware corporation, TAG-IT, INC., a California corporation, A.G.S. STATIONARY, INC., a California corporation, TAG-IT PACIFIC LIMITED, a Hong Kong corporation, TAG-IT PACIFIC (HK) LTD., a British Virgin Islands corporation, TAGIT de MEXICO, S.A. de C.V., TALON ZIPPER (SHENZHEN) COMPANY, LTD., a Chinese corporation, and TALON INTERNATIONAL PVT. LTD., an Indian corporation (each a "GUARANTOR" and collectively the "GUARANTORS"), in favor of BLUEFIN CAPITAL, LLC, a Delaware limited liability company (the "LENDER"). STATEMENT OF PURPOSE Pursuant to the terms of the Revolving Credit and Term Loan Agreement of even date herewith by and between Tag-It Pacific, Inc. (the "BORROWER") and the Lender (as same may be amended, modified, supplemented and/or restated from time to time, the "LOAN AGREEMENT"), the Lender has agreed to make Loans to the Borrower in the principal amount of up to $14,500,000 at any time outstanding, upon the terms and subject to the conditions set forth therein. Each of the Guarantors is a direct wholly-owned Subsidiary of the Borrower. The Borrower and the Guarantors, though separate legal entities, comprise one integrated financial enterprise, and the Loans will inure, directly or indirectly, to the benefit of each of the Guarantors. It is a condition precedent to the obligation of the Lender to make the Loans under the Loan Agreement that the Guarantors shall have executed and delivered this Guaranty to the Lender. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged by the parties hereto, and to induce the Lender to enter into the Loan Agreement and to make the Loans thereunder, the Guarantors hereby agree with the Lender as follows: ARTICLE I DEFINED TERMS SECTION 1.1 DEFINITIONS. The following terms when used in this Guaranty shall have the meanings assigned to them below: "ADDITIONAL GUARANTOR" means each direct or indirect Domestic Subsidiary of the Borrower which hereafter becomes a Guarantor pursuant to SECTION 4.17 hereof and SECTION 5.11 of the Loan Agreement. "APPLICABLE INSOLVENCY LAWS" means all Applicable Laws governing bankruptcy, reorganization, arrangement, adjustment of debts, relief of debtors, dissolution, insolvency, fraudulent transfers or conveyances or other similar laws (including, without limitation, 11 U.S.C. Sections 544, 547, 548 and 550 and other "avoidance" provisions of Title 11 of the United States Code, as amended or supplemented). "GUARANTEED OBLIGATIONS" has the meaning set forth in SECTION 2.1. "GUARANTY" means this Guaranty Agreement, as amended, modified, supplemented and/or restated from time to time. SECTION 1.2 OTHER DEFINITIONAL PROVISIONS. Capitalized terms used and not otherwise defined in this Guaranty, including the preambles and recitals hereof, shall have the meanings ascribed to them in the Loan Agreement. In the event of a conflict between capitalized terms defined herein and in the Loan Agreement, the Loan Agreement shall control. The words "hereof," "herein", "hereto" and "hereunder" and words of similar import when used in this Guaranty shall refer to this Guaranty as a whole and not to any particular provision of this Guaranty, and Section references are to this Guaranty unless otherwise specified. The meanings given to terms defined herein shall be equally applicable to both the singular and plural forms of such terms. Where the context requires, terms relating to the Collateral or any part thereof, when used in relation to a Guarantor, shall refer to such Guarantor's Collateral or the relevant part thereof. The word "including" and words of similar import when used in this Agreement shall mean "including, without limitation," unless otherwise specified. ARTICLE II GUARANTY SECTION 2.1 GUARANTY. Each Guarantor hereby, jointly and severally with the other Guarantors, unconditionally guarantees to the Lender and its successors, endorsees, transferees and assigns, the prompt payment and performance of all Obligations of the Borrower, whether primary or secondary (whether by way of endorsement or otherwise), whether now existing or hereafter arising, whether or not from time to time reduced or extinguished (except by payment thereof) or hereafter increased or incurred, whether enforceable or unenforceable as against the Borrower, whether or not discharged, stayed or otherwise affected by any Applicable Insolvency Law or proceeding thereunder, whether matured or unmatured, whether joint or several, as and when the same become due and payable (whether at maturity or earlier, by reason of acceleration, mandatory repayment or otherwise), in accordance with the terms of the agreements and instruments evidencing such Obligations, including all renewals, extensions or modifications thereof (all such Obligations of the Borrower being hereafter collectively referred to as the "GUARANTEED OBLIGATIONS"). SECTION 2.2 BANKRUPTCY LIMITATIONS ON GUARANTORS. Notwithstanding anything to the contrary contained in SECTION 2.1, it is the intention of each Guarantor and the Lender that, in any proceeding involving the bankruptcy, reorganization, arrangement, adjustment of debts, relief of debtors, dissolution or insolvency or any similar proceeding with respect to any Guarantor or its assets, the amount of such Guarantor's obligations with respect to the Guaranteed Obligations shall be equal to, but not in excess of, the maximum amount thereof not subject to avoidance or recovery by operation of Applicable Insolvency Laws after giving effect to SECTION 2.3. To that end, but only in the event and to the extent that after giving effect to 2 SECTION 2.3 such Guarantor's obligations with respect to the Guaranteed Obligations or any payment made pursuant to such Guaranteed Obligations would, but for the operation of the first sentence of this SECTION 2.2, be subject to avoidance or recovery in any such proceeding under Applicable Insolvency Laws after giving effect to SECTION 2.3, the amount of such Guarantor's obligations with respect to the Guaranteed Obligations shall be limited to the largest amount which, after giving effect thereto, would not, under Applicable Insolvency Laws, render such Guarantor's obligations with respect to the Guaranteed Obligations unenforceable or avoidable or otherwise subject to recovery under Applicable Insolvency Laws. To the extent any payment actually made pursuant to the Guaranteed Obligations exceeds the limitation of the first sentence of this SECTION 2.2 and is otherwise subject to avoidance and recovery in any such proceeding under Applicable Insolvency Laws, the amount subject to avoidance shall in all events be limited to the amount by which such actual payment exceeds such limitation and the Guaranteed Obligations as limited by the first sentence of this SECTION 2.2 shall in all events remain in full force and effect and be fully enforceable against such Guarantor. The first sentence of this Section 2.2 is intended solely to preserve the rights of the Lender hereunder against such Guarantor in such proceeding to the maximum extent permitted by Applicable Insolvency Laws and neither such Guarantor, the Borrower, any other Guarantor nor any other Person shall have any right or claim under such sentence that would not otherwise be available under Applicable Insolvency Laws in such proceeding. SECTION 2.3 AGREEMENTS FOR CONTRIBUTION. (a) To the extent that any Guarantor is required, by reason of its obligations hereunder, to pay to the Lender an amount greater than the amount of value (as determined in accordance with Applicable Insolvency Laws) actually made available to or for the benefit of such Guarantor on account of the Loan Agreement, this Guaranty or any other Loan Document, such Guarantor shall have an enforceable right of contribution against the remaining Guarantors, and the remaining Guarantors shall be jointly and severally liable for repayment of the full amount of such excess payment. Subject only to the subordination provided in SECTION 2.3(D), such Guarantor further shall be subrogated to any and all rights of the Lender against the Borrower and the remaining Guarantors to the extent of such excess payment. (b) To the extent that any Guarantor would, but for the operation of this SECTION 2.3 and by reason of its obligations hereunder or its obligations to other Guarantors under this SECTION 2.3, be rendered insolvent for any purpose under Applicable Insolvency Laws, each of the Guarantors hereby agrees to indemnify such Guarantor and commits to make a contribution to such Guarantor's capital in an amount at least equal to the amount necessary to prevent such Guarantor from having been rendered insolvent by reason of the incurrence of any such obligations. (c) To the extent that any Guarantor would, but for the operation of this SECTION 2.3, be rendered insolvent under any Applicable Insolvency Law by reason of its incurring of obligations to any other Guarantor under the foregoing SECTIONS 2.3(A) and (B), such Guarantor shall, in turn, have rights of contribution to the full extent provided in the foregoing SECTIONS 2.3(A) and (B) against the remaining Guarantors, such that all obligations of all of the Guarantors hereunder and under this SECTION 2.3 shall be allocated in a manner such that no 3 Guarantor shall be rendered insolvent for any purpose under Applicable Insolvency Law by reason of its incurrence of such obligations. (d) Notwithstanding any payment or payments by any of the Guarantors hereunder, or any set-off or application of funds of any of the Guarantors by the Lender, or the receipt of any amounts by the Lender with respect to any of the Guaranteed Obligations, none of the Guarantors shall be entitled to be subrogated to any of the rights of the Lender against the Borrower or the other Guarantors or against any collateral security held by the Lender for the payment of the Guaranteed Obligations, nor shall any of the Guarantors seek any reimbursement from the Borrower or any of the other Guarantors in respect of payments made by such Guarantor in connection with the Guaranteed Obligations, until all amounts owing to the Lender on account of the Guaranteed Obligations are paid in full and the Revolving Credit Commitment has been terminated. If any amount shall be paid to any Guarantor on account of such subrogation rights at any time when all of the Guaranteed Obligations shall not have been paid in full or the Revolving Credit Commitment has not terminated, such amount shall be held by such Guarantor in trust for the benefit of the Lender, segregated from other funds of such Guarantor, and shall, forthwith upon receipt by such Guarantor, be turned over to the Lender in the exact form received by such Guarantor (duly endorsed by such Guarantor to the Lender, if required) to be applied against the Guaranteed Obligations, whether matured or unmatured, in the order set forth in the Loan Agreement. SECTION 2.4 NATURE OF GUARANTY. (a) Each Guarantor agrees that this Guaranty is a continuing, unconditional guaranty of payment and performance and not of collection, and that its obligations under this Guaranty shall be primary, absolute and unconditional, irrespective of, and unaffected by: (i) the genuineness, validity, regularity, enforceability or any future amendment of, or change in, the Loan Agreement or any other Loan Document or any other agreement, document or instrument to which the Borrower or any Subsidiary is or may become a party; (ii) the absence of any action to enforce this Guaranty, the Loan Agreement or any other Loan Document or the waiver or consent by the Lender with respect to any of the provisions of this Guaranty, the Loan Agreement or any other Loan Document; (iii) the existence, value or condition of, or failure to perfect any Lien against, any security for or other guaranty of the Guaranteed Obligations or any action, or the absence of any action, by the Lender in respect of such security or guaranty (including, without limitation, the release of any such security or guaranty); or (iv) any other action or circumstances which might otherwise constitute a legal or equitable discharge or defense of a surety or guarantor; it being agreed by each Guarantor that, subject to the first sentence of SECTION 2.2, its obligations under this Guaranty shall not be discharged until the final indefeasible payment and performance, in full, of the Guaranteed Obligations. 4 (b) Each Guarantor represents, warrants and agrees that its obligations under this Guaranty are not and shall not be subject to any counterclaims, offsets or defenses of any kind against the Lender or the Borrower, whether now existing or which may arise in the future. (c) Each Guarantor hereby agrees and acknowledges that the Guaranteed Obligations, and any of them, shall conclusively be deemed to have been created, contracted or incurred, or renewed, extended, amended or waived, in reliance upon this Guaranty, and all dealings between the Borrower and any of the Guarantors, on the one hand, and the Lender, on the other hand, likewise shall be conclusively presumed to have been had or consummated in reliance upon this Guaranty. SECTION 2.5 WAIVERS. To the extent permitted by law, each Guarantor expressly waives all of the following rights and defenses (and agrees not to take advantage of or assert any such right or defense): (a) any rights it may now or in the future have under any statute, or at law or in equity, or otherwise, to compel the Lender to proceed in respect of the Obligations against the Borrower or any other Person or against any security for or other guaranty of the payment and performance of the Guaranteed Obligations before proceeding against, or as a condition to proceeding against, such Guarantor; (b) any defense based upon the failure of the Lender to commence an action in respect of the Guaranteed Obligations against the Borrower, such Guarantor, any other guarantor or any other Person or any security for the payment and performance of the Guaranteed Obligations; (c) any right to insist upon, plead or in any manner whatever claim or take the benefit or advantage of, any appraisal, valuation, stay, extension, marshalling of assets or redemption laws, or exemption, whether now or at any time hereafter in force, which may delay, prevent or otherwise affect the performance by such Guarantor of its obligations under, or the enforcement by the Lender of this Guaranty; (d) any right of diligence, presentment, demand, protest and notice (except as specifically required herein) of whatever kind or nature with respect to any of the Guaranteed Obligations and waives, to the extent permitted by Applicable Law, the benefit of all provisions of law which are or might be in conflict with the terms of this Guaranty; and (e) any and all right to notice of the creation, renewal, extension or accrual of any of the Obligations and notice of or proof of reliance by the Lender upon, or acceptance of, this Guaranty. Each Guarantor agrees that any notice or directive given at any time to the Lender which is inconsistent with any of the foregoing waivers shall be null and void and may be ignored by the Lender, and, in addition, may not be pleaded or introduced as evidence in any litigation relating to this Guaranty for the reason that such pleading or introduction would be