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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934. FOR THE TRANSITION PERIOD FROM ____________ TO
COMMISSION FILE NUMBER: 0-26006
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TARRANT APPAREL GROUP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-4181026
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
3151 EAST WASHINGTON BOULEVARD
LOS ANGELES, CALIFORNIA 90023
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (323) 780-8250
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.
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]
Number of shares of Common Stock of the Registrant outstanding as of November
9, 2007: 30,543,763.
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TARRANT APPAREL GROUP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 2007 (unaudited)
and December 31, 2006............................................ 2
Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 2007 and
September 30, 2006 (unaudited)................................... 3
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2007 and September 30, 2006 (unaudited)...... 4
Notes to Consolidated Financial Statements (unaudited)........... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................... 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...... 40
Item 4. Controls and Procedures.......................................... 41
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 42
Item 1A. Risk Factors..................................................... 42
Item 6. Exhibits......................................................... 48
SIGNATURES....................................................... 49
CAUTIONARY LEGEND REGARDING FORWARD-LOOKING STATEMENTS
Some of the information in this Quarterly Report on Form 10-Q may
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
both as amended. These forward-looking statements are subject to various risks
and uncertainties. The forward-looking statements include, without limitation,
statements regarding our future business plans and strategies and our future
financial position or results of operations, as well as other statements that
are not historical. You can find many of these statements by looking for words
like "will", "may", "believes", "expects", "anticipates", "plans" and
"estimates" and for similar expressions. Because forward-looking statements
involve risks and uncertainties, there are many factors that could cause the
actual results to differ materially from those expressed or implied. These
include, but are not limited to, economic conditions. This Quarterly Report on
Form 10-Q contains important cautionary statements and a discussion of many of
the factors that could materially affect the accuracy of Tarrant's
forward-looking statements and such statements and discussions are incorporated
herein by reference. Any subsequent written or oral forward-looking statements
made by us or any person acting on our behalf are qualified in their entirety by
the cautionary statements and factors contained or referred to in this section.
We do not intend or undertake any obligation to update any forward-looking
statements to reflect events or circumstances after the date of this document or
the date on which any subsequent forward-looking statement is made or to reflect
the occurrence of unanticipated events.
1
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ..................................... $ 1,644,076 $ 904,553
Accounts receivable, net of $2.2 million and $2.1 million
allowance for returns, discounts and bad debts at September 30,
2007 and December 31, 2006, respectively ...................... 49,010,282 48,079,527
Due from related parties ...................................... 8,637,795 3,688,355
Inventory ..................................................... 10,913,005 17,774,103
Temporary quota rights ........................................ 41,047 32,217
Prepaid expenses .............................................. 1,190,331 1,515,087
Deferred tax assets ........................................... 148,332 123,607
Income taxes receivable ....................................... -- 25,468
------------- -------------
Total current assets ............................................ 71,584,868 72,142,917
Property and equipment, net of $9.6 million and $9.4 million
accumulated depreciation at September 30, 2007 and December 31,
2006, respectively ............................................... 1,571,172 1,414,354
Notes receivable - related parties, net of $27.1 million reserve
at December 31, 2006 ............................................. -- 14,000,000
Due from related parties ......................................... 3,556,941 4,168,205
Equity method investment ......................................... 2,292,705 2,151,061
Deferred financing cost, net of $1.0 million and $1.7 million
accumulated amortization at September 30, 2007 and December 31,
2006, respectively ............................................... 259,135 2,448,526
Other assets ..................................................... 233,174 6,223,816
Goodwill, net .................................................... 8,582,845 8,582,845
------------- -------------
Total assets ..................................................... $ 88,080,840 $ 111,131,724
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings .................................... $ 12,684,656 $ 13,696,182
Accounts payable .............................................. 19,026,880 22,685,674
Accrued expenses .............................................. 8,891,612 8,907,658
Derivative liability .......................................... -- 195,953
Income taxes .................................................. 17,277,776 16,865,125
Current portion of long-term obligations and factoring
arrangement ................................................. 11,303,660 19,586,565
------------- -------------
Total current liabilities ....................................... 69,184,584 81,937,157
Term loan, net of $4.3 million debt discount at December 31, 2006. -- 11,212,724
Other long-term obligations ...................................... -- 5,338
------------- -------------
Total liabilities ................................................ 69,184,584 93,155,219
Minority interest in PBG7 ........................................ 49,847 54,338
Commitments and contingencies
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized; no shares at
September 30, 2007 and December 31, 2006 issued and outstanding -- --
Common stock, no par value, 100,000,000 shares authorized;
30,543,763 shares at September 30, 2007 and December 31, 2006
issued and outstanding ........................................ 114,977,465 114,977,465
Warrant to purchase common stock .............................. 7,314,239 7,314,239
Contributed capital ........................................... 10,560,634 10,191,511
Accumulated deficit (See Note 12) ............................. (111,987,372) (112,410,363)
Notes receivable from officer/shareholder ..................... (2,018,557) (2,150,685)
------------- -------------
Total shareholders' equity ...................................... 18,846,409 17,922,167
------------- -------------
Total liabilities and shareholders' equity ....................... $ 88,080,840 $ 111,131,724
============= =============
The accompanying notes are an integral part of these
consolidated financial statements
2
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------ ------------- -------------
2007 2006 2007 2006
------------- ------------- ------------- -------------
Net sales .................................. $ 62,920,140 $ 54,645,223 $ 172,239,904 $ 174,989,008
Net sales to related party ................. 7,283,117 -- 14,170,449 --
------------- ------------- ------------- -------------
Total net sales ............................ 70,203,257 54,645,223 186,410,353 174,989,008
Cost of sales .............................. 50,596,259 42,844,174 135,641,449 138,006,628
Cost of sales to related party ............. 6,659,261 -- 12,919,890 --
------------- ------------- ------------- -------------
Total cost of sales ........................ 57,255,520 42,844,174 148,561,339 138,006,628
Gross profit ............................... 12,947,737 11,801,049 37,849,014 36,982,380
Selling and distribution expenses .......... 3,754,062 2,568,038 10,544,801 8,295,815
General and administrative expenses ........ 6,111,199 6,551,393 18,838,153 19,914,629
Royalty expenses ........................... 421,454 263,583 1,212,882 2,099,392
Loss on notes receivable - related parties.. -- 27,137,297 -- 27,137,297
Terminated acquisition expenses ............ -- -- 2,000,000 --
------------- ------------- ------------- -------------
Income (loss) from operations ............. 2,661,022 (24,719,262) 5,253,178 (20,464,753)
Interest expense ........................... (1,282,763) (1,562,426) (3,845,649) (4,696,279)
Interest income ............................ 39,462 165,399 127,419 1,131,601
Interest in income (loss) of equity method
investee ................................ 15,102 (7,307) 141,644 103,015
Other income ............................... 3,866,835 109,093 4,019,233 233,466
Adjustment to fair value of derivative ..... -- 729,394 195,953 511,087
Other expense .............................. (4,954,015) -- (4,965,155) (400,000)
------------- ------------- ------------- -------------
Income (loss) before provision for income
taxes ................................... 345,643 (25,285,109) 926,623 (23,581,863)
Provision (credit) for income taxes ........ (1,265,961) 80,946 (491,877) 340,667
Minority interest .......................... 3,043 13,641 4,491 17,772
------------- ------------- ------------- -------------
Net income (loss) .......................... $ 1,614,647 $ (25,352,414) $ 1,422,991 $ (23,904,758)
============= ============= ============= =============
Net income (loss) per share:
Basic ................................... $ 0.05 $ (0.83) $ 0.05 $ (0.78)
============= ============= ============= =============
Diluted ................................. $ 0.05 $ (0.83) $ 0.05 $ (0.78)
============= ============= ============= =============
Weighted average common and common
equivalent shares:
Basic ................................... 30,543,763 30,543,763 30,543,763 30,546,217
============= ============= ============= =============
Diluted ................................. 30,543,763 30,543,763 30,543,875 30,546,217
============= ============= ============= =============
The accompanying notes are an integral part of these
consolidated financial statements
3
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------
2007 2006
------------- -------------
Operating activities:
Net income (loss) ......................................... $ 1,422,991 $ (23,904,758)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Deferred taxes ......................................... (24,724) (8,073)
Depreciation and amortization of fixed assets .......... 310,134 353,261
Amortization of deferred financing cost ................ 1,480,554 2,030,636
Write-off of deferred financing cost and debt discount.. 4,950,616 --
Adjustment to fair value of derivative ................. (195,953) (511,087)
Loss (gain) on notes receivable - related parties ...... (3,750,000) 27,137,297
Terminated acquisition expenses ........................ 2,000,000 --
Change in the provision for returns and discounts ...... (55,348) 318,208
Change in the provision for bad debts .................. 172,374 (6,885)
Loss (gain) on sale of fixed assets .................... 9,543 (2,054)
Income from equity method investment ................... (141,644) (103,015)
Minority interest ...................................... (4,491) (17,772)
Stock-based compensation ............................... 469,124 96,820
Changes in operating assets and liabilities:
Accounts receivable .................................. (548,643) 7,295,637
Due to/from related parties .......................... (4,951,432) (35,830)
Inventory ............................................ 6,861,098 11,173,258
Temporary quota rights ............................... (8,830) (111,207)
Prepaid expenses ..................................... 350,224 1,196,077
Accounts payable ..................................... (3,658,793) (15,083,937)
Accrued expenses and income tax payable .............. (603,396) 480,420
------------- -------------
Net cash provided by operating activities ............ 4,083,404 10,296,996
Investing activities:
Purchase of fixed assets ............................... (476,496) (130,177)
Proceeds from sale of fixed assets ..................... -- 4,707
Proceeds from notes receivable ......................... 17,750,000 --
Due diligence fees in acquisition ...................... (699,744) --
Refund of deposit on acquisition ....................... 4,750,000 --
Distribution from equity method investee ............... -- 67,500
Collection on notes receivable - related parties ....... -- 1,086,111
Collection of advances from shareholders/officers ...... 132,129 96,669
------------- -------------
Net cash provided by investing activities ............ 21,455,889 1,124,810
Financing activities:
Short-term bank borrowings, net ........................ (1,011,526) (1,298,595)
Proceeds from long-term obligations .................... 156,969,797 183,669,591
Payment of financing costs ............................. -- (2,821,647)
Repayments of term loan ................................ (15,500,000) --
Repayments of borrowings from convertible debentures ... -- (6,912,626)
Payment of long-term obligations and bank borrowings ... (165,258,041) (184,723,816)
------------- -------------
Net cash used in financing activities ................ (24,799,770) (12,087,093)
------------- -------------
Increase (decrease) in cash and cash equivalents .......... 739,523 (665,287)
Cash and cash equivalents at beginning of period .......... 904,553 1,641,768
------------- -------------
Cash and cash equivalents at end of period ................ $ 1,644,076 $ 976,481
============= =============
The accompanying notes are an integral part of these
consolidated financial statements
4
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF CONSOLIDATION
The accompanying financial statements consist of the consolidation of
Tarrant Apparel Group, a California corporation, and its majority owned
subsidiaries located primarily in the U.S., Asia, Mexico, and Luxembourg. At
September 30, 2007, we own 75% of PBG7, LLC ("PBG7"). We previously owned 50.1%
of United Apparel Ventures ("UAV"), which was dissolved on February 27, 2007.
The dissolution of UAV did not have a material impact on our consolidated
financial statements. We consolidate these entities and reflect the minority
interests in earnings (losses) of the ventures in the accompanying financial
statements. All inter-company amounts are eliminated in consolidation. The 49.9%
minority interest in UAV was owned by Azteca Production International, a
corporation owned by the brothers of our Chairman and Interim Chief Executive
Officer, Gerard Guez. The 25% minority interest in PBG7 is owned by BH7, LLC, an
unrelated party.
We serve specialty retail, mass merchandisers and department store
chains and branded wholesalers by designing, merchandising, contracting for the
manufacture of, and selling casual apparel for women, men and children under
private label and private brand.
Historically, our operating results have been subject to seasonal
trends when measured on a quarterly basis. This trend is dependent on numerous
factors, including the markets in which we operate, holiday seasons, consumer
demand, climate, economic conditions and numerous other factors beyond our
control. Generally, the second and third quarters are stronger than the first
and fourth quarters. There can be no assurance that the historic operating
patterns will continue in future periods.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles in the United States of
America ("US GAAP") for interim financial information and 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 US GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation of the results
of operations for the periods presented have been included.
The consolidated financial data at December 31, 2006 is derived from
audited financial statements which are included in our Annual Report on Form
10-K for the year ended December 31, 2006, and should be read in conjunction
with the audited financial statements and notes thereto. Interim results are not
necessarily indicative of results for the full year.
The accompanying unaudited consolidated financial statements include
all majority-owned subsidiaries in which we exercise control. Investments in
which we exercise significant influence, but which we do not control, are
accounted for under the equity method of accounting. The equity method of
accounting is used when we have a 20% to 50% interest in other entities, except
for variable interest entities for which we are considered the primary
beneficiary under Financial Accounting Standards Board ("FASB") Interpretation
No. 46, "Consolidation of Variable Interest Entities," an interpretation of ARB
No. 51. Under the equity method, original investments are recorded at cost and
adjusted by our share of undistributed earnings or losses of these entities. All
significant inter-company transactions and balances have been eliminated from
the consolidated financial statements.
The preparation of financial statements in conformity with US GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Significant
estimates used by us in preparation of the consolidated financial statements
include allowance for returns, discounts and bad debts, inventory, notes
receivable - related parties reserve, valuation of long-lived and intangible
assets and goodwill, income taxes, stock options valuation, contingencies and
litigation. Actual results could differ from those estimates.
5
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
LICENSE AGREEMENTS AND ROYALTY EXPENSES
We enter into license agreements from time to time that allow us to use
certain trademarks and trade names on certain of our products. These agreements
require us to pay royalties and marketing fund commitments, generally based on
the sales of such products, and may require guaranteed minimum royalties, a
portion of which may be paid in advance. Our accounting policy is to match
royalty expense with revenue by recording royalties at the time of sale at the
greater of the contractual rate or an effective rate calculated based on the
guaranteed minimum royalty and our estimate of sales during the contract period.
If a portion of the guaranteed minimum royalty is determined not to be
recoverable, the unrecoverable portion is charged to expense at that time. See
Note 15 of the "Notes to Consolidated Financial Statements" regarding various
agreements we have entered into.
Royalty expense in the nine months ended September 30, 2007 and 2006
was $1.2 million and $2.1 million, respectively.
DEFERRED RENT PROVISION
When a lease requires fixed escalation of the minimum lease payments,
rental expense is recognized on a straight line basis over the initial term of
the lease, and the difference between the average rental amount charged to
expense and amounts payable under the lease is included in deferred amount. As
of September 30, 2007 and December 31, 2006, deferred rent of $246,000 and
$93,000, respectively, was recorded under accrued expense in our consolidated
financial statements.
DERIVATIVE ACTIVITIES
WARRANT DERIVATIVES
Statement of Financial Accounting Standards ("SFAS") No. 133
"Accounting for Derivative Instruments and Hedging Activities" requires
measurement of certain derivative instruments at their fair value for accounting
purposes. In determining the appropriate fair value, we use the
Black-Scholes-Merton Option Pricing Formula ("Black-Scholes model"). Derivative
liabilities are adjusted to reflect fair value at each period end, with any
increase or decrease in the fair value being recorded in consolidated statements
of operations as adjustments to fair value of derivatives.
FOREIGN CURRENCY FORWARD CONTRACT
We source our product in a number of countries throughout the world, as
a result, are exposed to movements in foreign currency exchange rates. The
primary purpose of our foreign currency hedging activities is to manage the
volatility associated with foreign currency purchases of materials in the normal
course of business. We utilize derivative financial instruments consisting
primarily of forward currency contracts. These instruments are intended to
protect against exposure related to financing transactions and income from
international operations. We do not enter into derivative financial instruments
for speculative or trading purposes. We enter into certain foreign currency
derivative instruments that do not meet hedge accounting criteria.
SFAS No. 133 requires measurement of certain derivative instruments at
their fair value for accounting purposes. All derivative instruments are
recorded on our balance sheet at fair value; as a result, we mark to market all
derivative instruments. Derivative liabilities are adjusted to reflect fair
value at each period end, with any increase or decrease in the fair value being
recorded in consolidated statements of operations as adjustments to fair value
of derivatives. During 2006, we entered into foreign currency forward contracts
to hedge against the effect of exchange rate fluctuations on cash flows
denominated in foreign currencies and certain inter-company financing
transactions. At September 30, 2007, we had no open foreign exchange forward
contracts. Hedge ineffectiveness resulted in an impact of $196,000 in our
consolidated statements of operations in the nine months of 2007.
6
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
ACCOUNTING FOR UNCERTAIN TAX POSITIONS
In June 2006, the FASB issued 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 in accordance with FASB
Statement No. 109, "Accounting for Income Taxes." FIN 48 also prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return that results in a tax benefit. Additionally, FIN 48 provides guidance
on de-recognition, income statement classification of interest and penalties,
accounting in interim periods, disclosure, and transition. We adopted the
provisions of FIN 48 on January 1, 2007. As a result of the implementation of
FIN 48, we recognized no material adjustment for unrecognized tax benefits but
reduced retained earnings as of January 1, 2007 by approximately $1 million
attributable to penalties accrued as a component of income tax payable. As of
the date of adoption, our unrecognized tax benefits totaled approximately $8.9
million.
We and several of our subsidiaries file income tax returns in the U.S.,
Hong Kong, Luxembourg, Mexico and various state jurisdictions. We are currently
subject to Internal Revenue Service ("IRS") audit for the years including 1996
through 2002 and State of New York audit for the years 2002 to 2005 but are not
being audited for other states or non-U.S. income tax examinations for years
open in those taxing jurisdictions.
In January 2004, the IRS completed its examination of our Federal
income tax returns for the years ended December 31, 1996 through 2001. The IRS
has proposed adjustments to increase our income tax payable for the six years
under examination. In addition, in July 2004, the IRS initiated an examination
of our Federal income tax return for the year ended December 31, 2002. We are
currently at the appellate level of the IRS and believe the proposed adjustments
made to our federal income tax returns for the years ended 1996 through 2002
will be resolved within the next twelve months and if so, unrecognized tax
benefits related to U.S. tax positions may decrease by up to $7.8 million by
December 31, 2007. If the proposed adjustments are upheld through the
administrative and legal process, they could have a material impact on our
earnings and cash flow. We believe we have provided adequate reserves for any
reasonably foreseeable outcome related to these matters on the consolidated
balance sheets under the caption "Income Taxes". We do not believe that the
adjustments, if any, arising from the IRS examination, will result in an
additional income tax liability beyond what is recorded in the accompanying
consolidated balance sheets.
The total unrecognized tax benefits as of January 1, 2007 were $8.9
million, excluding interest, penalties and related income tax benefits and would
be recorded as a component of income tax expense if recognized. We recognize
interest accrued related to unrecognized tax benefits and penalties as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties were $8.0 million and $1.2 million, respectively, excluding any
related income tax benefits. In the third quarter of 2007, the unrecognized tax
benefits related to IRS and the associated state liabilities had been adjusted
to $8.4 million, excluding interest, penalties and related income tax benefits
and would be recorded as a component of income tax expense if recognized. During
the third quarter of 2007, we derecognized a previous uncertain tax position
through negotiations with the state tax jurisdiction. The negotiated settlement
resulted in a decrease of $1.4 million in unrecognized tax benefits and $1.0
million in penalties. After the above adjustments, the total unrecognized tax
benefits as of September 30, 2007 were $8.4 million. As of September 30, 2007,
the accrued interest and penalties were $7.5 million and $142,000, respectively,
excluding any related income tax benefits.
In many cases, the uncertain tax positions are related to tax years
that remain subject to examination by the relevant tax authorities. Federal and
state statutes are open from 1996 through the present period. Hong Kong statutes
are open from 2001, Luxembourg from 2003 and Mexico from 2001.
Certain 2006 amounts have been reclassified to conform to the 2007
presentation.
