UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
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
TARRANT APPAREL GROUP
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-4181026
(State or other jurisdiction (I.R.S. Employer
of 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
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registration is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
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]
The aggregate market value of the Common Stock held by non-affiliates
of the Registrant is approximately $51,515,376 based upon the closing price of
the Common Stock on June 30, 2005.
Number of shares of Common Stock of the Registrant outstanding as of
March 30, 2006: 30,543,763.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A in
connection with the 2006 Annual Meeting of Shareholders are incorporated by
reference into Part III of this Report.
TARRANT APPAREL GROUP
INDEX TO FORM 10-K
PART I PAGE
Item 1. Business..................................................... 1
Item 1A. Risk Factors................................................. 10
Item 1B. Unresolved Staff Comments.................................... 15
Item 2. Properties................................................... 16
Item 3. Legal Proceedings............................................ 16
Item 4. Submission of Matters to a Vote of Security Holders.......... 16
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities......... 17
Item 6. Selected Financial Data...................................... 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 20
Item 7A. Quantitative and Qualitative Disclosures about Market Risk .. 38
Item 8. Financial Statements and Supplementary Data.................. 38
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 38
Item 9A. Controls and Procedures...................................... 38
Item 9B. Other Information............................................ 39
PART III
Item 10. Directors and Executive Officers of the Registrant........... 39
Item 11. Executive Compensation....................................... 39
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters................ 39
Item 13. Certain Relationships and Related Transactions............... 39
Item 14. Principal Accounting Fees and Services....................... 39
PART IV
Item 15. Exhibits and Financial Statement Schedules................... 39
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PART I
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This 2005 Annual Report on Form 10-K contains statements which
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. Those statements include statements regarding our intent,
belief or current expectations. Prospective investors are cautioned that any
such forward-looking statements are not guarantees of future performance and
involve risks and uncertainties, and that actual results may differ materially
from those projected in the forward-looking statements. Such risks and
uncertainties include, among other things, our ability to face stiff
competition, profitably manage a sourcing and distribution business, the
financial strength of our major customers, the continued acceptance of our
existing and new products by our existing and new customers, dependence on key
customers, the risks of foreign manufacturing, competitive and economic factors
in the textile and apparel markets, the availability of raw materials, the
ability to manage growth, weather-related delays, dependence on key personnel,
general economic conditions, global manufacturing costs and restrictions, and
other risks and uncertainties that may be detailed herein.
See "Item 1A. Risk Factors."
ITEM 1. BUSINESS
OVERVIEW
Tarrant Apparel Group is 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 Chico's, Macy's
Merchandising Group, the Avenue, Lane Bryant, Lerner New York, Mothers Work,
J.C. Penney, Kohl's, Sears, Mervyn's and Wal-Mart. Our products are manufactured
in a variety of woven and knit fabrications and include jeans wear, casual
pants, t-shirts, shorts, blouses, shirts and other tops, dresses and jackets.
In 2003 and 2004, our net sales were $320 million and $155 million,
respectively. In 2005, our net sales increased by 38.1% to $215 million. In
2003, we experienced a net loss of $35.9 million, which included non-cash
charges of inventory write-down of $11 million and an impairment of asset charge
of $22.3 million. In 2004, we experienced a net loss of $104.7 million, which
included non-cash charges of $22.8 million of foreign currency translation loss
and $78.0 million of asset impairments. In 2005, we experienced net income of
$1.0 million. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
We launched our private brands initiative in 2003, in which we acquire
ownership of or license rights to a brand name and sell apparel products under
the brand, generally to a single retail company within a geographic region. At
March 31, 2006, we are selling apparel products under the following brands at
the following retailers:
BRAND STORES
---------------- --------------------------
American Rag CIE Macy's Merchandising Group
Alain Weiz Dillard's
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In addition to these brands, we own or license rights to "Souvenir by
Cynthia Rowley", "Gear 7" and brands associated with Jessica Simpson, which
include "JS by Jessica Simpson", "Princy by Jessica Simpson" and "Sweet Kisses
by Jessica Simpson". With the exception of Souvenir by Cynthia Rowley, during
2005 we sold apparel products under all of these private brands and under the
brand "House of Dereon by Tina Knowles".
During 2005 we sold Gear 7 branded apparel to K-Mart. During the fourth
quarter of 2005, K-Mart decided to discontinue this line, and we do not
anticipate sales of Gear 7 products in 2006. Additionally, in March 2006, we
terminated our license agreement for the brand House of Dereon by Tina Knowles,
and sold our remaining inventory to the licensor. As a result, we will no longer
sell apparel products under this private brand. In March 2006, we became
involved in a dispute with the licensor of the Jessica Simpson brands over our
continued rights to these brands. Accordingly, we do not anticipate sales of
Jessica Simpson branded apparel after the first quarter of 2006 unless and until
we successfully resolve our dispute with the licensor.
The expertise acquired in designing and developing our private brands
collections has created new opportunities within the private label business to
use that same operating method to market new initiatives for Sears, Mothers
Work, Avenue, Chico's, and other retailers. These initiatives were launched
during 2005.
BUSINESS STRATEGY
We believe that the following trends are currently affecting apparel
retailing and manufacturing:
o Consolidation among apparel retailers has increased their
ability to demand value-added services from apparel
manufacturers, including fashion expertise, rapid response,
just-in-time delivery, Electronic Data Interchange and
favorable pricing.
o Increased competition among retailers due to consolidation has
resulted in an increased demand for private label and private
brand apparel, which generally offers retailers higher margins
and permits them to differentiate their products.
o The current fashion cycle requires more design and product
development, in addition to quickly responding to emerging
trends. Apparel manufacturers that offer these capabilities
are in demand.
We believe that we have the capabilities to take advantage of these
trends and remain a principal value-added supplier of casual, moderately priced
apparel as well as increase our share of the higher retail, "branded" segment
that the major retailers are pursuing.
DESIGN EXPERTISE. As one of the very few sourcing companies with our
own design team, we believe that we have established a reputation with our
customers as a fashion resource and manufacturer that is capable of providing
design assistance to customers in the face of rapidly changing fashion trends.
RESEARCH AND DEVELOPMENT CAPABILITIES. We believe our design capability
combined with our fabric research and development provide a major advantage that
our customers respond to, and that we have skills in the advanced development of
washes and finishes that give us a position of competitive strength.
MARKETING EXPERTISE. We have the understanding and resources to develop
strong "brand-like" product marketing to support the need to extend traditional
store brands into product presentations that have more value to the consumer in
terms of product design and imaging.
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SAMPLE-MAKING AND MARKET-TESTING CAPABILITIES. We seek to support
customers with our design expertise, sample-making capability and ability to
rapidly produce small test orders of products.
ON-TIME DELIVERY. We have developed a diversified network of
international contract manufacturers and fabric suppliers, which enable us to
accept orders of varying sizes and delivery schedules and to produce a broad
range of garments at varying prices depending upon lead time and other
requirements of the customer.
QUALITY AND COMPETITIVELY PRICED PRODUCTS. We believe that our long
time presence in the Far East and our experienced product management teams
provide a superior supply chain that enables us to meet the individual needs of
our customers in terms of quality and lead time.
PRODUCT DIVERSIFICATION. Our experiencing in designing and delivering
complete apparel collections for some of our customers has improved our overall
ability to deliver product classifications beyond our core casual bottoms
offerings, which has further diversified the merchandise we offer to other
customers.
PRIVATE BRANDS. With a private brand relationship, we own and control
the brand and thus build equity in the brand as the product gains acceptance by
consumers. In a private label relationship, we source products for our customers
who own and control the brand and thus benefit from any increase in value of the
brand.
We believe that forming strong alliances with premier retailers allows
us greater penetration of apparel categories in addition to our core casual
bottoms business. In addition to the increased breadth of classifications, we
have improved our ability to compete for private label business based on
expertise gained from our private brand development. We receive higher margins
for development of product by design and marketing assistance.
PRODUCTS
Women's jeans historically have been, and continue to be, our principal
product. In recent years, we have expanded our sales of moderately priced
women's apparel to include casual, non-denim, fabrications including twill and
other cotton and cotton blends, in woven tops and bottoms. Our women's apparel
products currently include jeans wear, casual pants, t-shirts, shorts, blouses,
shirts, other tops, dresses and jackets. These products are manufactured in
petite, standard and large sizes and are sold at a variety of wholesale prices
generally ranging from less than $5.00 to over $35.00 per garment. We have
produced men's and children's apparel in varying significance for the last seven
years.
Over the past three years, approximately 70% of net sales were derived
from the sales of pants and jeans, approximately 6% from the sale of shorts,
approximately 10% from the sale of shirts, blouses and tops and approximately 6%
from the sale of skirts and skort-alls. The balance of net sales consisted of
sales of dresses, jackets and other products.
CUSTOMERS
We generally market our products to high-volume retailers that we
believe can grow into major accounts. By limiting our customer base to a select
group of larger accounts, we seek to build stronger long-term relationships and
leverage our operating costs against large bulk orders. Although we continue to
diversify our customer base, the majority of sales growth is most predictable
from existing customers.
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The following table shows the percentage of our net sales in fiscal
year 2005 attributable to each customer that accounted for more than 10% of net
sales.
PERCENTAGE OF NET SALES
--------------------------------
CUSTOMER 2005
------------------------------------ --------------------------------
Kohl's.............................. 13.5
Macy's Merchandising Group.......... 13.4
Mervyn's............................ 11.2
Wal-Mart............................ 11.1
We currently serve over 20 customers, which in addition to those
identified above, include, Lerner New York, Lane Bryant, Chico's, Mothers Work,
Sears, the Avenue, Dillard's and J.C. Penney. In 2003, 2004 and 2005, net sales
of private brands represented approximately 6%, 14% and 26%, respectively, of
our total net sales. We launched our private brands initiative in 2003, in 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. We sell products in our brands "American Rag Cie" exclusively
to Macy's Merchandising Group, and our licensed brand "Alain Weiz" exclusively
to Dillard's. During 2005, we also sold products under the Gear 7, House of
Dereon by Tina Knowles and Princy and JS by Jessica Simpson brands. Gear 7 was
discontinued by K-Mart, JS by Jessica Simpson was purchased by Charming Shoppes
for early fall only, and we terminated our agreement to design and market House
of Dereon by Tina Knowles in March 2006. We are currently in disagreement with
the licensor for Jessica Simpson brand apparel over licensing rights.
We do not have long-term contracts with any of our customers except
for Macy's Merchandising Group for American Rag Cie and, therefore, there can be
no assurance that other customers will continue to place orders with us of the
same magnitude as it has in the past, or at all. In addition, the apparel
industry historically has been subject to substantial cyclical variation, with
consumer spending for purchases of apparel and related goods tending to decline
during recessionary periods. To the extent that these financial difficulties
occur, there can be no assurance that our financial condition and results of
operations would not be adversely affected. See "Item 1A. Risk Factors."
DESIGN, MERCHANDISING AND SALES
While many private label producers only arrange for the bulk production
of styles specified by their customers, we not only design garments, but also
assist some of our customers in market testing new designs. We believe that our
design, sample-production and test-run capabilities give us a competitive
advantage in obtaining bulk orders from our customers. We also often receive
bulk orders for garments we have not designed because many of our customers
allocate bulk orders among more than one producer.
We have developed integrated teams of design, merchandising and support
personnel, some of whom serve on more than one team, that focus on designing and
producing merchandise that reflects the style and image of their customers.
Teams are divided between private label and private brands for sourcing
operations.
Each team is responsible for all aspects of its customer's needs,
including designing products, developing product samples and test items,
obtaining orders, coordinating fabric choices and procurement, monitoring
production and delivering finished products. The team seeks to identify
prevailing fashion trends that meet its customer's retail strategies and design
garments incorporating those trends. The team also works with the buyers of its
customer to revise designs as necessary to better
4
reflect the style and image that the customer desires to project to consumers.
During the production process, the team is responsible for informing the
customer about the progress of the order, including any difficulties that might
affect the timetable for delivery. In this way, our customer and we can make
appropriate arrangements regarding any delay or other change in the order. We
believe that this team approach enables our employees to develop an
understanding of the customer's distinctive styles and production requirements
in order to respond effectively to the customer's needs.
From time to time and at scheduled seasonal meetings, we present
samples to the customer's buyers who determine which, if any, of the samples
will be produced on a test run or a bulk order. Samples are often presented in
coordinated groupings or as part of a product line. Some customers, particularly
specialty retail stores, may require that a product be tested before placing a
bulk order. Testing involves the production of as few as several hundred copies
of a given sample in different size, fabric and color combinations. The customer
pays for these test items, which are placed in selected stores to gauge consumer
response. The production of test items enables our customers to identify
garments that may appeal to consumers and also provides us with important
information regarding the cost and feasibility of the bulk production of the
tested garment. If the test is determined to be successful, we generally receive
a significant percentage of the customer's total bulk order of the tested item.
In addition, as is typical in the private label business, we receive bulk
production orders to produce merchandise designed by our competitors or other
designers, since most customers allocate bulk orders among a number of
suppliers.
SOURCING
GENERAL
When bidding for or filling an order, our international sourcing
network enables us to choose from among a number of suppliers and manufacturers
based on the customer's price requirements, product specifications and delivery
schedules. Historically, we manufactured our products through independent
cutting, sewing and finishing contractors located primarily in Hong Kong and
China, and have purchased our fabric from independent fabric manufacturers with
weaving mills located primarily in Hong Kong and China. In recent years, we have
expanded our network to include suppliers and manufacturers located in a number
of additional countries, including India, Nepal, Thailand, Egypt and Mexico. Our
sourcing strategy is based on a strong presence in Hong Kong and China, and a
continued presence in Southeast Asia. We also continue to source production in
Mexico and Nicaragua. The following table sets forth the percentage of our
merchandise, on the basis of the free on board cost at the supplier's plant, or
FOB Basis, by country for the periods indicated:
2003 2004 2005
------- -------- -------
INTERNATIONAL SOURCING:
Hong Kong, Macau and China...... 29.7% 46.9% 71.3%
Other (1)....................... 23.3% 33.4% 14.6%
DOMESTIC SOURCING:
United States................... 4.4% 7.1% 9.4%
Mexico and Central America...... 42.6% 12.6% 4.7%
--------------------
(1) In 2005, this category consisted mainly of Mongolia, Egypt,
Thailand, Vietnam, Nepal and India.