at variance with the written terms of this Guaranty, unless the Lender has specifically agreed otherwise in writing. The foregoing waivers are of the essence of the transaction contemplated by the Loan 5 Agreement and the other Loan Documents and, but for this Guaranty and such waivers, the Lender would decline to enter into the Loan Agreement and the other Loan Documents. SECTION 2.6 MODIFICATION OF LOAN DOCUMENTS, ETC. The Lender shall not incur any liability to any Guarantor as a result of any of the following, and none of the following shall impair, limit or release this Guaranty or any of the obligations of any Guarantor under this Guaranty: (a) any change or extension of the manner, place or terms of payment of, or renewal or alteration of all or any portion of, the Guaranteed Obligations; (b) any action under or in respect of the Loan Agreement or the other Loan Documents in the exercise of any remedy, power or privilege contained therein or available to any of them at law, in equity or otherwise, or waiver or refrain from exercising any such remedies, powers or privileges; (c) any amendment or modification, in any manner whatsoever, of the Loan Documents; (d) any extension or waiver of the time for performance by any Guarantor, any other guarantor, the Borrower or any other Person, or compliance with, any term, covenant or agreement on its part to be performed or observed under a Loan Document, or waiver of such performance or compliance or consent to a failure of, or departure from, such performance or compliance; (e) the taking and holding security or Collateral for the payment of the Obligations or the sale, exchange, release, disposal of, or other dealing with, any property pledged, mortgaged or conveyed, or in which the Lender has been granted a Lien, to secure any indebtedness of any Guarantor, any other guarantor or the Borrower to the Lender; (f) the release of anyone who may be liable in any manner for the payment of any amounts owed by any Guarantor, any other guarantor or the Borrower to the Lender; or (g) any modification or termination of any intercreditor or subordination agreement pursuant to which claims of other creditors of any Guarantor, any other guarantor or the Borrower are subordinated to the claims of the Lender. SECTION 2.7 DEMAND BY THE LENDER. In addition to the terms set forth in this Article II and in no manner imposing any limitation on such terms, if all or any portion of the then outstanding Guaranteed Obligations are declared to be immediately due and payable, then the Guarantors shall, upon demand in writing therefor by the Lender to the Guarantors, pay all or such portion of the outstanding Guaranteed Obligations then due and payable or declared due and payable. SECTION 2.8 REMEDIES. Upon the occurrence and during the continuance of any Event of Default, the Lender may enforce against the Guarantors their respective obligations and liabilities hereunder and exercise such other rights and remedies as may be available to the Lender hereunder, under the Loan Agreement or the other Loan Documents or otherwise. 6 SECTION 2.9 BENEFITS OF GUARANTY. The provisions of this Guaranty are for the benefit of the Lender and its successors, transferees, endorsees and assigns, and nothing herein contained shall impair, as between the Borrower and the Lender, the obligations of the Borrower under the Loan Documents. In the event that all or any part of the Obligations are transferred, endorsed or assigned by the Lender to any Person or Persons as permitted under the Loan Agreement, any reference to a "Lender" herein shall be deemed to refer similarly and ratably to such Person or Persons. SECTION 2.10 TERMINATION; REINSTATEMENT. (a) Subject to SECTION 2.10(C) below, this Guaranty shall remain in full force and effect until all the Guaranteed Obligations shall have been indefeasibly paid in full. (b) No payment made by the Borrower, any Guarantor, or any other Person received or collected by the Lender from the Borrower, any Guarantor, or any other Person by virtue of any action or proceeding or any set-off or appropriation or application at any time or from time to time in reduction of or in payment of the Guaranteed Obligations shall be deemed to modify, reduce, release or otherwise affect the liability of any Guarantor hereunder which shall, notwithstanding any such payment (other than any payment made by such Guarantor in respect of the obligations of the Guarantors or any payment received or collected from such Guarantor in respect of the obligations of the Guarantors), remain liable for the obligations of the Guarantors up to the maximum liability of such Guarantor hereunder until the Guaranteed Obligations shall have been indefeasibly paid in full. (c) Each Guarantor agrees that, if any payment made by the Borrower or any other Person applied to the Obligations is at any time annulled, set aside, rescinded, invalidated, declared to be fraudulent or preferential or otherwise required to be refunded or repaid, or the proceeds of any Collateral are required to be refunded by the Lender to the Borrower, its estate, trustee, receiver or any other Person, including, without limitation, any Guarantor, under any Applicable Law or equitable cause, then, to the extent of such payment or repayment, each Guarantor's liability hereunder (and any Lien or Collateral securing such liability) shall be and remain in full force and effect, as fully as if such payment had never been made, and, if prior thereto, this Guaranty shall have been canceled or surrendered (and if any Lien or Collateral securing such Guarantor's liability hereunder shall have been released or terminated by virtue of such cancellation or surrender), this Guaranty (and such Lien or Collateral) shall be reinstated in full force and effect, and such prior cancellation or surrender shall not diminish, release, discharge, impair or otherwise affect the obligations of such Guarantor in respect of the amount of such payment (or any Lien or Collateral securing such obligation). SECTION 2.11 PAYMENTS. Payments by the Guarantors shall be made to the Lender, to be credited and applied to the Guaranteed Obligations in accordance with the Loan Agreement, in immediately available Dollars to the account designated by the Lender. 7 ARTICLE III REPRESENTATIONS AND WARRANTIES To induce the Lender to make the Loans, each Guarantor hereby represents and warrants that: SECTION 3.1 EXISTENCE. Such Guarantor is duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or formation, has the requisite power and authority to own, lease and operate its properties and to carry on its business as now being and hereafter proposed to be conducted and is duly qualified and authorized to do business in each jurisdiction in which the character of its properties or the nature of its business requires such qualification and authorization and the failure to be so qualified would have a Material Adverse Effect. SECTION 3.2 AUTHORIZATION OF AGREEMENT; ENFORCEABILITY. Such Guarantor has the right, power and authority to execute, deliver and perform this Guaranty and has taken all necessary corporate or other organizational action to authorize its execution, delivery and performance of this Guaranty. This Guaranty has been duly executed and delivered by the duly authorized officers of such Guarantor and this Guaranty constitutes the legal, valid and binding obligation of such Guarantor enforceable against such Guarantor in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or similar state or federal debtor relief laws from time to time in effect which affect the enforcement of creditors' rights in general and the availability of equitable remedies. SECTION 3.3 NO CONFLICT; CONSENTS. The execution, delivery and performance by such Guarantor of this Guaranty will not, by the passage of time, the giving of notice or otherwise, violate any material provision of any Applicable Law or contractual obligation of such Guarantor and will not result in the creation or imposition of any Lien upon or with respect to any property or revenues of such Guarantor. No consent or authorization of, filing with, or other act by or in respect of, any arbitrator or governmental authority and no consent of any other Person (including, without limitation, any stockholder or creditor of such Guarantor), is required in connection with the execution, delivery, performance, validity or enforceability of this Guaranty. SECTION 3.4 LITIGATION. No actions, suits or proceedings before any arbitrator or governmental authority are pending or, to the knowledge of such Guarantor, threatened by or against such Guarantor or against any of its properties with respect to this Guaranty or any of the transactions contemplated hereby. SECTION 3.5 TITLE TO ASSETS. Such Guarantor has a valid ownership or leasehold interest in any and all real property owned or occupied by it, and has good title to all of its personal property sufficient to carry on its business free of any and all Liens of any type whatsoever, except Permitted Liens. SECTION 3.6 SOLVENCY. As of the Closing Date (or such later date upon which such Guarantor became a party hereto), such Guarantor (i) has capital sufficient to carry on its 8 business and transactions and all business and transactions in which it engages and is able to pay its debts as they mature, (ii) owns property having a value, both at fair valuation on a going concern basis, and at present fair saleable value on a going concern basis, greater than the amount required to pay its probable liabilities (including contingencies), and (iii) does not believe that it will incur debts or liabilities beyond its ability to pay such debts or liabilities as they mature, subject in each case to the first sentence of SECTION 2.2. ARTICLE IV MISCELLANEOUS SECTION 4.1 AMENDMENTS IN WRITING. None of the terms or provisions of this Guaranty may be waived, amended, supplemented or otherwise modified except in accordance with SECTION 9.04 of the Loan Agreement. SECTION 4.2 NOTICES. All notices and communications hereunder shall be given to the addresses and otherwise made in accordance with SECTION 9.06 of the Loan Agreement; provided that notices and communications to the Guarantors shall be directed to the Guarantors at the address of the Borrower set forth in SECTION 9.06 of the Loan Agreement. SECTION 4.3 ENFORCEMENT EXPENSES, INDEMNIFICATION. (a) Each Guarantor agrees to pay or reimburse the Lender for all its reasonable costs and expenses incurred in connection with enforcing or preserving any rights under this Guaranty and the other Loan Documents to which such Guarantor is a party, including, without limitation, the reasonable fees and disbursements of counsel (including the allocated fees and expenses of in-house counsel) to the Lender. (b) Each Guarantor agrees to pay, and to save the Lender harmless from, any and all liabilities with respect to, or resulting from any delay in paying, any and all stamp, excise, sales or other taxes which may be payable or determined to be payable with respect to any of the Collateral or in connection with any of the transactions contemplated by this Guaranty. (c) Each Guarantor agrees to pay, and to save the Lender harmless from, any and all liabilities, obligations, losses, damages, penalties, costs and expenses in connection with actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever with respect to the execution, delivery, enforcement, performance and administration of this Guaranty to the extent the Borrower would be required to do so pursuant to the Loan Agreement and/or the Collateral Agreement. (d) The agreements in this SECTION 4.3 shall survive repayment of the Obligations and all other amounts payable under the Loan Agreement and the other Loan Documents. SECTION 4.4 GOVERNING LAW. This Guaranty shall be governed by, and construed and interpreted in accordance with, the laws of the State of New York, without giving effect to principles of conflicts of laws. 9 SECTION 4.5 CONSENT TO JURISDICTION AND VENUE. (a) Each Guarantor hereby irrevocably consents to the personal jurisdiction of all state and federal courts located in New York, New York (and any courts from which an appeal from any of such courts must or may be taken) in any action, claim or other proceeding arising out of any dispute in connection with this Agreement and the other Loan Documents, any rights or obligations hereunder or thereunder, or the performance of such rights and obligations. Each Guarantor hereby irrevocably consents to the service of a summons and complaint and other process in any action, claim or proceeding brought by the Lender in connection with this Agreement or the other Loan Documents, any rights or obligations hereunder or thereunder, or the performance of such rights and obligations, on behalf of itself or its property, by registered or certified mail, return receipt requested, in the manner specified in SECTION 9.06 of the Loan Agreement. Nothing in this SECTION 4.5 shall affect the right of the Lender to serve legal process in any other manner permitted by Applicable Law or affect the right of the Lender to bring any action or proceeding against any Guarantor or its properties in the courts of any other jurisdictions. (b) The Guarantors hereby irrevocably waive any objection each may have now or in the future to the laying of venue in the aforesaid jurisdiction in any action, claim or other proceeding arising out of or in connection with this Guaranty, any other Loan Document or the rights and obligations of the parties hereunder or thereunder. The Guarantors irrevocably waive, in connection with such action, claim or proceeding, any plea or claim that the action, claim or proceeding has been brought in an inconvenient forum. SECTION 4.6 PRESERVATION OF REMEDIES, DAMAGES. (a) PRESERVATION OF CERTAIN REMEDIES. The parties hereto and the other Loan Documents preserve, without diminution, certain remedies that such Persons may employ or exercise freely, either alone, in conjunction with or during a dispute. Each such Person shall have and hereby reserves the right to proceed in any court of proper jurisdiction or by self-help to exercise or prosecute the following remedies, as applicable: (i) all rights to foreclose against any real or personal property or other security by exercising a power of sale granted in the Loan Documents or under Applicable Law or by judicial foreclosure and sale, including a proceeding to confirm the sale, (ii) all rights of self-help including peaceful occupation of property and collection of rents, set-off, and peaceful possession of property, and (iii) obtaining provisional or ancillary remedies including injunctive relief, sequestration, garnishment, attachment, appointment of receiver and in filing an involuntary bankruptcy proceeding. Preservation of these remedies does not limit the power of an arbitrator to grant similar remedies that may be requested by a party in a dispute. (b) NO PUNITIVE/EXEMPLARY DAMAGES. The Lender and each Guarantor hereby agree that no such Person shall have a remedy of punitive or exemplary damages against any other party to a Loan Document and each such Person hereby waives any right or claim to punitive or exemplary damages that it may now have or may arise in the future in connection with any dispute hereunder or under any other Loan Document, whether such dispute is resolved through arbitration or judicially. 