3. STOCK-BASED COMPENSATION
Our Employee Incentive Plan, formerly the 1995 Stock Option Plan (the
"1995 Plan"), authorized the grant of both incentive and non-qualified stock
options to our officers, employees, directors and consultants for shares of our
common stock. As of September 30, 2007, there were outstanding options to
purchase a total of 1,041,000 shares of common stock granted under the 1995
7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Plan. No further grants may be made under the 1995 Plan. On May 25, 2006, we
adopted the Tarrant Apparel Group 2006 Stock Incentive Plan (the "2006 Plan"),
which authorizes the issuance of up to 5,100,000 shares of our common stock
pursuant to options or awards granted under the 2006 Plan. As of September 30,
2007, there were outstanding options to purchase a total of 1,858,000 shares of
common stock, and 3,242,000 shares remained available for issuance pursuant to
award granted under the 2006 Plan. The exercise price of options under the plan
must be equal to 100% of fair market value of common stock on the date of grant.
The 2006 Plan also permits other types of awards, including stock appreciation
rights, restricted stock and other performance-based benefits.
On January 1, 2006, we adopted SFAS No. 123 (revised 2004),
"Share-Based Payment," ("SFAS No. 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. SFAS No. 123(R)
supersedes our previous accounting under Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees" for periods beginning
in fiscal 2006. In March 2005, the Securities and Exchange Commission issued
Staff Accounting Bulletin ("SAB") No. 107 relating to SFAS No. 123(R). We have
applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).
We adopted SFAS No. 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006, the first day of our fiscal year 2006. Our financial statements as of
and for the three months and nine months ended September 30, 2007 and 2006
reflect the impact of SFAS No. 123(R). SFAS No. 123(R) requires companies to
estimate the fair value of share-based payment awards to employees and directors
on the date of grant using an option-pricing model. The value of the portion of
the award that is ultimately expected to vest is recognized as expense over the
requisite service periods in our consolidated statements of operations.
A summary of our stock option activity, and related information for the
year ended December 31, 2006 and the nine months ended September 30, 2007 is as
follows:
EMPLOYEES
---------------------------
NUMBER OF
SHARES EXERCISE PRICE
---------------------------
Options outstanding at December 31, 2005.......... 6,733,050 $1.39-$45.50
Granted........................................... 1,233,259 $1.84-$1.94
Exercised......................................... -- --
Forfeited......................................... (19,650) $1.94-$33.13
Expired........................................... (273,000) $6.75-$7.38
---------------------------
Options outstanding at December 31, 2006.......... 7,673,659 $1.39-$45.50
Granted........................................... 630,000 $1.63-$1.99
Exercised......................................... -- --
Forfeited......................................... (2,200) $3.60-18.50
Expired........................................... (2,000) $8.50
---------------------------
Options outstanding at September 30, 2007......... 8,299,459 $1.39-$45.50
We had no stock options outstanding to non-employees as of December 31,
2006 and September 30, 2007.
8
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes information about stock options
outstanding as of December 31, 2006 and September 30, 2007:
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
NUMBER OF EXERCISE CONTRACTUAL INTRINSIC
SHARES PRICE LIFE (YEARS) VALUE
------------ ------------ ------------ ------------
As of December 31, 2006
Employees - Outstanding .............. 7,673,659 $ 5.52 5.9 $ 0
Employees - Expected to vest ......... 7,579,083 $ 5.57 5.9 $ 0
Employees - Exercisable .............. 6,445,400 $ 6.22 5.3 $ 0
As of September 30, 2007:
Employees - Outstanding .............. 8,299,459 $ 5.24 5.5 $ 0
Employees - Expected to vest ......... 8,156,373 $ 5.30 5.5 $ 0
Employees - Exercisable .............. 6,748,265 $ 6.01 4.7 $ 0
The following table summarizes our non-vested options as of December
31, 2006 and changes during the nine months ended September 30, 2007:
WEIGHTED
AVERAGE
NUMBER OF GRANT-DATE
NON-VESTED OPTIONS SHARES FAIR VALUE
------------------------------------------------ ---------- ----------
Non-vested at December 31, 2006 ................ 1,228,259 $ 1.26
Granted ...................................... 630,000 $ 1.28
Vested ....................................... (307,065) $ 1.26
Forfeited .................................... -- --
----------
Non-vested at September 30, 2007 ............... 1,551,194 $ 1.27
The following table shows the fair value of each option granted to
employees and directors estimated on the date of grant using the Black-Scholes
model with the following weighted average assumptions used for grants in the
nine months ended September 30, 2007 and 2006:
NINE MONTHS ENDED SEPTEMBER 30,
2007 2006
---- ----
Expected dividend ...... 0.0% 0.0%
Risk free interest rate 4.49% to 4.67% 5.075 to 5.13%
Expected volatility .... 70% 70%
Expected term (in years) 5.75 to 6.18 6.25
9
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Stock-based compensation expense recognized during the period is based
on the value of the portion of share-based payment awards that is ultimately
expected to vest during the period. Stock-based compensation expense recognized
in the consolidated statements of operations for the three months and nine
months ended September 30, 2007 and 2006 consisted of compensation expense for
the share-based payment awards granted subsequent to January 1, 2006 based on
the grant date fair value estimated in accordance with the provisions of SFAS
No. 123(R). For stock-based payment awards issued to employees and directors,
stock-based compensation is attributed to expense using the straight-line single
option method. As stock-based compensation expense recognized in the
consolidated statements of operations for the three months and nine months ended
September 30, 2007 and 2006 is based on awards ultimately expected to vest, it
has been reduced for estimated forfeitures, which we estimate to be 7.7%. SFAS
No. 123(R) requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates.
Our determination of fair value of share-based payment awards to
employees and directors on the date of grant using the Black-Scholes model is
affected by our stock price as well as assumptions regarding a number of highly
complex and subjective variables. These variables include, but are not limited
to our expected stock price volatility over the term of the awards. When valuing
awards, we estimate the expected terms using the "safe harbor" provisions
provided in SAB No. 107 and the volatility using historical data. We granted
1,233,259 shares of stock options to purchase shares of common stock for the
nine months ended September 30, 2006. The options granted were fair valued in
the aggregate at $1.6 million and had a weighted-average exercise of $1.86 in
the nine months ended September 30, 2006. We granted 630,000 shares of options
in the nine months ended September 30, 2007. The options granted were fair
valued in the aggregate at $805,000 and had a weighted-average exercise of $1.92
in the nine months ended September 30, 2007. The stock-based compensation
expense related to employees or director stock options recognized for the nine
months ended September 30, 2007 was $469,000, of which $144,000 was recorded
under general and administrative expenses and $325,000 was recorded under
selling and distribution expenses in our consolidated statements of operation.
The stock-based compensation expense related to employees or director stock
options recognized for the nine months ended September 30, 2006 was $97,000
which was recorded under general and administrative expenses in our consolidated
statements of operation. Basic and dilutive income per share for the three
months and nine months ended September 30, 2006 was not materially affected by
the additional stock-based compensation recognized. Basic and dilutive earnings
per share for the three months and nine months ended September 30, 2007 was
decreased by $0.01 from $0.06 to $0.05 by the additional stock-based
compensation recognized.
The total intrinsic value of options exercised for the three months and
nine months ended September 30, 2007 and 2006 was $0. Cash received from stock
options exercised for the three months and nine months ended September 30, 2007
and 2006 was $0. The total fair value of shares vested for the nine months ended
September 30, 2007 and 2006 were approximately $388,000 and $0, respectively.
As of September 30, 2007, there was $1.6 million of total unrecognized
compensation cost related to non-vested share-based compensation arrangements
granted under the plans. That cost is expected to be recognized over the
weighted-average period of 2.7 years.
When options are exercised, our policy is to issue previously unissued
shares of common stock to satisfy share option exercises. As of September 30,
2007, we had 69.5 million shares of authorized, unissued shares of common stock.
4. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------ ------------
U.S. trade accounts receivable ................. $ 3,455,825 $ 2,975,840
Foreign trade accounts receivable .............. 17,117,999 16,986,357
Factored accounts receivable ................... 30,473,197 29,697,935
Other receivables .............................. 157,145 496,253
Allowance for returns, discounts and bad debts.. (2,193,884) (2,076,858)
------------ ------------
$ 49,010,282 $ 48,079,527
============ ============
10
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. INVENTORY
Inventory consists of the following:
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------ ------------
Raw materials - fabric and trim accessories.. .... $ 1,431,885 $ 3,271,610
Work in process .................................. 1,155 --
Finished goods shipments-in-transit .............. 3,332,339 7,331,422
Finished goods ................................... 6,147,626 7,171,071
------------ ------------
$ 10,913,005 $ 17,774,103
============ ============
6. NOTES RECEIVABLE - RELATED PARTY RESERVE
In connection with the sale in 2004 of our assets and real property in
Mexico, the purchasers of the Mexico assets, Solticio, S.A. de C.V.
("Solticio"), and Acabados y Cortes Textiles, S.A. de C.V. ("Acotex"), issued us
unsecured promissory notes of $3,910,000 that matured on November 30, 2007 and
secured promissory notes of $40,204,000 with payments due on December 31, 2005
and every year thereafter until December 31, 2014. The secured promissory notes
were payable in partial or total amounts anytime prior to the maturity of each
note. The secured notes were secured by the real and personal property in Mexico
that we sold to the purchasers. As of September 30, 2006, the outstanding
balance of the notes and interest receivables was $41.1 million prior to the
reserve. Historically, we had placed orders for purchases of fabric from the
purchasers pursuant to the purchase commitment agreement we entered into at the
time of the sale of the Mexico assets, and we had satisfied our payment
obligations for the fabric by offsetting the amounts payable against the amounts
due to us under the notes. However, during the third quarter of 2006, the
purchasers ceased providing fabric and were not making payments under the notes.
We further evaluated the recoverability of the notes receivable and recorded a
loss on the notes receivable in the third quarter of 2006 in an amount equal to
the outstanding balance less the value of the underlying assets securing the
notes. The loss was estimated to be approximately $27.1 million, resulting in a
net notes receivable balance at September 30, 2006 of approximately $14 million.
We believe there was no significant change subsequently on the value of the
underlying assets securing the notes; therefore, we did not have additional
reserve after the third quarter of 2006.
On March 21, 2007, our wholly-owned subsidiary, Tarrant Luxembourg
S.a.r.l., entered into a letter agreement with Solticio, Inmobiliaria Cuadros,
S.A. de C.V. ("Inmobiliaria"), and Acotex, (Acotex and together with Solticio
and Inmobiliaria, the "Sellers"), and Tavex Algodonera, S.A. ("Tavex"). On July
19, 2007, the parties amended the letter agreement. Pursuant to the agreement,
as amended, Tavex had the right and option (but not an obligation), at any time
on or prior to September 1, 2007, to pay to Tarrant Luxembourg an aggregate of
U.S. $17.75 million in cash, whereupon, among other things:
o Tarrant Luxembourg would terminate the Solticio and Acotex
promissory notes described above and release the Sellers from
any further obligations thereunder, and terminate and release
all liens on the collateral securing those notes;
o Tarrant Luxembourg and the Sellers would terminate all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and
o Tarrant Luxembourg would agree to purchase from Tavex at least
U.S. $1.25 million of fabric prior to the end of 2007, and
Tarrant Luxembourg would deliver an irrevocable letter of
credit for the full purchase price.
During the option period, we agreed that we would not seek to enforce
the Solticio and Acotex promissory notes, including by taking action with
respect to the collateral, nor would we enter into any agreement with a third
party that would adversely affect Tavex's rights under the agreement. The
Sellers also agreed during the option period, to work exclusively with Tavex in
11
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
respect of the payment of the Solticio and Acotex promissory notes and the other
transactions contemplated by the letter agreement, and not to enter into any
agreement with any person other than Tavex with respect to the payment and/or
assignment of the Solticio and Acotex promissory notes and the transactions
contemplated by the agreement.
On August 21, 2007, we received a payment of $17.75 million from Tavex
upon the exercise by Tavex of its option in accordance with the agreement
described above. In return for the Tavex's payment of $17.75 million, we have
taken the following actions pursuant to the terms of the agreement:
o Tarrant Luxembourg terminated the Solticio and Acotex
promissory notes described above and released the Sellers from
any further obligations thereunder, and terminated and
released all liens on the collateral securing those notes;
o Tarrant Luxembourg and the Sellers terminated all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and
o Tarrant Luxembourg agreed to purchase from Tavex at least U.S.
$1.25 million of fabric prior to the end of 2007, and Tarrant
Luxembourg agreed to deliver an irrevocable letter of credit
for the full purchase price.
Upon closing of the transaction and receiving the payment of $17.75
million, we recorded a gain of $3.75 million on our consolidated statements of
operations as other income in the third quarter of 2007. We have placed a fabric
order with Tavex on August 21, 2007 for $1.25 million pursuant to the agreement.
7. EQUITY METHOD INVESTMENT - AMERICAN RAG
In the second quarter of 2003, we acquired a 45% equity interest in the
owner of the trademark "American Rag CIE" and the operator of American Rag
retail stores for $1.4 million; and our subsidiary, Private Brands, Inc.,
acquired a license to certain exclusive rights to this trademark. We have
guaranteed the payment to the licensor of minimum royalties of $10.4 million
over the initial 10-year term of the agreement. The guaranteed annual minimum
royalty is payable in advance in monthly installments during the term of the
agreement. The royalty owed to the licensor in excess of the guaranteed minimum,
if any, is payable no later than 30 days after the end of the preceding full
quarter with the amount for last quarter adjusted based on actual royalties owed
for the year. If a portion of the guaranteed minimum royalty is determined not
to be recoverable, the unrecoverable portion is charged to expense at that time.
The guaranteed annual minimum royalty for 2007 is $760,000. At September 30,
2007, the total commitment on royalties remaining on the term was $7.8 million.
Private Brands also entered into a multi-year exclusive distribution agreement
with Macy's Merchandising Group, LLC ("MMG"), the sourcing arm of Federated
Department Stores, to supply MMG with American Rag CIE, a casual sportswear
collection for juniors and young men. Under this arrangement, Private Brands
designs and manufactures American Rag apparel, which is distributed by MMG
exclusively to Federated stores across the country. Beginning in August 2003,
the American Rag collection was available in select Macy's locations and is
currently available in approximately 600 Macy's stores nationally. The
investment in American Rag CIE, LLC totaling $2.3 million at September 30, 2007,
is accounted for under the equity method and included in equity method
investment on the accompanying consolidated balance sheets. Income from the
equity method investment is recorded in the United States geographical segment.
The change in investment in American Rag during the nine month ended September
30, 2007 is as follows:
Balance as of December 31, 2006 $2,151,061
Share of income ................ 141,644
Distribution ................... --
----------
Balance as of September 30, 2007 $2,292,705
==========
We hold a 45% member interest in American Rag. The remaining 55% owners
are an unrelated third party who contributed the American Rag trademark and
other assets and liabilities relating to two retail stores operating under the
name of "American Rag". The royalty income paid by us to American Rag is
12
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
considered other income and is ancillary to the primary operations. We do not
have sole decision-making ability. Day to day management of American Rag is
effectively controlled by one of the 55% owners.
We do not expect to receive a guaranteed return on our investment. We
determined that we were not the primary beneficiary of American Rag under FIN
46. In June 2006, we signed a guarantee of certain liabilities of American Rag
CIE to California United Bank to the aggregate amount equal at all times to the
lesser of (A) 45% of the aggregate amount of the outstanding liabilities or (B)
$675,000, which guarantee was re-affirmed in September 2007. Upon execution of
the guarantee, we re-evaluated our investment under the provisions of FIN 46. In
our analysis, we determined that consolidation under FIN 46 is still not
appropriate. Our variable interest will not absorb a majority of the VIE's
expected losses. We record its proportionate share of income and losses but are
not obligated nor do we intend to absorb losses beyond its 45% investment
interest. Additionally, we do not expect to receive a majority of the entity's
expected residual returns, other than their 45% ownership interest.
8. OTHER ASSETS AND WRITE OFF OF ACQUISITION EXPENSES
On December 6, 2006, we entered into a definitive stock and asset
purchase agreement (the "Purchase Agreement") to acquire certain assets and
entities comprising The Buffalo Group. The Buffalo Group designs, imports and
sells contemporary branded apparel and accessories, primarily in Canada and the
United States.
Pursuant to the Purchase Agreement, we and our subsidiaries agreed to
acquire (1) all the outstanding capital stock of four principal operating
subsidiaries of The Buffalo Group - Buffalo Inc., 3163946 Canada Inc., 3681441
Canada Inc. and Buffalo Corporation, and (2) certain assets, consisting
primarily of intellectual property rights and licenses, from The Buffalo Trust,
for a total aggregate purchase price of up to approximately $120 million
consisting of:
o $40 million in cash, subject to reduction prior to closing;
o $15 million in promissory notes that are due and payable in
five equal annual installments beginning on the second
anniversary of the closing date;
o The issuance to the sellers of 13 million exchangeable shares
of our Canadian subsidiary, which shares will be exchangeable
by the holders into shares of our common stock on a 1-to-1
basis;
o The issuance by us to a trustee of shares of our Series A
Special Voting Preferred Stock that will entitle the sellers
to direct the trustee to vote a number of shares equal to the
number of exchangeable shares of our Canadian subsidiary that
remain outstanding from time to time on all matters on which
our shareholders are entitled to vote;
o Assumption of debt of the entities being acquired by us; and
o Earn-out payments of up to $12 million in the aggregate over a
four year period, contingent upon achievement by the acquired
business of specified earnings targets in years 2007 through
2010.
In addition, we agreed to make a contingent cash payment following the
fifth anniversary of the closing if the average price of our common stock does
not equal or exceed $3.076 within any 10 trading days during the five year
period following the closing of the purchase transaction.
At signing of the Purchase Agreement, we delivered $5.0 million to the
sellers as a deposit against the purchase price payable under the agreement.
On April 19, 2007, we entered into a Mutual Termination and Release
Agreement with The Buffalo Group, pursuant to which we and the other parties to
the Purchase Agreement mutually agreed to terminate the Purchase Agreement. The
parties determined that it was in the mutual best interest of each party to
terminate the proposed agreement. Under the terms of the Mutual Termination and
Release Agreement, Buffalo agreed to return to us $4,750,000 of the $5,000,000
13
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
deposit previously provided by us to The Buffalo Group pursuant to the Purchase
Agreement, and the parties have released each other from any claims arising
under or related to the Purchase Agreement. We received $4,750,000 in April
2007. The remaining portion of the deposit of $250,000 and other due diligence
fees incurred in the acquisition process were recorded as terminated acquisition
expenses in the first quarter of 2007.
9. DEBT
Short-term bank borrowings consist of the following:
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------ ------------
Import trade bills payable - DBS Bank and Aurora Capital $ 5,570,374 $ 5,844,887
Bank direct acceptances - DBS Bank ..................... 1,582,187 3,368,054
Other Hong Kong credit facilities - DBS Bank ........... 5,532,095 4,483,241
------------ ------------
$ 12,684,656 $ 13,696,182
============ ============
Long-term obligations consist of the following:
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------ ------------
Equipment financing .................................. $ 14,519 $ 38,148
Credit facility - Guggenheim, net .................... -- 11,212,724
Debt facility and factoring agreement - GMAC CF ...... 11,289,141 19,553,755
------------ ------------
11,303,660 30,804,627
Less current portion ................................. (11,303,660) (19,586,565)
------------ ------------
$ -- $ 11,218,062
============ ============
IMPORT TRADE BILLS PAYABLE, BANK DIRECT ACCEPTANCES AND OTHER HONG KONG CREDIT
FACILITIES
Since March 2003, DBS Bank (Hong Kong) Limited ("DBS") had made
available a letter of credit facility of up to HKD 20 million (equivalent to US
$2.6 million at September 30, 2007) to our subsidiaries in Hong Kong. This was a
demand facility and was secured by the pledge of our office property, which is
owned by Gerard Guez, our Chairman and Interim Chief Executive Officer, and Todd
Kay, our Vice Chairman; and by our guarantee. The letter of credit facility was
increased to HKD 30 million (equivalent to US $3.9 million) in June 2004. In
September 2006, a tax loan for HKD 8.438 million (equivalent to US $1.1 million)
was also made available to our Hong Kong subsidiaries and bears interest at the
rate equal to the Hong Kong prime rate plus 1% and are subject to the same
security. It bore interest at 8.75% per annum at September 30, 2007. As of
September 30, 2007, $188,000 was outstanding under this tax loan.