DEPENDENCE ON CONTRACT MANUFACTURERS
The use of contract manufacturers and the resulting lack of direct
control over the production of our products could result in our failure to
receive timely delivery of products of acceptable quality.
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Although we believe that alternative sources of cutting, sewing and finishing
services are readily available, the loss of one or more contract manufacturers
could have a materially adverse effect on our results of operations until an
alternative source can be located and commence producing our products.
Although we have adopted a code of vendor conduct and monitor the
compliance of our independent contractors with our code of conduct and
applicable labor laws, we do not control our contractors or their labor
practices. The violation of federal, state or foreign labor laws by one of our
contractors can result in us being subject to fines and our goods, which are
manufactured in violation of such laws, being seized or their sale in interstate
commerce being prohibited. Additionally, certain of our customers may refuse to
do business with us based on our contractors' labor practices. 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 or could have a
material adverse effect upon us, 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 or lose business from our customers
as a result of violations of applicable labor laws by our contractors, or that
such sanctions or loss of business will not have a material adverse effect on
us. In addition, our customers require strict compliance by their apparel
manufacturers, including us, with applicable labor laws. To that end, we are
regularly inspected by some of our major customers. 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.
Except for a commitment to purchase $5 million of fabric annually
manufactured at facilities in Mexico that we previously owned and sold to
affiliates of Mr. Nacif, a shareholder at the time of transaction in 2004, we do
not have any long-term contracts with independent fabric suppliers. The loss of
any of our major fabric suppliers could have a material adverse effect on our
financial condition and results of operations until alternative arrangements are
secured.
DIVERSIFIED PRODUCTION NETWORK
We have a production network that is capable of servicing a wide range
of customer needs. Some customers place a priority on "speed to market," and are
willing to pre-approve several different fabric styles, and pay air freight in
order to quickly get the most current styling into their stores. Other customers
seek lower costs, and are willing to source production from more remote areas
with long lead-times. Although mass merchandisers, such as Wal-Mart, are
beginning to operate on shorter lead times, they are occasionally able to
estimate their needs as much as six months to nine months in advance for
"program" business--basic products that do not change in style significantly
from season to season. Our ability to operate on different production schedules
helps us to meet our customers' varying needs.
By allocating an order among different manufacturers, we seek to fill
the high-volume orders of our customers, while meeting their delivery
requirements. Upon receiving an order, we determine which of our suppliers and
manufacturers can best fill the order and meet the customer's price, quality and
delivery requirements. We consider, among other things, the price charged by
each manufacturer and the manufacturer's available production capacity to
complete the order, as well as the availability of quota, if applicable, for the
product from various countries and the manufacturer's ability to produce goods
on a timely basis subject to the customer's quality specifications. Our
personnel also consider the transportation lead times required to deliver an
order from a given manufacturer to the customer. In addition, some customers
prefer not to carry excess inventory and therefore require that we stagger the
delivery of products over several weeks.
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INTERNATIONAL SOURCING
We conduct and monitor our sourcing operations from our international
offices. At December 31, 2005, we had offices in Hong Kong, Mexico and Thailand.
The staffs at these locations have extensive knowledge about, and experience
with, sourcing and production in their respective regions, including purchasing,
manufacturing and quality control. Several times each year, members of our
senior management, including local staff, visit and inspect the facilities and
operations of our international suppliers and manufacturers.
Foreign manufacturing is subject to a number of risk factors,
including, among other things, transportation delays and interruptions,
political instability, expropriation, currency fluctuations and the imposition
of tariffs, import and export controls, other non-tariff barriers (including
changes in the allocation of quotas), natural disasters and cultural issues.
Each of these factors could have a material adverse effect on us.
While we are in the process of establishing business relationships with
manufacturers and suppliers located in countries other than Hong Kong, Macau or
China, such as in India, Nepal, Vietnam, Thailand and Egypt, we still primarily
contract with manufacturers and suppliers located in Hong Kong and China for our
international sourcing needs, and currently expect that we will continue to do
so for the foreseeable future. Any significant disruption in our operations or
our relationships with our manufacturers and suppliers located in Hong Kong or
China could have a material adverse effect on us.
THE IMPORT SOURCING PROCESS
As is customary in the apparel industry, we do not have any long-term
contracts with our manufacturers. During the manufacturing process, our quality
control personnel visit each factory to inspect garments when the fabric is cut,
as it is being sewn and as the garment is being finished. Daily information on
the status of each order is transmitted from the various manufacturing
facilities to our offices in Hong Kong and Los Angeles. We, in turn, keep our
customers apprised, often through daily telephone calls and frequent written
reports. These calls and reports include candid assessments of the progress of a
customer's order, including a discussion of the difficulties, if any, that have
been encountered and our plans to rectify them.
We often arrange, on behalf of manufacturers, for the purchase of
fabric from a single supplier. We have the fabric shipped directly to the
cutting factory and invoice the factory for the fabric. Generally, the factories
pay us for the fabric with offsets against the price of the finished goods. For
our longstanding program business, we may purchase or produce fabric in advance
of receiving the order, but in accordance with the customer's specifications. By
procuring fabric for an entire order from one source, we believe that production
costs per garment are reduced and customer specifications as to fabric quality
and color can be better controlled.
The anti-terrorist measures adopted by the U.S. government and in
particular, by the U.S. Customs, have meant more stringent inspection processes
before imported goods are cleared for delivery into the U.S. In some instances,
these measures have caused delays in the pre-planned delivery of products to
customers.
DISTRIBUTION
Based on our world wide sourcing capability and in order to properly
fulfill orders, we have tailored our distribution system to meet the needs of
the customer. Some customers, like Wal-Mart and Kohl's, use Electronic Data
Interchange, or "EDI", to send orders and receive merchandise and invoices.
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The EDI distribution function has been centralized in our Los Angeles corporate
headquarters in order to expedite and control the flow of merchandise and
electronic information, and to insure that the special requirements of our EDI
customers are met.
For orders sourced outside the United States and Mexico, the
merchandise is shipped from the production facility by truck to a port where it
is consolidated and loaded on containerized vessels for ocean transport to the
United States. For customers with West Coast and Mid West distribution centers,
the merchandise is brought into the port of Los Angeles. After Customs
clearance, the merchandise is shipped by truck to either our Los Angeles
warehouse facility or an independent bonded warehouse in Ohio. Proximity to the
customer's distribution center is important for customer support. For
merchandise produced in the Middle East and destined for an East Coast customer
distribution center, the port of entry is New York. After Customs clearance, the
merchandise is trucked to an independent public warehouse in New Jersey. The
independent warehouses are instructed in writing by the Los Angeles office when
to ship the merchandise to the customer.
BACKLOG
As of March 22, 2006, we had unfilled customer orders of approximately
$74 million as compared to approximately $73 million as of March 22, 2005. We
believe that all of our backlog of orders as of March 22, 2006 will be filled
before the end of the third quarter of fiscal 2006. Backlog is based on our
estimates derived from internal management reports. The amount of unfilled
orders at a particular time is affected by a number of factors, including the
scheduling of manufacturing and shipping of the product, which in some
instances, depends on the customer's requirements. Accordingly, a comparison of
unfilled orders from period to period is not necessarily meaningful and may not
be indicative of eventual annual bookings or actual shipments. Our experience
has been that the cancellations, rejections or returns of orders have not
materially reduced the amount of sales realized from our backlog.
SEGMENT INFORMATION
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 four geographic
regions: the United States, Asia, Mexico and Luxembourg. 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. For
information regarding the revenues and assets associated with our geographic
regions, see Note 16 of the "Notes to Consolidated Financial Statements."
IMPORT RESTRICTIONS
QUOTAS
We imported approximately 90% of our products sold in 2005.
Approximately 5% of this merchandise was imported from Mexico, which is subject
to special rules under NAFTA. NAFTA allows for the duty and quota free entry
into the United States of certain qualifying merchandise.
A majority of the merchandise imported by us in 2005 was manufactured
in various countries (e.g., China) with which the U.S. had entered into
bilateral trade agreements.
As of January 1, 2005, quota on apparel from all WTO countries,
including China (except that certain commodities still require quotas as a
result of "safeguard measures"), was eliminated. As China is
8
now a member of the WTO, its exports of textiles and apparel to the U.S. are
covered by the WTO Agreement on Textiles and Clothing.
DUTIES AND TARIFFS
As with all goods imported into the U.S., our imported merchandise is
subject to duty (unless statutorily exempt from duty) at rates established by
U.S. law. These rates range, depending on the type of product, from
approximately 2% to 35% of the FOB value of the product. In addition to duties,
in the ordinary course of our business, we are occasionally subject to claims by
the U.S. Bureau of Customs and Border Protection for penalties, liquidated
damages and other charges relating to import activities. Similarly, we are at
times entitled to refunds from Customs, resulting from the overpayment of
duties.
Products imported from China into the United States receive the same
preferential tariff treatment accorded goods from other countries granted Normal
Trade Relations ("NTR") status. This status has been in place conditionally for
a number of years and is now guaranteed on a more permanent basis by China's
accession to WTO membership in December 2001.
Our continued ability to source products from foreign countries may be
adversely affected or improved by future trade agreements and restrictions,
changes in U.S. trade policy, embargoes, the disruption of trade from exporting
countries as a result of political instability or the imposition of additional
duties, taxes and other charges or restrictions on all imports or specified
classes of imports.
COMPETITION
There is intense competition in the sectors of the apparel industry in
which we participate. We compete with many other manufacturers, many of which
are larger and have greater resources than us. We also face competition from our
own customers and potential customers, many of which have established, or may
establish, their own internal product development and sourcing capabilities. We
believe that we compete favorably on the basis of design and sample
capabilities, the quality and value of our products, price, and the production
flexibility that we enjoy as a result of our sourcing network.
TRADEMARKS
As part of our private brands strategy, we acquire ownership of or
rights to a brand name and sell apparel products under this brand. We have
ownership rights to the registered trademarks "American Rag Cie," "Gear7" and
"NO! Jeans." In addition, we have acquired license rights to design, market and
distribute certain apparel products under the Cynthia Rowley, Alain Weiz and
Jessica Simpson brands.
SEASONALITY
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.
EMPLOYEES
At December 31, 2005, we had approximately 183 full-time employees in
the United States, 14 in Mexico, 138 in Hong Kong, 3 in China and 8 in Thailand.
None of our employees are unionized. We consider our relations with our
employees to be satisfactory in all areas of our operations.
9
ITEM 1A. RISK FACTORS
This Annual Report on Form 10-K 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.
Four customers accounted for approximately 49% of our net sales in
fiscal year 2005. 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. 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, 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.
10
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.
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
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.
11
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. Such disruption
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
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 initiated 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
12
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 DEPENDENCE ON THIRD PARTIES FOR BRANDED APPAREL PRODUCTS REDUCES OUR ABILITY
TO CONTROL THE MARKETING PROCESS, WHICH COULD HARM OUR SALES, REPUTATION AND
OVERALL PROFITABILITY.
For certain branded apparel lines, in particular celebrity brands, we
depend on the cooperation and efforts of the celebrity personality and/or master
licensor to support our design and marketing efforts for apparel products. A
celebrity's failure to adequately support our marketing efforts could adversely
affect the sales for new products and lines. In addition, we are subject to the
terms of our agreements with the master licensor for licensed brands, and our
rights to exploit certain brands may therefore be limited. Further, we may, from
time to time, become involved in disputes with the master licensor with respect
to our contractual relationship. To the extent we are not able to receive
adequate support from the master licensor and/or celebrity or maintain good
working relationships with master licensors, our business would be harmed.
OUR BUSINESS IS SUBJECT TO RISKS OF OPERATING IN A FOREIGN COUNTRY AND TRADE
RESTRICTIONS.
Approximately 90% of our products were imported from outside the U.S.
in fiscal 2005. 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.
13
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
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 proposed adjustments to
increase our federal income tax payable for the years ended December 31, 1996
through 2001. This adjustment would also result in additional state taxes,
penalties and interest. In addition, in July 2004, the IRS initiated an
examination of our Federal income tax return for the year ended December 31,
2002. In March 2005, the IRS proposed an adjustment to our taxable income of
approximately $6 million related to similar issues identified in their audit of
the 1996 through 2001 federal income tax returns. We believe that we have
meritorious defenses to and intend to vigorously contest the proposed
adjustments made to our federal income tax returns for the years ended 1996
through 2002. 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
included in the Consolidated Financial Statements. The maximum amount of loss in
excess of the amount accrued in the financial statements is $7.7 million. If the
amount of any actual liability, however, exceeds our reserves, we would
experience an immediate adverse earnings impact in the amount of such additional
liability, which could be material. Additionally, we anticipate that the
ultimate resolution of these matters will require that we make significant cash
payments to the taxing authorities. Presently we do not have sufficient cash or
borrowing ability to make any future payments that may be required. No assurance
can be given that we will have sufficient surplus cash from operations to make
the required payments. Additionally, any cash used for these purposes will not
be available for other corporate purposes, which could have a material adverse
effect on our financial condition and results of operations.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR
SHAREHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS.
As of March 31, 2006, our executive officers and directors and their
affiliates owned approximately 43% of the outstanding shares of our common
stock. Gerard Guez, our Chairman, and Todd Kay, our Vice Chairman, alone own
approximately 33.1% and 8.4%, respectively, of the outstanding shares of our
common stock at March 31, 2006. Accordingly, our executive officers and
14
directors have the ability to affect the outcome of, or exert considerable
influence over, all 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 National Market System, 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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
15
ITEM 2. PROPERTIES
At March 31, 2006, we conducted our operations from 9 facilities, 7 of
which were leased. Our leased facilities included:
Annual
Location Purpose Rental Amount Expiration
----------------------------- -------------------- --------------- -------------
Los Angeles, CA Executive offices $656,000 Monthly
(Washington Blvd.)