10 SECTION 4.7 WAIVER OF JURY TRIAL. TO THE EXTENT PERMITTED BY APPLICABLE LAW, THE LENDER AND EACH GUARANTOR HEREBY IRREVOCABLY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL WITH RESPECT TO ANY ACTION, CLAIM OR OTHER PROCEEDING ARISING OUT OF ANY DISPUTE IN CONNECTION WITH THIS GUARANTY, THE NOTE OR THE OTHER LOAN DOCUMENTS, ANY RIGHTS OR OBLIGATIONS HEREUNDER OR THEREUNDER, OR THE PERFORMANCE OF SUCH RIGHTS AND OBLIGATIONS. SECTION 4.8 NO WAIVER BY COURSE OF CONDUCT, CUMULATIVE REMEDIES. The Lender shall not by any act (except by a written instrument pursuant to SECTION 4.1), delay, indulgence, omission or otherwise be deemed to have waived any right or remedy hereunder or to have acquiesced in any Default or Event of Default. No failure to exercise, nor any delay in exercising on the part of the Lender, any right, power or privilege hereunder shall operate as a waiver thereof. No single or partial exercise of any right, power or privilege hereunder shall preclude any other or further exercise thereof or the exercise of any other right, power or privilege. A waiver by the Lender of any right or remedy hereunder on any one occasion shall not be construed as a bar to any right or remedy which the Lender would otherwise have on any future occasion. The rights and remedies herein provided are cumulative, may be exercised singly or concurrently and are not exclusive of any other rights or remedies provided by law. SECTION 4.9 SUCCESSORS AND ASSIGNS. This Guaranty shall be binding upon and shall inure to the benefit of each Guarantor (and shall bind all Persons who become bound as a Guarantor under this Guaranty), the Lender and their successors and assigns; PROVIDED that no Guarantor may assign, transfer or delegate any of its rights or obligations under this Guaranty without the prior written consent of all holders of Obligations. SECTION 4.10 SEVERABILITY. If any provision hereof is held by a court of competent jurisdiction to be invalid or unenforceable in any jurisdiction, then, to the fullest extent permitted by law, (a) the other provisions hereof shall remain in full force and effect in such jurisdiction and shall be liberally construed in favor of the Lender in order to carry out the intentions of the parties hereto as nearly as may be possible; and (b) the invalidity or unenforceability of any provisions hereof in any jurisdiction shall not affect the validity or enforceability of such provision in any other jurisdiction. SECTION 4.11 HEADINGS. The various section headings used in this Guaranty are for convenience of reference only and shall not affect the meaning or interpretation of this Guaranty or any provisions hereof. SECTION 4.12 COUNTERPARTS. This Guaranty may be executed by the parties hereto in several counterparts, each of which shall be deemed to be an original and all of which shall constitute together but one and the same agreement. SECTION 4.13 SET-OFF. Each Guarantor hereby irrevocably authorizes the Lender, at any time and from time to time during the continuance of an Event of Default, without notice to such Guarantor or any other Guarantor, any such notice being expressly waived by each Guarantor, to set off and appropriate and apply any and all deposits (general or special, time or demand, provisional or final), in any currency, and any other credits, indebtedness or claims, in 11 any currency, in each case whether direct or indirect, absolute or contingent, matured or unmatured, at any time held or owing by the Lender (or any agent of the Lender) to or for the credit or the account of such Guarantor, or any part thereof, in such amounts as the Lender may elect, against and on account of the obligations and liabilities of such Guarantor to the Lender hereunder, as the Lender may elect, whether or not the Lender has made any demand for payment. The Lender shall notify such Guarantor promptly of any such set-off and the application made by the Lender of the proceeds thereof; PROVIDED that the failure to give such notice shall not affect the validity of such set-off and application. The rights of the Lender under this Section 4.13 are in addition to other rights and remedies (including, without limitation, other rights of set-off) which the Lender may have. SECTION 4.14 INTEGRATION. This Guaranty and the other Loan Documents represent the agreement of the Guarantors and the Lender with respect to the subject matter hereof and thereof, and there are no promises, undertakings, representations or warranties by the Lender relative to subject matter hereof and thereof not expressly set forth or referred to herein or in the other Loan Documents. SECTION 4.15 ACKNOWLEDGEMENTS. Each Guarantor hereby acknowledges that: (a) it has been advised by counsel in the negotiation, execution and delivery of this Guaranty and the other Loan Documents to which it is a party; (b) the Lender as such has no fiduciary relationship with or duty to any Guarantor arising out of or in connection with this Guaranty or any of the other Loan Documents, and the relationship between the Guarantors, on the one hand, and the Lender as such, on the other hand, in connection herewith or therewith is solely that of debtor and creditor; and (c) no joint venture is created hereby or by the other Loan Documents or otherwise exists by virtue of the transactions contemplated hereby among the Lender or among the Guarantors and the Lender. SECTION 4.16 RELEASES. At such time as the Guaranteed Obligations shall have been indefeasibly paid in full, this Guaranty and all obligations (other than those expressly stated to survive such termination) of the Guarantors hereunder shall terminate, all without delivery of any instrument or performance of any act by any party. SECTION 4.17 ADDITIONAL GUARANTORS. Each direct or indirect Domestic Subsidiary of the Borrower that is required to become a party to this Guaranty pursuant to Section 5.11 of the Loan Agreement shall become a Guarantor for all purposes of this Guaranty upon execution and delivery by such Domestic Subsidiary of a joinder or supplement in form and substance satisfactory to the Lender. [Signature Page to Follow] 12 IN WITNESS WHEREOF, each of the Guarantors has executed and delivered this Guaranty by its duly authorized officer, all as of the date first set forth above. TALON INTERNATIONAL, INC., a Delaware corporation By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TAG-IT, INC., a California corporation By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer A.G.S. STATIONARY, INC., a California corporation By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TAG-IT PACIFIC LIMITED, a Hong Kong corporation By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TAG-IT PACIFIC (HK) LTD., a British Virgin Islands corporation By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer 13 TAG IT de MEXICO, S.A. de C.V. By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TALON ZIPPER (SHENZHEN) COMPANY, LTD., a Chinese corporation By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TALON INTERNATIONAL PVT. LTD., an Indian corporation By: /s/ Lonnie D. Schnell ------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer 14 EX-10 6 ex10-37.txt EX-10.37 EXHIBIT 10.37 COLLATERAL AGREEMENT, dated as of June 27, 2007, by and among TAG-IT PACIFIC, INC., a Delaware corporation (the "BORROWER"), Tag-It Pacific, Inc., Talon International, Inc., Tag-It, Inc., A.G.S. Stationary, inc., Tag-It Pacific Limited, Tag-It Pacific (HK) Ltd, Tagit de Mexico, S.A. de C.V., Talon Zipper (Shenzhen) Company, Ltd. and Talon International Pvt. Ltd, and any and all Additional Grantors who may become party to this Agreement (the Borrower, such other named entities, and such Additional Grantors are hereinafter referred to each as a "GRANTOR" and collectively as the "GRANTORS"), and BLUEFIN CAPITAL, LLC (the "SECURED PARTY") as Lender under the Revolving Credit and Term Loan Agreement of even date herewith (as same may be amended, modified, supplemented and/or restated from time to time, the "LOAN AGREEMENT") by and between the Borrower and the Secured Party. STATEMENT OF PURPOSE Pursuant to the Loan Agreement, the Secured Party is making and may hereafter from time to time make Loans to the Borrower in the aggregate principal amount of up to $14,500,000 at any time outstanding, upon the terms and subject to the conditions set forth therein. Pursuant to the terms of a Guaranty Agreement of even date herewith, the Grantors (other than the Borrower), which are Subsidiaries of the Borrower, have guaranteed the payment and performance of the Obligations of the Borrower. It is a condition precedent to the obligation of the Secured Party to make the Loans to the Borrower under the Loan Agreement that the Grantors shall have executed and delivered this Agreement to the Secured Party. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged by the parties hereto, and to induce the Secured Party to enter into the Loan Agreement and make the Loans to the Borrower thereunder, each Grantor hereby agrees with the Secured Party, as follows: ARTICLE I DEFINED TERMS Section 1.1. TERMS DEFINED IN THE UNIFORM COMMERCIAL CODE. (a) The following terms when used in this Agreement shall have the meanings assigned to them in the UCC (as defined in Section 1.2 below) as in effect from time to time: "Account", "Account Debtor", "Authenticate", "Certificated Security", "Chattel Paper"; "Commercial Tort Claim", "Deposit Account", "Documents", "Electronic Chattel Paper", "Equipment", "Farm Products" "Fixture", "General Intangible", "Instrument", "Inventory", "Investment Company Security", "Investment Property", "Issuer", "Letter of Credit Rights", "Proceeds", "Record", "Registered Organization", "Security", "Securities Entitlement", "Securities Intermediary", "Securities Account", "Supporting Obligation", "Tangible Chattel Paper", and "Uncertificated Security". (b) Terms defined in the UCC and not otherwise defined herein or in the Loan Agreement shall have the meaning assigned in the UCC as in effect from time to time. Section 1.2. DEFINITIONS. The following terms when used in this Agreement shall have the meanings assigned to them below: "ADDITIONAL GRANTOR" means each Subsidiary of the Borrower which hereafter becomes a Grantor pursuant to Section 7.15 hereof and Section 5.11 of the Loan Agreement. "AGREEMENT" means this Collateral Agreement, as amended, modified, supplemented and/or restated from time to time. "APPLICABLE INSOLVENCY LAWS" means all Applicable Laws governing bankruptcy, reorganization, arrangement, adjustment of debts, relief of debtors, dissolution, insolvency, fraudulent transfers or conveyances or other similar laws (including, without limitation, 11 U.S.C. Sections 547, 548 and 550 and other "avoidance" provisions of Title 11 of the United States Code, as amended or supplemented). "ASSIGNMENT OF CLAIMS ACT" means the Assignment of Claims Act of 1940 (41 U.S.C. Section 15, 31 U.S.C. Section 3737, and 31 U.S.C. Section 3727), including all amendments thereto and regulations promulgated thereunder. "COLLATERAL" has the meaning assigned thereto in Section 2.1. "COLLATERAL ACCOUNT" means any collateral account established by the Secured Party as provided in Section 5.2. "CONTROL" means the manner in which "control" is achieved under the UCC with respect to any Collateral for which the UCC specifies a method of achieving "control". "CONTROLLED INTERMEDIARY" has the meaning assigned thereto in Section 4.6(a). "COPYRIGHTS" means collectively, all of the following of any Grantor: (a) all copyrights, rights and interests in copyrights, works protectable by copyright, copyright registrations and copyright applications, (b) all reissues, extensions, continuations (in whole or in part) and renewals of any of the foregoing, (c) all income, royalties, damages and payments now or hereafter due and/or payable under any of the foregoing or with respect to any of the foregoing, including, without limitation, damages or payments for past or future infringements of any of the foregoing, (d) the right to sue for past, present and future infringements of any of the foregoing, and (e) all rights corresponding to any of the foregoing. "COPYRIGHT LICENSES" means any written agreement naming any Grantor as licensor or licensee, granting any right under any Copyright, including, without limitation, the grant of rights to manufacture, distribute, exploit and sell materials derived from any Copyright. 2 "EFFECTIVE ENDORSEMENT AND ASSIGNMENT" means, with respect to any specific type of Collateral, all such endorsements, assignments and other instruments of transfer reasonably requested by the Secured Party with respect to the Security Interest granted in such Collateral, and in each case, in form and substance satisfactory to the Secured Party. "EXCESS COLLATERAL" has the meaning assigned thereto in Section 4.6(c). "GOVERNMENT CONTRACT" means a contract between any Grantor and an agency, department or instrumentality of the United States or any state, municipal or local Governmental Authority located in the United States or all obligations of any such Governmental Authority arising under any Account now or hereafter owing by any such Governmental Authority, as account debtor, to any Grantor. "GRANTORS" has the meaning set forth in the preamble of this Agreement. "GUARANTORS" has the meaning assigned thereto in the Guaranty Agreement. "GUARANTY AGREEMENT" has the meaning assigned thereto in the Loan Agreement. "INTELLECTUAL PROPERTY" means collectively, all of the following of any Grantor: (a) all systems software, applications software and internet rights, including, without limitation, screen displays and formats, internet domain names, web sites (including web links), program structures, sequence and organization, all documentation for such software, including, without limitation, user manuals, flowcharts, programmer's notes, functional specifications, and operations manuals, all formulas, processes, ideas and know-how embodied in any of the foregoing, and all program materials, flowcharts, notes and outlines created in connection with any of the foregoing, whether or not patentable or copyrightable, (b) concepts, discoveries, improvements and ideas, (c) any useful information relating to the items described in clause (a) or (b), including know-how, technology, engineering drawings, reports, design information, trade secrets, practices, laboratory notebooks, specifications, test procedures, maintenance manuals, research, development, manufacturing, marketing, merchandising, selling, purchasing and accounting, (d) Patents and Patent Licenses, Copyrights and Copyright Licenses, Trademarks and Trademark Licenses, and (e) other licenses to use any of the items described in the foregoing clauses (a), (b), (c) and (d) or any other similar items of such Grantor necessary for the conduct of its business. "ISSUER" means any issuer of any Investment Property or Partnership/LLC Interests (including, without limitation, any Issuer as defined in the UCC). "LOAN AGREEMENT" has the meaning assigned thereto in the preamble of this Agreement. "OBLIGATIONS" means, with respect to the Borrower, the meaning assigned to such term in the Loan Agreement, and with respect to each Guarantor, the obligations of such Guarantor under the Guaranty Agreement, and with respect to all Grantors, all liabilities and obligations of the Grantors hereunder. 