In June 2006, our subsidiaries in Hong Kong, Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited, entered into a new credit
facility with DBS. Under this facility, we may arrange for letters of credit and
acceptances. The maximum amount our Hong Kong subsidiaries may borrow under this
facility at any time is US $25 million. The interest rate under the letter of
credit facility is equal to the Standard Bills Rate quoted by DBS minus 0.5% if
paid in Hong Kong Dollars, which the interest rate was 8.25% per annum at
September 30, 2007, or the Standard Bills Rate quoted by DBS plus 0.5% if paid
in any other currency, which the interest rate was 8.38% per annum at September
30, 2007. This is a demand facility and is secured by a security interest in all
the assets of the Hong Kong subsidiaries; by a pledge of our office property
where our Hong Kong office is located, which is owned by Gerard Guez and Todd
Kay; and by our guarantee. The DBS facility includes customary default
provisions. In addition, we are subject to certain restrictive covenants,
including that we maintain a specified tangible net worth, and a minimum level
of EBITDA at December 31, 2006, interest coverage ratio, leverage ratio and
limitations on additional indebtedness. We are in the process of revising these
covenants for 2007. As of September 30, 2007, $11.8 million was outstanding
under this facility. In addition, $9.5 million of open letters of credit were
outstanding and $3.7 million was available for future borrowings as of September
30, 2007.
14
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
As of September 30, 2007, the total balance outstanding under the DBS
Bank credit facilities was $11.8 million (classified above as follows: $4.7
million in import trade bills payable, $1.6 million in bank direct acceptances
and $5.5 million in other Hong Kong credit facilities).
From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates which issues these letters of credits
out of Israeli Discount Bank. As of September 30, 2007, $870,000 was outstanding
under this facility (classified above under import trade bills payable) and
$765,000 of letters of credit was open under this arrangement. We pay a
commission fee of 2.25% on all letters of credits issued under this arrangement.
EQUIPMENT FINANCING
We had three equipment loans outstanding at September 30, 2007. One of
these equipment loans bore interest at 15.8% payable in installments through
2007. The second loan bears interest at 6.15% payable in installments through
2007 and the third loan bears interest at 4.75% payable in installments through
2008. As of September 30, 2007, $15,000 was outstanding under these loans.
DEBT FACILITY AND FACTORING AGREEMENT - GMAC COMMERCIAL FINANCE
On October 1, 2004, we amended and restated our previously existing
credit facility with GMAC Commercial Finance LLC ("GMAC CF") by entering into a
new factoring agreement with GMAC CF. The amended and restated agreement (the
factoring agreement) extended the expiration date of the facility to September
30, 2007 and added as parties our subsidiaries Private Brands, Inc and No!
Jeans, Inc. In addition, in connection with the factoring agreement, our
indirect majority-owned subsidiary PBG7, LLC entered into a separate factoring
agreement with GMAC CF. Pursuant to the terms of the factoring agreement, we and
our subsidiaries agree to assign and sell to GMAC CF, as factor, all accounts
which arise from our sale of merchandise or rendition of service created on a
going forward basis. At our request, GMAC CF, in its discretion, may make
advances to us up to the lesser of (a) up to 90% of our accounts on which GMAC
CF has the risk of loss or (b) $40 million, minus in each case, any amount owed
by us to GMAC CF. In May 2005, we amended our factoring agreement with GMAC CF
to permit our subsidiaries party thereto and us, to borrow up to the lesser of
$3 million or 50% of the value of eligible inventory. In connection with this
amendment, we granted GMAC CF a lien on certain of our inventory located in the
United States. On January 23, 2006, we further amended our factoring agreement
with GMAC CF to increase the amount we might borrow against inventory to the
lesser of $5 million or 50% of the value of eligible inventory. The $5 million
limit was reduced to $4 million on April 1, 2006.
On June 16, 2006, we expanded our credit facility with GMAC CF by
entering into a new Loan and Security Agreement and amending and restating our
previously existing Factoring Agreement with GMAC CF. UPS Capital Corporation is
also a lender under the Loan and Security Agreement. This is a revolving credit
facility and has a term of 3 years. The amount we may borrow under this credit
facility is determined by a percentage of eligible accounts receivable and
inventory, up to a maximum of $55 million, and includes a letter of credit
facility of up to $4 million. Interest on outstanding amount under this credit
facility is payable monthly and accrues at the rate of the "prime rate" plus
0.5%. Our obligations under the GMAC CF credit facility are secured by a lien on
substantially all our domestic assets, including a first priority lien on our
accounts receivable and inventory. This credit facility contains customary
financial covenants, including covenants that we maintain minimum levels of
EBITDA and interest coverage ratios and limitations on additional indebtedness.
On November 2, 2007, the minimum level of EBITDA for September 30, 2007 was
amended. This facility includes customary default provisions, and all
outstanding obligations may become immediately due and payable in the event of a
default. The facility bore interest at 8.25% per annum at September 30, 2007. As
of September 30, 2007, we were in compliance with the covenants, as amended. A
total of $11.3 million was outstanding with respect to receivables factored
under the GMAC CF facility at September 30, 2007.
CREDIT FACILITY FROM GUGGENHEIM CORPORATE FUNDING LLC AND WARRANTS
On June 16, 2006, we entered into a Credit Agreement with certain
lenders and Guggenheim Corporate Funding LLC ("Guggenheim"), as administrative
agent and collateral agent for the lenders. This credit facility provides for
borrowings of up to $65 million. This facility consists of an initial term loan
of up to $25 million, of which we borrowed $15.5 million at the initial funding,
15
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
to be used to repay certain existing indebtedness and fund general operating and
working capital needs. An additional term loan of up to $40 million was
available under this facility to finance acquisitions acceptable to Guggenheim.
All amounts under the term loans become due and payable in December 2010.
Interest under this facility was payable monthly, with the interest rate equal
to the LIBOR rate plus an applicable margin based on our debt leverage ratio (as
defined in the credit agreement). Our obligations under the Guggenheim credit
facility are secured by a lien on substantially all of our assets and our
domestic subsidiaries, including a pledge of the equity interests of our
domestic subsidiaries and 65% of our Luxembourg subsidiary. This credit facility
contains customary financial covenants, including covenants that we maintain
minimum levels of EBITDA and interest coverage ratios and limitations on
additional indebtedness.
In connection with Guggenheim credit facility, on June 16, 2006, we
issued the lenders under this facility warrants to purchase up to an aggregate
of 3,857,143 shares of our common stock. These warrants have a term of 10 years.
These warrants are exercisable at a price of $1.88 per share with respect to 20%
of the shares, $2.00 per share with respect to 20% of the shares, $3.00 per
share with respect to 20% of the shares, $3.75 per share with respect to 20% of
the shares and $4.50 per share with respect to 20% of the shares. The exercise
prices are subject to adjustment for certain dilutive issuances pursuant to the
terms of the warrants. These warrants are exercisable for 3,500,000 shares, and
the remaining 357,143 shares of the warrants will not become exercisable because
a specified portion of the initial term loan was not funded by the lenders. The
warrants were evaluated under SFAS No. 133 and Emerging Issues Task Force
("EITF") No. 00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" and determined to be a
derivative instrument due to certain registration rights. As such, the warrants
excluding the ones not exercisable were valued at $4.9 million using the
Black-Scholes model with the following assumptions: risk-free interest rate of
5.1%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.70; and contractual term of ten years. We also paid to
Guggenheim 2.25% of the committed principal amount of the loans which was
$563,000 on June 16, 2006. The $563,000 fee paid to Guggenheim was included in
the deferred financing cost, and the value of the warrants to purchase 3.5
million shares of our common stock of $4.9 million was recorded as debt
discount, both of them were amortized over the life of the loan. For the nine
months ended September 30, 2007, $906,000 was amortized.
Durham Capital Corporation ("Durham") acted as our advisor in
connection with the Guggenheim credit facility. As compensation for its
services, we agreed to pay Durham a cash fee in an amount equal to 1% of the
committed principal amount of the loans under the Guggenheim credit facility. As
a result, $250,000 was paid on June 16, 2006. In addition, we issued Durham a
warrant to purchase 77,143 shares of our common stock. This warrant has a term
of 10 years and is exercisable at a price of $1.88 per share, subject to
adjustment for certain dilutive issuances. This warrant is exercisable for
70,000 shares, and the remaining 7,143 shares of this warrant will not become
exercisable because a specified portion of the initial term loan was not funded
by the lenders. The warrants were evaluated under SFAS No. 133 and EITF 00-19
and determined to be a derivative instrument due to certain registration rights.
As such, the warrants excluding the ones not exercisable were valued at $105,000
using the Black-Scholes model with the following assumptions: risk-free interest
rate of 5.1%; dividend yields of 0%; volatility factors of the expected market
price of our common stock of 0.70; and contractual term of ten years. The
$250,000 fee paid to Durham and the value of the warrants to purchase 70,000
shares of our common stock of $105,000 was included in the deferred financing
cost, and was amortized over the life of the loan. For the nine months ended
September 30, 2007, $59,000 was amortized.
As of June 30, 2006, the warrants were being accounted for as a
liability pursuant to the provisions of SFAS No. 133 and EITF No. 00-19. This
was because we granted the warrant holders certain registration rights that were
outside our control. In accordance with SFAS No. 133, the warrants were being
valued at each reporting period. Changes in fair value were recorded as
adjustment to fair value of derivative in the statements of operations. The
outstanding warrants were fair valued on June 16, 2006, the date of the
transaction, at $5.0 million and we, in accordance with SFAS No. 133, revaluated
the warrants on June 30, 2006 at the closing stock price on June 30, 2006 to
$5.2 million; as a result, an expense of $218,000 was recorded as an adjustment
to fair value of derivative in the second quarter of 2006 on our consolidated
statements of operations. On August 11, 2006, the registration rights agreement
relating to the warrants was amended to provide that if we were unable to file
or have the registration statement declared effective by the required deadlines,
we would be required to pay the warrant holders cash payments as partial
liquidated damages each month until the registration statement was filed and/or
declared effective. The liquidated damages payable by us to the warrant holders
16
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
are limited to 20% of the purchase price of the shares underlying the warrants,
which we determined to be a reasonable discount for restricted stock as compared
to registered stock. As a result of amending the registration rights relating to
the warrants on August 11, 2006, the warrants were reclassified from debt to
equity in accordance with EITF No. 00-19 in the third quarter of 2006. The
outstanding warrants were revaluated on August 11, 2006 at the closing stock
price on August 11, 2006 to $4.5 million; as a result, income of $729,000 was
recorded as an adjustment to fair value of derivative in the third quarter of
2006 on our consolidated statements of operations. As such, a net gain of
$511,000 was recognized in our statements of operations as an adjustment to fair
value of derivative in 2006.
On September 26, 2007, we repaid in full the term loan of $15.5 million
outstanding under the Guggenheim credit facility. Upon paying off the loan, the
unamortized loan fee paid to Guggenheim of $401,000 and the unamortized value of
the warrants to purchase 3.5 million shares of our common stock of $3.5 million
was expensed. The unamortized loan fee paid to Durham of $178,000 and the
unamortized value of the warrants to purchase 70,000 shares of our common stock
of $75,000 was also expensed. Other unamortized expenses of $822,000 related to
obtaining the loan were also expensed. All the above expenses amounted to $5.0
million were recorded on our consolidated statements of operations as other
expense in the third quarter of 2007. On November 2, 2007 we executed a payoff
letter with Guggenheim and the lenders, which released all liens held by
Guggenheim and the lenders.
The credit facility with GMAC CF prohibits us from paying dividends or
other distributions on our common stock. In addition, the credit facility with
GMAC CF prohibits our subsidiaries that are borrowers under the facility from
paying dividends or other distributions to us, and the credit facility with DBS
prohibits our Hong Kong facilities from paying any dividends or other
distributions or advances to us.
10. DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS
We use forward currency contracts to manage risks generally associated
with foreign exchange rate. During 2006, we entered into foreign currency
forward contracts to hedge against the effect of exchange rate fluctuations on
cash flows denominated in foreign currencies and certain inter-company financing
transactions. At September 30, 2007, we had no open foreign exchange forward
contracts. Hedge ineffectiveness resulted in an impact of $196,000 in our
consolidated statements of operations in the nine months of September 30, 2007.
11. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements". SFAS No. 157 establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007. We are required to adopt the
provision of SFAS No. 157, as applicable, beginning in fiscal year 2008. We do
not believe the adoption of SFAS No. 157 will have a material impact on our
financial condition or results of operations.
In September 2006, the FASB issued SFAS No. 158, "Employer's Accounting
for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB
Statements No. 87, 88, 106 and 132(R)". SFAS No. 158 requires us to (a)
recognize a plan's funded status in the statement of financial position, (b)
measure a plan's assets and its obligations that determine its funded status as
of the end of the employer's fiscal year and (c) recognize changes in the funded
status of a defined postretirement plan in the year in which the changes occur
through other comprehensive income. SFAS No. 158 is effective for fiscal years
ending after December 15, 2006. The adoption of SFAS No. 158 did not have a
material impact on our results of operations and financial condition.
In September 2006, the SEC issued SAB No. 108, "Considering the Effects
of Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements", to address diversity in practice in quantifying financial
statement misstatements. SAB No. 108 requires the quantification of
misstatements based on their impact on both the balance sheet and the income
statement to determine materiality. The guidance provides for a one-time
cumulative effect adjustment to correct for misstatements that were not deemed
material under a company's prior approach but are material under the SAB No. 108
approach. SAB No. 108 is effective for fiscal years ending after November 15,
2006. The adoption of SAB 108 did not have a material impact on our results of
operations and financial condition.
17
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Liabilities- Including an amendment of FASB Statement
No. 115". SFAS No. 159 permits entities to choose to measure certain financial
assets and liabilities at fair value (the "fair value option"). Unrealized gains
and losses, arising subsequent to adoption, are reported in earnings. SFAS No.
159 is effective for fiscal years beginning after November 15, 2007. We are
currently assessing the impact of SFAS No. 159 on our results of operations and
financial condition.
12. INCOME TAXES
Our effective tax rate differs from the statutory rate principally due
to the following reasons: (1) a substantial valuation allowance has been
provided for deferred tax assets as a result of the operating losses in the
United States and Mexico, since recoverability of those assets has not been
assessed as more likely than not; and (2) the earnings of our Hong Kong
subsidiary are taxed at a rate of 17.5% versus the 35% U.S. federal rate. The
impairment charge in Mexico did not result in a tax benefit due to an increase
in the valuation allowance against the future tax benefit. We believe it is more
likely than not that the tax benefit will not be realized based on our future
business plans in Mexico.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109." FIN
48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes." FIN 48 also prescribes a recognition threshold
and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return that
results in a tax benefit. Additionally, FIN 48 provides guidance on
de-recognition, income statement classification of interest and penalties,
accounting in interim periods, disclosure, and transition. We adopted the
provisions of FIN 48 on January 1, 2007. As a result of the implementation of
FIN 48, we recognized no material adjustment for unrecognized tax benefits but
reduced retained earnings as of January 1, 2007 by approximately $1 million
attributable to penalties accrued as a component of income tax payable. As of
the date of adoption, our unrecognized tax benefits totaled approximately $8.9
million.
We and several of our subsidiaries file income tax returns in the U.S.,
Hong Kong, Luxembourg, Mexico and various state jurisdictions. We are currently
subject to an IRS audit for the years including 1996 through 2002 and State of
New York audit for the years 2002 to 2005 but are not being audited for other
states or non-U.S. income tax examinations for years open in those taxing
jurisdictions.
In January 2004, the IRS completed its examination of our Federal
income tax returns for the years ended December 31, 1996 through 2001. The IRS
has proposed adjustments to increase our income tax payable for the six years
under examination. In addition, in July 2004, the IRS initiated an examination
of our Federal income tax return for the year ended December 31, 2002. We are
currently at the appellate level of the IRS and believe the proposed adjustments
made to our federal income tax returns for the years ended 1996 through 2002
will be resolved within the next twelve months and if so, unrecognized tax
benefits related to U.S. tax positions may decrease by up to $7.8 million by
December 31, 2007. If the proposed adjustments are upheld through the
administrative and legal process, they could have a material impact on our
earnings and cash flow. We believe we have provided adequate reserves for any
reasonably foreseeable outcome related to these matters on the consolidated
balance sheets under the caption "Income Taxes". We do not believe that the
adjustments, if any, arising from the IRS examination, will result in an
additional income tax liability beyond what is recorded in the accompanying
consolidated balance sheets.
The total unrecognized tax benefits as of January 1, 2007 were $8.9
million, excluding interest, penalties and related income tax benefits and would
be recorded as a component of income tax expense if recognized. We recognize
interest accrued related to unrecognized tax benefits and penalties as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties were $8.0 million and $1.2 million, respectively, excluding any
related income tax benefits. In the third quarter of 2007, the unrecognized tax
benefits related to IRS and the associated state liabilities had been adjusted
to $8.4 million, excluding interest, penalties and related income tax benefits
and would be recorded as a component of income tax expense if recognized. During
the third quarter of 2007, we derecognized a previous uncertain tax position
through negotiations with the state tax jurisdiction. The negotiated settlement
resulted in a decrease of $1.4 million in unrecognized tax benefits and $1.0
million in penalties. After the above adjustments, the total unrecognized tax
18
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
benefits as of September 30, 2007 were $8.4 million. As of September 30, 2007,
the accrued interest and penalties were $7.5 million and $142,000, respectively,
excluding any related income tax benefits.
In many cases, the uncertain tax positions are related to tax years
that remain subject to examination by the relevant tax authorities. Federal and
state statutes are open from 1996 through the present period. Hong Kong statutes
are open from 2001, Luxembourg from 2003 and Mexico from 2001.
13. NET INCOME (LOSS) PER SHARE
Basic and diluted income (loss) per share has been computed in
accordance with SFAS No. 128, "Earnings Per Share". A reconciliation of the
numerator and denominator of basic earnings (loss) per share and diluted
earnings (loss) per share is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2007 2006 2007 2006
------------ ------------ ------------ ------------
Basic EPS Computation:
Numerator ............................. $ 1,614,647 $(25,352,414) $ 1,422,991 $(23,904,758)
Denominator:
Weighted average common shares
outstanding ........................... 30,543,763 30,543,763 30,543,763 30,546,217
------------ ------------ ------------ ------------
Basic EPS ............................. $ 0.05 (0.83) $ 0.05 (0.78)
============ ============ ============ ============
Diluted EPS Computation:
Numerator ............................. $ 1,614,647 $(25,352,414) $ 1,422,991 (23,904,758)
Denominator:
Weighted average common share
outstanding ........................... 30,543,763 30,543,763 30,543,763 30,546,217
Options ............................... -- -- 112 --
------------ ------------ ------------ ------------
Total shares .......................... 30,543,763 30,543,763 30,543,875 30,546,217
------------ ------------ ------------ ------------
Diluted EPS ........................... $ 0.05 $ (0.83) $ 0.05 $ (0.78)
============ ============ ============ ============
Only 112 shares of outstanding options were included in the computation
of income per share in the nine months ended September 30, 2007 as the exercise
prices of the remaining shares were greater than the average market price for
the nine months ended September 30, 2007. All options were excluded in the
computation of income per share in the three months ended September 30, 2007 as
the exercise prices of the remaining shares were greater than the average market
price for the three months ended September 30, 2007. All options were excluded
from the computation of net loss per share in the three months and nine months
ended September 30, 2006 as the impact would be anti-dilutive. All warrants were
excluded from the computation of net income (loss) per share in the three months
and nine months ended September 30, 2007 and 2006, as the exercise prices of the
warrants were greater than the average market price for the three months and
nine months ended September 30, 2007 and 2006. The following table presents
potentially dilutive securities that were not included in the computation of
income (loss) per share:
AS OF SEPTEMBER 30,
-----------------------
2007 2006
---------- ----------
Options ....... 8,299,347 7,946,859
Warrants ...... 5,931,732 5,931,732
---------- ----------
Total ......... 14,231,079 13,878,591
========== ==========
14. RELATED PARTY TRANSACTIONS
As of September 30, 2007, related party affiliates were indebted to us
in the amounts of $14.2 million. These include amounts due from Gerard Guez, our
Chairman and Interim Chief Executive Officer. From time to time in the past, we
19
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
had advanced funds to, Mr. Guez. These were net advances to Mr. Guez or payments
paid on his behalf before the enactment of the Sarbanes-Oxley Act in 2002. The
promissory note documenting these advances contains a provision that the entire
amount together with accrued interest is immediately due and payable upon our
written demand. The greatest outstanding balance of such advances to Mr. Guez in
the third quarter of 2007 was approximately $2,069,000. At September 30, 2007,
the entire balance due from Mr. Guez totaling $2.0 million has been shown as
reductions to shareholders' equity in the accompanying financial statements. All
amounts due from Mr. Guez bore interest at the rate of 7.75% during the period.