New York, NY Showroom $150,000 August 2007
New York, NY Showroom $535,000 June 2015
Ruleville, MS (2 facilities) Office and warehouse Own
Hong Kong Office and warehouse $420,000 December 2006
Hong Kong Warehouse $17,000 July 2007
Bangkok Office $6,000 March 2007
Tehuacan, Mexico Storage $5,000 Monthly
We lease our executive offices in Los Angeles, California from GET, a
corporation which is owned by Gerard Guez and Todd Kay, our Chairman and Vice
Chairman, respectively. Additionally, we lease our warehouse and office space in
Hong Kong from Lynx International Limited, a Hong Kong corporation that is owned
by Messrs. Guez and Kay. Our Los Angeles offices and warehouse is leased on a
month to month basis. On January 1, 2006, we entered into a one year lease
agreement with Lynx International Limited for our office space in Hong Kong.
We own two facilities in Ruleville, Mississippi with an aggregate of
70,000 square feet.
We extended our lease for the facility in Bangkok through March 2007.
We extended the lease for our Hong Kong warehouse facility through July 2007.
We entered into a new lease agreement in June 2005 in New York as our
showroom through June 2015. This is currently the location used for the private
brands sales, design and technical departments, which functions were moved from
our Los Angeles executive office.
We believe that all of our existing facilities are well maintained, in
good operating condition and adequate to meet our current and foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of our shareholders during
the fourth quarter of 2005.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY
NASDAQ NATIONAL MARKET
Our common stock has been quoted on The NASDAQ Stock Market's National
Market System under the symbol "TAGS" since 1995.
The following table sets forth, for the periods indicated, the range of
high and low sale prices for our common stock as reported by NASDAQ.
Low High
--------- --------
2004
First Quarter...................................... 1.68 3.73
Second Quarter..................................... 1.45 2.53
Third Quarter...................................... 0.79 1.57
Fourth Quarter..................................... 0.78 2.44
2005
First Quarter...................................... 1.50 2.62
Second Quarter..................................... 1.35 3.88
Third Quarter...................................... 2.76 4.12
Fourth Quarter..................................... 1.02 3.15
On March 24, 2006, the last reported sale price of our common stock as
reported by NASDAQ was $1.27. As of March 24, 2006, we had 26 shareholders of
record.
DIVIDEND POLICY
We have not declared dividends on our common stock during either of the
last two fiscal years. We intend to retain any future earnings for use in our
business and, therefore, do not anticipate declaring or paying any cash
dividends in the foreseeable future. The declaration and payment of any cash
dividends in the future will depend upon our earnings, financial condition,
capital needs and other factors deemed relevant by the Board of Directors. In
addition, our credit agreements prohibit the payment of dividends during the
term of the agreements.
17
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is qualified in its entirety by,
and should be read in conjunction with, the other information and financial
statements, including the notes thereto, appearing elsewhere herein.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2001 2002 2003 2004 2005
--------- --------- --------- --------- ---------
(In thousands, except per share data)
INCOME STATEMENT DATA:
Net sales ..................... $ 330,253 $ 347,391 $ 320,423 $ 155,453 $ 214,648
Cost of sales ................. 277,525 302,082 288,445 134,492 169,767
--------- --------- --------- --------- ---------
Gross profit ............... 52,728 45,309 31,978 20,961 44,881
Selling and distribution
expenses ................... 14,345 10,757 11,329 9,291 10,726
General and administrative
expenses ................... 33,136 30,082 31,767 32,084 26,865
Royalty expense ............... 500 656 242 605 3,665
Amortization of
Intangibles (2) ............ 3,317 -- -- -- --
Impairment charges (3) ........ -- -- 22,277 77,982 --
Cumulative translation loss (4) -- -- -- 22,786 --
--------- --------- --------- --------- ---------
Income (loss) from operations . $ 1,430 3,814 (33,637) (121,787) 3,625
Interest expense .............. (7,808) (5,444) (5,603) (2,857) (4,625)
Interest income ............... 3,256 4,748 425 377 2,081
Minority interest ............. (412) (4,581) 3,461 15,331 (75)
Interest in income of equity
method investee ............ -- -- -- 770 560
Other income (1) .............. 1,853 2,648 4,784 6,366 354
Other expense (1) ............. (356) (1,348) (1,183) (529) --
--------- --------- --------- --------- ---------
Income (loss) before provision
for income taxes and
cumulative effect of
accounting change .......... (2,037) (163) (31,753) (102,329) 1,920
Provision for income taxes .... (852) (1,051) (4,132) (2,348) (927)
--------- --------- --------- --------- ---------
Income (loss) before cumulative
effect of accounting change $ (2,889) $ (1,214) $ (35,885) $(104,677) $ 993
Cumulative effect of
accounting change (2) ...... -- (4,871) -- -- --
--------- --------- --------- --------- ---------
Net income (loss) ............. $ (2,889) $ (6,085) $ (35,885) $(104,677) $ 993
Dividend to preferred
stockholders ............... -- -- (7,494) -- --
--------- --------- --------- --------- ---------
Net income (loss) available to
common stockholders (as
restated) .................. $ (2,889) $ (6,085) $ (43,379) $(104,677) $ 993
========= ========= ========= ========= =========
Net income (loss) per share -
Basic:
Before cumulative effect of
accounting change (as
restated) .................. $ (0.18) $ (0.08) $ (2.38) $ (3.64) $ 0.03
Cumulative effect of
accounting change ........ -- (0.30) -- -- --
After cumulative effect of
accounting change (as
restated) ................ $ (0.18) $ (0.38) $ (2.38) $ (3.64) $ 0.03
Net income (loss) per share -
Diluted:
Before cumulative effect of
accounting change (as
restated) ................ $ (0.18) $ (0.08) $ (2.38) $ (3.64) $ 0.03
18
Cumulative effect of
accounting change ........ -- (0.30) -- -- --
After cumulative effect of
accounting change (as
restated) ................ $ (0.18) $ (0.38) $ (2.38) $ (3.64) $ 0.03
Weighted average shares
outstanding (000)
Basic ...................... 15,825 15,834 18,215 28,733 29,729
Diluted .................... 15,825 15,834 18,215 28,733 29,734
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2001 2002 2003 2004 2005
--------- --------- --------- --------- ---------
(In thousands)
BALANCE SHEET DATA:
Working capital ............ $ 25,109 $ 11,731 $ (18,018) $ (12,295) $ (11,004)
Total assets ............... 288,467 316,444 253,105 131,811 151,242
Bank borrowings, convertible
debenture and long-term
obligations ............. 111,336 106,937 68,587 48,455 56,148
Shareholders' equity ....... 125,164 121,161 107,709 30,678 35,360
----------
(1) Major components of other income (expense) (as presented above) include
rental and lease income, and foreign currency gains or losses. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results
of Operations."
(2) 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 annual assessment of
impairment applied on a fair-value-based test. We adopted SFAS No. 142 in
fiscal 2002 and performed our first annual assessment of impairment, which
resulted in an impairment loss of $4.9 million.
(3) The expense in 2004 was the impairment of long-lived assets of our Mexico
operations due to our decision to sell the manufacturing operations in
Mexico. The expense in 2003 was the impairment of our goodwill and
intangible assets and write-off of prepaid expenses due to our decision to
cease directly operating a substantial majority of our equipment and fixed
assets in Mexico commencing in the third quarter of 2003. See Note 5 and
Note 7 of the "Notes to Consolidated Financial Statements."
(4) Cumulative translation loss attributable to liquidated Mexico operations
in 2004 was due to our decision to cease our Mexico operations.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following 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-K. This
discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity and cash flows of Tarrant
Apparel Group for the fiscal years ended December 31, 2003, 2004 and 2005.
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
"Cautionary Statement Regarding Forward-Looking Statements" and "Item 1A. Risk
Factors."
OVERVIEW
Tarrant Apparel Group is a design and sourcing provider of private
label and private brand casual apparel serving mass merchandisers, department
stores, branded wholesalers and specialty chains located primarily in the United
States. Our private brands include American Rag Cie, No! Jeans, Alain Weiz, Gear
7, Souvenir by Cynthia Rowley and brands associated with Jessica Simpson, which
include "JS by Jessica Simpson", "Princy by Jessica Simpson" and "Sweet Kisses
by Jessica Simpson.
We generate revenues from the sale of apparel merchandise to our
customers that we have manufactured by third party contract manufacturers
located outside of the United States. Revenues and net income (loss) for the
years ended December 31, 2003, 2004 and 2005 were as follows (dollars in
thousands):
REVENUES AND NET LOSS: 2003 2004 2005
--------- --------- ---------
Net sales .................... $ 320,423 $ 155,453 $ 214,648
Net income (loss) ............ $ (35,885) $(104,677) $ 993
Cash flows for the years ended December 31, 2003, 2004 and 2005 were as
follows (dollars in thousands):
CASH FLOWS: 2003 2004 2005
-------- -------- --------
Net cash provided by (used in)
operating activities .............. $ 9,935 $ 12,168 $(12,900)
Net cash provided by (used in)
investing activities .............. $ (1,504) $ 1,250 $ 3,555
Net cash provided by (used in)
financing activities .............. $ (6,295) $(15,552) $ 9,772
SIGNIFICANT DEVELOPMENTS IN 2005
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 2005 were
$159.6 million compared to $133.8 million in 2004.
The success of our private brands collections has created new
opportunities within the private
20
label business to add value in the development and marketing of new initiatives
for Sears, Mothers Work, Avenue, Chico's, and other retailers. These initiatives
were launched during 2005, and are on track to be significant growth areas for
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 2005 were $55.0 million compared to $21.7
million in 2004. At December 31, 2005, 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 for six
years, pursuant to which we exclusively distribute our
American Rag Cie brand through Macy's Merchandising Group's
national Department Store organization of more than 500
stores. Net sales of American Rag Cie branded apparel totaled
$21.8 million in 2005.
o ALAIN WEIZ: We continue to sell Alan Weiz apparel exclusively
to Dillard's Department Stores. Net sales of Alain Weiz
branded apparel totaled $5.3 million in 2005.
o SOUVENIR BY CYNTHIA ROWLEY: We are in discussions with
retailers to identify a potential distribution alliance for
the 2006 fall or holiday season for Souvenir by Cynthia
Rowley.
o GEAR 7: During the fourth quarter of 2005, K-Mart discontinued
sales of Gear 7 products, which resulted in a decline in sales
for this brand in the fourth quarter of 2005. Net sales of
Gear 7 branded apparel totaled $14.4 million in 2005. We do
not anticipate sales of Gear 7 branded apparel in 2006.
o JESSICA SIMPSON brands: The JS by Jessica Simpson brand was
originally launched as a denim line with Charming Shoppes.
However, Charming Shoppes informed us that they would not go
forward with the line, resulting in reduced sales for this
brand in the fourth quarter of 2005. Net sales of JS by
Jessica Simpson and Princy by Jessica Simpson, which is the
department store and better specialty store brand, totaled
$12.6 million in 2005. In March 2006, we became involved in a
dispute with the licensor of the Jessica Simpson brands over
our continued rights to these brands. Accordingly, we do not
anticipate sales of Jessica Simpson branded apparel after the
first quarter of 2006 unless and until we successfully resolve
our dispute with the licensor.
o HOUSE OF DEREON BY TINA KNOWLES: We began shipping products
for the House of Dereon by Tina Knowles brand in the fourth
quarter of 2005, resulting in net sales of $309,000 in 2005.
In March 2006, we terminated our license agreement for this
brand, and sold our remaining inventory to the licensor. Prior
to December 31, 2005, we had written off the capitalized
balance of $1.2 million related to the agreement and
recognized a loss accordingly in 2005. The loss was classified
as royalty expense on our consolidated statements of
operations.
INTERNAL REVENUE SERVICE AUDIT
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. This adjustment would also result in
21
additional state taxes and interest. In addition, in July 2004, the IRS
initiated an examination of our Federal income tax return for the year ended
December 31, 2002. In March 2005, the IRS proposed an adjustment to our taxable
income of approximately $6 million related to similar issues identified in their
audit of the 1996 through 2001 federal income tax returns. The proposed
adjustments to our 2002 federal income tax return would not result in additional
tax due for that year due to the tax loss reported in the 2002 federal return.
However, it could reduce the amount of net operating losses available to offset
taxes due from the preceding tax years. We believe that we have meritorious
defenses to and intend to vigorously contest the proposed adjustments made to
our federal income tax returns for the years ended 1996 through 2002. 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 included in the Consolidated
Financial Statements under the caption "Income Taxes". The maximum amount of
loss in excess of the amount accrued in the financial statements is $7.7
million. 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.
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 returns, discounts, bad debts,
inventories, intangible assets, income taxes, and 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.
Management believes 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."
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
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
22
experience. If 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 December 31, 2005, the balance in the allowance for returns,
discounts and bad debts reserves was $3.0 million, compared to $2.4 million at
December 31, 2004.
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 annual assessment of impairment
applied on a fair-value-based test.
We utilized the discounted cash flow methodology to estimate fair
value. At December 31, 2005, we have a goodwill balance of $8.6 million, and a
net property and equipment balance of $1.7 million, as compared to a goodwill
balance of $8.6 million and a net property and equipment balance of $1.9 million
at December 31, 2004. Our net property and equipment balance at December 31,
2004 reflects the disposal of our Mexico fixed assets of $123.3 million in the
fourth quarter of 2004. During the year ended December 31, 2005, we did not
recognize any impairment related to goodwill and property and equipment.
We assess the carrying value of long-lived assets in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
In 2004, we evaluated the long-lived assets in Mexico for recoverability and
concluded that the book value of the asset group was significantly higher than
the expected future cash flows and that impairment had occurred. Accordingly, we
recognized a non-cash impairment loss of approximately $78 million in the second
quarter of 2004. The impairment charge was the difference between the carrying
value and fair value of the impaired assets. Our determination of fair value was
determined based on independent appraisals of the property and equipment
obtained in June 2004.
23
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of our Mexico and Hong Kong subsidiaries are
translated at the rate of exchange in effect on the balance sheet date; income
and expenses are translated at the average rates of exchange prevailing during
the respective periods. The functional currency in which we transact business in
Hong Kong is the Hong Kong dollar and in Mexico is the peso.
Foreign currency gains and losses resulting from translation of assets
and liabilities are included in other comprehensive income (loss). Transaction
gains or losses, other than inter-company debt deemed to be of a long-term
nature, are included in net income (loss) in the period in which they occur.