3 "PARTNERSHIP/LLC INTERESTS" means, with respect to any Grantor, the entire partnership, membership interest or limited liability company interest, as applicable, of such Grantor in each partnership, limited partnership or limited liability company owned thereby, including, without limitation, such Grantor's capital account, its interest as a partner or member, as applicable, in the net cash flow, net profit and net loss, and items of income, gain, loss, deduction and credit of any such partnership, limited partnership or limited liability company, as applicable, such Grantor's interest in all distributions made or to be made by any such partnership, limited partnership or limited liability company, as applicable, to such Grantor and all of the other economic rights, titles and interests of such Grantor as a partner or member, as applicable, of any such partnership, limited partnership or limited liability company, as applicable, whether set forth in the partnership agreement or membership agreement, as applicable, of such partnership, limited partnership or limited liability company, as applicable, by separate agreement or otherwise. "PATENTS" means collectively, all of the following of any Grantor: (a) all patents, rights and interests in patents, patentable inventions and patent applications, (b) all reissues, extensions, continuations (in whole or in part) and renewals of any of the foregoing, (c) all income, royalties, damages or payments now or hereafter due and/or payable under any of the foregoing or with respect to any of the foregoing, including, without limitation, damages or payments for past or future infringements of any of the foregoing, (d) the right to sue for past, present and future infringements of any of the foregoing, and (e) all rights corresponding to any of the foregoing. "PATENT LICENSE" means all agreements now or hereafter in existence, whether written or oral, providing for the grant by or to any Grantor of any right to manufacture, use or sell any invention covered in whole or in part by a Patent. "PERFECTION CERTIFICATE" means the perfection certificate dated as of the date hereof, substantially in the form of EXHIBIT A attached hereto, and otherwise in form and substance satisfactory to the Secured Party, and duly certified by an officer, partner or member, as applicable, of each Grantor. "RESTRICTED SECURITIES COLLATERAL" has the meaning assigned thereto in Section 5.3(a) below. "SECURED PARTY" has the meaning assigned thereto in the preamble of this Agreement. "SECURITIES ACT" means the Securities Act of 1933, including all amendments thereto and regulations promulgated thereunder. "SECURITY INTERESTS" means the liens and security interests granted pursuant to Article II. "SUBSIDIARY ISSUER" means any Issuer of Investment Property or any Partnership/LLC Interests, which is a direct or indirect Subsidiary of any Grantor. "TRADEMARKS" means collectively, all of the following of any Grantor: (a) all trademarks, rights and interests in trademarks, trade names, corporate names, company names, business names, fictitious business names, trade styles, service marks, logos, other business identifiers, 4 prints and labels on which any of the foregoing have appeared or appear, all registrations and recordings thereof, and all applications in connection therewith, (b) all reissues, extensions, continuations (in whole or in part) and renewals of any of the foregoing, (c) all income, royalties, damages and payments now or hereafter due and/or payable under any of the foregoing or with respect to any of the foregoing, including, without limitation, damages or payments for past or future infringements of any of the foregoing, (d) the right to sue for past, present and future infringements of any of the foregoing, and (e) all rights corresponding to any of the foregoing. "TRADEMARK LICENSE" means any agreement now or hereafter in existence, whether written or oral, providing for the grant by or to any Grantor of any right to use any Trademark. "UCC" means the Uniform Commercial Code as in effect in the State of New York, as amended or modified from time to time. "VEHICLES" means all cars, trucks, trailers, and other vehicles covered by a certificate of title under the laws of any state, all tires and all other appurtenances to any of the foregoing. Section 1.3. OTHER DEFINITIONAL PROVISIONS. Terms defined in the Loan Agreement and not otherwise defined herein shall have the meanings assigned thereto in the Loan Agreement. The words "hereof," "herein", "hereto" and "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement, and Section and Schedule references are to this Agreement unless otherwise specified. The meanings given to terms defined herein shall be equally applicable to both the singular and plural forms of such terms. Where the context requires, terms relating to the Collateral or any part thereof, when used in relation to a Grantor, shall refer to such Grantor's Collateral or the relevant part thereof. The word "including" and words of similar import when used in this Agreement shall mean "including, without limitation," unless otherwise specified. ARTICLE II SECURITY INTEREST Section 2.1. GRANT OF SECURITY INTEREST. (a) Each Grantor hereby grants, pledges and collaterally assigns to the Secured Party a security interest in all of such Grantor's right, title and interest in the following property now owned or at any time hereafter acquired by such Grantor or in which such Grantor now has or at any time in the future may acquire any right, title or interest, and wherever located or deemed located (collectively, the "COLLATERAL"), as collateral security for the prompt and complete payment and performance when due (whether at the stated maturity, by acceleration or otherwise) of the Obligations: (i) all Accounts; (ii) all cash and currency; 5 (iii) all Chattel Paper; (iv) all Commercial Tort Claims; (v) all Deposit Accounts; (vi) all Documents; (vii) all Equipment; (viii) all Fixtures; (ix) all General Intangibles, including but not limited to all rights of the Borrower to indemnification under the Acquisition Agreement; (x) all Instruments; (xi) all Intellectual Property; (xii) all Inventory; (xiii) all Investment Property; (xiv) all Letter of Credit Rights; (xv) all Vehicles; (xvi) all other personal property not otherwise described above; (xvii) all books and records pertaining to the Collateral; and (xviii) to the extent not otherwise included, all Proceeds and products of any and all of the foregoing and all collateral security and Supporting Obligations (as now or hereafter defined in the UCC) given by any Person with respect to any of the foregoing. (b) Notwithstanding clause (a) of this Section 2.1, to the extent that, at any time, the grant of a security interest in any contract rights would, notwithstanding Sections 9-407 and 9-408 of the UCC or other applicable law, cause a breach of the subject Contract permitting the conterparty thereto to terminate such Contract under applicable law, such contract rights shall not at such time be part of the Collateral (but the proceeds thereof and any supporting obligations therefor shall be part of the Collateral). Each Grantor shall use all commercially reasonable efforts to obtain any necessary consents or waivers required in order for such Grantor to grant the Security Interests in any affected Contract. Section 2.2. GRANTORS REMAIN LIABLE. Anything herein to the contrary notwithstanding: (a) each Grantor shall remain liable under the contracts and agreements included in the Collateral to the extent set forth therein to perform all of its duties and obligations thereunder to the same extent as if this Agreement had not been executed, (b) the exercise by 6 Secured Party of any of the rights hereunder shall not release any Grantor from any of its duties or obligations under the contracts and agreements included in the Collateral, (c) the Secured Party shall have no obligation or liability under the contracts and agreements included in the Collateral by reason of this Agreement, nor shall the Secured Party be obligated to perform any of the obligations or duties of any Grantor thereunder or to take any action to collect or enforce any claim for payment assigned hereunder, and (d) the Secured Party shall have no liability in contract or tort for any Grantor's acts or omissions. ARTICLE III REPRESENTATIONS AND WARRANTIES To induce the Secured Party to enter into the Loan Agreement and to make the Loans to the Borrower thereunder, each Grantor hereby represents and warrants to the Secured Party that: Section 3.1. EXISTENCE. Each Grantor is duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or formation, has the requisite power and authority to own, lease and operate its properties and to carry on its business as now being and hereafter proposed to be conducted and is duly qualified and authorized to do business in each jurisdiction in which the character of its properties or the nature of its business requires such qualification and authorization other than in any such jurisdiction where failure to so qualify would not reasonably be expected to have a Material Adverse Effect. Section 3.2. AUTHORIZATION OF AGREEMENT; NO CONFLICT. Each Grantor has the right, power and authority and has taken all necessary corporate or other organizational action to authorize the execution, delivery and performance of, this Agreement. This Agreement has been duly executed and delivered by the duly authorized officers of each Grantor, and this Agreement constitutes the legal, valid and binding obligation of the Grantors, enforceable against the Grantors in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or similar state or federal debtor relief laws from time to time in effect which affect the enforcement of creditors' rights in general, and general limitations on the availability of equitable remedies. The execution, delivery and performance by the Grantors of this Agreement will not, by the passage of time, the giving of notice or otherwise, violate any material provision of any Applicable Law or any Contract material to the business of any Grantor and will not result in the creation or imposition of any Lien, other than the Security Interests, upon or with respect to any property or revenues of any Grantor. Section 3.3. CONSENTS. No approval, consent, exemption, authorization or other action by, or notice to, or filing with, any Governmental Authority or any other Person is necessary or required in connection with the execution, delivery or performance by, or enforcement against any Grantor or any Subsidiary Issuer of this Agreement, except (i) as may be required by laws affecting the offering and sale of securities generally, (ii) filings with the United States Copyright Office and/or the United States Patent and Trademark Office, and (iii) filings under the UCC and/or the Assignment of Claims Act. Section 3.4. PERFECTED FIRST PRIORITY LIENS. The Security Interests granted pursuant to this Agreement (a) constitute valid security interests in all of the Collateral in favor 7 of the Secured Party, as collateral security for the Obligations, enforceable in accordance with the terms hereof against all creditors of such Grantor and any Persons purporting to purchase any Collateral from such Grantor, and (b) are prior to all other Liens on the Collateral in existence on the date hereof except to the extent of any priority accorded under Applicable Law to any Permitted Liens. Upon the filing of financing statements in the jurisdiction of formation of the respective Grantors reflected in the Perfection Certificate, and the filing of appropriate collateral assignments with the United States Copyright Office and the United States Patent and Trademark Office, the Security Interests will be perfected first priority security interests in all Collateral in which a security interest can be perfected by means of filing; and upon delivery to the Secured Party of the certificates representing the Collateral consisting of Certificated Securities, the Security Interests will be perfected first priority security interests in such Collateral. Section 3.5. TITLE; NO OTHER LIENS. Except for the Security Interests, each Grantor owns each item of the Collateral free and clear of any and all Liens or claims other than Permitted Liens. No financing statement under the UCC of any state which names a Grantor as debtor or other public notice with respect to all or any part of the Collateral is on file or of record in any public office, except such as have been filed in favor of the Secured Party pursuant to this Agreement or in connection with Permitted Liens. No Collateral is in the possession or Control of any Person asserting any claim thereto or security interest therein, except that (a) the Secured Party or its designee may have possession or Control of Collateral as contemplated hereby, (b) a depositary bank may have Control of a Deposit Account owned by a Grantor at such depositary bank and a Securities Intermediary may have Control over a Securities Account owned by a Grantor at such Securities Intermediary, in each case subject to the terms of any Deposit Account control agreement or Securities Account control agreement, as applicable and to the extent required by Section 4, in favor of the Secured Party, and (c) a bailee, consignee or other Person may have possession of Collateral as contemplated by, and so long as, the applicable Grantors have complied to the satisfaction of the Secured Party with the applicable provisions of Section 4. Section 3.6. STATE OF ORGANIZATION; LOCATION OF INVENTORY, EQUIPMENT AND FIXTURES; OTHER INFORMATION. (a) The exact legal name of each Grantor is as set forth in the Perfection Certificate. (b) Each Grantor is a Registered Organization organized under the laws of the jurisdiction identified for such Grantor in the Perfection Certificate. The taxpayer identification number and Registered Organization number of each Grantor is as set forth for such Grantor in the Perfection Certificate. (c) All Collateral consisting of Inventory, Equipment and Fixtures (whether now owned or hereafter acquired) is (or will be) located at the locations specified in the Perfection Certificate. (d) The mailing address, chief place of business, chief executive office and office where each Grantor keeps its books and records relating to the Accounts, Documents, General Intangibles, Instruments and Investment Property in which it has any interest is located at the locations specified for such Grantor in the Perfection Certificate. No Grantor has any other 8 places of business. No Grantor does business or has done business during the past five years under any trade name or fictitious business name except as disclosed for such Grantor in the Perfection Certificate. Except as disclosed in the Perfection Certificate, no Grantor has acquired assets from any