Total interest paid by Mr. Guez was $120,000 and $129,000 for the nine months
ended September 30, 2007 and 2006, respectively. Mr. Guez paid expenses on our
behalf of approximately $252,000 and $226,000 for the nine months ended
September 30, 2007 and 2006, respectively, which amounts were applied to reduce
accrued interest and principal on Mr. Guez's loan. These amounts included fuel
and related expenses incurred by 477 Aviation, LLC, a company owned by Mr. Guez,
when our executives used this company's aircraft for business purposes. Since
the enactment of the Sarbanes-Oxley Act in 2002, no further personal loans (or
amendments to existing loans) have been or will be made to our executive
officers or directors.
Azteca Production International, Inc. ("Azteca") is a corporation owned
by the brothers of Gerard Guez, our Chairman and Interim Chief Executive
Officer. We purchased $499,000 and $0 of finished goods, fabric and service from
Azteca and its affiliates in the nine months ended September 30, 2007 and 2006,
respectively. Our total sales of fabric and service to Azteca in the nine months
ended September 30, 2007 and 2006 were $0 and $9,000, respectively.
At September 30, 2007, Messrs. Guez and Kay beneficially owned 488,400
and 1,003,500 shares, respectively, of common stock of Tag-It Pacific, Inc.
("Tag-It"), collectively representing approximately 8.0% of Tag-It's common
stock. Tag-It is a provider of brand identity programs to manufacturers and
retailers of apparel and accessories. We purchased $144,000 and $205,000 of trim
from Tag-It in the nine months ended September 30, 2007 and 2006, respectively.
Our sales of garment accessories to Tag-It were $76,000 and $39,000 in the nine
months ended September 30, 2007 and 2006, respectively.
On September 1, 2006, our subsidiary in Hong Kong, Tarrant Company
Limited, entered into an agreement with Seven Licensing Company, LLC ("Seven
Licensing") to act as its buying agent to source apparel merchandise. Seven
Licensing is beneficially owned by Gerard Guez. Total sales to Seven Licensing
in the nine months ended September 30, 2007 were $14.2 million. Net amount due
from Azetca and Seven Licensing as of September 30, 2007 and December 31, 2006
was $12.0 million and $7.5 million, respectively.
In August 2004, we entered into an Agreement for Purchase of Assets
with affiliates of Mr. Kamel Nacif, a shareholder at the time of the
transaction, which agreement was amended in October 2004. Pursuant to the
agreement, as amended, on November 30, 2004, we sold to the purchasers
substantially all of our assets and real property in Mexico, including the
equipment and facilities we previously leased to Mr. Nacif's affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and $3,910,000 by delivery of unsecured promissory notes bearing interest at
5.5% per annum; and b) $40,204,000, by delivery of secured promissory notes
bearing interest at 4.5% per annum, with payments due on December 31, 2005 and
every year thereafter until December 31, 2014. The secured promissory notes were
payable in partial or total amounts anytime prior to the maturity of each note.
As of September 30, 2006, the outstanding balance of the notes and interest
receivables was $41.1 million prior to the reserve. Historically, we had placed
orders for purchases of fabric from the purchasers pursuant to the purchase
commitment agreement we entered into at the time of the sale of the Mexico
assets, and we had satisfied our payment obligations for the fabric by
offsetting the amounts payable against the amounts due to us under the notes.
However, during the third quarter of 2006, the purchasers ceased providing
fabric and were not making payments under the notes. We further evaluated the
recoverability of the notes receivable and recorded a loss on the notes
receivable in the third quarter of 2006 in an amount equal to the outstanding
balance less the value of the underlying assets securing the notes. The loss was
estimated to be approximately $27.1 million, resulting in a notes receivable
balance at September 30, 2006 of approximately $14 million. We believe there was
no significant change subsequently on the value of the underlying assets
securing the notes; therefore, we did not have additional reserve after the
third quarter of 2006. Upon consummation of the sale, we entered into a purchase
commitment agreement with the purchasers, pursuant to which we had agreed to
purchase annually over the ten-year term of the agreement, $5 million of fabric
manufactured at our former facilities acquired by the purchasers at negotiated
market prices. We did not purchase fabric from Acabados y Terminados in the nine
months ended September 30, 2007 and 2006. Net amount due from these parties as
of September 30, 2007 was $0.
20
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On March 21, 2007, our wholly-owned subsidiary, Tarrant Luxembourg
S.a.r.l., entered into a letter agreement with Solticio, Inmobiliaria Cuadros,
S.A. de C.V. ("Inmobiliaria"), and Acotex, (Acotex and together with Solticio
and Inmobiliaria, the "Sellers"), and Tavex Algodonera, S.A. ("Tavex"). On July
19, 2007, the parties amended the letter agreement. On August 21, 2007, we
received a payment of $17.75 million from Tavex upon the exercise by Tavex of
its option under the letter agreement among the parties. In return for the
Tavex's payment of $17.75 million, we have taken the following actions pursuant
to the terms of the agreement:
o Tarrant Luxembourg terminated the Solticio and Acotex
promissory notes described above and released the Sellers from
any further obligations thereunder, and terminated and
released all liens on the collateral securing those notes;
o Tarrant Luxembourg and the Sellers terminated all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and
o Tarrant Luxembourg agreed to purchase from Tavex at least U.S.
$1.25 million of fabric prior to the end of 2007, and Tarrant
Luxembourg agreed to deliver a irrevocable letter of credit
for the full purchase price.
Upon closing of the transaction and receiving the payment of $17.75
million, we recorded a gain of $3.75 million on our consolidated statements of
operations as other income in the third quarter of 2007. See Note 6 of the
"Notes to Consolidated Financial Statements". We have placed a fabric order with
Tavex on August 21, 2007 for $1.25 million pursuant to the agreement.
We lease our executive offices and warehouse in Los Angeles, California
from GET. Additionally, we lease our office space and warehouse in Hong Kong
from Lynx International Limited. GET and Lynx International Limited are each
owned by Gerard Guez, our Chairman and Interim Chief Executive Officer, and Todd
Kay, our Vice Chairman. We paid $847,000 and $807,000 in rent in the nine months
ended September 30, 2007 and 2006, respectively, for office and warehouse
facilities. On August 1, 2006, we entered into a lease agreement with GET for
the Los Angeles offices and warehouse, which lease has a term of five years with
an option to renew for an additional five year term. On February 1, 2007, we
entered into a one year lease agreement with Lynx International Limited for our
office space and warehouse in Hong Kong.
On May 1, 2006, we sublet a portion of our executive office in Los
Angeles, California and our sales office in New York to Seven Licensing Company,
LLC for a monthly payment of $25,000 on a month to month basis. Seven Licensing
is beneficially owned by Gerard Guez. We received $225,000 and $125,000 in
rental income from this sublease in the nine months ended September 30, 2007 and
2006, respectively.
At September 30, 2007, we had various employee receivables totaling
$228,000 included in due from related parties.
We believe that each of the transactions described above has been
entered into on terms no less favorable to us than could have been obtained from
unaffiliated third parties.
15. COMMITMENTS AND CONTINGENCIES
In the second quarter of 2003, we acquired a 45% equity interest in the
owner of the trademark "American Rag CIE" and the operator of American Rag
retail stores for $1.4 million, and our subsidiary, Private Brands, Inc.,
acquired a license to certain exclusive rights to this trademark. We have
guaranteed the payment to the licensor of minimum royalties of $10.4 million
over the initial 10-year term of the agreement. The guaranteed annual minimum
royalty is payable in advance in monthly installments during the term of the
agreement. The royalty owed to the licensor in excess of the guaranteed minimum,
if any, is payable no later than 30 days after the end of the preceding full
quarter with the amount for last quarter adjusted based on actual royalties owed
for the year. If a portion of the guaranteed minimum royalty is determined not
21
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
to be recoverable, the unrecoverable portion is charged to expense at that time.
At September 30, 2007, the total commitment on royalties remaining on the term
was $7.8 million.
On October 17, 2004, Private Brands, Inc. entered into an agreement
with J.S. Brand Management to design, manufacture and distribute Jessica Simpson
branded jeans and casual apparel. This agreement had an initial three-year term,
and provided we were in compliance with the terms of the agreement, was
renewable for one additional two-year term. Minimum net sales were $20 million
in year 1, $25 million in year 2 and $30 million in year 3. The agreement
provided for payment of a sales royalty and advertising commitment at the rate
of 8% and 3%, respectively, of net sales, for a total minimum payment obligation
of $8.3 million over the initial term of the agreement. On July 19, 2005, Camuto
Consulting Group replaced J.S. Brand Management as the master licensor. In
December 2004, we advanced $2.2 million as payment for the first year's minimum
royalties. We applied $1.1 million from the above advance against the royalty
and marketing expenses in 2005 and $884,000 in the first three months of 2006.
In March 2006, we had written off the capitalized balance of $192,000 and
recognized a corresponding loss. The loss was classified as royalty expense on
our consolidated statements of operations. In March 2006, we became involved in
a dispute with the licensor of the Jessica Simpson brands over our continued
rights to these brands, and we had been in litigation with the licensor. See
Note 17 of the "Notes to Consolidated Financial Statements". The licensor
refused to accept payments and maintained that the agreement has been
terminated. There have been no sales of new products since the licensor started
refusing to approve products for manufacture and sale. As a result of this
litigation, in 2006 and in the first nine months of 2007, we did not accrue for
the payments of minimum royalty, sales royalty and advertising commitment of
$4.4 million pursuant to the agreement. In November 2007, we entered into a
settlement agreement with the licensor, Jessica Simpson and related parties with
respect to the litigation, pursuant to which the parties agreed to dismiss with
prejudice all claims relating to these actions or the sublicense agreement. As a
result, we are no longer required to make the guaranteed payments contemplated
under the agreement.
In August 2004, we entered into an Agreement for Purchase of Assets
with affiliates of Mr. Kamel Nacif; a shareholder at the time of the
transaction, with agreement was amended in October 2004. Pursuant to the
agreement, as amended, on November 30, 2004, we sold to the purchasers
substantially all of our assets and real property in Mexico, including the
equipment and facilities we previously leased to Mr. Nacif's affiliates. Upon
consummation of the sale, we entered into a purchase commitment agreement with
the purchasers, pursuant to which we had agreed to purchase annually over the
ten-year term of the agreement, $5 million of fabric manufactured at our former
facilities acquired by the purchasers at negotiated market prices. We did not
purchase fabric in the nine months ended September 30, 2007 and 2006. On August
21, 2007, we received a payment of $17.75 million from Tavex upon the exercise
by Tavex of its option, and this fabric purchase commitment agreement was
terminated. Instead, Tarrant Luxembourg agreed to purchase from Tavex at least
U.S. $1.25 million of fabric prior to the end of 2007, and Tarrant Luxembourg
agreed to deliver an irrevocable letter of credit for the full purchase price.
We have placed a fabric order with Tavex on August 21, 2007 for $1.25 million
pursuant to the agreement. See Note 6 of the "Notes to Consolidated Financial
Statements".
On September 1, 2006, our subsidiary in Hong Kong, Tarrant Company
Limited, entered into an agreement with Seven Licensing Company, LLC to act as
its buying agent to source apparel merchandise. Seven Licensing is beneficially
owned by Gerard Guez. Total sales to Seven Licensing in the nine months ended
September 30, 2007 were $14.2 million.
22
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
16. OPERATIONS BY GEOGRAPHIC AREAS
Our predominant business is the design, distribution and importation of
private label and private brand casual apparel. Substantially all of our
revenues are from the sales of apparel. We are organized into two geographic
regions: the United States and Asia. We evaluate performance of each region
based on profit or loss from operations before income taxes not including the
cumulative effect of change in accounting principles. Information about our
operations in the United States and Asia is presented below. Inter-company
revenues and assets have been eliminated to arrive at the consolidated amounts.
ADJUSTMENTS
AND
UNITED STATES ASIA ELIMINATIONS TOTAL
------------- ------------- ------------- -------------
THREE MONTHS ENDED
SEPTEMBER 30, 2007
Sales ..................... $ 63,448,000 $ 6,755,000 $ -- $ 70,203,000
Inter-company sales ....... -- 26,201,000 (26,201,000) --
------------- ------------- ------------- -------------
Total revenue ............. $ 63,448,000 $ 32,956,000 $ (26,201,000) $ 70,203,000
============= ============= ============= =============
Income from operations (1). $ 1,797,000 $ 864,000 $ -- $ 2,661,000
============= ============= ============= =============
Interest income ........... $ 39,000 $ -- $ -- $ 39,000
============= ============= ============= =============
Interest expense .......... $ 1,234,000 $ 49,000 $ -- $ 1,283,000
============= ============= ============= =============
Provision for depreciation
and amortization ......... $ 567,000 $ 36,000 $ -- $ 603,000
============= ============= ============= =============
Capital expenditures ...... $ 135,000 $ 69,000 $ -- $ 204,000
============= ============= ============= =============
THREE MONTHS ENDED
SEPTEMBER 30, 2006
Sales ..................... $ 53,100,000 $ 1,545,000 $ -- $ 54,645,000
Inter-company sales ....... -- 28,221,000 (28,221,000) --
------------- ------------- ------------- -------------
Total revenue ............. $ 53,100,000 $ 29,766,000 $ (28,221,000) $ 54,645,000
============= ============= ============= =============
Income (loss)
from operations (2) ...... $ (25,776,000) $ 1,057,000 $ -- $ (24,719,000)
============= ============= ============= =============
Interest income (3) ....... $ 165,000 $ -- $ -- $ 165,000
============= ============= ============= =============
Interest expense .......... $ 1,530,000 $ 32,000 $ -- $ 1,562,000
============= ============= ============= =============
Provision for depreciation
and amortization ......... $ 574,000 $ 28,000 $ -- $ 602,000
============= ============= ============= =============
Capital expenditures ...... $ 31,000 $ 36,000 $ -- $ 67,000
============= ============= ============= =============
NINE MONTHS ENDED
SEPTEMBER 30, 2007
Sales ..................... $ 171,239,000 $ 15,171,000 $ -- $ 186,410,000
Inter-company sales ....... -- 87,016,000 (87,016,000) --
------------- ------------- ------------- -------------
Total revenue ............. $ 171,239,000 $ 102,187,000 $ (87,016,000) $ 186,410,000
============= ============= ============= =============
Income from operations (4). $ 2,017,000 $ 3,236,000 $ -- $ 5,253,000
============= ============= ============= =============
Interest income ........... $ 126,000 $ 1,000 $ -- $ 127,000
============= ============= ============= =============
Interest expense .......... $ 3,707,000 $ 139,000 $ -- $ 3,846,000
============= ============= ============= =============
Provision for depreciation
and amortization ......... $ 1,693,000 $ 98,000 $ -- $ 1,791,000
============= ============= ============= =============
Capital expenditures ...... $ 249,000 $ 227,000 $ -- $ 476,000
============= ============= ============= =============
Total assets (5) .......... $ 61,438,000 $ 126,481,000 $ (99,838,000) $ 88,081,000
============= ============= ============= =============
NINE MONTHS ENDED
SEPTEMBER 30, 2006
Sales ..................... $ 172,463,000 $ 2,526,000 $ -- $ 174,989,000
Inter-company sales ....... -- 89,145,000 (89,145,000) --
------------- ------------- ------------- -------------
Total revenue ............. $ 172,463,000 $ 91,671,000 $ (89,145,000) $ 174,989,000
============= ============= ============= =============
Income (loss) from
operations (6) ........... $ (23,832,000) $ 3,367,000 $ -- $ (20,465,000)
============= ============= ============= =============
Interest income (7) ....... $ 1,130,000 $ 2,000 $ -- $ 1,132,000
============= ============= ============= =============
Interest expense .......... $ 4,537,000 $ 159,000 $ -- $ 4,696,000
============= ============= ============= =============
Provision for depreciation
and amortization ......... $ 2,302,000 $ 82,000 $ -- $ 2,384,000
============= ============= ============= =============
Capital expenditures ...... $ 63,000 $ 67,000 $ -- $ 130,000
============= ============= ============= =============
Total assets (8) .......... $ 101,354,000 $ 117,481,000 $(114,342,000) $ 104,493,000
============= ============= ============= =============
(1) Income from operations in the U.S. included a loss of $1,416,000 recorded
in Luxembourg; of which $1,400,000 related to an inventory reserve taken on
fabric which was sold in the subsequent quarter.
23
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(2) Income (loss) from operations in the U.S. included a loss of $27,142,000
recorded in Luxembourg; of which $27,137,000 related to loss on notes
receivable - related parties.
(3) Interest income in the U.S. included $28,000 interest earned from the notes
receivable related to the sale of our fixed assets in Mexico of which notes
were recorded in Luxembourg.
(4) Income from operations in the U.S. included a loss of $1,418,000 recorded
in Luxembourg; of which $1,400,000 related to an inventory reserve taken on
fabric which was sold in the subsequent quarter.
(5) Total assets in the U.S. included $585,000 from Luxembourg and $1,318,000
from Mexico.
(6) Income (loss) from operations in the U.S. included a loss of $27,144,000
recorded in Luxembourg; of which $27,137,000 related to loss on notes
receivable - related parties.
(7) Interest income in the U.S. included $901,000 interest earned from the
notes receivable related to the sale of our fixed assets in Mexico of which
notes were recorded in Luxembourg.
(8) Total assets in the U.S. included $14,001,000 from Luxembourg and
$8,509,000 from Mexico.
17. LITIGATION
JESSICA SIMPSON & CAMUTO CONSULTING GROUP
On or about April 6, 2006, we commenced an action against the licensor
of the Jessica Simpson brands (captioned Tarrant Apparel Group v. Camuto
Consulting Group, Inc., VCJS LLC, With You, Inc. and Jessica Simpson) in the
Supreme Court of the State of New York, County of New York. The suit named
Camuto Consulting Group, Inc., VCJS LLC, With You, Inc. and Jessica Simpson as
defendants, and asserts that the defendants failed to provide promised support
in connection with our sublicense agreement for the Jessica Simpson brands, as
well as fraud against Camuto Consulting. The complaint was amended to add
Vincent Camuto as a defendant and includes nine causes of action, including two
seeking a declaration that the sublicense agreement is exclusive and remains in
full force and effect, as well as claims for breach of contract, breach of the
duty of good faith and fair dealing and fraudulent inducement against Camuto
Consulting, a claim against Vincent Camuto individually for fraudulent
inducement, and a claim against With You, Inc. and Ms. Simpson that we are an
intended third party beneficiary of the license between those defendants and
Camuto Consulting. On or about October 30, 2006, Camuto Consulting, VCJS and
Vincent Camuto served their answer to the amended complaint, which included a
counterclaim against us for breach of the sublicense agreement and alleged
damages of no less than $100 million. With You, Inc. and Jessica Simpson also
filed counterclaims against us alleging trademark infringement, unfair
competition and business practices, violation of the right of privacy and other
claims, and seeking injunctive relief and damages in an amount to be determined
but no less than $100 million plus treble and punitive damages. By Order filed
January 17, 2007, the Court granted the motion of With You, Inc. and Ms. Simpson
to discontinue all of Ms. Simpson's counterclaims, and her personal
counterclaims were dismissed with prejudice. With You, Inc.'s counterclaims
remained. On or about February 27, 2007, we served a motion seeking dismissal of
two of With You, Inc.'s counterclaims. With You, Inc. did not oppose the motion
and by Order dated March 22, 2007, the Court granted our motion, dismissing two
of With You, Inc.'s counterclaims. On July 5, 2007, the trial Court denied a
motion filed in December 2006 by Camuto Consulting, VCJS and Vincent Camuto to
dismiss our claims for declaratory judgment seeking a declaration that the
sublicense is exclusive and remains in full force and effect and those aspects
of our claims that seek specific performance. In November 2007, we entered into
a settlement agreement with Camuto Consulting Group, Inc., VCJS LLC, With You,
Inc. and Jessica Simpson with respect to the litigation regarding our previous
agreement to design, manufacture and distribute Jessica Simpson branded jeans
and casual apparel. Pursuant to the settlement agreement, the parties agreed to
dismiss with prejudice all claims relating to these actions or the sublicense
agreement and we received a payment of $3 million.