REVENUE RECOGNITION
Revenue is recognized at the point of shipment for all merchandise sold
based on FOB shipping point. For merchandise shipped on landed duty paid ("LDP")
terms, revenue is recognized at the point of either leaving Customs for direct
shipments or at the point of leaving our warehouse where title is transferred,
net of an estimate of returned merchandise and discounts. Customers are allowed
the rights of return or non-acceptance only upon receipt of damaged products or
goods with quality different from shipment samples. We do not undertake any
after-sale warranty or any form of price protection.
We often arrange, on behalf of manufacturers, for the purchase of
fabric from a single supplier. We have the fabric shipped directly to the
cutting factory and invoice the factory for the fabric. Generally, the factories
pay us for the fabric with offsets against the price of the finished goods.
INCOME TAXES
As part of the process of preparing our consolidated financial
statements, management is 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 sheets. Management records a valuation allowance to reduce
its deferred tax assets to the amount that is more likely than not to be
realized. Management has 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. See Note 10 of the "Notes to Consolidated
Financial Statements" for a discussion of current tax matters.
DEBT COVENANTS
Our debt agreements require certain covenants including a minimum level
of net worth as discussed in Note 8 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
24
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 an advance
waiver or reclassify the relevant 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, including 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.
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 1 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 income as a percentage of net sales:
YEARS ENDED DECEMBER 31,
2003 2004 2005
-------- -------- --------
Net sales ..................................... 100.0% 100.0% 100.0%
Cost of sales ................................. 90.0 86.5 79.1
-------- -------- --------
Gross profit .................................. 10.0 13.5 20.9
Selling and distribution expenses ............. 3.5 6.0 5.0
General and administration expenses ........... 9.9 20.6 12.5
Royalty Expenses .............................. 0.1 0.4 1.7
Impairment charges ............................ 7.0 50.2 --
Cumulative translation loss ................... -- 14.7 --
-------- -------- --------
Income (loss) from operations ................. (10.5) (78.4) 1.7
Interest expense .............................. (1.7) (1.8) (2.2)
Interest income ............................... 0.1 0.2 1.0
Minority interest ............................. 1.0 9.9 0.0
Interest in income of equity method investee .. 0.0 0.5 0.3
Other income .................................. 1.5 4.1 0.1
Other expense ................................. (0.3) (0.3) (0.0)
-------- -------- --------
Income (loss) before provision for income taxes (9.9) (65.8) 0.9
Provision for income taxes .................... (1.3) (1.5) (0.4)
-------- -------- --------
Net Income (loss) ............................. (11.2)% (67.3)% 0.5%
======== ======== ========
COMPARISON OF 2005 TO 2004
Net sales increased by $59.2 million, or 38.1%, from $155.5 million in
2004 to $214.6 million in 2005. The increase in net sales was primarily due to
increased sales of private brands, which was $55.0
25
million in 2005 compared to $21.7 million in 2004. Gear 7, JS by Jessica Simpson
and Princy by Jessica Simpson recorded significant sales contributions in 2005,
as compared to sales of $1.2 million for these brands in 2004. We expect sales
of these brands to decline significantly in 2006 due to the discontinuance of
the Gear 7 line by K-Mart, the dispute over our continued rights to the Jessica
Simpson line and the discontinuation of House of Dereon. Private label sales in
2005 were $159.6 million compared to $133.8 million in 2004, with the increase
resulting primarily from increased sales in 2005 to Wal-Mart, Chico's, Mothers
Work and Macy's Merchandising Group.
Gross profit consists of net sales less product costs, direct labor,
manufacturing overhead, duty, quota, freight in, and brokerage. Gross profit for
2005 was $44.9 million, or 20.9% of net sales, compared to $21.0 million, or
13.5 % of net sales, for 2004, representing an increase of $23.9 million or
114.1%. The increase in gross profit for 2005 occurred primarily because of an
increase in sales volume and gross margin. The improvement in gross margin is
primarily attributable to the change of relative product mix in favor of the
higher margin private brands business as compared to private label as well as
improved margins in the private label business due to expansion of our business
to include more knitwear and woven tops at better margins using private brand
product developments.
Selling and distribution expenses increased by $1.4 million, or 15.5%,
from $9.3 million in 2004 to $10.7 million in 2005. As a percentage of net
sales, these variable expenses decreased from 6.0% in 2004 to 5.0% in 2005 due
to the significant increase in sales volume during 2005.
General and administrative expenses decreased by $5.2 million, or
16.3%, from $32.1 million in 2004 to $26.9 million in 2005. The decrease was
primarily due to the depreciation and amortization of our Mexico assets of $6.8
million and $1.1 million of severance paid to the Mexican workers in 2004 as
compared to no such expense in 2005 after disposition of our fixed assets in
Mexico in late 2004. As a percentage of net sales, these expenses decreased from
20.6% in 2004 to 12.5% in 2005.
Royalty and marketing allowance expenses increased by $3.1 million, or
505.8%, to $3.7 million in 2005 from $605,000 in 2004. The increase was
primarily due to increased sales under the licensed Alain Weiz and Jessica
Simpson brands and a write-off of the remaining balance of $1.2 million of
prepaid royalty on House of Dereon in 2005 as a result of termination of our
agreement to design, market and sell House of Dereon by Tina Knowles branded
apparel in March 2006. See Note 11 of the "Notes to Consolidated Financial
Statements." As a percentage of net sales, these expenses increased to 1.7% in
2005 from 0.4% in 2004.
Impairment charges were $78.0 million in 2004 or (50.2)% of net sales,
compared to no such expense in 2005. The expense in 2004 was the impairment of
long-lived assets of our Mexico operations due to our decision to sell the
manufacturing operations in Mexico. See Note 5 and Note 7 of the "Notes to
Consolidated Financial Statements."
Cumulative translation loss attributable to liquidated Mexico
operations was $22.8 million in 2004, or (14.7)% of net sales, compared to no
such expense in 2005. We incurred this charge upon the sale of our fixed assets
in Mexico in the fourth quarter of 2004.
Income from operations was $3.6 million in 2005, or 1.7% of net sales,
compared to loss from operation of $121.8 million in 2004, or (78.4)% of net
sales, due to the factors described above.
Interest expense increased by $1.7 million, or 61.9%, from $2.9 million
in 2004 to $4.6 million in 2005. As a percentage of net sales, this expense
increased to 2.2% in 2005 from 1.8% in 2004. The increase was primarily due to
an interest expense of $1.3 million in 2005 related to interest payments to
holders of convertible debentures and amortization of debt discount arising from
issuing convertible
26
debentures, compared to no such expense in 2004. Interest income increased by
$1.7 million, or 451.3% from $378,000 in 2004 to $2.1 million in 2005. The
increase was primarily due to the interest earned from the notes receivable
related to the sale of our fixed assets in Mexico of $1.9 million in 2005,
compared to no such income in 2004. Other income decreased by $6.0 million, or
94.4%, from $6.4 million in 2004 to $354,000 in 2005, due primarily to $5.5
million of lease income received for the lease of our facilities and equipment
in Mexico in 2004, compared to no such income in 2005 due to the sale of our
Mexico operations in the fourth quarter of 2004. Other expenses were $529,000 in
2004 compared to $1,000 in 2005.
In 2005, we allocated $75,000 of profit to minority interest, which
consisted of profit shared with the minority partner in the PBG7, LLC. Loss
allocated to minority interests in 2004 was $15.3 million, representing $471,000
attributed to the minority shareholder in United Apparel Ventures, LLC, for its
49.9% share in the loss and $14.8 million attributed to the minority shareholder
in Tarrant Mexico for its 25% share in the loss.
Income before provision for income taxes was $1.9 million in 2005 and
loss before provision for income taxes was $102.3 million in 2004, representing
0.9% and (65.8)% of net sales, respectively. The increase in income before
provision for income taxes was due to the factors discussed above.
Provision for income taxes was $927,000 in 2005 compared to $2.3
million in 2004, representing (0.4)% and (1.5)% of net sales, respectively.
Net income was $1.0 million in 2005 as compared to net loss of $104.7
million in 2004, representing 0.5% and (67.3)% of net sales, respectively.
Included in the $104.7 million loss in 2004 were charges of $78.0 million for
the impairment of long-lived assets and $22.8 million of cumulative translation
loss attributable to liquidated Mexico operations. There were no such charges in
2005.
COMPARISON OF 2004 TO 2003
Net sales decreased by $165.0 million, or 51.5%, from $320.4 million in
2003 to $155.5 million in 2004. The decrease in net sales was largely
attributable to a decrease in Mexican sourced sales from $139.1 million in 2003
to $19.5 million in 2004. Several of our larger customers for Mexico produced
jeans wear refused to place orders with us following the restructuring of our
Mexico operations and resulting labor unrest in Mexico, which resulted in a
decline in revenue of approximately $75 million from sales of Mexico-produced
merchandise during 2004 as compared to 2003. Additionally, in 2004 we
experienced a decline in sales to certain customers of Mexico-sourced
merchandise that was unrelated to the labor unrest. In 2004, we also experienced
a reduction of sales of fabric to Mexican manufacturers of approximately $17
million. We also experienced a reduction of sales from our import operations in
the Far East of approximately $40 million, due in part to several of our larger
customers reducing their back-to-school and holiday order placements.
Gross profit for 2004 was $21.0 million, or 13.5% of net sales,
compared to $32.0 million, or 10.0 % of net sales, for 2003, representing a
decrease of $11.0 million or 34.5%. The decrease in gross profit for 2004 was
primarily due to the substantial decrease in sales volume. The lower gross
profit, especially in the fourth quarter, was primarily due to unplanned air
freight costs and higher quota costs in some categories coupled with additional
inventory markdowns. The increase in gross profit as a percentage of net sales
for 2004 when compared to 2003 was primarily because of an inventory write-down
of $11 million and severance payments to Mexican workers of approximately $2.5
million included in cost of goods sold in 2003. Excluding the inventory
write-down and severance payments in 2003, gross profit as a percentage of net
sales for 2003 was 14.2% compared to 13.5% for 2004.
27
Selling and distribution expenses decreased by $2.0 million, or 18%,
from $11.3 million in 2003 to $9.3 million in 2004. As a percentage of net
sales, these variable expenses increased from 3.5% in 2003 to 6.0% in 2004 due
to the significant decline in sales during 2004.
General and administrative expenses increased by $317,000, or 1.0%,
from $31.8 million in 2003 to $32.1 million in 2004. As a percentage of net
sales, these expenses increased from 9.9% in 2003 to 20.6% in 2004 due to
significant decline in sales during 2004. This increase was partly caused by the
reclassification of $3.2 million of depreciation of our Mexican facilities from
cost of goods sold in the fourth quarter of 2003, compared to $6.8 million of
depreciation and $1.1 million of severance payments to Mexican workers in 2004.
Royalty and marketing allowance expenses increased by $363,000, or
149.5%, to $605,000 in 2004 from $242,000 in 2003. As a percentage of net sales,
these expenses increased to 0.4% in 2004 from 0.1% in 2003.
Impairment charges were $78.0 million in 2004 or (50.2)% of net sales,
compared to $22.3 million in 2003 or (7.0)% of net sales. The expense in 2004
was the impairment of long-lived assets of our Mexico operations due to our
decision to sell the manufacturing operations in Mexico. The expense in 2003
included $19.5 million of the impairment of our goodwill and intangible assets
and $2.8 million of write-off of prepaid expenses due to our decision to cease
directly operating a substantial majority of our equipment and fixed assets in
Mexico commencing in the third quarter of 2003. See Note 5 and Note 7 of the
"Notes to Consolidated Financial Statements."
Cumulative translation loss attributable to liquidated Mexico
operations was $22.8 million in 2004, or (14.7)% of net sales, compared to no
such expense in 2003. As discussed above, we incurred this charge upon the sale
of our fixed assets in Mexico in the fourth quarter of 2004.
Loss from operations was $121.8 million in 2004, or (78.4)% of net
sales, compared to $33.6 million in 2003, or (10.5)% of net sales, due to the
factors described above.
Interest expense decreased by $2.7 million, or 49.0%, from $5.6 million
in 2003 to $2.9 million in 2004. This decrease in interest expense was a result
of a decrease of the amount we financed under our main credit facility in 2004.
Interest income was $378,000 in 2004 compared to $425,000 in 2003. Other income
increased by $1.6 million, or 33.1%, from $4.8 million in 2003 to $6.4 million
in 2004, due to $3.7 million of lease income received for our facilities and
equipment in Mexico in 2003, compared to $5.5 million in 2004. Other expenses
decreased from $1.2 million in 2003 to $529,000 in 2004.
Loss allocated to minority interests in 2004 was $15.3 million,
representing $471,000 attributed to the minority shareholder in United Apparel
Ventures, LLC, for its 49.9% share in the loss and $14.8 million attributed to
the minority shareholder in Tarrant Mexico for its 25% share in the loss. Loss
allocated to minority interests in 2003 was $3.5 million, representing the
minority partner's share of profit in UAV of $3.5 million, offset by $7.0
million attributed to the minority shareholder in Tarrant Mexico for its 25%
share in the loss including $4.4 million for its share in the special write-down
on goodwill and inventory of Tarrant Mexico.
Loss before provision for income taxes was $102.3 million in 2004 and
$31.8 million in 2003, representing (65.8)% and (9.9)% of net sales,
respectively. The increase in loss before provision for income taxes was due to
the factors discussed above.
Provision for income taxes was $2.3 million in 2004 versus $4.1 million
in 2003, representing (1.5)% and (1.3)% of net sales, respectively.