Person, other than assets acquired in the ordinary course of such Grantor's business, during the past five years. Section 3.7. ACCOUNTS. Each existing Account constitutes, and each hereafter arising Account will constitute, the legally valid and binding obligation of the applicable Account Debtor. The amount represented by each Grantor to the Secured Party as owing by each Account Debtor is, or will be, the correct amount actually and unconditionally owing, except for normal cash discounts and allowances in the ordinary course of business where applicable. No Account Debtor has any defense, set-off, claim or counterclaim against any Grantor that can be asserted against the Secured Party, whether in any proceeding to enforce Secured Party's rights in the Collateral or otherwise, except defenses, set-offs, claims or counterclaims that are not, in the aggregate, material to the value of the Accounts. None of the Accounts is, nor will any hereafter arising Account be, evidenced by a promissory note or other Instrument, other than a check, that has not been pledged and delivered to the Secured Party in accordance with the terms hereof. Section 3.8. CHATTEL PAPER. As of the date hereof, to the Grantors' knowledge, no Grantor holds any Chattel Paper. Section 3.9. COMMERCIAL TORT CLAIMS. As of the date hereof, no Grantor holds any Commercial Tort Claims except as described in the Perfection Certificate; and, upon becoming aware at any time and from time to time of any further Commercial Tort Claims, the Grantors shall notify the Secured Party thereof in accordance with Section 4.4. Section 3.10. DEPOSIT ACCOUNTS. As of the date hereof, all Deposit Accounts (including, without limitation, lockboxes and cash management accounts that are Deposit Accounts) owned by any Grantor are listed in the Perfection Certificate. Section 3.11. INTELLECTUAL PROPERTY. None of the Intellectual Property owned by any Grantor is the subject of any written licensing or franchise agreement pursuant to which such Grantor is the licensor or franchisor, except as would not reasonably be expected to have a Material Adverse Effect. Section 3.12. INVENTORY. Collateral consisting of Inventory is of good and merchantable quality, free from any material defects, and has been manufactured in accordance with the requirements of the Fair Labor Standards Act and all other Applicable Law. To the knowledge of each Grantor, none of such Inventory is subject to any licensing, Patent, Trademark, trade name or Copyright with any Person that restricts any Grantor's ability to manufacture and/or sell such Inventory. The completion of the manufacturing process of such Inventory by a Person other than the applicable Grantor would be permitted under any contract to which such Grantor is a party or to which the Inventory is subject. 9 Section 3.13. INVESTMENT PROPERTY; PARTNERSHIP/LLC INTERESTS. (a) As of the date hereof, all Investment Property (including, without limitation, Securities Accounts and cash management accounts that are Investment Property) and all Partnership/LLC Interests owned by any Grantor is listed in the Perfection Certificate. (b) All Investment Property and all Partnership/LLC Interests issued by any Subsidiary Issuer to any Grantor (i) have been duly and validly issued and, if applicable, are fully paid and nonassessable, (ii) are beneficially owned as of record by such Grantor, and (iii) constitute all the issued and outstanding shares of all classes of the capital stock or equity interest of such Subsidiary Issuer issued to such Grantor. (c) None of the Partnership/LLC Interests (i) are traded on a securities exchange or in securities markets, (ii) by their terms expressly provide that they are Securities governed by Article 8 of the UCC, or (iii) are Investment Company Securities. Section 3.14. INSTRUMENTS. As of the date hereof, no Grantor holds any Instruments or is named a payee of any promissory note or other evidence of indebtedness. ARTICLE IV COVENANTS Until the Obligations shall have been indefeasibly paid in full and the Revolving Credit Commitment has been terminated, unless express written consent has been obtained from the Lender, the Grantors covenant and agree that: Section 4.1. MAINTENANCE OF PERFECTED SECURITY INTEREST; FURTHER INFORMATION. (a) Each Grantor shall maintain the Security Interest created by this Agreement as a perfected Security Interests having at least the priority described in Section 3.4 and shall defend such Security Interest against the claims and demands of all Persons whomsoever. (b) Each Grantor will furnish to the Secured Party from time to time statements and schedules further identifying and describing the assets and property of such Grantor and such other reports in connection therewith as the Secured Party may reasonably request, all in reasonable detail. Section 4.2. MAINTENANCE OF INSURANCE. (a) Each Grantor will maintain, with financially sound and reputable companies, insurance policies (i) insuring the Collateral against loss by fire, explosion, theft, fraud and such other casualties, including business interruption, as may be reasonably satisfactory to the Secured Party in amounts and with deductibles at least as favorable as those generally maintained by businesses of similar size engaged in similar activities, and (ii) insuring such Grantor and the Secured Party against liability for hazards, risks and liability to persons and property relating to the Collateral (including, without limitation, products liability coverage), in amounts and with deductibles at least as favorable as those generally maintained by businesses of similar size 10 engaged in similar activities, such policies to be in such form and having such coverage as may be reasonably satisfactory to the Lender. (b) All such insurance (other than workers' compensation) shall (i) name the Secured Party as loss payee (to the extent covering risk of loss or damage to tangible property) and as an additional insured as its interests may appear (to the extent covering any other risk), (ii) provide that no cancellation shall be effective until at least thirty (30) days after receipt by the Secured Party of written notice thereof, and (iii) be reasonably satisfactory in all other respects to the Secured Party. (c) Upon the request of the Secured Party, each Grantor shall deliver to the Secured Party periodic information from a reputable insurance broker with respect to the insurance referred to in this Section 4.2. Section 4.3. CHANGES IN LOCATIONS; CHANGES IN NAME OR STRUCTURE. No Grantor will, except upon fifteen (15) days' prior written notice to the Secured Party and delivery to the Secured Party of (a) all additional financing statements (executed if necessary for any particular filing jurisdiction) and other instruments and documents reasonably requested by the Secured Party to maintain the validity, perfection and priority of the Security Interests, and (b) if applicable, a written supplement to the Perfection Certificate: (i) permit any Deposit Account to be held by or at a depositary bank other than the depositary bank that held such Deposit Account as of the date hereof as set forth in the Perfection Certificate; (ii) permit any of the Inventory, Equipment or Fixtures to be kept at a location other than those listed in the Perfection Certificate, except as otherwise permitted hereunder; (iii) permit any Investment Property (other than Certificated Securities delivered to the Secured Party pursuant to Section 4.5) to be held by a Securities Intermediary; (iv) change its organizational form or structure, jurisdiction of organization or the location of its chief executive office from that identified in the Perfection Certificate; or (v) change its name or identity to such an extent that any financing statement filed by the Secured Party in connection with this Agreement would become misleading. Section 4.4. REQUIRED NOTIFICATIONS. Each Grantor shall promptly notify the Secured Party, in writing, of: (a) any Lien (other than the Security Interests or Permitted Liens) on any of the Collateral, (b) the occurrence of any other event which could reasonably be expected to have a material adverse effect on the aggregate value of the Collateral or on the Security Interests, (c) any Collateral which, to the knowledge of such Grantor, constitutes a Government Contract, and (d) the acquisition or ownership by such Grantor of any (i) Commercial Tort Claim, (ii) Deposit Account, or (iii) Investment Property after the date hereof. 11 Section 4.5. DELIVERY COVENANTS. Each Grantor will deliver and pledge to the Secured Party all Certificated Securities, Partnership/LLC Interests evidenced by a certificate, negotiable Documents, Instruments, and Tangible Chattel Paper owned or held by such Grantor, in each case, together with an Effective Endorsement and Assignment and all Supporting Obligations, as applicable, unless such delivery and pledge has been waived in writing by the Secured Party. Section 4.6. CONTROL COVENANTS. (a) Each Grantor shall instruct (and otherwise use its reasonable efforts) to cause (i) each depositary bank holding a Deposit Account owned by such Grantor, and (ii) each Securities Intermediary holding any Investment Property owned by such Grantor, to execute and deliver a control agreement, sufficient to provide the Secured Party with Control of such Deposit Account or Investment Property, and otherwise in form and substance satisfactory to the Secured Party (any such depositary bank executing and delivering any such control agreement, a "CONTROLLED DEPOSITARY", and any such Securities Intermediary executing and delivering any such control agreement, a "CONTROLLED INTERMEDIARY"). In the event any such depositary bank or Securities Intermediary refuses to execute and deliver such control agreement, the Secured Party, in its sole discretion, may require the applicable Deposit Account and Investment Property to be transferred to the Secured Party or a Controlled Depositary or Controlled Intermediary, as applicable. (b) Each Grantor will, promptly upon request of the Secured Party, take such actions and deliver all such agreements as are requested by the Secured Party to provide the Secured Party with Control of all Letter of Credit Rights and Electronic Chattel Paper owned or held by such Grantor, including, without limitation, with respect to any such Electronic Chattel Paper, by having the Secured Party identified as the assignee of the Record(s) pertaining to the single authoritative copy thereof. (c) If any Collateral (other than Collateral specifically subject to the provisions of Section 4.6(a) and Section 4.6(b)) exceeding in value $100,000 in the aggregate (such Collateral exceeding such amount, the "EXCESS COLLATERAL") is at any time in the possession or control of any single consignee, warehouseman, bailee (other than a carrier transporting Inventory to a purchaser in the ordinary course of business), processor, or any other third party, such Grantor shall notify in writing such Person of the Security Interests created hereby, shall use its reasonable efforts to obtain such Person's written agreement in writing to hold all such Collateral for the Secured Party's account subject to the Secured Party's instructions, and shall, promptly upon request of the Secured Party, cause such Person to issue and deliver to the Secured Party warehouse receipts, bills of lading or any similar documents relating to such Collateral to the Secured Party's together with an Effective Endorsement and Assignment; provided that if such Grantor is not able to obtain such agreement and cause the delivery of such items, the Secured Party, in its sole discretion, may require such Excess Collateral to be moved to another location specified by the Secured Party. Further, each Grantor shall perfect and protect such Grantor's ownership interests in all Inventory exceeding $100,000 in the aggregate stored with a consignee against creditors of the consignee by filing and maintaining financing statements against the consignee reflecting the consignment arrangement filed in all appropriate filing offices, providing any written notices required to notify any prior creditors of the consignee of the consignment arrangement, and taking such other actions as may be appropriate to perfect and 12 protect such Grantor's interests in such Inventory under Section 2-326, Section 9-103, Section 9-324 and Section 9-505 of the UCC or otherwise. All such financing statements filed pursuant to this Section 4.6(c) shall be assigned, on the face thereof, to the Secured Party. Section 4.7. FILING COVENANTS. Pursuant to Section 9-509 of the UCC and any other Applicable Law, each Grantor authorizes the Secured Party to file or record financing statements and other filing or recording documents or instruments with respect to the Collateral without the signature of such Grantor in such form and in such offices as the Secured Party determines appropriate to perfect the Security Interests of the Secured Party under this Agreement. Such financing statements may describe the Collateral in the same manner as described herein or may contain an indication or description of Collateral that describes such property in any other manner as the Secured Party may determine, in its sole discretion, is necessary, advisable or prudent to ensure the perfection of the Security Interest in the Collateral granted herein, including, without limitation, describing such property as "all assets" or "all personal property." Further, a photographic or other reproduction of this Agreement shall be sufficient as a financing statement or other filing or recording document or instrument for filing or recording in any jurisdiction. Each Grantor hereby authorizes, ratifies and confirms all financing statements and other filing or recording documents or instruments filed by Secured Party prior to the date of this Agreement. Section 4.8. ACCOUNTS. (a) Other than in the ordinary course of business consistent with its past practice, no Grantor will (i) grant any extension of the time of payment of any Account, (ii) compromise or settle any Account for less than the full amount thereof, (iii) release, wholly or partially, any Account Debtor, (iv) allow any credit or discount whatsoever on any Account, or (v) amend, supplement or modify any Account in any manner that could adversely affect the value thereof. (b) Each Grantor will deliver to the Secured Party a copy of each material demand, notice or document received by such Grantor that questions or calls into doubt the validity or enforceability of any material Account. (c) The Secured Party shall have the right, upon prior notice to the Borrower (provided that no such notice shall be required during the continuance of any Default or Event of Default), to make test verifications of the Accounts in any manner and through any medium that it reasonably considers advisable, and each Grantor shall furnish all such assistance and information as the Secured Party may require in connection with such test verifications. At any time and from time to time, upon the Secured Party's reasonable request and at the expense of the relevant Grantor, such Grantor shall cause independent public accountants or others satisfactory