From time to time, we are involved in various routine legal proceedings
incidental to the conduct of our business. Our management does not believe that
any of these legal proceedings will have a material adverse impact on our
business, financial condition or results of operations, either due to the nature
of the claims, or because our management believes that such claims should not
exceed the limits of the our insurance coverage.
18. SUBSEQUENT EVENTS
On November 2, 2007, we terminated our credit agreement, entered into
in June 2006 with certain lenders and Guggenheim Corporate Funding, LLC), as
administrative agent and collateral agent for the lenders. Previously, on
24
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 26, 2007, we repaid all amounts due under the credit facility with
Guggenheim. In connection with the pay-off of this credit facility, Guggenheim
and the lenders agreed to waive the early prepayment penalty provided for in the
credit agreement and the credit agreement and other loan documents have been
terminated.
In November 2007, we entered into a settlement agreement with Camuto
Consulting Group, Inc., VCJS LLC, With You, Inc. and Jessica Simpson with
respect to the litigation regarding our previous agreement to design,
manufacture and distribute Jessica Simpson branded jeans and casual apparel. See
Note 17 of the "Notes to Consolidated Financial Statements". Pursuant to the
settlement agreement, the parties agreed to dismiss with prejudice all claims
relating to these actions or the sublicense agreement and we received a payment
of $3 million.
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following management's discussion and analysis should be read
together with the Consolidated Financial Statements of Tarrant Apparel Group and
the "Notes to Consolidated Financial Statements" included elsewhere in this Form
10-Q. This discussion summarizes the significant factors affecting the
consolidated operating results, financial condition and liquidity and cash flows
of Tarrant Apparel Group for the quarterly periods and year to date ended
September 30, 2007 and 2006. Except for historical information, the matters
discussed in this management's discussion and analysis of financial condition
and results of operations are forward looking statements that involve risks and
uncertainties and are based upon judgments concerning various factors that are
beyond our control. See "Item 1A. Risk Factors" in Part II of this Form 10-Q.
BUSINESS OVERVIEW AND RECENT DEVELOPMENTS
We are a design and sourcing company for private label and private
brand casual apparel serving mass merchandisers, department stores, branded
wholesalers and specialty chains located primarily in the United States. Our
major customers include retailers, such as Macy's Merchandising Group, New York
& Co., Kohl's, Chico's, Mervyn's, Mothers Work, the Avenue, Wal-Mart, Charlotte
Russe and Lane Bryant. Our products are manufactured in a variety of woven and
knit fabrications and include jeans wear, casual pants, shorts, skirts, dresses,
t-shirts, blouses, shirts and other tops and jackets. Our private brands include
American Rag CIE and Alain Weiz.
PRIVATE LABEL
Private label business has been our core competency for over twenty
years, and involves a one to one relationship with a large, centrally controlled
retailer with whom we can develop product lines that fit with the
characteristics of their particular customer. Private label sales in the first
nine months of 2007 were $154.3 million compared to $135.8 million in the first
nine months of 2006.
PRIVATE BRANDS
We launched our private brands initiative in 2003, pursuant to which we
acquire ownership of or license rights to a brand name and sell apparel products
under this brand, generally to a single retail company within a geographic
region. Private brands sales in the first nine months of 2007 were $32.1 million
compared to $39.2 million in the first nine months of 2006. At September 30,
2007, we owned or licensed rights to the following private brands:
o AMERICAN RAG CIE: During the first quarter of 2005, we
extended our agreement with Macy's Merchandising Group through
2014, pursuant to which we exclusively distribute our American
Rag CIE brand through Macy's Merchandising Group's national
Department Store organization of more than 600 stores. Net
sales of American Rag CIE branded apparel totaled $31.6
million in the first nine months of 2007 compared to $23.1
million in the first nine months of 2006.
o ALAIN WEIZ: We have previously sold Alan Weiz apparel
exclusively to Dillard's Department Stores. Net sales of Alain
Weiz branded apparel totaled $4.6 million in the first nine
months of 2006. From January 1, 2007, we may sell our licensed
brand "Alain Weiz" to specialty stores and department stores.
There were no sales in the first nine months of 2007.
THE BUFFALO GROUP
On December 6, 2006, we entered into a definitive stock and asset
purchase agreement to acquire certain assets and entities comprising The Buffalo
Group. The Buffalo Group designs, imports and sells contemporary branded apparel
and accessories, primarily in Canada and the United States.
Pursuant to the purchase agreement, we and our subsidiaries agreed to
acquire (1) all the outstanding capital stock of four principal operating
subsidiaries of The Buffalo Group - Buffalo Inc., 3163946 Canada Inc., 3681441
Canada Inc. and Buffalo Corporation, and (2) certain assets, consisting
26
primarily of intellectual property rights and licenses, from The Buffalo Trust,
for a total aggregate purchase price of up to approximately $120 million. At
signing of the purchase agreement, we delivered $5.0 million to the sellers as a
deposit against the purchase price payable under the agreement.
On April 19, 2007, we entered into a Mutual Termination and Release
Agreement with The Buffalo Group, pursuant to which we and the other parties to
the purchase agreement mutually agreed to terminate the purchase agreement. The
parties determined that it was in the mutual best interest of each party to
terminate the proposed agreement. Under the terms of the Mutual Termination and
Release Agreement, Buffalo agreed to return to us $4,750,000 of the $5,000,000
deposit previously provided by us to The Buffalo Group pursuant to the purchase
agreement, and the parties have released each other from any claims arising
under or related to the purchase agreement. We received $4,750,000 in April
2007. The remaining portion of the deposit of $250,000 and other due diligence
fees incurred in the acquisition process were recorded as terminated acquisition
expenses in the first quarter of 2007.
NOTES RECEIVABLE - RELATED PARTY RESERVE
In connection with the sale in 2004 of our assets and real property in
Mexico, the purchasers of the Mexico assets, Solticio, S.A. de C.V.
("Solticio"), and Acabados y Cortes Textiles, S.A. de C.V. ("Acotex"), issued us
unsecured promissory notes of $3,910,000 that matured on November 30, 2007 and
secured promissory notes of $40,204,000 with payments due on December 31, 2005
and every year thereafter until December 31, 2014. The secured promissory notes
were payable in partial or total amounts anytime prior to the maturity of each
note. The secured notes were secured by the real and personal property in Mexico
that we sold to the purchasers. As of September 30, 2006, the outstanding
balance of the notes and interest receivables was $41.1 million prior to the
reserve. Historically, we had placed orders for purchases of fabric from the
purchasers pursuant to the purchase commitment agreement we entered into at the
time of the sale of the Mexico assets, and we had satisfied our payment
obligations for the fabric by offsetting the amounts payable against the amounts
due to us under the notes. However, during the third quarter of 2006, the
purchasers ceased providing fabric and were not making payments under the notes.
We further evaluated the recoverability of the notes receivable and recorded a
loss on the notes receivable in the third quarter of 2006 in an amount equal to
the outstanding balance less the value of the underlying assets securing the
notes. The loss was estimated to be approximately $27.1 million, resulting in a
net notes receivable balance at September 30, 2006 of approximately $14 million.
We believe there was no significant change subsequently on the value of the
underlying assets securing the notes; therefore, we did not have additional
reserve after the third quarter of 2006.
On March 21, 2007, our wholly-owned subsidiary, Tarrant Luxembourg
S.a.r.l., entered into a letter agreement with Solticio, Inmobiliaria Cuadros,
S.A. de C.V., and Acotex, (Acotex and together with Solticio and Inmobiliaria,
the "Sellers"), and Tavex Algodonera, S.A. On July 19, 2007, the parties amended
the letter agreement. Pursuant to the agreement, as amended, Tavex has the right
and option (but not an obligation), at any time on or prior to September 1,
2007, to pay to Tarrant Luxembourg an aggregate of U.S. $17.75 million in cash,
whereupon, among other things:
o Tarrant Luxembourg would terminate the Solticio and Acotex
promissory notes described above and release the Sellers from any
further obligations thereunder, and terminate and release all
liens on the collateral securing those notes;
o Tarrant Luxembourg and the Sellers would terminate all other
executory obligations among the parties, including any obligation
of ours to purchase fabric from Solticio and Acotex; and
o Tarrant Luxembourg would agree to purchase from Tavex at least
U.S. $1.25 million of fabric prior to the end of 2007, and Tarrant
Luxembourg would deliver a irrevocable letter of credit for the
full purchase price.
During the option period, we agreed that we would not seek to enforce
the Solticio and Acotex promissory notes, including by taking action with
respect to the collateral, nor would we enter into any agreement with a third
party that would adversely affect Tavex's rights under the agreement. The
Sellers also agreed during the option period, to work exclusively with Tavex in
respect of the payment of the Solticio and Acotex promissory notes and the other
27
transactions contemplated by the letter agreement, and not to enter into any
agreement with any person other than Tavex with respect to the payment and/or
assignment of the Solticio and Acotex promissory notes and the transactions
contemplated by the agreement.
On August 21, 2007, we received a payment of $17.75 million from Tavex
upon the exercise by Tavex of its option in accordance with the agreement
described above. In return for the Tavex's payment of $17.75 million, we have
taken the following actions pursuant to the terms of the agreement:
o Tarrant Luxembourg terminated the Solticio and Acotex
promissory notes described above and released the Sellers from
any further obligations thereunder, and terminated and
released all liens on the collateral securing those notes;
o Tarrant Luxembourg and the Sellers terminated all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and
o Tarrant Luxembourg agreed to purchase from Tavex at least U.S.
$1.25 million of fabric prior to the end of 2007, and Tarrant
Luxembourg agreed to deliver an irrevocable letter of credit
for the full purchase price.
Upon closing of the transaction and receiving the payment of $17.75
million, we recorded a gain of $3.75 million on our consolidated statements of
operations as other income in the third quarter of 2007. We have placed a fabric
order with Tavex on August 21, 2007 for $1.25 million pursuant to the agreement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosures
of contingent assets and liabilities. We are required to make assumptions about
matters, which are highly uncertain at the time of the estimate. Different
estimates we could reasonably have used or changes in the estimates that are
reasonably likely to occur could have a material effect on our financial
condition or result of operations. Estimates and assumptions about future events
and their effects cannot be determined with certainty. On an ongoing basis, we
evaluate estimates, including those related to allowance for returns, discounts
and bad debts, inventory, notes receivable - related parties reserve, valuation
of long-lived and intangible assets and goodwill, income taxes, stock options
valuation, contingencies and litigation. We base our estimates on historical
experience and on various assumptions believed to be applicable and reasonable
under the circumstances. These estimates may change as new events occur, as
additional information is obtained and as our operating environment changes. In
addition, management is periodically faced with uncertainties, the outcomes of
which are not within its control and will not be known for prolonged period of
time.
We believe our financial statements are fairly stated in accordance
with accounting principles generally accepted in the United States of America
and provide a meaningful presentation of our financial condition and results of
operations.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. For a further discussion on the application of these and
other accounting policies, see Note 1 of the "Notes to Consolidated Financial
Statements" included in our Annual Report on Form 10-K for the year ended
December 31, 2006.
ACCOUNTS RECEIVABLE--ALLOWANCE FOR RETURNS, DISCOUNTS AND BAD DEBTS
We evaluate the collectibility of accounts receivable and chargebacks
(disputes from the customer) based upon a combination of factors. In
circumstances where we are aware of a specific customer's inability to meet its
financial obligations (such as in the case of bankruptcy filings or substantial
downgrading of credit sources), a specific reserve for bad debts is taken
28
against amounts due to reduce the net recognized receivable to the amount
reasonably expected to be collected. For all other customers, we recognize
reserves for bad debts and chargebacks based on our historical collection
experience. If our collection experience deteriorates (for example, due to an
unexpected material adverse change in a major customer's ability to meet its
financial obligations to us), the estimates of the recoverability of amounts due
us could be reduced by a material amount.
As of September 30, 2007, the balance in the allowance for returns,
discounts and bad debts reserves was $2.2 million.
INVENTORY
Our inventories are valued at the lower of cost or market. Under
certain market conditions, we use estimates and judgments regarding the
valuation of inventory to properly value inventory. Inventory adjustments are
made for the difference between the cost of the inventory and the estimated
market value and charged to operations in the period in which the facts that
give rise to the adjustments become known.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We assess the impairment of identifiable intangibles, long-lived assets
and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include, but are not limited to, the following:
o a significant underperformance relative to expected historical
or projected future operating results;
o a significant change in the manner of the use of the acquired
asset or the strategy for the overall business; or
o a significant negative industry or economic trend.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets." According to this
statement, goodwill and other intangible assets with indefinite lives are no
longer subject to amortization, but rather an assessment of impairment applied
on a fair-value-based test on an annual basis or more frequently if an event
occurs or circumstances change that would more likely than not reduce the fair
value of a reporting unit below its carrying amount.
We utilized the discounted cash flow methodology to estimate fair
value. As of September 30, 2007, we have a goodwill balance of $8.6 million, and
a net property and equipment balance of $1.6 million.
INCOME TAXES
As part of the process of preparing our consolidated financial
statements, we are required to estimate income taxes in each of the
jurisdictions in which we operate. The process involves estimating actual
current tax expense along with assessing temporary differences resulting from
differing treatment of items for book and tax purposes. These timing differences
result in deferred tax assets and liabilities, which are included in our
consolidated balance sheet. We record a valuation allowance to reduce our net
deferred tax assets to the amount that is more likely than not to be realized.
We have considered future taxable income and ongoing tax planning strategies in
assessing the need for the valuation allowance. Increases in the valuation
allowance result in additional expense to be reflected within the tax provision
in the consolidated statement of operations.
In addition, accruals are also estimated for ongoing audits regarding
U.S. Federal tax issues that are currently unresolved, based on our estimate of
whether, and the extent to which, additional taxes will be due. We routinely
monitor the potential impact of these situations and believe that amounts are
properly accrued for. If we ultimately determine that payment of these amounts
is unnecessary, we will reverse the liability and recognize a tax benefit during
the period in which we determine that the liability is no longer necessary. We
will record an additional charge in our provision for taxes in any period we
determine that the original estimate of a tax liability is less than we expect
the ultimate assessment to be.
29
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109." FIN
48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes." FIN 48 also prescribes a recognition threshold
and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return that
results in a tax benefit. Additionally, FIN 48 provides guidance on
de-recognition, income statement classification of interest and penalties,
accounting in interim periods, disclosure, and transition. We adopted the
provisions of FIN 48 on January 1, 2007. As a result of the implementation of
FIN 48, we recognized no material adjustment for unrecognized tax benefits but
reduced retained earnings as of January 1, 2007 by approximately $1 million
attributable to penalties accrued as a component of income tax payable. As of
the date of adoption, our unrecognized tax benefits totaled approximately $8.9
million.
We and several of our subsidiaries file income tax returns in the U.S.,
Hong Kong, Luxembourg, Mexico and various state jurisdictions. We are currently
subject to an IRS audit for the years including 1996 through 2002 and State of
New York audit for the years 2002 to 2005 but are not being audited for other
states or non-U.S. income tax examinations for years open in those taxing
jurisdictions.
In January 2004, the IRS completed its examination of our Federal
income tax returns for the years ended December 31, 1996 through 2001. The IRS
has proposed adjustments to increase our income tax payable for the six years
under examination. In addition, in July 2004, the IRS initiated an examination
of our Federal income tax return for the year ended December 31, 2002. We are
currently at the appellate level of the IRS and believe the proposed adjustments
made to our federal income tax returns for the years ended 1996 through 2002
will be resolved within the next twelve months and if so, unrecognized tax
benefits related to U.S. tax positions may decrease by up to $7.8 million by
December 31, 2007. If the proposed adjustments are upheld through the
administrative and legal process, they could have a material impact on our
earnings and cash flow. We believe we have provided adequate reserves for any
reasonably foreseeable outcome related to these matters on the consolidated
balance sheets under the caption "Income Taxes". We do not believe that the
adjustments, if any, arising from the IRS examination, will result in an
additional income tax liability beyond what is recorded in the accompanying
consolidated balance sheets.
The total unrecognized tax benefits as of January 1, 2007 were $8.9
million, excluding interest, penalties and related income tax benefits and would
be recorded as a component of income tax expense if recognized. We recognize
interest accrued related to unrecognized tax benefits and penalties as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties were $8.0 million and $1.2 million, respectively, excluding any
related income tax benefits. In the third quarter of 2007, the unrecognized tax
benefits related to IRS and the associated state liabilities had been adjusted
to $8.4 million, excluding interest, penalties and related income tax benefits
and would be recorded as a component of income tax expense if recognized. During
the third quarter of 2007, we derecognized a previous uncertain tax position
through negotiations with the state tax jurisdiction. The negotiated settlement
resulted in a decrease of $1.4 million in unrecognized tax benefits and $1.0
million in penalties. After the above adjustments, the total unrecognized tax
benefits as of September 30, 2007 were $8.4 million. As of September 30, 2007,
the accrued interest and penalties were $7.5 million and $142,000, respectively,
excluding any related income tax benefits.
In many cases, the uncertain tax positions are related to tax years
that remain subject to examination by the relevant tax authorities. Federal and
state statutes are open from 1996 through the present period. Hong Kong statutes
are open from 2001, Luxembourg from 2003 and Mexico from 2001.
DEBT COVENANTS
Our debt agreements require certain covenants including a minimum level
of EBITDA and specified tangible net worth; and required interest coverage ratio
and leverage ratio as discussed in Note 9 of the "Notes to Consolidated
Financial Statements." If our results of operations erode and we are not able to
obtain waivers from the lenders, the debt would be in default and callable by
our lenders. In addition, due to cross-default provisions in our debt
agreements, substantially all of our long-term debt would become due in full if
any of the debt is in default. In anticipation of us not being able to meet the
required covenants due to various reasons, we either negotiate for changes in
the relative covenants or obtain an advance waiver or reclassify the relevant
30
debt as current. We also believe that our lenders would provide waivers if
necessary. However, our expectations of future operating results and continued
compliance with other debt covenants cannot be assured and our lenders' actions
are not controllable by us. If projections of future operating results are not
achieved and the debt is placed in default, we would be required to reduce our
expenses, by curtailing operations, and to raise capital through the sale of
assets, issuance of equity or otherwise, any of which could have a material
adverse effect on our financial condition and results of operations. As of
September 30, 2007, we were in compliance of covenants, as amended.
NEW ACCOUNTING PRONOUNCEMENTS
For a description of recent accounting pronouncements including the
respective expected dates of adoption and effects on results of operations and
financial condition, see Note 11 of the "Notes to Consolidated Financial
Statements."
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in our consolidated statements of operations as a percentage of net sales:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
Total net sales ........................... 100.0% 100.0% 100.0% 100.0%
Total cost of sales ....................... 81.6 78.4 79.7 78.9
---------- ---------- ---------- ----------
Gross profit .............................. 18.4 21.6 20.3 21.1
Selling and distribution expenses ......... 5.3 4.7 5.7 4.7
General and administration expenses ....... 8.7 12.0 10.1 11.4
Royalty expenses .......................... 0.6 0.5 0.6 1.2
Loss on notes receivable - related parties -- 49.7 -- 15.5
Terminated acquisition expenses ........... -- -- 1.1 --
---------- ---------- ---------- ----------
Income (loss) from operations ............. 3.8 (45.3) 2.8 (11.7)
Interest expense .......................... (1.8) (2.8) (2.1) (2.7)
Interest Income ........................... 0.1 0.3 0.1 0.7
Interest in income (loss) of equity method
investee ............................... 0.0 0.0 0.1 0.1
Other income .............................. 5.5 0.2 2.2 0.1
Adjustment to fair value of derivative .... (0.0) 1.3 0.1 0.3
Other expense ............................. (7.1) (0.0) (2.7) (0.2)
---------- ---------- ---------- ----------
Income (loss) before provision (credit) for
income taxes ........................... 0.5 (46.3) 0.5 (13.4)
Provision (credit) for income taxes ....... (1.8) 0.1 (0.3) 0.2
Minority interest in consolidated
subsidiary ............................. 0.0 0.0 0.0 0.0
---------- ---------- ---------- ----------
Net income (loss) ......................... 2.3% (46.4)% 0.8% (13.6)%
========== ========== ========== ==========
THIRD QUARTER 2007 COMPARED TO THIRD QUARTER 2006
Net sales increased by $15.6 million, or 28.5%, to $70.2 million in the
third quarter of 2007 from $54.6 million in the third quarter of 2006. Sales of
private label in the third quarter of 2007 were $58.2 million compared to $46.1
million in the same period of 2006 with the increase resulting primarily from
increased sales to New York & Co and Seven Licensing in the third quarter of
2007. Sales of private brands in the third quarter of 2007 were $12.0 million
compared to $8.5 million in the same period of 2006 with the increase resulting
primarily from increased sales of American Rag brand to Macy's Merchandising
Group in the third quarter of 2007.