28
Loss after taxes and cumulative effect of accounting change was $104.7
million in 2004 and $35.9 million in 2003, representing (67.3)% and (11.2)% of
net sales, respectively. Included in the $104.7 million loss in 2004 were
charges of $78.0 million for the impairment of long-lived assets and $22.8
million of cumulative translation loss attributable to liquidated Mexico
operations. Included in the $35.9 million loss in 2003 were non-cash charges of
$22.3 million for the impairment of assets and an inventory write-down of $11
million.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in our consolidated statements of income in millions of dollars and as a
percentage of net sales:
QUARTER ENDED
MAR. 31 JUN. 30 SEP. 30 DEC. 31 MAR. 31 JUN. 30 SEP. 30 DEC. 31
2004 2004 2004 2004 2005 2005 2005 2005
------ ------ ------ ------ ------ ------ ------ ------
Net Sales ....... $ 42.2 $ 38.5 $ 38.1 $ 36.7 $ 44.8 $ 50.5 $ 69.6 $ 49.7
Gross profit .... 7.5 5.3 4.1 4.1 8.9 11.5 14.5 10.0
Operating income
(loss) ......... (6.0) (84.6) (3.6) (27.6) 0.2 1.5 3.0 (1.1)
Net income (loss) (3.0) (68.6) (4.0) (29.1) (0.1) 0.9 1.7 (1.5)
QUARTER ENDED
MAR. 31 JUN. 30 SEP. 30 DEC. 31 MAR. 31 JUN. 30 SEP. 30 DEC. 31
2004 2004 2004 2004 2005 2005 2005 2005
------ ------ ------ ------ ------ ------ ------ ------
Net sales ....... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit .... 17.8 13.7 10.9 11.1 20.0 22.7 20.9 20.0
Operating income
(loss) ......... (14.1) (219.8) (9.5) (75.2) 0.5 2.8 4.3 (2.1)
Net income (loss) (7.1) (178.1) (10.5) (79.3) (0.2) 1.7 2.5 (3.0)
As is typical for us, quarterly net sales fluctuated significantly
because our customers typically place bulk orders with us, and a change in the
number of orders shipped in any one period may have a material effect on the net
sales for that period.
29
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.
The disposition of our Mexico operations in 2004 enabled us to return
to the business model that was profitable prior to implementation of our
vertically integrated manufacturing operations that required major capital
expenditures and substantial working capital. The lease and subsequent sale of
our Mexican facilities significantly reduced our working capital requirements
due to fewer employees and the elimination of fixed overhead. Investment in
inventory also was substantially reduced as we no longer need to purchase raw
materials, such as cotton, at commencement of the manufacturing process and
carry the costs of such materials until finished goods are shipped to our
customers. Reduced working capital and capital expenditures in Mexico has
resulted in a corresponding reduction of outstanding indebtedness and interest
payments. Furthermore, we no longer need to accept orders with low or negative
margins to fill production capacity in slow seasons, which should improve
margins and allow us to source production in the best locations worldwide.
Certain of our private brands product lines are generally associated
with higher selling, general and administrative expenses, due to significant
design, development, and marketing costs compared to our private label business.
30
Cash flows for the years ended December 31, 2003, 2004 and 2005 were as
follows (dollars in thousands):
CASH FLOWS: 2003 2004 2005
-------- -------- --------
Net cash provided by (used in)
operating activities .............. $ 9,935 $ 12,168 $(12,900)
Net cash provided by (used in)
investing activities .............. $ (1,504) $ 1,250 $ 3,555
Net cash provided by (used in)
financing activities .............. $ (6,295) $(15,552) $ 9,772
Net cash used in operating activities was $12.9 million in 2005, as
compared to net cash provided by operating activities in 2004 of $12.2 million
and $9.9 million in 2003. Net cash used in operating activities in 2005 resulted
primarily from a net income of $1.0 million, reduced by increases of $16.8
million in accounts receivable and $8.5 million in inventory, partially offset
by depreciation and amortization of $2.1 million and an increase of $9.2 million
in accounts payable. The increase in accounts receivable, inventory and accounts
payable in 2005 was primarily due to increase in sales volume.
During 2005, net cash provided by investing activities was $3.6
million, as compared to net cash provided by investing activities of $1.3
million in 2004 and net cash used in investing activities of $1.5 million in
2003. Cash provided by investing activities in 2005 included approximately $2.5
million of collection of advances from our Chairman and $1.2 million of
collection on notes receivable.
During 2005, net cash provided by financing activities was $9.8 million
as compared to net cash used in financing activities of $15.6 million in 2004
and $6.3 million in 2003. Net cash provided by financing activities in 2005
included $13.9 million net proceeds from our credit facilities and offset by
$4.1 million net repayment of our short-term bank borrowings.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Following is a summary of our contractual obligations and commercial
commitments available to us as of December 31, 2005 (in millions):
PAYMENTS DUE BY PERIOD
---------------------------------------------------------
CONTRACTUAL OBLIGATIONS Total Less than Between Between After
1 year 2-3 years 4-5 years 5 years
---------------------------------- ---------- ------------ ---------- --------- ------------
Long-term debt(1)................. $ 36.3 $ 36.1 $ 0.2 $ -- $ --
Convertible debentures, net....... $ 6.9 $ -- $ 6.9 $ -- $ --
Operating leases.................. $ 6.8 $ 1.2 $ 1.3 $ 1.2 $ 3.1
Minimum royalties................. $ 17.2 $ 4.9 $ 5.5 $ 2.2 $ 4.6
Purchase commitment............... $ 45.4 $ 5.4 $ 10.0 $ 10.0 $ 20.0
---------- ------------ ---------- --------- ------------
Total Contractual Cash Obligations $112.6 $ 47.6 $ 23.9 $ 13.4 $ 27.7
----------
(1) Excludes interest on long-term debt obligations. Based on outstanding
borrowings as of December 31, 2005, and assuming all such indebtedness
remained outstanding during 2006 and the interest rates remained
unchanged, we estimate that our interest cost on long-term debt would be
approximately $3.4 million.
31
AMOUNT OF COMMITMENT
EXPIRATION PER PERIOD
TOTAL AMOUNTS -----------------------------------------
OTHER COMMERCIAL COMMITTED Less than Between Between After
COMMITMENTS AVAILABLE TO US TO US 1 year 2-3 years 4-5 years 5 years
------------------------------------------ ------------- ---------- --------- --------- ----------
Lines of credit........................... $61.9 $61.9 -- -- --
Letters of credit (within lines of credit) $16.9 $16.9 -- -- --
Total Commercial Commitments.............. $61.9 $61.9 -- -- --
On June 13, 2002, we entered into a letter of credit facility of $25
million with UPS Capital Global Trade Finance Corporation ("UPS"). Under this
facility, we may arrange for the issuance of letters of credit and acceptances.
The facility is collateralized by the shares and debentures of all of our
subsidiaries in Hong Kong. In addition to the guarantees provided by Tarrant
Apparel Group and our subsidiaries, Fashion Resource (TCL) Inc. and Tarrant
Luxembourg Sarl, Gerard Guez, our Chairman, also signed a guarantee of $5
million in favor of UPS to secure this facility. This facility bore interest at
10.25% per annum at December 31, 2005. Under this facility, we were subject to
certain restrictive covenants, including that we maintain a specified tangible
net worth, fixed charge ratio, and leverage ratio. On June 27, 2005, we amended
the letter of credit facility with UPS to extend the expiration date of the
facility from June 30, 2005 to August 31, 2005 and to reduce the tangible net
worth requirement at June 30, 2005. On August 31, 2005, we amended the letter of
credit facility with UPS to further extend the expiration date of the facility
to October 31, 2005, immediately reduce the maximum amount of borrowings to
$14.5 million on September 1, 2005 and further reduced the maximum amount of
borrowing to $14.0 million on October 1, 2005. On October 31, 2005, we further
amended the letter of credit facility with UPS to extend the expiration date of
the facility to January 31, 2006 and amend the interest rate to "prime rate"
plus 3%. The facility amendment also provided for reduction in the maximum
amount of borrowings to $13.5 million commencing on November 1, 2005, to $13.0
million commencing on December 1, 2005, and to $12.5 million commencing on
January 1, 2006. Additionally, Gerard Guez, our Chairman, pledged to UPS 4.6
million shares of our common stock held by Mr. Guez to secure the obligations
under the credit facility. On January 27, 2006, we further amended the letter of
credit facility with UPS to extend the expiration date of the facility from
January 31, 2006 to July 31, 2006. The amendment provides for reduction of the
maximum amount of borrowings under the facility to $12.0 million commencing on
April 1, 2006, $11.5 million commencing on May 1, 2006, $11.0 million commencing
on June 1, 2006 and to $10.5 million commencing on July 1, 2006. Under the
amended letter of credit facility, we are subject to restrictive financial
covenants of maintaining tangible net worth of $25 million as of December 31,
2005 and the last day of each fiscal quarter thereafter. There is also a
provision capping maximum capital expenditures per quarter of $800,000. As of
December 31, 2005, we were in compliance with the covenants. As of December 31,
2005, $9.2 million was outstanding under this facility with UPS and an
additional $2.5 million was available for future borrowings. In addition, $1.3
million of open letters of credit was outstanding as of December 31, 2005.
On December 31, 2004, our Hong Kong subsidiaries entered into a new
loan agreement with UPS pursuant to which UPS made a $5 million term loan, the
proceeds of which were used to repay $5 million of indebtedness owed to UPS
under the letter of credit of facility. The principal amount of this loan is due
and payable in 24 equal monthly installments of approximately $208,333 each,
plus interest equivalent to the "prime rate" plus 2% commencing on February 1,
2005. This facility bore interest at 9.25% per annum at December 31, 2005. On
June 27, 2005, we amended the loan agreement with UPS to reduce the tangible net
worth requirement at June 30, 2005. Under the amended loan agreement, we are
subject to restrictive financial covenants of maintaining tangible net worth of
$25 million at December 31, 2005 and the last day of each fiscal quarter
thereafter. There is also a provision capping maximum capital expenditure per
quarter at $800,000. As of December 31, 2005, we were in compliance with the
32
covenants. As of December 31, 2005, $2.7 million was outstanding. The
obligations under the loan agreement are collateralized by the same security
interests and guarantees provided under our letter of credit facility with UPS.
Additionally, the term loan is secured by two promissory notes payable to
Tarrant Luxembourg Sarl in the amounts of $2,550,000 and $1,360,000 and a pledge
by Gerard Guez, our Chairman, of 4.6 million shares of our common stock.
Since March 2003, DBS Bank (Hong Kong) Limited (formerly known as Dao
Heng Bank) has made available a letter of credit facility of up to HKD 20
million (equivalent to US $2.6 million) to our subsidiaries in Hong Kong. This
is a demand facility and is secured by the pledge of our office property, which
is owned by Gerard Guez, our Chairman 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. As of December 31, 2005, $2.9
million was outstanding under this facility. In addition, $1.1 million of open
letters of credit was outstanding and $0 was available for future borrowings as
of December 31, 2005. In October 2005, a tax loan for HKD 6.233 million
(equivalent to US $804,000) was also made available to our Hong Kong
subsidiaries. As of December 31, 2005, $675,000 was outstanding under this tax
loan.
On October 1, 2004, we amended and restated our previously existing
debt facility with GMAC Commercial Credit, LLC ("GMAC") by entering into a new
factoring agreement with GMAC. 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. Pursuant to the terms of the factoring agreement, we and our
subsidiaries agree to assign and sell to GMAC, 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, in its discretion, may make advances to us
up to the lesser of (a) up to 90% of our accounts on which GMAC has the risk of
loss and (b) $40 million, minus in each case, any amount owed by us to GMAC.
Pursuant to the terms of the PBG7 factoring agreement, PBG7 agreed to assign and
sell to GMAC, as factor, all accounts, which arise from PBG7's sale of
merchandise or rendition of services created on a going-forward basis. At PBG7's
request, GMAC, in its discretion, may make advances to PBG7 up to the lesser of
(a) up to 90% of PBG7's accounts on which GMAC has the risk of loss, and (b) $5
million minus in each case, any amounts owed to GMAC by PBG7. The facility bears
interest at 7.385% per annum and the facility under PBG7, LLC bears interest at
7.75% per annum at December 31, 2005. Restrictive covenants under the revised
facility include a limit on quarterly capital expenses of $800,000 and tangible
net worth of $25 million at December 31, 2005 and at the end of each fiscal
quarter thereafter. As of December 31, 2005, we were in compliance with the
covenants. A total of $30.6 million was outstanding with respect to receivables
factored under the GMAC facility at December 31, 2005.
In May 2005, we amended our factoring agreement with GMAC to permit
our subsidiaries party thereto and us, to borrow up to the lesser of $3 million
or fifty percent (50%) of the value of eligible inventory. In connection with
this amendment, we granted GMAC a lien on certain of our inventory located in
the United States. On January 23, 2006, we further amended our factoring
agreement with GMAC to increase the amount we may borrow against inventory to
the lesser of $5 million or 50% of the value of eligible inventory. The $5
million limit will be reduced to $4 million on April 1, 2006 and will be further
reduced to $3 million on July 1, 2006. The maximum borrowing availability under
the factoring agreement, based on the borrowing base formula remains at $40
million. A total of $3.0 million was outstanding under the GMAC facility at
December 31, 2005 with respect to collateralized inventory.
The credit facility with GMAC and the credit facility with UPS carry
cross-default clauses. A breach of a financial covenant set by GMAC or UPS
constitutes an event of default under the other
33
credit facility, entitling both financial institutions to demand payment in full
of all outstanding amounts under their respective debt and credit facilities.
The amount we can borrow under the factoring facility with GMAC 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 December 14, 2004, we completed a $10 million financing through the
issuance of 6% Secured Convertible Debentures ("Debentures") and warrants to
purchase up to 1,250,000 shares of our common stock. Prior to maturity, the
investors may convert the Debentures into shares of our common stock at a price
of $2.00 per share. The warrants have a term of five years and an exercise price
of $2.50 per share. The Debentures bear interest at a rate of 6% per annum and
have a term of three years. We may elect to pay interest on the Debentures in
shares of our common stock if certain conditions are met, including a minimum
market price and trading volume for our common stock. The Debentures contain
customary events of default and permit the holders thereof to accelerate the
maturity if the full principal amount together with interest and other amounts
owing upon the occurrence of such events of default. The Debentures are secured
by a subordinated lien on certain of our accounts receivable and related assets.
The placement agent in the financing, received compensation for its services in
the amount of $620,000 in cash and issuance of five year warrants to purchase up
to 200,000 shares of our common stock at an exercise price of $2.50 per share.
In June 2005, holders of our Debentures converted an aggregate of $2.3
million of Debentures into 1,133,687 shares of our common stock. In August 2005,
holders of our Debentures converted an aggregate of $820,000 of Debentures into
410,000 shares of our common stock. The Debentures were converted at the option
of the holders at a price of $2.00 per share. Debt discount of $248,000 related
to the intrinsic value of the conversion option of $804,000 was expensed upon
the conversion. Of the $620,000 financing cost paid to the placement agent,
$191,000 was expensed upon the conversion. The intrinsic value of the conversion
option, and the value of the warrant amortized in 2005 was $474,000. Total
deferred financing cost amortized in 2005 was $189,000. Total interest paid to
the holders of the Debentures in 2005 was $539,000. As of December 31, 2005,
$6.0 million, net of $0.9 million of debt discount, remained outstanding under
the Debentures.