to the Secured Party to furnish to the Secured Party reports showing reconciliations, aging and test verifications of, and trial balances for, the Accounts. (d) Upon request of the Secured Party at any time after five (5) days' notice to the Borrower and for good reason (provided that no such notice or reason shall be required during the continuance of any Default or Event of Default), each Grantor shall direct is Account Debtors to remit all payments on Accounts owing to such Grantor from time to time to a lockbox 13 maintained in the name or under the Control of the Secured Party and swept on a regular basis into a Deposit Account at a Controlled Depositary or the Collateral Account. Section 4.9. INTELLECTUAL PROPERTY. (a) Within thirty (30) days after the close of each calendar quarter (or more frequently if reasonably requested by the Secured Party), each Grantor shall give written notice to the Secured Party of the existence of any new registered Intellectual Property owned or claimed to be owned by such Grantor, which notice shall set forth the particulars thereof (including the name or title of the subject Intellectual Property, the filing office in which any filings may have been made in respect thereof, and the filing date and registration number of each such filing); and each such Grantor shall execute and deliver to the Secured Party, for filing, any and all such collateral assignments as the Secured Party may reasonably request in order to confirm and/or perfect the Security Interests in such Intellectual Property. (b) If deemed by the Grantors, in their reasonable business judgment, to be necessary or beneficial for use in their business, each Grantor (either itself or through licensees) (i) will continue to use each registered Trademark (owned by such Grantor) and Trademark for which an application (owned by such Grantor) is pending, to the extent reasonably necessary to maintain such Trademark in full force free from any claim of abandonment for non-use, (ii) will maintain products and services offered under such Trademark at a level substantially consistent with the quality of such products and services as of the date hereof, (iii) will not (and will not permit any licensee or sublicensee thereof to) do any act or knowingly omit to do any act whereby such Trademark could reasonably be expected to become invalidated or impaired in any way, (iv) will not do any act, or knowingly omit to do any act, whereby any issued Patent owned by such Grantor would reasonably be expected to become forfeited, abandoned or dedicated to the public, (v) will not (and will not permit any licensee or sublicensee thereof to) do any act or knowingly omit to do any act whereby any registered Copyright owned by such Grantor or Copyright for which an application is pending (owned by such Grantor) could reasonably be expected to become invalidated or otherwise impaired, and (vi) will not (either itself or through licensees) do any act whereby any material portion of the Copyrights may fall into the public domain. (c) Each Grantor will notify the Secured Party promptly if it knows, or has reason to know, that any application or registration relating to any material Intellectual Property owned by such Grantor may become forfeited, abandoned or dedicated to the public, or of any adverse determination or development (including, without limitation, the institution of, or any such determination or development in, any proceeding in the United States Patent and Trademark Office, the United States Copyright Office or any court or tribunal in any country) regarding such Grantor's ownership of, or the validity of, any material Intellectual Property owned by such Grantor or such Grantor's right to register the same or to own and maintain the same. (d) Whenever such Grantor, either by itself or through any agent, employee, licensee or designee, shall file an application for the registration of any Intellectual Property with the United States Patent and Trademark Office, the United States Copyright Office or any similar office or agency in any other country or any political subdivision thereof, such Grantor shall report such filing to the Secured Party within thirty (30) days after the last day of the fiscal 14 quarter in which such filing occurs. Upon request of the Secured Party, such Grantor shall execute and deliver, and have recorded, any and all agreements, instruments, documents, and papers as the Secured Party may reasonably request to evidence the Secured Party's security interest in any material Copyright, Patent or Trademark and the goodwill and General Intangibles of such Grantor relating thereto or represented thereby. (e) Each Grantor will, if deemed by the Grantors, in their reasonable business judgment, to be necessary or beneficial for use in their business, take all commercially reasonable and necessary steps, at such Grantor's sole cost and expense, including, without limitation, in any proceeding before the United States Patent and Trademark Office, the United States Copyright Office or any similar office or agency in any other country or any political subdivision thereof, to maintain and pursue each application (and to obtain the relevant registration) and to maintain each registration of the material Intellectual Property, including, without limitation, filing of applications for renewal, affidavits of use and affidavits of incontestability. (f) In the event that any material Intellectual Property owned by a Grantor is infringed, misappropriated or diluted by a third party, the applicable Grantor shall (i) at such Grantor's sole cost and expense, take such actions as such Grantor shall reasonably deem appropriate under the circumstances to protect such Intellectual Property, and (ii) if such Intellectual Property is of material economic value, promptly notify the Secured Party after it learns of such infringement, misappropriation or dilution. Section 4.10. INVESTMENT PROPERTY; PARTNERSHIP/LLC INTERESTS. (a) Without the prior written consent of the Lender, no Grantor will (i) vote to enable, or take any other action to permit, any Subsidiary Issuer to issue any Investment Property or Partnership/LLC Interests, except for those additional Investment Property or Partnership/LLC Interests that will be subject to the Security Interest granted herein in favor of the Secured Party, or (ii) enter into any agreement or undertaking restricting the right or ability of such Grantor or the Secured Party to sell, assign or transfer any Investment Property or Partnership/LLC Interests or Proceeds thereof. The Grantors will defend the right, title and interest of the Secured Party in and to any Investment Property and Partnership/LLC Interests against the claims and demands of all Persons whomsoever. (b) If any Grantor shall become entitled to receive or shall receive (i) any Certificated Securities (including, without limitation, any certificate representing a stock dividend or a distribution in connection with any reclassification, increase or reduction of capital or any certificate issued in connection with any reorganization), option or rights in respect of the ownership interests of any Issuer, whether in addition to, in substitution of, as a conversion of, or in exchange for, any Investment Property, or otherwise in respect thereof, or (ii) any sums paid upon or in respect of any Investment Property upon the liquidation or dissolution of any Issuer, such Grantor shall accept the same as the agent of the Secured Party, hold the same in trust for the Secured Party, segregated from other funds of such Grantor, and promptly deliver the same to the Secured Party in accordance with the terms hereof. 15 Section 4.11. EQUIPMENT. Each Grantor will maintain each item of Equipment in good working order and condition (reasonable wear and tear and obsolescence excepted), and in accordance with any manufacturer's manual and/or recommendations, and will as quickly as practicable provide all maintenance, service and repairs necessary for such purpose and will promptly furnish to the Secured Party a statement respecting any material loss or damage to any of the Equipment. Section 4.12. VEHICLES. Upon the request of the Secured Party at any time and from time to time, any and all applications for certificates of title or ownership indicating the Secured Party's first priority Lien on the Vehicle covered by such certificate, and any other necessary documentation, shall be filed in each office in each jurisdiction which the Secured Party shall deem reasonably advisable to perfect its Liens on the Vehicles. Prior thereto, each certificate of title or ownership relating to each Vehicle shall be maintained by the applicable Grantor in accordance with Applicable Law to reflect the ownership interest of such Grantor. Section 4.13. FURTHER ASSURANCES. Upon the request of the Secured Party and at the sole expense of the Grantors, each Grantor will promptly and duly execute and deliver, and have recorded, such further instruments and documents and take such further actions as the Secured Party may reasonably request for the purpose of obtaining or preserving the full benefits of this Agreement and of the rights and powers herein granted, including, without limitation, (a) the collateral assignment of any Contract, (b) with respect to Government Contracts, collateral assignment agreements and notices of collateral assignment, in form and substance satisfactory to the Secured Party, duly executed by the subject Grantor in compliance with the Assignment of Claims Act (or analogous state Applicable Law), and (c) all applications, certificates, instruments, registration statements, and all other documents and papers the Secured Party may reasonably request and as may be required by law in connection with the obtaining of any consent, approval, registration, qualification, or authorization of any Person deemed necessary or appropriate for the effective exercise of any rights under this Agreement. ARTICLE V REMEDIAL PROVISIONS Section 5.1. GENERAL REMEDIES. If an Event of Default shall occur and be continuing, the Secured Party may exercise, in addition to all other rights and remedies granted to it in this Agreement and in any other instrument or agreement securing, evidencing or relating to the Obligations, all rights and remedies of a secured party under the UCC or any other Applicable Law. Without limiting the generality of the foregoing, the Secured Party, without demand of performance or other demand, presentment, protest, advertisement or notice of any kind (except any notice required by law referred to below) to or upon any Grantor or any other Person (all and each of which demands, defenses, advertisements and notices are hereby waived), may in such circumstances forthwith collect, receive, appropriate and realize upon the Collateral, or any part thereof, and/or may forthwith sell, lease, assign, give option or options to purchase, or otherwise dispose of and deliver the Collateral or any part thereof (or contract to do any of the foregoing), in one or more parcels at public or private sale or sales, at any exchange, broker's board or office of the Secured Party or elsewhere upon such terms and conditions as it may deem advisable and at such prices as it may deem best, for cash or on credit or for future 16 delivery without assumption of any credit risk. The Secured Party may disclaim any warranties of title, possession and quiet enjoyment. The Secured Party shall have the right upon any such public sale or sales, and, to the extent permitted by law, upon any such private sale or sales, to purchase the whole or any part of the Collateral so sold, free of any right or equity of redemption in any Grantor, which right or equity is hereby waived and released. Each Grantor further agrees, at the Secured Party's request, to assemble the Collateral and make it available to the Secured Party at places which the Secured Party shall reasonably select, whether at such Grantor's premises or elsewhere. To the extent permitted by Applicable Law, each Grantor waives all claims, damages and demands it may acquire against the Secured Party arising out of the exercise by it of any rights hereunder except to the extent any such claims, damages, or demands result solely from the gross negligence or willful misconduct of the Secured Party. If any notice of a proposed sale or other disposition of Collateral shall be required by law, such notice shall be deemed reasonable and proper if given at least ten (10) days before such sale or other disposition. Section 5.2. SPECIFIC REMEDIES. (a) The Secured Party hereby authorizes each Grantor to collect its Accounts, under the Secured Party's direction and control; provided that, the Secured Party may curtail or terminate such authority at any time after the occurrence and during the continuance of an Event of Default. (b) Upon the occurrence and during the continuance of an Event of Default: (i) the Secured Party may communicate with Account Debtors of any Account subject to a Security Interest and upon the request of the Secured Party, each Grantor shall notify (such notice to be in form and substance satisfactory to the Secured Party) its Account Debtors and parties to the Contracts subject to a Security Interest that such Accounts and the Contracts have been assigned to the Secured Party; (ii) each Grantor shall forward to the Secured Party, on the last Business Day of each week (or more frequently if requested by the Secured Party), deposit slips related to all cash, money, checks or any other similar items of payment received by the Grantor during such week, and, if requested by the Secured Party, copies of such checks or any other similar items of payment, together with a statement showing the application of all payments on the Collateral during such week and a collection report with regard thereto, in form and substance satisfactory to the Secured Party. (iii) whenever any Grantor shall receive any cash, money, checks or any other similar items of payment relating to any Collateral (including any Proceeds of any Collateral), such Grantor agrees that it will, within one (1) Business Day of such receipt, deposit all such items of payment into the Collateral Account or in a Deposit Account at a Controlled Depositary; and until such Grantor shall deposit such cash, money, checks or any other similar items of payment in the Collateral Account or in a Deposit Account at a Controlled Depositary, such Grantor shall hold such cash, money, checks or any other similar items of payment in trust for the Secured Party and as property of the Secured Party, separate from the other funds of such Grantor, and the Secured Party shall have the 17 right to transfer or direct the transfer of the balance of each Deposit Account to the Collateral Account. All such Collateral and Proceeds of Collateral received by the Secured Party hereunder shall be held by the Secured Party in the Collateral Account as collateral security for all the Obligations and shall not constitute payment thereof until applied as provided in Section 5.4. (iv) the Secured Party shall have the right to receive any and all cash dividends, payments or distributions made in respect of any Investment Property or