Gross profit consists of net sales less product costs, direct labor,
duty, quota, freight in, and brokerage, warehouse handling and markdown. Gross
profit increased by $1.1 million to $12.9 million in the third quarter of 2007
from $11.8 million in the third quarter of 2006. The increase in gross profit
occurred primarily because of the increase in sales. As a percentage of net
sales, gross profit decreased from 21.6% in the third quarter of 2006 to 18.4%
in the third quarter of 2007. The decrease in gross margin in the third quarter
of 2007 was due primarily to an inventory reserve of $1.4 million taken on
fabric which was sold in the subsequent quarter.
31
Selling and distribution expenses increased by $1.2 million, or 46.2%,
to $3.8 million in the third quarter of 2007 from $2.6 million in the third
quarter of 2006. As a percentage of net sales, these expenses increased to 5.3%
in the third quarter of 2007 from 4.7% in the third quarter of 2006. The
increase in selling and distribution expenses was primarily due to overhead
related to a new label and increased advertising expenses during the third
quarter of 2007.
General and administrative expenses decreased by $440,000, or 6.7%, to
$6.1 million in the third quarter of 2007 from $6.6 million in the third quarter
of 2006. As a percentage of net sales, these expenses decreased to 8.7% in the
third quarter of 2007 from 12.0% in the third quarter of 2006.
Royalty expenses increased by $158,000, or 59.9%, to $421,000 in the
third quarter of 2007 from $264,000 in the third quarter of 2006. The increase
was primarily due to an increase in sales under American Rag brand in the third
quarter of 2007. As a percentage of net sales, these expenses increased to 0.6%
in the third quarter of 2007 from 0.5% in the third quarter of 2006.
Loss on notes receivable - related parties was $27.1 million, or 49.7%
of net sales, in the third quarter of 2006, compared to $0 in the third quarter
of 2007. During the third quarter of 2006, the purchasers of the Mexico assets
ceased providing fabric and were not making payments under the notes. We
evaluated the recoverability of the notes receivable and recorded a loss on the
notes receivable in an amount equal to the outstanding balance less the value of
the underlying assets securing the notes. See Note 6 of the "Notes to
Consolidated Financial Statements".
Operating income in the third quarter of 2007 was $2.7 million, or 3.8%
of net sales, compared to operating loss of $24.7 million, or (45.3)% of net
sales, in the comparable period of 2006, because of the factors discussed above.
Interest expense decreased by $280,000, or 17.9%, to $1.3 million in
the third quarter of 2007 from $1.6 million in the third quarter of 2006. As a
percentage of net sales, this expense decreased to 1.8% in the third quarter of
2007 from 2.8% in the third quarter of 2006. Interest income decreased by
$126,000, or 76.1%, to $39,000 in the third quarter of 2007 from $165,000 in the
third quarter of 2006.
Interest in income (loss) of equity method investee was $15,000 in the
third quarter of 2007, compared to $(7,000) in the third quarter of 2006.
Interest in income (loss) of equity method investee represented our 45% share of
equity interest in the owner of the trademark "American Rag CIE" and the
operator of American Rag retail stores. Other income was $3.9 million in the
third quarter of 2007, compared to $109,000 in the third quarter of 2006. Other
income in the third quarter of 2007 included a gain of $3.8 million on notes
receivable - related parties. See Note 6 of the "Notes to Consolidated Financial
Statements". Adjustment to fair value of derivative was $729,000 in the third
quarter of 2006, compared to $0 in the third quarter of 2007. Other expense was
$5.0 million in the third quarter of 2007, compared to $0 in the third quarter
of 2006. Other expense in the third quarter of 2007 included $5.0 million of
expenses of financing and related costs and the remaining value of the warrants
to credit facility and placement agent upon repaying our term loan in full. See
Note 9 of the "Notes to Consolidated Financial Statements".
Loss allocated to minority interest in the third quarter of 2007 was
$3,000, compared to $14,000 in the third quarter of 2006, representing the
minority partner's share of losses in PBG7.
FIRST NINE MONTHS OF 2007 COMPARED TO FIRST NINE MONTHS OF 2006
Net sales increased by $11.4 million, or 6.5%, to $186.4 million in the
first nine months of 2007 from $175.0 million in the first nine months of 2006.
Sales of private label in the first nine months of 2007 were $154.3 million
compared to $135.8 million in the same period of 2006, with the increase
resulting primarily from increased sales to New York & Co and Seven Licensing,
and partially offset by decreased sales to Kohl's and Mervyn's in the first nine
months of 2007. Sales of private brands in the first nine months of 2007 were
$32.1 million compared to $39.2 million in the same period of 2006. The decline
in private brands sales was the result of sales of Alain Weiz, Jessica Simpson
and House of Dereon brands in the first nine months of 2006, compared to no such
sales in the first nine months of 2007, and partially offset by an increase in
sales of American Rag brand to Macy's Merchandising Group in the first nine
months of 2007.
32
Gross profit consists of net sales less product costs, direct labor,
duty, quota, freight in, and brokerage, warehouse handling and markdown. Gross
profit increased by $867,000 to $37.8 million in the first nine months of 2007
from $37.0 million in the first nine months of 2006. The increase in gross
profit occurred primarily because of the increase in sales. As a percentage of
net sales, gross profit decreased from 21.1% in the first nine months of 2006 to
20.3% in the first nine months of 2007. The decrease in gross margin in the
current period is primarily attributable to an inventory reserve of $1.4 million
taken on fabric which was sold in the subsequent quarter.
Selling and distribution expenses increased by $2.2 million, or 27.1%,
to $10.5 million in the first nine months of 2007 from $8.3 million in the first
nine months of 2006. As a percentage of net sales, these expenses increased from
4.7% for the first nine months of 2006 to 5.7% for the first nine months of
2007. The increase in selling and distribution expenses was primarily due to
overhead related to a new label and increased advertising expenses during the
first nine months of 2007.
General and administrative expenses decreased by $1.1 million, or 5.4%,
to $18.8 million in the first nine months of 2007 from $19.9 million in the
first nine months of 2006. As a percentage of net sales, these expenses
decreased to 10.1% in the first nine months of 2007 from 11.4% in the first nine
months of 2006. General and administrative expenses in the first nine months of
2006 included $284,000 of expenses of financing cost paid to the placement agent
and the remaining value of the warrants to placement agent and $171,000 of
prepayment penalty paid to the debenture holders as a result of the repayment of
the debentures in June 2006.
Royalty and marketing allowance expenses decreased by $887,000, or
42.2%, to $1.2 million in the first nine months of 2007 from $2.1 million in the
first nine months of 2006. As a percentage of net sales, these expenses
decreased to 0.6% in the first nine months of 2007 from 1.2% in the first nine
months of 2006 due to royalties on sales under the licensed Jessica Simpson and
Alain Weiz brands in the first nine months of 2006, for which there were no such
sales in the first nine months of 2007, and partially offset by an increase in
sales under American Rag brand in the first nine months of 2007.
Loss on notes receivable - related parties was $27.1 million, or 15.5%
of net sales, in the first nine months of 2006, compared to $0 in the first nine
months of 2007. During the third quarter of 2006, the purchasers of the Mexico
assets ceased providing fabric and were not making payments under the notes. We
evaluated the recoverability of the notes receivable and recorded a loss on the
notes receivable in an amount equal to the outstanding balance less the value of
the underlying assets securing the notes. See Note 6 of the "Notes to
Consolidated Financial Statements".
Terminated acquisition expenses in the first nine months of 2007 were
$2.0 million, or 1.1% of net sales, compared to no such expense in the first
nine months of 2006. These expenses consisted of the non-refunded portion of a
deposit in the amount of $250,000 and other due diligence fees incurred in
connection with the proposed acquisition of The Buffalo Group, which transaction
was mutually terminated on April 19, 2007.
Operating income for the first nine months of 2007 was $5.3 million, or
2.8% of net sales, compared to operating loss of $20.5 million, or (11.7)% of
net sales, in the comparable prior period of 2006 as a result of the factors
discussed above.
Interest expense decreased by $851,000 or 18.1%, to $3.8 million in the
first nine months of 2007 from $4.7 million in the first nine months of 2006. As
a percentage of net sales, interest expense decreased to 2.1% in the first nine
months of 2007 from 2.7% in the first nine months of 2006. The decrease was
primarily due to expensing $711,000 in the nine months of 2006 of debt discount
related to the intrinsic value of the conversion option of debentures and the
remaining value of the warrants issued to holders of debentures as a result of
the repayment of the debentures in June 2006. Interest income decreased by $1.0
million, or 88.7%, to $127,000 in the first nine months of 2007 from $1.1
million in the first nine months of 2006. The decrease in interest income was
primarily due to the interest earned from the notes receivable related to the
sale of our fixed assets in Mexico in the first nine months of 2006, but no such
income in the first nine months of 2007.
Interest in income of equity method investee was $142,000 in the first
nine months of 2007, compared to $103,000 in the first nine months of 2006.
Interest in income of equity method investee represented our 45% share of equity
interest in the owner of the trademark "American Rag CIE" and the operator of
33
American Rag retail stores. Other income was $4.0 million in the first nine
months of 2007, compared to $233,000 in the first nine months of 2006. Other
income in the first nine months of 2007 included a gain of $3.8 million on notes
receivable - related parties. See Note 6 of the "Notes to Consolidated Financial
Statements". Adjustment to fair value of derivative was $196,000 in the first
nine months of 2007, compared to $511,000 in the first nine months of 2006.
Other expense was $5.0 million in the first nine months of 2007, compared to
$400,000 in the first nine months of 2006. Other expense in the first nine
months of 2007 included $5.0 million of expenses of financing and related costs
and the remaining value of the warrants to credit facility and placement agent
upon repaying our term loan in full. See Note 9 of the "Notes to Consolidated
Financial Statements".
Loss allocated to minority interest in the nine months of 2007 was
$4,000, representing the minority partner's share of losses in PBG7. Loss
allocated to minority interest in the first nine months of 2006 was $18,000.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity requirements arise from the funding of our working
capital needs, principally inventory, finished goods shipments-in-transit,
work-in-process and accounts receivable, including receivables from our contract
manufacturers that relate primarily to fabric we purchase for use by those
manufacturers. Our primary sources for working capital and capital expenditures
are cash flow from operations, borrowings under our bank and other credit
facilities, issuance of long-term debt, sales of equity and debt securities, and
vendor financing. In the near term, we expect that our operations and borrowings
under bank and other credit facilities will provide sufficient cash to fund our
operating expenses, capital expenditures and interest payments on our debt. In
the long-term, we expect to use internally generated funds and external sources
to satisfy our debt and other long-term liabilities.
Our liquidity is dependent, in part, on customers paying on time. Any
abnormal chargebacks or returns may affect our source of short-term funding. Any
changes in credit terms given to major customers may have an impact on our cash
flow. Suppliers' credit is another major source of short-term financing and any
adverse changes in their terms will have negative impact on our cash flow.
Other principal factors that could affect the availability of our
internally generated funds include:
o deterioration of sales due to weakness in the markets in which
we sell our products;
o decreases in market prices for our products;
o increases in costs of raw materials; and
o changes in our working capital requirements.
Principal factors that could affect our ability to obtain cash from
external sources include:
o financial covenants contained in our current or future bank
and debt facilities; and
o volatility in the market price of our common stock or in the
stock markets in general.
As of September 30, 2007, we had $1.6 million in cash and cash
equivalents as noted on our consolidated balance sheet and statement of cash
flows. This represented an increase of $740,000 or 81.8% compared to a total of
$905,000 as of December 31, 2006.
In September 2007, we repaid in full the outstanding term loan due
under our credit facility with Guggenheim Corporate Funding, LLC, as agent. We
used proceeds received from Tavex upon exercise of its option with respect to
the notes receivable to repay the term loan.
34
Cash flows for the nine months ended September 30, 2007 and 2006 were
as follows (dollars in thousands):
CASH FLOWS: 2007 2006
-------- --------
Net cash provided by operating activities .......... $ 4,083 $ 10,297
Net cash provided by investing activities .......... $ 21,456 $ 1,125
Net cash used in financing activities .............. $(24,800) $(12,087)
During the first nine months of 2007, net cash provided by operating
activities was $4.1 million, as compared to net cash provided by operating
activities of $10.3 million for the same period in 2006. Net cash provided by
operating activities in the first nine months of 2007 resulted primarily from a
net income of $1.4 million, a decrease of inventory of $6.9 million,
depreciation and amortization expense of $1.8 million and a $2.0 million due
diligence fees expensed in connection with termination of our proposed
acquisition of The Buffalo Group offset by a decrease of accounts payable of
$3.7 million and a $3.8 million gain on notes receivable.
During the first nine months of 2007, net cash provided by investing
activities was $21.5 million, as compared to net cash provided by investing
activities of $1.1 million for the same period in 2006. Net cash provided by
investing activities in the first nine months of 2007 resulted primarily from
$17.8 million proceeds from notes receivable and a return of $4.8 million of
deposit offset by approximately $700,000 of due diligence fees incurred in
connection with previously proposed acquisition of The Buffalo Group.
During the first nine months of 2007, net cash used in financing
activities was $24.8 million, as compared to net cash used in financing
activities of $12.1 million for the same period in 2006. Net cash used in
financing activities in the first nine months of 2007 resulted primarily from
the re-payment of $15.5 million of our term loan, $8.3 million of our long-term
bank borrowings and $1.0 million on our short-term bank borrowings.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Following is a summary of our contractual obligations and commercial
commitments available to us as of September 30, 2007 (in millions):
PAYMENTS DUE BY PERIOD
---------------------------------------------------------
Less than Between Between After
CONTRACTUAL OBLIGATIONS Total 1 year 2-3 years 4-5 years 5 years
------------------------------------------- --------- --------- --------- --------- ---------
Long-term debt (1) ........................ $ 12.2 $ 12.2 $ -- $ -- $ --
Operating leases .......................... 8.0 1.5 2.6 1.9 2.0
Minimum royalties (2) ..................... 13.9 6.9 2.1 2.8 2.1
Purchase commitment ....................... 1.3 1.3 -- -- --
--------- --------- --------- --------- ---------
Total Contractual Cash Obligations.. ...... $ 35.4 $ 21.9 $ 4.7 $ 4.7 $ 4.1
(1) Includes interest on long-term debt obligations. Based on outstanding
borrowings as of September 30, 2007, and assuming all such indebtedness
remained outstanding and the interest rates remained unchanged, we
estimate that our interest cost on long-term debt would be
approximately $933,000.
(2) Includes minimum royalties of $6.1 million under the agreement with the
licensor of the Jessica Simpson brands. In November 2007, we entered
into a settlement agreement with the licensor, Jessica Simpson and
related parties with respect to the litigation, pursuant to which the
parties agreed to dismiss with prejudice all claims relating to these
actions or the sublicense agreement. As a result, we are no longer
required to make the guaranteed payments contemplated under the
agreement.
TOTAL AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
AMOUNTS ---------------------------------------------
COMMERCIAL COMMITMENTS COMMITTED LESS THAN BETWEEN BETWEEN AFTER
AVAILABLE TO US TO US 1 YEAR 2-3 YEARS 4-5 YEARS 5 YEARS
---------------------------------- --------- --------- --------- --------- ---------
Lines of credit .................. $ 80.0 $ 80.0 $ -- $ -- $ --
Letters of credit (within lines of
credit) ....................... $ 25.0 $ 25.0 $ -- $ -- $ --
Total commercial commitments ..... $ 80.0 $ 80.0 $ -- $ -- $ --
35
Since March 2003, DBS Bank (Hong Kong) Limited had made available a
letter of credit facility of up to HKD 20 million (equivalent to US $2.6 million
at September 30, 2007) to our subsidiaries in Hong Kong. This was a demand
facility and was secured by the pledge of our office property, which is owned by
Gerard Guez, our Chairman and Interim Chief Executive Officer, and Todd Kay, our
Vice Chairman; and by our guarantee. The letter of credit facility was increased
to HKD 30 million (equivalent to US $3.9 million) in June 2004. In September
2006, a tax loan for HKD 8.438 million (equivalent to US $1.1 million) was also
made available to our Hong Kong subsidiaries and bears interest at the rate
equal to the Hong Kong prime rate plus 1% and are subject to the same security.
It bore interest at 8.75% per annum at September 30, 2007. As of September 30,
2007, $188,000 was outstanding under this tax loan.
In June 2006, our subsidiaries in Hong Kong, Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited, entered into a new credit
facility with DBS. Under this facility, we may arrange for letters of credit and
acceptances. The maximum amount our Hong Kong subsidiaries may borrow under this
facility at any time is US $25 million. The interest rate under the letter of
credit facility is equal to the Standard Bills Rate quoted by DBS minus 0.5% if
paid in Hong Kong Dollars, which the interest rate was 8.25% per annum at
September 30, 2007, or the Standard Bills Rate quoted by DBS plus 0.5% if paid
in any other currency, which the interest rate was 8.38% per annum at September
30, 2007. This is a demand facility and is secured by a security interest in all
the assets of the Hong Kong subsidiaries; by a pledge of our office property
where our Hong Kong office is located, which is owned by Gerard Guez and Todd
Kay; and by our guarantee. The DBS facility includes customary default
provisions. In addition, we are subject to certain restrictive covenants,
including that we maintain a specified tangible net worth, and a minimum level
of EBITDA at December 31, 2006, interest coverage ratio, leverage ratio and
limitations on additional indebtedness. We are in the process of revising these
covenants for 2007. As of September 30, 2007, $11.8 million was outstanding
under this facility. In addition, $9.5 million of open letters of credit were
outstanding and $3.7 million was available for future borrowings as of September
30, 2007.
On October 1, 2004, we amended and restated our previously existing
credit facility with GMAC Commercial Finance LLC by entering into a new
factoring agreement with GMAC CF. The amended and restated agreement (the
factoring agreement) extended the expiration date of the facility to September
30, 2007 and added as parties our subsidiaries Private Brands, Inc and No!
Jeans, Inc. In addition, in connection with the factoring agreement, our
indirect majority-owned subsidiary PBG7, LLC entered into a separate factoring
agreement with GMAC CF. Pursuant to the terms of the factoring agreement, we and
our subsidiaries agree to assign and sell to GMAC CF, as factor, all accounts
which arise from our sale of merchandise or rendition of service created on a
going forward basis. At our request, GMAC CF, in its discretion, may make
advances to us up to the lesser of (a) up to 90% of our accounts on which GMAC
CF has the risk of loss or (b) $40 million, minus in each case, any amount owed
by us to GMAC CF. In May 2005, we amended our factoring agreement with GMAC CF
to permit our subsidiaries party thereto and us, to borrow up to the lesser of
$3 million or 50% of the value of eligible inventory. In connection with this
amendment, we granted GMAC CF a lien on certain of our inventory located in the
United States. On January 23, 2006, we further amended our factoring agreement
with GMAC CF to increase the amount we might borrow against inventory to the
lesser of $5 million or 50% of the value of eligible inventory. The $5 million
limit was reduced to $4 million on April 1, 2006.