On February 14, 2005, we borrowed $5 million from Max Azria, which
amount bore interest at the rate of 4% per annum and was payable in weekly
installments of $250,000 beginning on February 28, 2005. In early August 2005,
we repaid the remaining balance of this loan in its entirety. On January 19,
2006, we borrowed an additional $4 million from Max Azria, which amount bears
interest at the rate of 5.5% per annum and is payable in weekly installments of
$200,000 beginning on March 1, 2006. This is an unsecured loan.
We had three equipment loans outstanding at December 31, 2005 totaling
$83,000. One of these equipment loans bears interest at 6% payable in
installments through 2009, the second loan bears interest at 15.8% payable in
installments through 2007, and the third loan bears interest at 6.15% payable in
installments through 2007.
During 2000, we financed equipment purchases for a manufacturing
facility with certain vendors. A total of $16.9 million was financed with
five-year promissory notes, which bear interest ranging from
34
7.0% to 7.5%, and were payable in semiannual payments commencing in February
2000. All remaining balances under these notes were paid off in February 2005. A
portion of the debt was denominated in Euros. Unrealized transaction (loss) gain
associated with the debt denominated in Euros totaled $(561,000), $367,000 and
$0 for the years ended December 31, 2003, 2004 and 2005, respectively. These
amounts were recorded in other income (expense) in the accompanying consolidated
statements of operations.
From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates who issues these letters of credit out
of Israeli Discount Bank. As of December 31, 2005, $1.0 million was outstanding
under this facility and $7.1 million of letters of credit were open under this
arrangement. We pay a commission of 2.25% on all letters of credits issued under
this arrangement.
The effective interest rates on short-term bank borrowing as of
December 31, 2004 and 2005 were 5.7% and 7.8%, respectively.
We have financed our operations from our cash flow from operations,
borrowings under our bank and other credit facilities, issuance of long-term
debt (including debt to or arranged by vendors of equipment purchased for our
Mexican twill and production facility), 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.
The Internal Revenue Service has proposed adjustments to our Federal
income tax returns to increase our income tax payable for the years ended
December 31, 1996 through 2001. This adjustment would also result in additional
state taxes and interest. In addition, in July 2004, the IRS initiated an
examination of our Federal income tax return for the year ended December 31,
2002. In March 2005, the IRS proposed an adjustment to our taxable income of
approximately $6 million related to similar issues identified in their audit of
the 1996 through 2001 federal income tax returns. We believe that we have
meritorious defenses to and intend to vigorously contest the proposed
adjustments made to our federal income tax returns for the years ended 1996
through 2002. We believe that we have meritorious defenses to and intend to
vigorously contest the proposed adjustments. If the proposed adjustments are
upheld through the administrative and legal process, they could have a material
impact on our earnings and, in particular, cash flow. We may not have an
adequate cash reserve to pay the final adjustments resulting from the IRS
examination. As a result, we may be required to arrange for payments over time
or raise additional capital in order to meet these obligations. We believe we
have provided adequate reserves for any reasonably foreseeable outcome related
to these matters on the consolidated balance sheets included in the consolidated
financial statements under the caption "Income Taxes." The maximum amount of
loss in excess of the amount accrued in the financial statements is $7.7
million. 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. To date, there is no plan for any
major capital expenditure.
35
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.
RELATED PARTY TRANSACTIONS
We lease our principal offices and warehouse located in Los Angeles,
California from GET and office space in Hong Kong from Lynx International
Limited. GET and Lynx International Limited are each owned by Gerard Guez, our
Chairman of the Board of Directors, and Todd Kay, our Vice Chairman of the Board
of Directors. We believe, at the time the leases were entered into, the rents on
these properties were comparable to then prevailing market rents. Our Los
Angeles offices and warehouse is leased on a month to month basis. On January 1,
2006, we entered into a one year lease agreement with Lynx International Limited
for our office space in Hong Kong. We paid $1,330,000 in each of 2003 and 2004,
and $1,019,000 in 2005 in rent for office and warehouse facilities at these
locations.
In February 2004, our Hong Kong subsidiary entered into a 50/50 joint
venture with Auto Enterprises Limited, an unrelated third party, to source
products for Seven Licensing Company, LLC and our private brands subsidiary in
mainland China. On May 31, 2004, after realizing an accumulated loss from the
venture of approximately $200,000 (our share being half), we sold our interest
for $1 to Asia Trading Limited, a company owned by Jacqueline Rose, wife of
Gerard Guez. The venture owed us $221,000 as of December 31, 2004. This amount
was repaid in the first quarter of 2005.
On October 16, 2003, we leased to affiliates of Mr. Kamel Nacif, a
shareholder at the time of the transaction, for a substantial portion of our
manufacturing facilities and operations in Mexico including real estate and
equipment. We leased our twill mill in Tlaxcala, Mexico, and our sewing plant in
Ajalpan, Mexico, for a period of 6 years and for an annual rental fee of $11
million. In connection with this lease transaction, we also entered into a
management services agreement pursuant to which Mr. Nacif's affiliates agreed to
manage the operation of our remaining facilities in Mexico in exchange for the
use of such facilities. The term of the management services agreement was also
for a period of 6 years. In 2004, $5.5 million of lease income was recorded in
other income. We agreed to purchase annually, six million yards of fabric
manufactured at the facilities leased and/or operated by Mr. Nacif's affiliates
at market prices to be negotiated. We purchased $3.6 million and $5.3 million of
fabric under this agreement in 2003 and 2004, respectively.
In August 2004, we entered into a purchase and sale agreement to sell
to Mr. Nacif's affiliates, substantially all of our assets and real property in
Mexico, including the equipment and facilities we previously leased to Mr.
Nacif's affiliates. Upon completion of this transaction in the fourth quarter of
2004, we entered into a purchase commitment agreement with Mr. Nacif's
affiliates to replace our previous purchase commitment agreement. Pursuant the
purchase commitment agreement we agreed to purchase $5 million of fabric
manufactured at the facilities we sold to Mr. Nacif's affiliates annually over
the ten-year term of the agreement, at negotiated market prices. See Note 5 of
the "Notes to Consolidated Financial Statements". In 2005, we purchased $6.4
million of fabric, of which $2.4 million was paid in cash and $4.0 million was
offset against the notes receivable principal and accrued interest on the note
receivable from the affiliates of Mr. Kamel Nacif. Net amount due from Mr. Kamel
Nacif and his affiliates was $236,000 as of December 31, 2005.
From time to time in the past, we borrowed funds from, and advanced
funds to, Mr. Guez. The greatest outstanding balance of such advances to Mr.
Guez during 2005 was approximately $4,766,000. At December 31, 2005, the entire
balance due from Mr. Guez totaling $2.3 million was reflected as a reduction of
shareholders' equity. All advances to, and borrowings from, Mr. Guez bore
interest at the rate of 7.75% during the period. Total interest paid by Mr. Guez
was $374,000, $370,000 and $209,000 for the years ended December 31, 2003, 2004
and 2005, respectively. Mr. Guez paid expenses on our
36
behalf of approximately $400,000 and $397,000 for the years ended December 31,
2004 and 2005, 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 officers or directors
of Tarrant.
On July 1, 2001, we formed an entity to jointly market, share certain
risks and achieve economies of scale with Azteca Production International, Inc.
("Azteca"), called United Apparel Ventures, LLC ("UAV"). Azteca is owned by the
brothers of Gerard Guez, our Chairman. This entity was created to coordinate the
production of apparel for a single customer of our branded business. UAV is
owned 50.1% by Tag Mex, Inc., our wholly owned subsidiary, and 49.9% by Azteca.
Results of the operation of UAV have been consolidated into our results since
July 2001 with the minority partner's share of all gains and loses eliminated
through the minority interest line in our financial statements. Due to the
restructuring of our Mexico operations, we discontinued manufacturing for UAV
customers in the second quarter of 2004. Two and one half percent of gross sales
as management fees were paid in 2003 and 2004 to each of the members of UAV, per
the operating agreement. We purchased $37.1 million, $11.5 million and $135,000
of finished goods and service from Azteca and its affiliates for the years ended
December 31, 2003, 2004 and 2005, respectively. Our total sales of fabric and
service to Azteca in 2003, 2004 and 2005 were $9.9 million, $1.0 million and
$88,000, respectively.
Since June 2003, UAV had been selling to Seven Licensing Company, LLC
("Seven Licensing"), jeans wear bearing the brand "Seven7", which is ultimately
purchased by Express. Seven Licensing is beneficially owned by Gerard Guez. In
the third quarter of 2004, in order to strengthen our own private brand
business, we decided to discontinue sourcing for Seven7. Total sales to Seven
Licensing in the year ended December 31, 2003, 2004 and 2005 were $8.1 million,
$2.6 million and $0, respectively.
At December 31, 2005, Messrs. Guez and Kay beneficially owned 590,000
and 1,003,500 shares, respectively, of common stock of Tag-It Pacific, Inc.
("Tag-It"), collectively representing 8.7% of Tag-It Pacific's common stock at
December 31, 2005. Tag-It is a provider of brand identity programs to
manufacturers and retailers of apparel and accessories. Tag-It assumed the
responsibility for managing and sourcing all trim and packaging used in
connection with products manufactured by or on our behalf in Mexico. We believe
that the terms of this arrangement, which is subject to the acceptance of our
customers, are no less favorable to us than could be obtained from unaffiliated
third parties. Due to the restructuring of our Mexico operations, Tag-It no
longer manages our trim and packaging requirements. We purchased $16.8 million,
$1.0 million and $450,000 of trim from Tag-It during the years ended December
31, 2003, 2004 and 2005. We sold to Tag-It $1.5 million from our trim and fabric
inventory for the year ended December 31, 2003. In the past, we guaranteed the
indebtedness of Tag-It for the purchase of trim on our behalf. See Note 8 of the
"Notes to Consolidated Financial Statements."
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.
37
ITEM 7A. 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 Mexico as well as certain debt denominated in Euro. As a result, we
bear the risk of exchange rate gains and losses that may result in the future as
a result of this financing. 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 and fixed asset purchase obligations. 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 (primarily prime rates), we are
sensitive to changes in prevailing interest rates. Any major increase or
decrease in market interest 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 15. Exhibits, Financial Statement Schedules and Reports on
Form 8K" for our financial statements, and the notes thereto, and the financial
statement schedules filed as part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH THE ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
Members of the company's management, including our 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
Rules 13a-15 or 15d-15, as of December 31, 2005, the end of the period covered
by this report. Members of the Company's management, including our 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 further quarter of 2005 that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective.
CHANGES IN CONTROLS AND PROCEDURES
There were no significant changes in our internal controls or in other
factors that could significantly affect internal controls, known to the Chief
Executive Officer or the Chief Financial Officer, during the fourth quarter of
2005.
38
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information concerning our directors and executive officers will
appear in our definitive Proxy Statement to be filed pursuant to Regulation 14A
within 120 days after the end of our last fiscal year (the "Proxy Statement"),
and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning executive compensation will appear in our
definitive Proxy Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information concerning the security ownership of certain beneficial
owners and management and related stockholder matters will appear in our
definitive Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning certain relationships and related
transactions will appear in our definitive Proxy Statement and is incorporated
herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information concerning principal accountant fees and services will
appear in our definitive Proxy Statement and is incorporated herein by
reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Schedule. Reference is made to the
Index to Financial Statements and Schedule on page F-1 for a list of financial
statements and the financial statement schedule filed as part of this report.
All other schedules are omitted because they are not applicable or the required
information is shown in the Company's financial statements or the related notes
thereto.
(b) Exhibits. See the Exhibit Index attached to this Form 10-K
annual report.
39
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
PAGE
----
Financial Statements
Report of Independent Registered Public Accounting Firm,
Singer Lewak Greenbaum & Goldstein LLP................................F-2
Report of Independent Registered Public Accounting Firm,
Grant Thornton LLP....................................................F-3
Consolidated Balance Sheets--December 31, 2004 and 2005..................F-4
Consolidated Statements of Operations and Comprehensive
Loss--Three year period ended December 31, 2005.......................F-5
Consolidated Statements of Shareholders' Equity--Three
year period ended December 31, 2005...................................F-6
Consolidated Statements of Cash Flows--Three year period
ended December 31, 2005...............................................F-7
Notes to Consolidated Financial Statements...............................F-8
Financial Statement Schedule
Schedule II--Valuation and Qualifying Accounts..........................F-40
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Tarrant Apparel Group
Los Angeles, California
We have audited the consolidated balance sheet of Tarrant Apparel Group and
subsidiaries (collectively, the "Company") as of December 31, 2005, and the
related consolidated statement of operations, stockholders' equity and cash
flows for the year then ended. Our audit also included the financial statement
schedule of Tarrant Apparel Group, listed in Item 15(a). These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provided a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tarrant Apparel
Group and subsidiaries as of December 31, 2005, and the results of their
operations and their cash flows for the year then ended, in conformity with U.S.
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements, taken as a whole, presents fairly in all
material respects the information set forth therein.
/S/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
------------------------------------------
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
March 15, 2006
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Tarrant Apparel Group
We have audited the accompanying consolidated balance sheets of Tarrant Apparel
Group (a California corporation) and subsidiaries as of December 31, 2004, and
the related consolidated statements of operations and comprehensive loss,
shareholders' equity, and cash flows for each of the two years in the period
ended December 31, 2004. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tarrant Apparel
Group and subsidiaries as of December 31, 2004 and the results of its operations
and its cash flows for each of the two years in the period ended December 31,
2004 in conformity with accounting principles generally accepted in the United
States of America.
We have also audited Schedule II of Tarrant Apparel Group for each of the two
years in the period ended December 31, 2004. In our opinion, this schedule
presents fairly, in all material respects, the information required to be set
forth therein.