Partnership/LLC Interests or other Proceeds paid in respect of any Investment Property or Partnership/LLC Interests, and any or all of any Investment Property or Partnership/LLC Interests shall be registered in the name of the Secured Party or its nominee, and the Secured Party or its nominee may thereafter exercise (A) all voting, corporate and other rights pertaining to such Investment Property or Partnership/LLC Interests, at any meeting of shareholders, partners or members of the relevant Issuers, and (B) any and all rights of conversion, exchange and subscription and any other rights, privileges or options pertaining to such Investment Property or Partnership/LLC Interests as if it were the absolute owner thereof (including, without limitation, the right to exchange at its discretion any and all of the Investment Property or Partnership/LLC Interests upon the merger, consolidation, reorganization, recapitalization or other fundamental change in the corporate, partnership or company structure of any Issuer or upon the exercise by any Grantor or the Secured Party of any right, privilege or option pertaining to such Investment Property or Partnership/LLC Interests, and in connection therewith, the right to deposit and deliver any and all of the Investment Property or Partnership/LLC Interests with any committee, depositary, transfer agent, registrar or other designated agency upon such terms and conditions as the Secured Party may determine), all without liability except to account for property actually received by it; but the Secured Party shall have no duty to any Grantor to exercise any such right, privilege or option and the Secured Party shall not be responsible for any failure to do so or delay in so doing. In furtherance thereof, each Grantor hereby authorizes and instructs each Issuer with respect to any Collateral consisting of Investment Property and Partnership/LLC Interests to (i) comply with any instruction received by it from the Secured Party in writing that (A) states that an Event of Default has occurred and is continuing, and (B) is otherwise in accordance with the terms of this Agreement, without any other or further instructions from such Grantor, and each Grantor agrees that each Issuer shall be fully protected in so complying, and (ii) except as otherwise expressly permitted hereby, pay any dividends, distributions or other payments with respect to any Investment Property or Partnership/LLC Interests directly to the Secured Party; and (v) the Secured Party shall be entitled to (but shall not be required to): (A) proceed to perform any and all obligations of the applicable Grantor under any Contract and exercise all rights of such Grantor thereunder as fully as such Grantor itself could, (B) do all other acts which the Secured Party may deem necessary or proper to protect its Security Interest granted hereunder, provided such acts are not inconsistent with or in violation of the terms of the Loan Agreement or Applicable Law, and (C) sell, assign or otherwise transfer any Contract constituting Collateral, subject, however, to the prior approval of each other party to such Contract, to the extent required under the Contract. 18 (c) Unless an Event of Default shall have occurred and be continuing and the Secured Party shall have given notice to the relevant Grantor of the Secured Party's intent to exercise its corresponding rights pursuant to Section 5.2(b), each Grantor shall be permitted to receive all cash dividends, payments or other distributions made in respect of any Investment Property and Partnership/LLC Interests, in each case paid in the normal course of business of the relevant Issuer and consistent with past practice, to the extent permitted in the Loan Agreement, and to exercise all voting and other corporate, company or partnership rights with respect to any Investment Property and Partnership/LLC Interests; provided that no vote shall be cast or other corporate, company or partnership right exercised or other action taken which, in the Secured Party's reasonable judgment, would impair the Collateral or which would result in a Default or Event of Default under any provision of the Loan Agreement, this Agreement or any other Loan Document. Section 5.3. PRIVATE SALE. (a) Each Grantor recognizes that the Secured Party may be unable to effect a public sale of any or all Collateral consisting of Securities which have not been registered for resale under the Securities Act ("RESTRICTED SECURITIES COLLATERAL"), by reason of certain prohibitions contained in the Securities Act and applicable state securities laws or otherwise, and may be compelled to resort to one or more private sales thereof to a restricted group of purchasers which will be obliged to agree, among other things, to acquire such securities for their own account for investment and not with a view to the distribution or resale thereof. Each Grantor acknowledges and agrees that any such private sale may result in prices and other terms less favorable than if such sale were a public sale and, notwithstanding such circumstances, agrees that any such private sale shall not by reason thereof be deemed not to have been made in a commercially reasonable manner. The Secured Party shall be under no obligation to delay a sale of any of the Restricted Securities Collateral for the period of time necessary to permit the Issuer thereof to register such securities for public sale under the Securities Act, or under applicable state securities laws, even if such Issuer would agree to do so. (b) Each Grantor agrees to use its best efforts to do or cause to be done all such other acts as may be necessary to make such sale or sales of all or any portion of the Restricted Securities Collateral valid and binding and in compliance with any and all other Applicable Laws. Section 5.4. APPLICATION OF PROCEEDS. At such intervals as may be agreed upon by the Borrower and the Secured Party, or, if an Event of Default shall have occurred and be continuing, at any time at the Lender's election, the Secured Party may apply all or any part of the Collateral or any Proceeds of the Collateral in payment in whole or in part of the Obligations (after deducting all reasonable costs and expenses of every kind incurred in connection therewith or incidental to the care or safekeeping of any of the Collateral or in any way relating to the Collateral or the rights of the Secured Party hereunder, including, without limitation, reasonable attorneys' fees and disbursements) in accordance with Section 2.06 of the Loan Agreement. Any balance of such Proceeds remaining after payment in full of the Obligations shall be paid over to the Grantors, or to whomever else may be lawfully entitled to receive the same. Only after (a) the payment by the Secured Party of any other amount required by any provision of law, including, without limitation, Section 9-610 and Section 9-615 of the UCC, and (b) the payment in full of 19 the Obligations, shall the Secured Party account for the surplus, if any, to any Grantor, or to whomever else may be lawfully entitled to receive the same. Section 5.5. WAIVER, DEFICIENCY. Each Grantor hereby waives, to the extent permitted by Applicable Law, all rights of redemption, appraisement, valuation, stay, extension or moratorium now or hereafter in force under any Applicable Law in order to prevent or delay the enforcement of this Agreement or the absolute sale of the Collateral or any portion thereof. Each Grantor shall remain liable for any deficiency if the proceeds of any sale or other disposition of the Collateral are insufficient to pay its Obligations and the fees and disbursements of any attorneys employed by the Secured Party to collect such deficiency. ARTICLE VI THE SECURED PARTY Section 6.1. SECURED PARTY'S APPOINTMENT AS ATTORNEY-IN-FACT. (a) Each Grantor hereby irrevocably constitutes and appoints the Secured Party and any officer or agent thereof, with full power of substitution, as its true and lawful attorney-in-fact with full irrevocable power and authority in the place and stead of such Grantor and in the name of such Grantor or in its own name, for the purpose of carrying out the terms of this Agreement, to take any and all appropriate action and to execute any and all documents and instruments which may be necessary or desirable to accomplish the purposes of this Agreement, and, without limiting the generality of the foregoing, each Grantor hereby gives the Secured Party the power and right, on behalf of such Grantor, without notice to or assent by such Grantor, to do any or all of the following upon the occurrence and during the continuance of an Event of Default: (i) in the name of such Grantor or its own name, or otherwise, take possession of and indorse and collect any checks, drafts, notes, acceptances or other instruments for the payment of moneys due under any Account or Contract subject to a Security Interest or with respect to any other Collateral and file any claim or take any other action or proceeding in any court of law or equity or otherwise deemed appropriate by the Secured Party for the purpose of collecting any and all such moneys due under any Account or Contract subject to a Security Interest or with respect to any other Collateral whenever payable; (ii) in the case of any Intellectual Property, execute and deliver, and have recorded, any and all agreements, instruments, documents and papers as the Secured Party may request to evidence the Secured Party's security interest in such Intellectual Property and the goodwill and General Intangibles of such Grantor relating thereto or represented thereby; (iii) pay or discharge taxes and Liens levied or placed on or threatened against the Collateral, effect any repairs or any insurance called for by the terms of this Agreement and pay all or any part of the premiums therefor and the costs thereof, 20 (iv) execute, in connection with any sale provided for in this Agreement, any endorsements, assignments or other instruments of conveyance or transfer with respect to the Collateral; and (v) (A) direct any party liable for any payment under any of the Collateral to make payment of any and all moneys due or to become due thereunder directly to the Secured Party or as the Secured Party shall direct; (B) ask or demand for, collect, and receive payment of and receipt for, any and all moneys, claims and other amounts due or to become due at any time in respect of or arising out of any Collateral; (C) sign and indorse any invoices, freight or express bills, bills of lading, storage or warehouse receipts, drafts against debtors, assignments, verifications, notices and other documents in connection with any of the Collateral; (D) commence and prosecute any suits, actions or proceedings at law or in equity in any court of competent jurisdiction to collect the Collateral or any portion thereof and to enforce any other right in respect of any Collateral; (E) defend any suit, action or proceeding brought against such Grantor with respect to any Collateral; (F) settle, compromise or adjust any such suit, action or proceeding and, in connection therewith, give such discharges or releases as the Secured Party may deem appropriate; (G) assign any Copyright, Patent or Trademark (along with the goodwill of the business to which any such Copyright, Patent or Trademark pertains), for such term or terms, on such conditions, and in such manner, as the Secured Party shall in its sole discretion determine; and (H) generally, sell, transfer, pledge and make any agreement with respect to or otherwise deal with any of the Collateral as fully and completely as though the Secured Party were the absolute owner thereof for all purposes, and do, at the Secured Party's option and such Grantor's expense, at any time, or from time to time, all acts and things which the Secured Party deems necessary to protect, preserve or realize upon the Collateral and the Secured Party's Security Interests therein and to effect the intent of this Agreement, all as fully and effectively as such Grantor might do. (b) If any Grantor fails to perform or comply with any of its agreements contained herein, the Secured Party, at its option, but without any obligation so to do, may perform or comply, or otherwise cause performance or compliance, with such agreement in accordance with the provisions of Section 6.1(a). (c) The expenses of the Secured Party incurred in connection with actions taken pursuant to the terms of this Agreement shall be deemed to be Advances under the Loan Agreement and shall, together with interest thereon at the rate(s) in effect from time to time pursuant to the Revolving Credit Note, from the date of payment by the Secured Party to the date reimbursed by the Grantors, be payable by the Grantors to the Secured Party on demand. (d) Each Grantor hereby ratifies all that said attorneys shall lawfully do or cause to be done by virtue hereof in accordance with Section 6.1(a). All powers, authorizations and agencies contained in this Agreement are coupled with an interest and are irrevocable until this Agreement is terminated and the Security Interests created hereby are released. Section 6.2. DUTY OF SECURED PARTY. The Secured Party's sole duty with respect to the custody, safekeeping and physical preservation of the Collateral in its possession, under 21 Section 9-207 of the UCC or otherwise, shall be to deal with it in the same manner as the Secured Party deals with similar property for its own account. Neither the Secured Party nor any of its officers, directors, employees or agents shall be liable for failure to demand, collect or realize upon any of the Collateral or for any delay in doing so or shall be under any obligation to sell or otherwise dispose of any Collateral upon the request of any Grantor or any other Person or to take any other action whatsoever with regard to the Collateral or any part thereof. The powers conferred on the Secured Party hereunder are solely to protect the Secured Party's interests in the Collateral and shall not impose any duty upon the Secured Party to exercise any such powers. The Secured Party shall be accountable only for amounts that it actually receives as a result of the exercise of such powers, and neither it nor any of its officers, directors, employees or agents shall be responsible to any Grantor for any act or failure to act hereunder, except for their own gross negligence or willful misconduct. ARTICLE VII MISCELLANEOUS Section 7.1. AMENDMENTS IN WRITING. None of the terms or provisions of this Agreement may be waived, amended, supplemented or otherwise modified except in accordance with Section 9.04 of the Loan Agreement. Section 7.2. NOTICES. All notices, requests and demands to or upon the Secured Party or any Grantor hereunder shall be effected in the manner provided for in Section 9.06 of the Loan Agreement. Section 7.3. NO WAIVER BY COURSE OF CONDUCT, CUMULATIVE REMEDIES. The Secured Party shall not by any act (except by a written instrument pursuant to Section 7.1), delay, indulgence, omission or otherwise be deemed to have waived any right or remedy hereunder or to have acquiesced in any Default or Event of Default. No failure to exercise, nor any delay in exercising on the part of the Secured Party, any right, power or privilege hereunder shall operate as a waiver thereof. No single or partial exercise of any right, power or privilege hereunder shall preclude any other or further exercise thereof or the exercise of any other right, power or privilege. A waiver by the Secured Party of any right or remedy hereunder on any one occasion shall not be construed as a bar to any right or remedy which the Secured Party would otherwise have on any future occasion. The rights and remedies herein provided are cumulative, may be exercised singly or concurrently and are not exclusive of any other rights or remedies provided by law. Section 7.4. ENFORCEMENT EXPENSES, INDEMNIFICATION. (a) Each Grantor agrees to pay or reimburse the Secured Party on demand for all of its reasonable costs and expenses incurred in connection with enforcing or preserving any rights under this Agreement and the other Loan Documents (including, without limitation, in connection with any workout, restructuring, bankruptcy or other similar proceeding), including, without limitation, the reasonable fees and disbursements of counsel to the Secured Party. 