On June 16, 2006, we expanded our credit facility with GMAC CF by
entering into a new Loan and Security Agreement and amending and restating our
previously existing Factoring Agreement with GMAC CF. UPS Capital Corporation is
also a lender under the Loan and Security Agreement. This is a revolving credit
facility and has a term of 3 years. The amount we may borrow under this credit
facility is determined by a percentage of eligible accounts receivable and
inventory, up to a maximum of $55 million, and includes a letter of credit
facility of up to $4 million. Interest on outstanding amount under this credit
facility is payable monthly and accrues at the rate of the "prime rate" plus
0.5%. Our obligations under the GMAC CF credit facility are secured by a lien on
substantially all our domestic assets, including a first priority lien on our
accounts receivable and inventory. This credit facility contains customary
financial covenants, including covenants that we maintain minimum levels of
EBITDA and interest coverage ratios and limitations on additional indebtedness.
On November 2, 2007, the minimum level of EBITDA for September 30, 2007 was
amended. This facility includes customary default provisions, and all
outstanding obligations may become immediately due and payable in the event of a
default. The facility bore interest at 8.25% per annum at September 30, 2007. As
of September 30, 2007, we were in compliance with the covenants, as amended. A
total of $11.3 million was outstanding with respect to receivables factored
under the GMAC CF facility at September 30, 2007.
36
The amount we can borrow under the new factoring facility with GMAC CF
is determined based on a defined borrowing base formula related to eligible
accounts receivable. A significant decrease in eligible accounts receivable due
to the aging of receivables, can have an adverse effect on our borrowing
capabilities under our credit facility, which may adversely affect the adequacy
of our working capital. In addition, we have typically experienced seasonal
fluctuations in sales volume. These seasonal fluctuations result in sales volume
decreases in the first and fourth quarters of each year due to the seasonal
fluctuations experienced by the majority of our customers. During these
quarters, borrowing availability under our credit facility may decrease as a
result of decrease in eligible accounts receivables generated from our sales.
On June 16, 2006, we entered into a Credit Agreement with certain
lenders and Guggenheim Corporate Funding LLC, as administrative agent and
collateral agent for the lenders. This credit facility provides for borrowings
of up to $65 million. This facility consists of an initial term loan of up to
$25 million, of which we borrowed $15.5 million at the initial funding, to be
used to repay certain existing indebtedness and fund general operating and
working capital needs. An additional term loan of up to $40 million was
available under this facility to finance acquisitions acceptable to Guggenheim.
All amounts under the term loans become due and payable in December 2010.
Interest under this facility was payable monthly, with the interest rate equal
to the LIBOR rate plus an applicable margin based on our debt leverage ratio (as
defined in the credit agreement). Our obligations under the Guggenheim credit
facility are secured by a lien on substantially all of our assets and our
domestic subsidiaries, including a pledge of the equity interests of our
domestic subsidiaries and 65% of our Luxembourg subsidiary. This credit facility
contains customary financial covenants, including covenants that we maintain
minimum levels of EBITDA and interest coverage ratios and limitations on
additional indebtedness.
In connection with Guggenheim credit facility, on June 16, 2006, we
issued the lenders under this facility warrants to purchase up to an aggregate
of 3,857,143 shares of our common stock. These warrants have a term of 10 years.
These warrants are exercisable at a price of $1.88 per share with respect to 20%
of the shares, $2.00 per share with respect to 20% of the shares, $3.00 per
share with respect to 20% of the shares, $3.75 per share with respect to 20% of
the shares and $4.50 per share with respect to 20% of the shares. The exercise
prices are subject to adjustment for certain dilutive issuances pursuant to the
terms of the warrants. These warrants are exercisable for 3,500,000, and the
remaining 357,143 shares of the warrants will not become exercisable because a
specified portion of the initial term loan was not funded by the lenders. The
warrants were evaluated under SFAS No. 133 and EITF No. 00-19, "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock" and determined to be a derivative instrument due to certain
registration rights. As such, the warrants excluding the ones not exercisable
were valued at $4.9 million using the Black-Scholes model with the following
assumptions: risk-free interest rate of 5.1%; dividend yields of 0%; volatility
factors of the expected market price of our common stock of 0.70; and
contractual term of ten years. We also paid to Guggenheim 2.25% of the committed
principal amount of the loans which was $563,000 on June 16, 2006. The $563,000
fee paid to Guggenheim was included in the deferred financing cost, and the
value of the warrants to purchase 3.5 million shares of our common stock of $4.9
million was recorded as debt discount, both of them were amortized over the life
of the loan. For the nine months ended September 30, 2007, $906,000 was
amortized.
Durham Capital Corporation acted as our advisor in connection with the
Guggenheim credit facility. As compensation for its services, we agreed to pay
Durham a cash fee in an amount equal to 1% of the committed principal amount of
the loans under the Guggenheim credit facility. As a result, $250,000 was paid
on June 16, 2006. In addition, we issued Durham a warrant to purchase 77,143
shares of our common stock. This warrant has a term of 10 years and is
exercisable at a price of $1.88 per share, subject to adjustment for certain
dilutive issuances. This warrant is exercisable for 70,000 shares, and the
remaining 7,143 shares of this warrant will not become exercisable because a
specified portion of the initial term loan was not funded by the lenders. The
warrants were evaluated under SFAS No. 133 and EITF 00-19 and determined to be a
derivative instrument due to certain registration rights. As such, the warrants
excluding the ones not exercisable were valued at $105,000 using the
Black-Scholes model with the following assumptions: risk-free interest rate of
5.1%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.70; and contractual term of ten years. The $250,000 fee
paid to Durham and the value of the warrants to purchase 70,000 shares of our
common stock of $105,000 was included in the deferred financing cost, and was
amortized over the life of the loan. For the nine months ended September 30,
2007, $59,000 was amortized.
37
On September 26, 2007, we repaid in full the term loan of $15.5 million
outstanding under the Guggenheim credit facility. Upon paying off the loan, the
unamortized loan fee paid to Guggenheim of $401,000 and the unamortized value of
the warrants to purchase 3.5 million shares of our common stock of $3.5 million
was expensed. The unamortized loan fee paid to Durham of $178,000 and the
unamortized value of the warrants to purchase 70,000 shares of our common stock
of $75,000 was also expensed. Other unamortized expenses of $822,000 related to
obtaining the loan were also expensed. All the above expenses amounted to $5.0
million were recorded on our consolidated statements of operations as other
expense in the third quarter of 2007. On November 2, 2007, we executed a payoff
letter with Guggenheim and the lenders, which released all liens held by
Guggenheim and the lenders.
The credit facility with GMAC CF prohibits us from paying dividends or
other distributions on our common stock. In addition, the credit facility with
GMAC CF prohibits our subsidiaries that are borrowers under the facility from
paying dividends or other distributions to us, and the credit facility with DBS
prohibits our Hong Kong facilities from paying any dividends or other
distributions or advances to us.
We had three equipment loans outstanding at September 30, 2007. One of
these equipment loans bore interest at 15.8% payable in installments through
2007. The second loan bears interest at 6.15% payable in installments through
2007 and the third loan bears interest at 4.75% payable in installments through
2008. As of September 30, 2007, $15,000 was outstanding under the three
remaining loans.
From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates which issues these letters of credits
out of Israeli Discount Bank. As of September 30, 2007, $870,000 was outstanding
under this facility and $765,000 of letters of credit was open under this
arrangement. We pay a commission fee of 2.25% on all letters of credits issued
under this arrangement.
We have financed our operations from our cash flow from operations,
borrowings under our bank and other credit facilities, issuance of long-term
debt, and sales of equity and debt securities. Our short-term funding relies
very heavily on our major customers, banks, and suppliers. From time to time, we
have had temporary over-advances from our banks. Any withdrawal of support from
these parties will have serious consequences on our liquidity.
From time to time in the past, we borrowed funds from, and advanced
funds to, certain officers and principal shareholders, including Gerard Guez and
Todd Kay. See disclosure under "-Related Party Transactions" below.
In January 2004, the Internal Revenue Service completed its examination
of our Federal income tax returns for the years ended December 31, 1996 through
2001. The IRS has proposed adjustments to increase our income tax payable for
the six years under examination. In addition, in July 2004, the IRS initiated an
examination of our Federal income tax return for the year ended December 31,
2002. We are currently at the appellate level of the IRS and believe the
proposed adjustments made to our federal income tax returns for the years ended
1996 through 2002 will be resolved within the next twelve months and if so,
unrecognized tax benefits related to U.S. tax positions may decrease by up to
$7.8 million by December 31, 2007. If the proposed adjustments are upheld
through the administrative and legal process, they could have a material impact
on our earnings and cash flow. We believe we have provided adequate reserves for
any reasonably foreseeable outcome related to these matters on the consolidated
balance sheets under the caption "Income Taxes". We do not believe that the
adjustments, if any, arising from the IRS examination, will result in an
additional income tax liability beyond what is recorded in the accompanying
consolidated balance sheets. We may seek to finance future capital investment
programs through various methods, including, but not limited to, borrowings
under our bank credit facilities, issuance of long-term debt, sales of equity
securities, leases and long-term financing provided by the sellers of facilities
or the suppliers of certain equipment used in such facilities.
We do not believe that the moderate levels of inflation in the United
States in the last three years have had a significant effect on net sales or
profitability.
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RELATED PARTY TRANSACTIONS
We lease our executive offices and warehouse in Los Angeles, California
from GET. Additionally, we leased office space and warehouse in Hong Kong from
Lynx International Limited. GET and Lynx International Limited are each owned by
Gerard Guez, our Chairman and Interim Chief Executive Officer, and Todd Kay, our
Vice Chairman. We believe, at the time the leases were entered into, the rents
on these properties were comparable to then prevailing market rents. We paid
$847,000 and $807,000 in rent in the nine months ended September 30, 2007 and
2006, respectively, for office and warehouse facilities. On August 1, 2006, we
entered into a lease agreement with GET for the Los Angeles offices and
warehouse, which lease has a term of five years with an option to renew for an
additional five year term. On February 1, 2007, we entered into a one year lease
agreement with Lynx International Limited for our office space and warehouse in
Hong Kong.
On May 1, 2006, we sublet a portion of our executive office in Los
Angeles, California and our sales office in New York to Seven Licensing Company,
LLC for a monthly payment of $25,000 on a month to month basis. Seven Licensing
is beneficially owned by Gerard Guez. We received $225,000 and $125,000 in
rental income from this sublease in the nine months ended September 30, 2007 and
2006, respectively.
In August 2004, we entered into an Agreement for Purchase of Assets
with affiliates of Mr. Kamel Nacif, a shareholder at the time of the
transaction, which agreement was amended in October 2004. Pursuant to the
agreement, as amended, on November 30, 2004, we sold to the purchasers
substantially all of our assets and real property in Mexico, including the
equipment and facilities we previously leased to Mr. Nacif's affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and $3,910,000 by delivery of unsecured promissory notes bearing interest at
5.5% per annum; and b) $40,204,000, by delivery of secured promissory notes
bearing interest at 4.5% per annum, with payments due on December 31, 2005 and
every year thereafter until December 31, 2014. The secured promissory notes were
payable in partial or total amounts anytime prior to the maturity of each note.
As of September 30, 2006, the outstanding balance of the notes and interest
receivables was $41.1 million prior to the reserve. Historically, we had placed
orders for purchases of fabric from the purchasers pursuant to the purchase
commitment agreement we entered into at the time of the sale of the Mexico
assets, and we had satisfied our payment obligations for the fabric by
offsetting the amounts payable against the amounts due to us under the notes.
However, during the third quarter of 2006, the purchasers ceased providing
fabric and were not making payments under the notes. We further evaluated the
recoverability of the notes receivable and recorded a loss on the notes
receivable in the third quarter of 2006 in an amount equal to the outstanding
balance less the value of the underlying assets securing the notes. The loss was
estimated to be approximately $27.1 million, resulting in a notes receivable
balance at September 30, 2006 of approximately $14 million. We believe there was
no significant change subsequently on the value of the underlying assets
securing the notes; therefore, we did not have additional reserve after the
third quarter of 2006. Upon consummation of the sale, we entered into a purchase
commitment agreement with the purchasers, pursuant to which we had agreed to
purchase annually over the ten-year term of the agreement, $5 million of fabric
manufactured at our former facilities acquired by the purchasers at negotiated
market prices. We did not purchase fabric from Acabados y Terminados in the nine
months ended September 30, 2007 and 2006. Net amount due from these parties as
of September 30, 2007 was $0.
On March 21, 2007, our wholly-owned subsidiary, Tarrant Luxembourg
S.a.r.l., entered into a letter agreement with Solticio, Inmobiliaria Cuadros,
S.A. de C.V. ("Inmobiliaria"), and Acotex, (Acotex and together with Solticio
and Inmobiliaria, the "Sellers"), and Tavex Algodonera, S.A. ("Tavex"). On July
19, 2007, the parties amended the letter agreement. On August 21, 2007, we
received a payment of $17.75 million from Tavex upon the exercise by Tavex of
its option under the letter agreement among the parties. In return for the
Tavex's payment of $17.75 million, we have taken the following actions pursuant
to the terms of the agreement:
o Tarrant Luxembourg terminated the Solticio and Acotex
promissory notes described above and released the Sellers from
any further obligations thereunder, and terminated and
released all liens on the collateral securing those notes;
o Tarrant Luxembourg and the Sellers terminated all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and
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o Tarrant Luxembourg agreed to purchase from Tavex at least U.S.
$1.25 million of fabric prior to the end of 2007, and Tarrant
Luxembourg agreed to deliver an irrevocable letter of credit
for the full purchase price.
Upon closing of the transaction and receiving the payment of $17.75
million, we recorded a gain of $3.75 million on our consolidated statements of
operations as other income in the third quarter of 2007. See Note 6 of the
"Notes to Consolidated Financial Statements". We have placed a fabric order with
Tavex on August 21, 2007 for $1.25 million pursuant to the agreement.
From time to time in the past, we had advanced funds to Mr. Guez. These
were net advances to Mr. Guez or payments paid on his behalf before the
enactment of the Sarbanes-Oxley Act in 2002. The promissory note documenting
these advances contains a provision that the entire amount together with accrued
interest is immediately due and payable upon our written demand. The greatest
outstanding balance of such advances to Mr. Guez in the third quarter of 2007
was approximately $2,069,000. At September 30, 2007, the entire balance due from
Mr. Guez totaling $2.0 million is payable on demand and has been shown as
reductions to shareholders' equity in the accompanying financial statements. All
amounts due from Mr. Guez bore interest at the rate of 7.75% during the period.
Total interest paid by Mr. Guez was $120,000 and $129,000 for the nine months
ended September 30, 2007 and 2006, respectively. Mr. Guez paid expenses on our
behalf of approximately $252,000 and $226,000 for the nine months ended
September 30, 2007 and 2006, respectively, which amounts were applied to reduce
accrued interest and principal on Mr. Guez's loan. These amounts included fuel
and related expenses incurred by 477 Aviation, LLC, a company owned by Mr. Guez,
when our executives used this company's aircraft for business purposes. Since
the enactment of the Sarbanes-Oxley Act in 2002, no further personal loans (or
amendments to existing loans) have been or will be made to our executive
officers or directors.
Azteca Production International, Inc. is a corporation owned by the
brothers of Gerard Guez, our Chairman and Interim Chief Executive Officer. We
purchased $499,000 and $0 of finished goods, fabric and service from Azteca and
its affiliates in the nine months ended September 30, 2007 and 2006,
respectively. Our total sales of fabric and service to Azteca in the nine months
ended September 30, 2007 and 2006 were $0 and $9,000, respectively.
On September 1, 2006, our subsidiary in Hong Kong, Tarrant Company
Limited, entered into an agreement with Seven Licensing Company, LLC to act as
its buying agent to source apparel merchandise. Seven Licensing is beneficially
owned by Gerard Guez. Total sales to Seven Licensing in the nine months ended
September 30, 2007 and 2006 were $14.2 million. Net amount due from Azetca and
Seven Licensing as of September 30, 2007 and December 31, 2006 was $12.0 million
and $7.5 million, respectively.
We believe that each of the transactions described above has been
entered into on terms no less favorable to us than could have been obtained from
unaffiliated third parties. We have adopted a policy that any transactions
between us and any of our affiliates or related parties, including our executive
officers, directors, the family members of those individuals and any of their
affiliates, must (i) be approved by a majority of the members of the Board of
Directors and by a majority of the disinterested members of the Board of
Directors and (ii) be on terms no less favorable to us than could be obtained
from unaffiliated third parties.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
FOREIGN CURRENCY RISK. Our earnings are affected by fluctuations in the
value of the U.S. dollar as compared to foreign currencies as a result of doing
business in foreign jurisdictions. As a result, we bear the risk of exchange
rate gains and losses that may result in the future. At times we use forward
exchange contracts to reduce the effect of fluctuations of foreign currencies on
purchases and commitments. These short-term assets and commitments are
principally related to trade payables positions. At September 30, 2007, we had
no open foreign exchange forward contracts. We do not utilize derivative
financial instruments for trading or other speculative purposes. We actively
evaluate the creditworthiness of the financial institutions that are counter
parties to derivative financial instruments, and we do not expect any counter
parties to fail to meet their obligations.
INTEREST RATE RISK. Because our obligations under our various credit
agreements bear interest at floating rates, we are sensitive to changes in
prevailing interest rates. Any major increase or decrease in market interest
40
rates that affect our financial instruments would have a material impact on
earning or cash flows during the next fiscal year.
Our interest expense is sensitive to changes in the general level of
U.S. interest rates. In this regard, changes in U.S. interest rates affect
interest paid on our debt. A majority of our credit facilities are at variable
rates. As of September 30, 2007, we had $884,000 of fixed-rate borrowings and
$23.1 million of variable-rate borrowings outstanding. A one percentage point
increase in interest rates would result in an annualized increase to interest
expense of approximately $231,000 on our variable-rate borrowings.
ITEM 4. CONTROLS AND PROCEDURES.
EVALUATION OF CONTROLS AND PROCEDURES
Members of the our management, including our Interim Chief Executive
Officer and Chief Financial Officer, have evaluated the effectiveness of our
disclosure controls and procedures, as defined by paragraph (e) of Exchange Act
Rule 13a-15, as of September 30, 2007, the end of the period covered by this
report. Members of the our management, including our Interim Chief Executive
Officer and Chief Financial Officer, also conducted an evaluation of our
internal control over financial reporting to determine whether any changes
occurred during the third quarter of 2007 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. Based upon that evaluation, the Interim Chief Executive Officer and
Chief Financial Officer concluded that our disclosure controls and procedures
are effective.
CHANGES IN CONTROLS AND PROCEDURES
During the third quarter ended September 30, 2007, there were no
changes in our internal control over financial accounting that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
SARBANES-OXLEY ACT OF 2002 SECTION 404 COMPLIANCE
In 2003, we began our efforts to comply with Section 404 of the
Sarbanes-Oxley Act of 2002 ("SOX 404"), which requires detailed review,
documentation and testing of our internal controls over financial reporting.
This detailed review, documentation and testing includes an assessment of the
risks that could adversely affect the timely and accurate preparation of our
financial statements and the identification of internal controls that are
currently in place to mitigate the risks of untimely or inaccurate preparation
of these financial statements. We will be required to include a report on
management's assessment of internal controls over financial reporting in our
annual report on Form 10-K for the fiscal year ended December 31, 2007.