/S/ GRANT THORNTON LLP
-------------------------
GRANT THORNTON LLP
Los Angeles, California
March 24, 2005, except for Note 19,
as to which the date is March 30, 2005,
and Note 13, as to which the date is May 31, 2005
F-3
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
2004 2005
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents .............................. $ 1,214,944 $ 1,641,768
Accounts receivable, net ............................... 37,759,343 54,598,443
Due from related parties ............................... 10,651,914 3,100,928
Inventory .............................................. 19,144,105 31,628,960
Current portion of note receivable from related party .. 5,323,733 5,139,387
Prepaid expenses ....................................... 1,251,684 1,292,441
Prepaid royalties ...................................... 2,257,985 1,123,531
Income taxes receivable ................................ 144,796 25,468
------------- -------------
Total current assets ................................. 77,748,504 98,550,926
Property and equipment, net ............................ 1,874,893 1,702,840
Notes receivable - related party, net of current portion 40,107,337 36,268,446
Due from related parties ............................... -- 2,994,945
Equity method investment ............................... 1,880,281 2,138,865
Deferred financing cost, net ........................... 1,203,259 838,786
Other assets ........................................... 414,161 164,564
Goodwill, net .......................................... 8,582,845 8,582,845
------------- -------------
Total assets ......................................... $ 131,811,280 $ 151,242,217
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings ............................. $ 17,951,157 $ 13,833,532
Accounts payable ....................................... 24,394,553 33,278,959
Accrued expenses ....................................... 11,243,179 9,503,806
Income taxes ........................................... 16,826,383 16,828,538
Current portion of long-term obligations and factoring
arrangement ......................................... 19,628,701 36,109,699
------------- -------------
Total current liabilities ............................ 90,043,973 109,554,534
Long-term obligations .................................... 2,544,546 239,935
Convertible debentures, net .............................. 8,330,483 5,965,098
Deferred tax liabilities ................................. 213,784 47,098
Minority interest in PBG7 ................................ -- 75,241
Commitments and contingencies
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized;
no shares (2004) and no shares (2005) issued and
outstanding ........................................... -- --
Common stock, no par value, 100,000,000 shares authorized;
28,814,763 shares (2004) and 30,553,763 shares (2005)
issued and outstanding ................................ 111,515,091 114,977,465
Warrant to purchase common stock ......................... 2,846,833 2,846,833
Contributed capital ...................................... 9,965,591 10,004,331
Accumulated deficit ...................................... (91,182,959) (90,189,615)
Notes receivable from officer/shareholder ................ (2,466,062) (2,278,703)
------------- -------------
Total shareholders' equity ........................... 30,678,494 35,360,311
------------- -------------
Total liabilities and shareholders' equity ........... $ 131,811,280 $ 151,242,217
============= =============
See accompanying notes.
F-4
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
YEAR ENDED DECEMBER 31,
2003 2004 2005
------------- ------------- -------------
Net sales ....................................... $ 320,422,850 $ 155,452,663 $ 214,648,218
Cost of sales ................................... 288,445,173 134,492,460 169,767,051
------------- ------------- -------------
Gross profit .................................... 31,977,677 20,960,203 44,881,167
Selling and distribution expenses ............... 11,329,414 9,290,819 10,726,425
General and administrative expenses ............. 31,767,122 32,083,637 26,864,789
Write-off of prepaid expenses ................... 2,771,989 -- --
Royalty expense ................................. 242,426 604,888 3,664,454
Impairment charges .............................. 19,504,521 77,982,034 --
Cumulative translation loss attributable to
liquidated Mexico operations ................. -- 22,786,125 --
------------- ------------- -------------
Income (loss) from operations ................... (33,637,795) (121,787,300) 3,625,499
Interest expense ................................ (5,602,556) (2,857,096) (4,624,590)
Interest income ................................. 424,518 377,587 2,081,456
Minority interest ............................... 3,461,243 15,331,171 (75,241)
Interest in income of equity method investee .... -- 769,706 559,634
Other income .................................... 4,784,479 6,366,637 354,347
Other expense ................................... (1,182,920) (529,257) (580)
------------- ------------- -------------
Income (loss) before provision for income taxes . (31,753,031) (102,328,552) 1,920,525
Provision for income taxes ...................... 4,131,629 2,348,119 927,181
------------- ------------- -------------
Net income (loss) ............................... $ (35,884,660) $(104,676,671) $ 993,344
============= ============= =============
Net income (loss) per share - Basic (as restated,
see Note 13): ................................. $ (2.38) $ (3.64) $ 0.03
============= ============= =============
Net income (loss) per share - Diluted (as
restated, see Note 13) ........................ $ (2.38) $ (3.64) $ 0.03
============= ============= =============
Weighted average common and common equivalent
shares outstanding:
Basic ........................................... 18,215,071 28,732,796 29,728,997
============= ============= =============
Diluted ......................................... 18,215,071 28,732,796 29,734,291
============= ============= =============
Net income (loss) ............................... $ (35,884,660) $(104,676,671) $ 993,344
Foreign currency translation adjustment ......... (9,945,727) -- --
------------- ------------- -------------
Total comprehensive income (loss) ............... $ (45,830,387) $(104,676,671) $ 993,344
============= ============= =============
See accompanying notes.
F-5
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005
PREFERRED NUMBER COMMON NUMBER
STOCK OF SHARES STOCK OF SHARES WARRANTS
------------- ------------- ------------- ------------- -------------
Balance at January 1, 2003 ................... $ 8,820,573 100,000 $ 69,368,239 15,846,315 $ --
Net loss .................................. -- -- -- -- --
Currency translation ...................... -- -- -- -- --
Comprehensive loss ........................ -- -- -- -- --
Conversion of preferred stock to
common stock ........................... (8,820,573) (100,000) 8,820,573 3,000,000 --
Issuance of preferred stock and
warrant, net ........................... 29,226,041 881,732 -- -- 1,798,733
Conversion of preferred stock to
common stock ........................... (29,226,041) (881,732) 29,226,041 8,817,320 --
Intrinsic value of beneficial conversion
associated with convertible preferred
stock .................................. -- -- -- -- --
Issuance of common stock .................. -- -- 788,000 200,000 --
Retirement of stock ....................... -- -- (311,427) (248,872) --
Compensation expense ...................... -- -- -- -- --
Repayment from shareholders ............... -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2003 (as restated,
see Note 13) ................................. -- -- 107,891,426 27,614,763 1,798,733
Currency translation ...................... -- -- -- -- --
Net loss .................................. -- -- -- -- --
Cumulative translation loss attributable to
liquidated Mexico operations ........... -- -- -- -- --
Compensation expense ...................... -- -- -- -- --
Issuance of common stock .................. -- -- 3,623,665 1,200,000 44,100
Issuance of warrants with debentures ...... -- -- -- -- 1,004,000
Intrinsic value of beneficial conversion
associated with convertible debentures . -- -- -- -- --
Repayment from shareholders ............... -- -- -- -- --
Reclassification of shareholders'
receivable to current asset ............ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2004 ................. $ -- -- $ 111,515,091 28,814,763 $ 2,846,833
Net income ................................ -- -- -- -- --
Compensation expense ...................... -- -- -- -- --
Issuance of common stock .................. -- -- 375,000 195,313 --
Conversion of debentures .................. -- -- 3,087,374 1,543,687 --
Repayment from shareholders ............... -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2005 ................. $ -- -- $ 114,977,465 30,553,763 $ 2,846,833
============= ============= ============= ============= =============
RETAINED ACCUMULATED
EARNINGS OTHER TOTAL
CONTRIBUTED (ACCUMULATED COMPREHENSIVE NOTES FROM SHAREHOLDERS'
CAPITAL DEFICIT) INCOME (LOSS) SHAREHOLDERS EQUITY
------------- ------------- ------------- ------------- -------------
Balance at January 1, 2003 ................... 1,434,259 56,873,094 (9,733,458) (5,601,804) 121,160,903
Net loss .................................. -- (35,884,660) -- -- (35,884,660)
Currency translation ...................... -- -- (9,945,727) -- (9,945,727)
-------------
Comprehensive loss ........................ -- -- -- -- (45,830,387)
Conversion of preferred stock to
common stock ........................... -- -- -- -- --
Issuance of preferred stock and
warrant, net ........................... -- -- -- -- 31,024,774
Conversion of preferred stock to
common stock ........................... -- -- -- -- --
Intrinsic value of beneficial conversion
associated with convertible preferred
stock .................................. 7,494,722 (7,494,722) -- -- --
Issuance of common stock .................. -- -- -- -- 788,000
Retirement of stock ....................... -- -- -- -- (311,427)
Compensation expense ...................... 71,572 -- -- -- 71,572
Repayment from shareholders ............... -- -- -- 805,376 805,376
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2003 (as restated,
see Note 13) ................................. 9,000,553 13,493,712 (19,679,185) (4,796,428) 107,708,811
Currency translation ...................... -- -- (3,106,940) -- (3,106,940)
Net loss .................................. -- (104,676,671) -- -- (104,676,671)
Cumulative translation loss attributable to
liquidated Mexico operations ........... -- -- 22,786,125 -- 22,786,125
Compensation expense ...................... 161,038 -- -- -- 161,038
Issuance of common stock .................. -- -- -- -- 3,667,765
Issuance of warrants with debentures ...... -- -- -- -- 1,004,000
Intrinsic value of beneficial conversion
associated with convertible debentures . 804,000 -- -- -- 804,000
Repayment from shareholders ............... -- -- -- 30,366 30,366
Reclassification of shareholders'
receivable to current asset ............ -- -- -- 2,300,000 2,300,000
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2004 ................. $ 9,965,591 $ (91,182,959) $ -- $ (2,466,062) $ 30,678,494
Net income ................................ -- 993,344 -- -- 993,344
Compensation expense ...................... 38,740 -- -- -- 38,740
Issuance of common stock .................. -- -- -- -- 375,000
Conversion of debentures .................. -- -- -- -- 3,087,374
Repayment from shareholders ............... -- -- -- 187,359 187,359
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2005 ................. $ 10,004,331 $ (90,189,615) $ -- $ (2,278,703) $ 35,360,311
============= ============= ============= ============= =============
See accompanying notes
F-6
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2003 2004 2005
------------- ------------- -------------
Operating activities:
Net Income (loss) .................................... $ (35,884,660) $(104,676,671) $ 993,344
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Deferred taxes .................................... (132,622) (61,345) (166,686)
Depreciation and amortization ..................... 16,097,595 8,337,946 2,126,585
Receipt of merchandise in lieu of interest on notes
receivable, related party ...................... -- -- (1,742,540)
Impairment charges ................................ 22,276,510 77,982,034 --
Cumulative transaction loss attributable to the
liquidated Mexico operations ................... -- 22,786,125 --
Inventory write-down .............................. 10,986,153 -- --
Prepaid royalties write-off ....................... -- -- 1,165,970
Income from equity method investment .............. -- (769,706) (559,634)
Loss (gain) on sale of fixed assets ............... 593,626 (15,272) (124,041)
Unrealized (gain) loss on foreign currency ........ 560,602 (367,262) --
Minority interest ................................. (3,218,069) (15,331,171) 75,241
Gain on legal settlement .......................... (235,785) -- --
Compensation expense related to stock options ..... 71,572 161,038 38,740
Change in the provision for returns and discounts . (324,387) (1,747,060) (78,060)
Changes in operating assets and liabilities:
Restricted cash ................................ (2,759,742) 2,759,742 --
Accounts receivable ............................ 7,856,700 21,224,454 (16,761,040)
Due to/from related parties .................... (14,801,324) (122,389) 2,702,047
Inventory ...................................... 9,626,509 4,162,158 (8,503,086)
Prepaid expenses ............................... 590,046 (1,860,955) 47,055
Other assets ................................... 450,782 -- --
Accounts payable ............................... (4,207,552) 687,758 9,248,667
Accrued expenses and income tax payable ........ 2,388,976 (981,196) (1,362,218)
------------- ------------- -------------
Net cash (used in) provided by operating activities 9,934,930 12,168,228 (12,899,656)
Investing activities:
Purchase of fixed assets ............................. (368,113) (111,836) (559,081)
Proceeds from sale of fixed assets ................... 209,788 1,219,904 130,552
Investment in equity investment method ............... (1,434,375) (137,000) --
Distribution from equity investment method ........... -- 460,800 301,050
Collection on notes receivable, related party ........ -- -- 1,194,722
Investment in joint venture .......................... -- (211,963) --
Collection of advances from shareholders/officers .... 88,723 30,366 2,487,360
------------- ------------- -------------
Net cash provided by (used in) investing activities (1,503,977) 1,250,271 3,554,603
Financing activities:
Short-term bank borrowings, net ...................... (161,194) (11,342,166) (4,117,625)
Proceeds from long-term obligations .................. 239,280,109 129,667,084 218,367,495
Payment of financing costs ........................... -- (1,124,668) --
Payment of long-term obligations and bank borrowings . (275,640,677) (146,375,987) (204,477,993)
Repayments of borrowings from shareholders/officers .. (486,379) -- --
Proceeds from issuance of preferred stock and warrant 31,024,774 3,623,665 --
Proceeds from convertible debentures, net ............ -- 10,000,000 --
Repurchase of shares ................................. (311,427) -- --
------------- ------------- -------------
Net cash provided by (used in) financing activities (6,294,794) (15,552,072) 9,771,877
Effect of exchange rate on cash ...................... (204,677) 28,553 --
------------- ------------- -------------
Increase (decrease) in cash and cash equivalents ..... 1,931,482 (2,105,020) 426,824
Cash and cash equivalents at beginning of year ....... 1,388,482 3,319,964 1,214,944
------------- ------------- -------------
Cash and cash equivalents at end of year ............. $ 3,319,964 $ 1,214,944 $ 1,641,768
============= ============= =============
See accompanying notes
F-7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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., Mexico, and Asia. At December 31, 2005, we own
50.1% of United Apparel Ventures ("UAV") and 75% of PBG7, LLC ("PBG7"). 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 is owned by Azteca Production International, a corporation owned
by the brothers of our Chairman, Gerard Guez. The 25% minority interest in PBG7
is owned by BH7, LLC, an unrelated party.