22 (b) Each Grantor agrees to pay, and to save the Secured Party harmless from, any and all liabilities with respect to, or resulting from any delay in paying, any and all stamp, excise, sales or other taxes which may be payable or determined to be payable with respect to any of the Collateral or in connection with any of the transactions contemplated by this Agreement (but not including franchise taxes or taxes based on net income of the Secured Party). (c) Each Grantor agrees to pay, and to save the Secured Party harmless from any and all liabilities, obligations, losses, damages, penalties, costs and expenses in connection with actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever with respect to the execution, delivery, enforcement, performance and administration of this Agreement to the extent any Grantor would be required to do so pursuant to Section 9.02 of the Loan Agreement. (d) The agreements in this Section 7.4 shall survive repayment of the Obligations and the termination of this Agreement and/or any other Loan Documents. Section 7.5. WAIVER OF JURY TRIAL; PRESERVATION OF REMEDIES. (a) EACH GRANTOR HEREBY IRREVOCABLY WAIVES ITS RIGHTS TO A JURY TRIAL WITH RESPECT TO ANY ACTION, CLAIM OR OTHER PROCEEDING ARISING OUT OF ANY DISPUTE IN CONNECTION WITH THIS AGREEMENT, ANY RIGHTS OR OBLIGATIONS HEREUNDER, OR THE PERFORMANCE OF SUCH RIGHTS AND OBLIGATIONS. (b) The parties hereto preserve, without diminution, certain remedies that such Persons may employ or exercise freely, either alone, in conjunction with or during a dispute. Each such Person shall have and hereby reserves the right to proceed in any court of proper jurisdiction or by self-help to exercise or prosecute the following remedies, as applicable: (i) all rights to foreclose against any real or personal property or other security by exercising a power of sale granted in the Loan Documents or under Applicable Law or by judicial foreclosure and sale, including a proceeding to confirm the sale, (ii) all rights of self-help including peaceful occupation of property and collection of rents, set-off, and peaceful possession of property, (iii) obtaining provisional or ancillary remedies including injunctive relief, sequestration, garnishment, attachment, appointment of receiver and in filing an involuntary bankruptcy proceeding, and (iv) when applicable, a judgment by confession of judgment. Preservation of these remedies does not limit the power of an arbitrator to grant similar remedies that may be requested by a party in a dispute. Section 7.6. SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon the successors and assigns of each Grantor and shall inure to the benefit of each Grantor (and shall bind all Persons who become bound as a Grantor to this Agreement), the Secured Party and their successors and assigns; PROVIDED, that no Grantor may assign, transfer or delegate any of its rights or obligations under this Agreement without the prior written consent of all holders of Obligations. Section 7.7. SET-OFF. Each Grantor hereby irrevocably authorizes the Secured Party at any time and from time to time, without notice to such Grantor, any such notice being 23 expressly waived by each Grantor, to set off and appropriate and apply any and all deposits (general or special, time or demand, provisional or final), in any currency, and any other credits, indebtedness or claims, in any currency, in each case whether direct or indirect, absolute or contingent, matured or unmatured, at any time held or owing by the Secured Party (or any agent of the Secured Party) to or for the credit or the account of such Grantor, or any part thereof in such amounts as the Secured Party may elect, against and on account of the obligations and liabilities of such Grantor to the Secured Party hereunder and claims of every nature and description of the Secured Party against such Grantor, in any currency, whether arising hereunder, under the Loan Agreement, any other Loan Document or otherwise, as the Secured Party may elect, whether or not the Secured Party has made any demand for payment and although such obligations, liabilities and claims may be contingent or unmatured. The Secured Party shall notify such Grantor promptly of any such set-off and the application made by the Secured Party of the proceeds thereof; PROVIDED, that the failure to give such notice shall not affect the validity of such setoff and application. The rights of the Secured Party under this Section 7.7 are in addition to other rights and remedies (including, without limitation, other rights of set-off) which the Secured Party may have. Section 7.8. COUNTERPARTS. This Agreement may be executed by one or more of the parties to this Agreement on any number of separate counterparts (including by telecopy), and all of said counterparts taken together shall be deemed to constitute one and the same instrument. Section 7.9. SEVERABILITY. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective only to the extent of such prohibition or unenforceability without invalidating the remainder of such provision or the remaining provisions hereof or thereof or affecting the validity or enforceability of such provision in any other jurisdiction. Section 7.10. SECTION HEADINGS. The Section headings used in this Agreement are for convenience of reference only and are not to affect the construction hereof or be taken into consideration in the interpretation hereof. Section 7.11. INTEGRATION. This Agreement and the other agreements, instruments and documents referred to herein represent the agreement of the Grantors and the Secured Party with respect to the subject matter hereof and thereof, and there are no promises, undertakings, representations or warranties by the Secured Party relative to subject matter hereof and thereof not expressly set forth or referred to herein or in the other agreements, instruments and documents referred to herein. Section 7.12. GOVERNING LAW. This Agreement shall be governed by, construed, interpreted and enforced in accordance with, the laws of the State of New York, without giving effect to principles of conflicts of laws; PROVIDED, HOWEVER, that to the extent that the laws of any other jurisdiction govern the perfection of the Security Interests in any Collateral located in such jurisdiction or owned by a Grantor located in such jurisdiction, then the laws of that jurisdiction shall govern as respects such perfection, and the Grantors shall comply therewith to the same extent as herein provided with respect to the UCC and other New York law. 24 Section 7.13. CONSENT TO JURISDICTION. Each Grantor hereby irrevocably consents to the personal jurisdiction of all state and federal courts located in New York, New York, in any action, claim or other proceeding arising out of any dispute in connection with this Agreement, the Loan Agreement, the Notes and the other Loan Documents, any rights or obligations hereunder or thereunder, or the performance of such rights and obligations. Each Grantor hereby irrevocably consents to the service of a summons and complaint and other process in any action, claim or proceeding brought by the Secured Party in connection with this Agreement, the Loan Agreement, the Notes or the other Loan Documents, any rights or obligations hereunder or thereunder, or the performance of such rights and obligations, on behalf of itself or its property, by registered or certified mail, return receipt requested, in the manner specified in Section 9.06 of the Loan Agreement. Nothing in this Section 7.13 shall affect the right of the Secured Party to serve legal process in any other manner permitted by Applicable Law or affect the right of the Secured Party to bring any action or proceeding against any Grantor or its properties in the courts of any other jurisdictions. Section 7.14. ACKNOWLEDGEMENTS. (a) Each Grantor hereby acknowledges that (i) it has been advised by counsel in the negotiation, execution and delivery of this Agreement, (ii) the Secured Party has no fiduciary relationship with or duty to any Grantor arising out of or in connection with the Loan Agreement, this Agreement or any of the other Loan Documents, and the relationship between the Grantors (on the one hand) and the Secured Party (on the other hand) in connection herewith or therewith is solely that of debtor and creditor, and (iii) no joint venture is created hereby or otherwise exists by virtue of the transactions contemplated hereby. (b) Each Issuer party to this Agreement acknowledges receipt of a copy of this Agreement and agrees to be bound thereby and to comply with the terms thereof insofar as such terms are applicable to it. Each Issuer agrees to provide such notices to the Secured Party as may be necessary to give full effect to the provisions of this Agreement. Section 7.15. ADDITIONAL GRANTORS. Each Subsidiary of the Borrower that is required to become a party to this Agreement pursuant to Section 5.11 of the Loan Agreement shall become a Grantor for all purposes of this Agreement upon execution and delivery by such Subsidiary of a joinder agreement (with a Perfection Certificate and/or other appropriate disclosure schedules respecting such Additional Grantor) in form and substance satisfactory to the Secured Party. Section 7.16. RELEASES. (a) At such time as the Obligations shall have been indefeasibly paid in full and the Revolving Credit Commitment has been terminated, the Collateral shall be released from the Liens created hereby, and this Agreement and all obligations (other than those expressly stated to survive such termination) of the Secured Party and each Grantor hereunder shall terminate, all without delivery of any instrument or performance of any act by any party, and all rights to the Collateral shall revert to the Grantors. At the request and sole expense of any Grantor following any such termination, the Secured Party shall deliver to such Grantor any Collateral held by the 25 Secured Party hereunder, and execute and deliver to such Grantor such documents as such Grantor shall reasonably request to evidence such termination. (b) If any of the Collateral shall be sold, transferred or otherwise disposed of by any Grantor in a transaction permitted by the Loan Agreement, then the Secured Party, at the request and sole expense of such Grantor, shall execute and deliver to such Grantor all releases or other documents reasonably necessary or desirable for the release of the Liens created hereby on such Collateral. [Signature Page to Follow] 26 IN WITNESS WHEREOF, the parties hereto have caused this Collateral Agreement to be executed by their duly authorized officers, all as of the day and year first written above. TAG-IT PACIFIC, INC., a Delaware corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TALON INTERNATIONAL, INC., a Delaware corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TAG-IT, INC., a California corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer A.G.S. STATIONARY, INC., a California corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TAG-IT PACIFIC LIMITED, a Hong Kong corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TAG-IT PACIFIC (HK) LTD., a British Virgin Islands corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer 27 TAGIT de MEXICO, S.A. de C.V. By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TALON ZIPPER (SHENZHEN) COMPANY, LTD., a Chinese corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer TALON INTERNATIONAL PVT. LTD., an Indian corporation By: /s/ Lonnie D. Schnell ---------------------------------------- Name: Lonnie D. Schnell Title: Chief Financial Officer BLUEFIN CAPITAL, LLC By: /S/ LARRY E. LENIG, JR. --------------------------------------- Name: Larry E. Lenig, Jr. Title: Senior Partner/Portfolio Manager 28 EX-10 7 ex10-40.txt EX-10.40 EXHIBIT 10.40 PROMISSORY NOTE $720,666 June 15, 2007 FOR VALUE RECEIVED, the undersigned, COLIN DYNE, an individual ("MAKER"), hereby promises to pay to TAG-IT PACIFIC, INC., a Delaware corporation, or assigns ("PAYEE"), in lawful money of the United States of America, the principal sum of Seven Hundred Twenty Thousand Six Hundred Sixty Six Dollars ($720,666). From and after the date hereof, interest shall accrue on the unpaid balance from time to time outstanding until the principal balance is paid in full, at a rate of seven and one-half percent (7.5%) per annum, compounded monthly. The entire unpaid principal balance of this Note, together with accrued interest, shall be due and payable within fifteen (15) days following receipt by Maker of written demand therefor from Payee. MAKER: /S/ COLIN DYNE ----------------------------- Colin Dyne Date Executed: June 27, 2007 EX-31 8 ex31-1t.txt Exhibit 31.1 Certification of CEO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Stephen P. Forte, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Talon International, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2007 /S/ STEPHEN P. FORTE ---------------------------- Stephen P. Forte Chief Executive Officer EX-31 9 ex31-2t.txt Exhibit 31.2 Certification of CFO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Lonnie D. Schnell, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Talon International, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2007 /S/ LONNIE D. SCHNELL --------------------------------- Lonnie D. Schnell Chief Financial Officer EX-32 10 ex32-2t.txt Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in connection with the filing of the Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2007 (the "Report") by Talon International, Inc. ("Registrant"), each of the undersigned hereby certifies that: 1. to the best of our knowledge, the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. to the best of our knowledge, the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Registrant. Dated: August 14, 2007 /S/ STEPHEN P. FORTE ----------------------------------- Stephen P. Forte Chief Executive Officer Dated: August 14, 2007 /S/ LONNIE D. SCHNELL ----------------------------------- Lonnie D. Schnell Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----