At the end of 2008, our independent registered public accountants will
be required to audit management's assessment. We are in the process of
performing the system and process documentation, evaluation and testing required
for management to make this assessment and for its independent registered public
accountants to provide their attestation report. We have not completed this
process or its assessment, and this process will require significant amounts of
management time and resources. In the course of evaluation and testing,
management may identify deficiencies that will need to be addressed and
remediated. We have invested significant internal resources and time in the SOX
404 compliance process, and we believe that we are on schedule to comply with
SOX 404.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On or about April 6, 2006, we commenced an action against the licensor
of the Jessica Simpson brands (captioned Tarrant Apparel Group v. Camuto
Consulting Group, Inc., VCJS LLC, With You, Inc. and Jessica Simpson) in the
Supreme Court of the State of New York, County of New York. The suit named
Camuto Consulting Group, Inc., VCJS LLC, With You, Inc. and Jessica Simpson as
defendants, and asserts that the defendants failed to provide promised support
in connection with our sublicense agreement for the Jessica Simpson brands, as
well as fraud against Camuto Consulting. The complaint was amended to add
Vincent Camuto as a defendant and includes nine causes of action, including two
seeking a declaration that the sublicense agreement is exclusive and remains in
full force and effect, as well as claims for breach of contract, breach of the
duty of good faith and fair dealing and fraudulent inducement against Camuto
Consulting, a claim against Vincent Camuto individually for fraudulent
inducement, and a claim against With You, Inc. and Ms. Simpson that we are an
intended third party beneficiary of the license between those defendants and
Camuto Consulting. On or about October 30, 2006, Camuto Consulting, VCJS and
Vincent Camuto served their answer to the amended complaint, which included a
counterclaim against us for breach of the sublicense agreement and alleged
damages of no less than $100 million. With You, Inc. and Jessica Simpson also
filed counterclaims against us alleging trademark infringement, unfair
competition and business practices, violation of the right of privacy and other
claims, and seeking injunctive relief and damages in an amount to be determined
but no less than $100 million plus treble and punitive damages. By Order filed
January 17, 2007, the Court granted the motion of With You, Inc. and Ms. Simpson
to discontinue all of Ms. Simpson's counterclaims, and her personal
counterclaims were dismissed with prejudice. With You, Inc.'s counterclaims
remained. On or about February 27, 2007, we served a motion seeking dismissal of
two of With You, Inc.'s counterclaims. With You, Inc. did not oppose the motion
and by Order dated March 22, 2007, the Court granted our motion, dismissing two
of With You, Inc.'s counterclaims. On July 5, 2007, the trial Court denied a
motion filed in December 2006 by Camuto Consulting, VCJS and Vincent Camuto to
dismiss our claims for declaratory judgment seeking a declaration that the
sublicense is exclusive and remains in full force and effect and those aspects
of our claims that seek specific performance. In November 2007, we entered into
a settlement agreement with Camuto Consulting Group, Inc., VCJS LLC, With You,
Inc. and Jessica Simpson with respect to the litigation regarding our previous
agreement to design, manufacture and distribute Jessica Simpson branded jeans
and casual apparel. Pursuant to the settlement agreement, the parties agreed to
dismiss with prejudice all claims relating to these actions or the sublicense
agreement and we received a payment of $3 million.
From time to time, we are involved in various routine legal proceedings
incidental to the conduct of our business. Our management does not believe that
any of these legal proceedings will have a material adverse impact on our
business, financial condition or results of operations, either due to the nature
of the claims, or because our management believes that such claims should not
exceed the limits of the our insurance coverage.
ITEM 1A. RISK FACTORS.
This Quarterly Report on Form 10-Q contains forward-looking statements,
which are subject to a variety of risks and uncertainties. Our actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below.
RISKS RELATED TO OUR BUSINESS
WE DEPEND ON A GROUP OF KEY CUSTOMERS FOR A SIGNIFICANT PORTION OF OUR SALES. A
SIGNIFICANT ADVERSE CHANGE IN A CUSTOMER RELATIONSHIP OR IN A CUSTOMER'S
FINANCIAL POSITION COULD HARM OUR BUSINESS AND FINANCIAL CONDITION.
Three customers accounted for approximately 43% of our net sales in
first nine months of 2007. We believe that consolidation in the retail industry
has centralized purchasing decisions and given customers greater leverage over
suppliers, like us, and we expect this trend to continue. If this consolidation
continues, our net sales and results of operations may be increasingly sensitive
to deterioration in the financial condition of, or other adverse developments
with, one or more of our customers.
While we have long-standing customer relationships, we generally do not
have long-term contracts with them except for Macy's Merchandising Group for
American Rag CIE. Purchases generally occur on an order-by-order basis, and
relationships exist as long as there is a perceived benefit to both parties. A
decision by a major customer, whether motivated by competitive considerations,
42
financial difficulties, and economic conditions or otherwise, to decrease its
purchases from us or to change its manner of doing business with us, could
adversely affect our business and financial condition. In addition, during
recent years, various retailers, including some of our customers, have
experienced significant changes and difficulties, including consolidation of
ownership, increased centralization of purchasing decisions, restructurings,
bankruptcies and liquidations.
These and other financial problems of some of our retailers, as well as
general weakness in the retail environment, increase the risk of extending
credit to these retailers. A significant adverse change in a customer
relationship or in a customer's financial position could cause us to limit or
discontinue business with that customer, require us to assume more credit risk
relating to that customer's receivables, limit our ability to collect amounts
related to previous purchases by that customer, or result in required prepayment
of our receivables securitization arrangements, all of which could harm our
business and financial condition.
FAILURE OF THE TRANSPORTATION INFRASTRUCTURE TO MOVE SEA FREIGHT IN ACCEPTABLE
TIME FRAMES COULD ADVERSELY AFFECT OUR BUSINESS.
Because the bulk of our freight is designed to move through the West
Coast ports in predictable time frames, we are at risk of cancellations and
penalties when those ports operate inefficiently creating delays in delivery. We
experienced such delays from June 2004 until November 2004, and we may
experience similar delays in the future especially during peak seasons.
Unpredictable timing for shipping may cause us to utilize air freight or may
result in customer penalties for late delivery, any of which could reduce our
operating margins and adversely affect our results of operations.
UNPREDICTABLE DELAYS AS THE RESULT OF INCREASED AND INTENSIFIED CUSTOMS
ACTIVITY.
U.S. Customs has stepped up efforts to scrutinize imports from Hong
Kong in order to verify all details of shipments under the OPA rules allowing
certain processes to be performed in China without shipping under China country
of origin documentation. Such "detentions" are unpredictable and cause serious
interruption of normally expected freight movement timetables.
FAILURE TO MANAGE OUR GROWTH AND EXPANSION COULD IMPAIR OUR BUSINESS.
Since our inception, we have experienced periods of rapid growth. No
assurance can be given that we will be successful in maintaining or increasing
our sales in the future. Any future growth in sales will require additional
working capital and may place a significant strain on our management, management
information systems, inventory management, sourcing capability, distribution
facilities and receivables management. Any disruption in our order processing,
sourcing or distribution systems could cause orders to be shipped late, and
under industry practices, retailers generally can cancel orders or refuse to
accept goods due to late shipment. Such cancellations and returns would result
in a reduction in revenue, increased administrative and shipping costs and a
further burden on our distribution facilities.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
We have experienced, and expect to continue to experience, substantial
variations in our net sales and operating results from quarter to quarter. We
believe that the factors which influence this variability of quarterly results
include the timing of our introduction of new product lines, the level of
consumer acceptance of each new product line, general economic and industry
conditions that affect consumer spending and retailer purchasing, the
availability of manufacturing capacity, the seasonality of the markets in which
we participate, the timing of trade shows, the product mix of customer orders,
the timing of the placement or cancellation of customer orders, the weather,
transportation delays, the occurrence of charge backs in excess of reserves and
the timing of expenditures in anticipation of increased sales and actions of
competitors. Due to fluctuations in our revenue and operating expenses, we
believe that period-to-period comparisons of our results of operations are not a
good indication of our future performance. It is possible that in some future
quarter or quarters, our operating results will be below the expectations of
securities analysts or investors. In that case, our stock price could fluctuate
significantly or decline.
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WE DEPEND ON OUR COMPUTER AND COMMUNICATIONS SYSTEMS.
As a multi-national corporation, we rely on our computer and
communication network to operate efficiently. Any interruption of this service
from power loss, telecommunications failure, weather, natural disasters or any
similar event could have a material adverse affect on our business and
operations. Additionally, hackers and computer viruses have disrupted operations
at many major companies. We may be vulnerable to similar acts of sabotage, which
could have a material adverse effect on our business and operations.
WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE.
We may not be able to fund our future growth or react to competitive
pressures if we lack sufficient funds. Currently, we believe we have sufficient
cash on hand and cash available through our bank credit facilities, issuance of
long-term debt and equity securities, and proceeds from the exercise of stock
options to fund existing operations for the foreseeable future. However, in the
future we may need to raise additional funds through equity or debt financings
or collaborative relationships. This additional funding may not be available or,
if available, it may not be available on economically reasonable terms. In
addition, any additional funding may result in significant dilution to existing
shareholders. If adequate funds are not available, we may be required to curtail
our operations or obtain funds through collaborative partners that may require
us to release material rights to our products.
OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS.
Substantially all of our import operations are subject to tariffs
imposed on imported products, safeguards and growth targets imposed by trade
agreements. In addition, the countries in which our products are manufactured or
imported may from time to time impose additional new duties, tariffs or other
restrictions on our imports or adversely modify existing restrictions. Adverse
changes in these import costs and restrictions, or our suppliers' failure to
comply with customs or similar laws, could harm our business. We cannot assure
that future trade agreements will not provide our competitors with an advantage
over us, or increase our costs, either of which could have an adverse effect on
our business and financial condition.
Our operations are also subject to the effects of international trade
agreements and regulations such as the North American Free Trade Agreement, and
the activities and regulations of the World Trade Organization. Generally, these
trade agreements benefit our business by reducing or eliminating the duties
assessed on products manufactured in a particular country. However, trade
agreements can also impose requirements that adversely affect our business, such
as limiting the countries from which we can purchase raw materials and setting
duties or restrictions on products that may be imported into the United States
from a particular country. In addition, the World Trade Organization may
commence a new round of trade negotiations that liberalize textile trade by
further eliminating or reducing tariffs. The elimination of quotas on World
Trade Organization member countries in 2005 has resulted in explosive growth in
textile imports from China, and subsequent safeguard measures including embargo
of certain China country of origin products. Actions taken to avoid these
measures caused disruption, and a negative impact on margins. In 2006, quota was
temporarily reinstated for China until 2008 for certain import merchandise
categories. Such disruptions and the temporary measures may continue to affect
us to some extent in the future.
OUR DEPENDENCE ON INDEPENDENT MANUFACTURERS REDUCES OUR ABILITY TO CONTROL THE
MANUFACTURING PROCESS, WHICH COULD HARM OUR SALES, REPUTATION AND OVERALL
PROFITABILITY.
We depend on independent contract manufacturers to secure a sufficient
supply of raw materials and maintain sufficient manufacturing and shipping
capacity in an environment characterized by declining prices, labor shortage,
continuing cost pressure and increased demands for product innovation and
speed-to-market. This dependence could subject us to difficulty in obtaining
timely delivery of products of acceptable quality. In addition, a contractor's
failure to ship products to us in a timely manner or to meet the required
quality standards could cause us to miss the delivery date requirements of our
customers. The failure to make timely deliveries may cause our customers to
cancel orders, refuse to accept deliveries, impose non-compliance charges
through invoice deductions or other charge-backs, demand reduced prices or
reduce future orders, any of which could harm our sales, reputation and overall
profitability. We do not have material long-term contracts with any of our
independent contractors and any of these contractors may unilaterally terminate
44
their relationship with us at any time. To the extent we are not able to secure
or maintain relationships with independent contractors that are able to fulfill
our requirements, our business would be harmed.
We have implemented a factory compliance agreement with our suppliers,
and monitor our independent contractors' compliance with applicable labor laws,
but we do not control our contractors or their labor practices. The violation of
federal, state or foreign labor laws by one of the our contractors could result
in our being subject to fines and our goods that are manufactured in violation
of such laws being seized or their sale in interstate commerce being prohibited.
From time to time, we have been notified by federal, state or foreign
authorities that certain of our contractors are the subject of investigations or
have been found to have violated applicable labor laws. To date, we have not
been subject to any sanctions that, individually or in the aggregate, have had a
material adverse effect on our business, and we are not aware of any facts on
which any such sanctions could be based. There can be no assurance, however,
that in the future we will not be subject to sanctions as a result of violations
of applicable labor laws by our contractors, or that such sanctions will not
have a material adverse effect on our business and results of operations. In
addition, certain of our customers, require strict compliance by their apparel
manufacturers, including us, with applicable labor laws and visit our facilities
often. There can be no assurance that the violation of applicable labor laws by
one of our contractors will not have a material adverse effect on our
relationship with our customers.
OUR BUSINESS IS SUBJECT TO RISKS OF OPERATING IN A FOREIGN COUNTRY AND TRADE
RESTRICTIONS.
We are subject to the risks associated with doing business in foreign
countries, including, but not limited to, transportation delays and
interruptions, political instability, expropriation, currency fluctuations and
the imposition of tariffs, import and export controls, other non-tariff barriers
and cultural issues. Any changes in those countries' labor laws and government
regulations may have a negative effect on our profitability.
RISK ASSOCIATED WITH OUR INDUSTRY
OUR SALES ARE HEAVILY INFLUENCED BY GENERAL ECONOMIC CYCLES.
Apparel is a cyclical industry that is heavily dependent upon the
overall level of consumer spending. Purchases of apparel and related goods tend
to be highly correlated with cycles in the disposable income of our consumers.
Our customers anticipate and respond to adverse changes in economic conditions
and uncertainty by reducing inventories and canceling orders. As a result, any
substantial deterioration in general economic conditions, increases in interest
rates, acts of war, terrorist or political events that diminish consumer
spending and confidence in any of the regions in which we compete, could reduce
our sales and adversely affect our business and financial condition.
OUR BUSINESS IS HIGHLY COMPETITIVE AND DEPENDS ON CONSUMER SPENDING PATTERNS.
The apparel industry is highly competitive. We face a variety of
competitive challenges including:
o anticipating and quickly responding to changing consumer
demands;
o developing innovative, high-quality products in sizes, colors
and styles that appeal to consumers of varying age groups and
tastes;
o competitively pricing our products and achieving customer
perception of value; and
o the need to provide strong and effective marketing support.
WE MUST SUCCESSFULLY GAUGE FASHION TRENDS AND CHANGING CONSUMER PREFERENCES TO
SUCCEED.
Our success is largely dependent upon our ability to gauge the fashion
tastes of our customers and to provide merchandise that satisfies retail and
customer demand in a timely manner. The apparel business fluctuates according to
changes in consumer preferences dictated in part by fashion and season. To the
extent we misjudge the market for our merchandise; our sales may be adversely
affected. Our ability to anticipate and effectively respond to changing fashion
trends depends in part on our ability to attract and retain key personnel in our
45
design, merchandising and marketing staff. Competition for these personnel is
intense, and we cannot be sure that we will be able to attract and retain a
sufficient number of qualified personnel in future periods.
OUR BUSINESS IS SUBJECT TO SEASONAL TRENDS.
Historically, our operating results have been subject to seasonal
trends when measured on a quarterly basis. This trend is dependent on numerous
factors, including the markets in which we operate, holiday seasons, consumer
demand, climate, economic conditions and numerous other factors beyond our
control. There can be no assurance that our historic operating patterns will
continue in future periods as we cannot influence or forecast many of these
factors.
OTHER RISKS RELATED TO AN INVESTMENT IN OUR COMMON STOCK
THE ULTIMATE RESOLUTION OF THE INTERNAL REVENUE SERVICE'S EXAMINATION OF OUR TAX
RETURNS MAY REQUIRE US TO INCUR AN EXPENSE BEYOND WHAT HAS BEEN RESERVED FOR ON
OUR BALANCE SHEET OR MAKE CASH PAYMENTS BEYOND WHAT WE ARE THEN ABLE TO PAY.
In January 2004, the Internal Revenue Service completed its examination
of our Federal income tax returns for the years ended December 31, 1996 through
2001. The IRS has proposed adjustments to increase our income tax payable for
the six years under examination. In addition, in July 2004, the IRS initiated an
examination of our Federal income tax return for the year ended December 31,
2002. We are currently at the appellate level of the IRS and believe the
proposed adjustments made to our federal income tax returns for the years ended
1996 through 2002 will be resolved within the next twelve months and if so,
unrecognized tax benefits related to U.S. tax positions may decrease by up to
$7.8 million by December 31, 2007. If the proposed adjustments are upheld
through the administrative and legal process, they could have a material impact
on our earnings and cash flow. We believe we have provided adequate reserves for
any reasonably foreseeable outcome related to these matters on the consolidated
balance sheets under the caption "Income Taxes". We do not believe that the
adjustments, if any, arising from the IRS examination, will result in an
additional income tax liability beyond what is recorded in the accompanying
consolidated balance sheets.
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. We cannot be certain that the measures we will undertake will ensure
that we will maintain adequate controls over our financial processes and
reporting in the future. Failure to implement required controls, or difficulties
encountered in their implementation, could harm our operating results or 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 NASDAQ or 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.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR
SHAREHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS.
As of November 9, 2007, our executive officers and directors and their
affiliates owned approximately 43% of our common stock. Gerard Guez, our
Chairman and Interim Chief Executive Officer, and Todd Kay, our Vice Chairman,
alone own approximately 33% and 8%, respectively, of our common stock at
November 9, 2007. Accordingly, our executive officers and directors have the
ability to affect the outcome of, or exert considerable influence over, all
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matters requiring shareholder approval, including the election and removal of
directors and any change in control. This concentration of ownership of our
common stock could have the effect of delaying or preventing a change of control
of us or otherwise discouraging or preventing a potential acquirer from
attempting to obtain control of us. This, in turn, could have a negative effect
on the market price of our common stock. It could also prevent our shareholders
from realizing a premium over the market prices for their shares of common
stock.
WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF
OUR COMMON STOCK.
Our shareholders rights plan, our ability to issue additional shares of
preferred stock and some provisions of our articles of incorporation and bylaws
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 without approval
of our board of directors.
OUR STOCK PRICE HAS BEEN VOLATILE.
Our common stock is quoted on the NASDAQ Global Market, and there can
be substantial volatility in the market price of our common stock. The market
price of our common stock has been, and is likely to continue to be, subject to
significant fluctuations due to a variety of factors, including quarterly
variations in operating results, operating results which vary from the
expectations of securities analysts and investors, changes in financial
estimates, changes in market valuations of competitors, announcements by us or
our competitors of a material nature, loss of one or more customers, additions
or departures of key personnel, future sales of common stock and stock market
price and volume fluctuations. In addition, general political and economic
conditions such as a recession, or interest rate or currency rate fluctuations
may adversely affect the market price of our common stock.
In addition, the stock market in general has experienced extreme price
and volume fluctuations that have affected the market price of our common stock.
Often, price fluctuations are unrelated to operating performance of the specific
companies whose stock is affected. In the past, following periods of volatility
in the market price of a company's stock, securities class action litigation has
occurred against the issuing company. If we were subject to this type of
litigation in the future, we could incur substantial costs and a diversion of
our management's attention and resources, each of which could have a material
adverse effect on our revenue and earnings. Any adverse determination in this
type of litigation could also subject us to significant liabilities.
ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO YOU.
Some investors favor companies that pay dividends, particularly in
general downturns in the stock market. We have not declared or paid any cash
dividends on our common stock. We currently intend to retain any future earnings
for funding growth, and we do not currently anticipate paying cash dividends on
our common stock in the foreseeable future. Additionally, we cannot pay
dividends on our common stock unless the terms of our bank credit facilities and
outstanding preferred stock, if any, permit the payment of dividends on our
common stock. Because we may not pay dividends, your return on this investment
likely depends on your selling our stock at a profit.
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ITEM 6. EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
-------- -----------------------------------------------------
3.2 Restated Bylaws. (Incorporated by reference to the
Registrant's Registration Statement on Form S-1 filed
on May 4, 1995.)
3.2.1 Amendment to Restated Bylaws of Tarrant Apparel
Group, dated August 9, 2007. (Incorporated by
reference to the Registrant's Current Report on Form
8-K filed on August 10, 2007.)
10.31.1 Amendment, dated July 19, 2007, to Letter Agreement
dated March 21, 2007, among Tarrant Luxembourg
S.a.r.l., Solticio, S.A. de C.V., Inmobiliaria
Cuadros, S.A. de C.V. , Acabados y Cortes Textiles,
S.A. de. C.V., and Tavex Algodonera, S.A.
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 pursuant to
Rule 13a-14(b) under the Securities and Exchange Act
of 1934, as amended.
32.2 Certificate of Chief Financial Officer pursuant to
Rule 13a-14(b) under the Securities and Exchange Act
of 1934, as amended.
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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.
TARRANT APPAREL GROUP
Date: November 13, 2007 By: /s/ David Burke
---------------------------------
David Burke,
Chief Financial Officer
Date: November 13, 2007 By: /s/ Gerard Guez
---------------------------------
Gerard Guez,
Interim Chief Executive Officer
49