We serve specialty retail, mass merchandise and department store chains and
major international brands by designing, merchandising, contracting for the
manufacture of, and selling casual apparel for women, men and children under
private label. Commencing in 1999, we expanded our operations from sourcing
apparel to sourcing and operating our own vertically integrated manufacturing
facilities. In August 2003, we determined to abandon our strategy of being both
a trading and vertically integrated manufacturing company, and effective
September 1, 2003, we leased and outsourced operation of our manufacturing
facilities in Mexico to affiliates of Mr. Kamel Nacif, a shareholder at the time
of the transaction. See Note 7 and Note 15 of the "Notes to Consolidated
Financial Statements." In August 2004, we entered into a purchase and sale
agreement to sell these facilities to affiliates of Mr. Nacif, which transaction
consummated in the fourth quarter of 2004. See Note 5 of the "Notes to
Consolidated Financial Statements."
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.
RISK AND UNCERTAINTIES - IRS EXAMINATION
As discussed in Note 10 of the "Notes to Consolidated Financial Statements," our
federal income tax returns for the years ended December 31, 1996 through 2002
are under examination by the Internal Revenue Service ("IRS"). The IRS has
proposed adjustments to increase our federal income tax payable for these years.
This adjustment would also result in additional state taxes, penalties and
interest. We believe that we have meritorious defenses to and intend to
vigorously contest the proposed adjustments made to our federal income tax
returns for the years ended 1996 through 2002. If the proposed adjustments are
upheld through the administrative and legal process, they could have a material
impact on our earnings and cash flow. The maximum amount of loss in excess of
the amount accrued in the financial statements is $7.7 million. If the amount of
any actual liability, however, exceeds our reserves, we would experience an
immediate adverse earnings impact in the amount of such additional liability,
which could be material. Additionally, we anticipate that the ultimate
resolution of these matters will require that we make significant cash payments
to the taxing authorities. Presently we do not have sufficient cash or borrowing
ability to make any future payments that may be required. No assurance can be
given that we will have sufficient surplus cash from operations to make the
required payments. Additionally, any cash used for these purposes will not be
available for other corporate purposes, which could have a material adverse
effect on our financial condition and results of operations. See Note 10 of the
"Notes to Consolidated Financial Statements" for a further discussion on the IRS
examination.
F-8
RISK AND UNCERTAINTIES - DEBT COVENANTS
As discussed in Note 8 of the "Notes to Consolidated Financial Statements," our
debt agreements require certain covenants including a minimum level of net
worth. 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
an advance waiver or reclassify the relevant 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, including 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. See Note 8 of the "Notes to Consolidated
Financial Statements" for a further discussion of the credit facilities and
related debt covenants.
REVENUE RECOGNITION
Revenue is recognized at the point of shipment for all merchandise sold based on
FOB shipping point. For merchandise shipped on landed duty paid ("LDP") terms,
revenue is recognized at the point of either leaving Customs for direct
shipments or at the point of leaving our warehouse where title is transferred,
net of an estimate of returned merchandise and discounts. Customers are allowed
the rights of return or non-acceptance only upon receipt of damaged products or
goods with quality different from shipment samples. We do not undertake any
after-sale warranty or any form of price protection.
We often arrange, on behalf of manufacturers, for the purchase of fabric from a
single supplier. We have the fabric shipped directly to the cutting factory and
invoice the factory for the fabric. Generally, the factories pay us for the
fabric with offsets against the price of the finished goods.
SHIPPING AND HANDLING COSTS
Freight charges are included in selling and distribution expenses in the
statement of operations and amounted to $1,817,000, $783,000 and $667,000 for
the years ended December 31, 2003, 2004 and 2005, respectively. We did not bill
customers for shipping and handling costs for the years 2003 and 2004. In 2005,
we did some billing for freight to specialty stores although the amount was not
material.
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH
Cash equivalents consist of cash and highly liquid investments with an original
maturity of three months or less when purchased. Cash and cash equivalents held
in foreign financial institutions totaled $1,206,000 and $1,062,000 as of
December 31, 2004 and 2005, respectively. Cash is deposited with what we believe
are highly credited quality financial institutions and may exceed FDIC insured
limits.
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
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 uncollectible chargebacks based on our historical
collection experience. If 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 to us could be reduced by a material amount. As of December 31, 2004 and
2005, the balance of the allowance for returns, discounts and bad debts was $2.4
million and $3.0 million, respectively.
F-9
INVENTORIES
Inventories are stated (valued) at the lower of cost (first-in, first-out) 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.
COST OF SALES
Cost of sales includes costs related to product costs, direct labor,
manufacturing overhead, duty, quota, freight in, and brokerage.
SELLING AND DISTRIBUTION EXPENSES
Selling and distribution expenses include expenses related to samples, travel
and entertainment, salaries, rent, warehouse handling and other office expenses,
professional fees, freight out, and selling commissions incurred in the sales
process.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include expenses related to research and
product development, travel and entertainment, salaries, rent and other office
expenses, depreciation and amortization, professional fees and bank charges.
ROYALTY EXPENSES
Royalty expenses consist of the royalty payments and marketing fund commitments
according to the various licensing agreements we have entered into. Royalty
expenses are calculated based on a certain percentage of net sales. All of these
agreements include minimum royalties. See Note 11 of the "Notes to Consolidated
Financial Statements" regarding various agreements we have entered into.
PRODUCT DESIGN, ADVERTISING AND SALES PROMOTION COSTS
Product design, advertising and sales promotion costs are expensed as incurred.
Product design, advertising and sales promotion costs included in selling,
general and administrative expenses in the accompanying statements of operations
(excluding the costs of manufacturing production samples) amounted to
approximately $1,306,000, $2,106,000 and $3,009,000 in 2003, 2004 and 2005,
respectively.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Additions and betterments are
capitalized while repair and maintenance costs are charged to operations as
incurred. Depreciation of property and equipment is provided for by the
straight-line method over their estimated useful lives. Leasehold improvements
are amortized using the straight-line method over the lesser of their estimated
useful lives or the term of the lease. Upon retirement or disposal of property
and equipment, the cost and related accumulated depreciation are eliminated from
the accounts and any gain or loss is reflected in the statement of operations.
The estimated useful lives of the assets are as follows:
Buildings 35 to 40 years
Equipment 7 to 15 years
Furniture and Fixtures 5 to 7 years
Vehicles 5 years
Leasehold Improvements Term of lease or Estimated useful life
F-10
IMPAIRMENT OF LONG-LIVED ASSETS
The carrying value of long-lived assets are reviewed when events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If it is determined that an impairment loss has occurred based on
the lowest level of identifiable expected future cash flow, then a loss is
recognized in the statement of operations using a fair value based model.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
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. At
December 31, 2005, we have a goodwill balance of $8.6 million, and a net
property and equipment balance of $1.7 million, as compared to a goodwill
balance of $8.6 million and a net property and equipment balance of $1.9 million
at December 31, 2004. Our net property and equipment balance at December 31,
2004 reflects the disposal of our Mexico fixed assets of $123.3 million in the
fourth quarter of 2004. See Note 5 and Note 7 of the "Notes to Consolidated
Financial Statements."
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.
During the year ended December 31, 2005, we did not recognize any impairment
related to goodwill and property and equipment.
DEFERRED FINANCING COST
Deferred financing costs were $1,203,000 and $839,000 at December 31, 2004 and
2005, respectively. These costs of obtaining financing and issuance of
convertible debt instruments are being amortized on a straight-line basis over
the term of the related debt. Amortization expenses for deferred charges were
$408,000, $387,000 and $1,399,000 for the years ended December 31, 2003, 2004
and 2005, respectively.
INCOME TAXES
We utilize SFAS No. 109, "Accounting for Income Taxes," which prescribes the use
of the liability method to compute the differences between the tax basis of
assets and liabilities and the related financial reporting amounts using
currently enacted tax laws and rates. A valuation allowance is recorded to
reduce deferred taxes to the amount that is more likely than not to be realized.
Our Hong Kong corporate affiliates are taxed at an effective Hong Kong rate of
17.5%. As of December 31, 2005, no domestic tax provision has been provided for
$41.9 million of un-remitted retained earnings of these Hong Kong corporations,
as we intend to maintain these amounts outside of the U.S. on a permanent basis.
F-11
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 loss per share and diluted loss per share is as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2003 2004 2005
------------- ------------- -------------
Basic EPS Computation:
Numerator:
Reported net income (loss) ......................... $ (35,884,660) $(104,676,671) $ 993,344
Dividend to the preferred stockholders ............. (7,494,722) -- --
------------- ------------- -------------
Net income (loss) available to common
stockholders..................................... $ (43,379,382) $(104,676,671) $ 993,344
Denominator:
Weighted average common shares outstanding ......... 18,215,071 28,732,796 29,728,997
Basic EPS .......................................... $ (2.38) $ (3.64) $ 0.03
============= ============= =============
Diluted EPS Computation:
Numerator:
Reported net income (loss) ......................... $ (35,884,660) $(104,676,671) $ 993,344
Dividend to the preferred stockholders ............. (7,494,722) -- --
------------- ------------- -------------
Net income (loss) available to common
stockholders..................................... $ (43,379,382) $(104,676,671) $ 993,344
Denominator:
Weighted average common shares outstanding ......... 18,215,071 28,732,796 29,728,997
Incremental shares from assumed exercise of
warrants ........................................... -- -- --
convertible debentures ............................. -- -- --
options ............................................ -- -- 5,294
------------- ------------- -------------
Total shares ....................................... 18,215,071 28,732,796 29,734,291
Diluted EPS ........................................ $ (2.38) $ (3.64) $ 0.03
============= ============= =============
The following potentially dilutive securities were not included in the
computation of loss per share, because to do so would have been anti-dilutive:
2003 2004 2005
---------- ---------- ----------
Options .............. 8,926,087 8,331,962 6,727,756
Warrants ............. 881,732 2,361,732 2,361,732
Convertible debentures -- 5,000,000 3,456,313
---------- ---------- ----------
Total ............. 9,807,819 15,693,694 12,545,801
DIVIDENDS
We did not declare or pay any cash dividends in 2003, 2004 or 2005. We intend to
retain any future earnings for use in our business and, therefore, do not
anticipate declaring or paying any cash dividends in the foreseeable future. The
declaration
F-12
and payment of any cash dividends in the future will depend upon our earnings,
financial condition, capital needs and other factors deemed relevant by the
Board of Directors. In addition, our credit agreements prohibit the payment of
dividends during the term of the agreements.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Mexico and Hong Kong subsidiaries are translated
at the rate of exchange in effect on the balance sheet date; income and expenses
are translated at the average rates of exchange prevailing during the year. The
functional currencies in which we transact business are the Hong Kong dollar and
the peso in Mexico.
Foreign currency gains and losses resulting from translation of assets and
liabilities are included in other comprehensive income (loss). Transaction gains
or losses, other than inter-company debt deemed to be of a long-term nature, are
included in net income (loss) in the period in which they occur. In 2004, we
substantially liquidated our Mexico subsidiaries following the sale of the fixed
assets in Mexico. The accumulated foreign currency translation adjustment
related to the Mexico subsidiaries of $22.8 million of loss was reclassified and
charged to income. The adjustment occurred in the fourth quarter of 2004. See
Note 5 of the "Notes to Consolidated Financial Statements."
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments is determined by reference to various
market data and other valuation techniques as appropriate. Considerable judgment
is required in estimating fair values. Accordingly, the estimates may not be
indicative of the amounts that we could realize in a current market exchange.
The carrying amounts of cash and cash equivalents, receivables and accounts
payable approximate fair values. The carrying amounts of our variable rate
borrowings under the various short-term borrowings and long-term debt
arrangements approximate fair value.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose us to concentration of credit
risk, consist primarily of cash equivalents, trade accounts receivable, related
party receivables and amounts due from factor.
Our products are primarily sold to mass merchandisers and specialty retail
stores. These customers can be significantly affected by changes in economic,
competitive or other factors. We make substantial sales to a relatively few,
large customers. In order to minimize the risk of loss, we assign certain of our
domestic accounts receivable to a factor without recourse or requires letters of
credit from our customers prior to the shipment of goods. For non-factored
receivables, account-monitoring procedures are utilized to minimize the risk of
loss. Collateral is generally not required. At December 31, 2004 and 2005,
approximately 19.6% and 22.5% of accounts receivable were due from two
customers, respectively. The following table presents the percentage of net
sales concentrated with certain customers.
PERCENTAGE OF NET
SALES
------------------
CUSTOMER 2003 2004 2005
----------------------------------------- ---- ---- ----
Kohl's .................................. 6.6 16.4 13.5
Macy's Merchandising Group .............. 5.2 10.3 13.4
Mervyn's ................................ 5.9 15.4 11.2
Wal-Mart ................................ 8.7 5.9 11.1
Lerner New York ......................... 8.3 15.0 8.6
Lane Bryant ............................. 12.1 2.0 4.9
The Limited (1) ......................... 15.3 4.6 0.0
(1) Includes Express and Limited stores
We maintain demand deposits with several major banks. At times, cash balances
may be in excess of Federal Deposit Insurance Corporation or equivalent foreign
insurance limits.
F-13
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States 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
financial statements include allowance for returns, inventory, discounts and bad
debts, valuation of long-lived and intangible assets and goodwill, and tax
provision. Actual results could differ from those estimates.
EMPLOYEE STOCK OPTIONS
We account for employee stock options using the intrinsic value method rather
than the alternative fair-value accounting method. Under the intrinsic-value
method, if the exercise price of the employee's stock options equals the market
price of the underlying stock on the date of the grant, no compensation expense
is recognized. For the years ended December 31, 2003, 2004 and 2005, $72,000,
$161,000 and $39,000 were recorded as an expense related to our stock options,
respectively.
Pro forma information regarding net income and earnings per share is required by
SFAS 148, and has been determined as if we had accounted for our employee stock
options under the fair value method of that Statement. The fair value for these
options was estimated at the date of grant using a Black-Scholes option pricing
model with the following weighted-average assumptions: weighted-average
risk-free interest rate of 4% for 2003, 3% to 4% for 2004, 4% for 2005; dividend
yields of 0% for 2003, 2004 and 2005; weighted-average volatility factors of the
expected market price of our common stock of 0.65 for 2003, 0.51 to 0.55 for
2004 and 0.55 for 2005; and a weighted-average expected life of the option of
four years for 2003, 2004 and 2005.
On September 23, 2005, the Board of Directors approved the acceleration of
vesting of all our unvested stock options. In total, 1.7 million stock options
with an average exercise price of $3.69 and an average remaining contractual
life of 7.9 years were subject to this acceleration. The exercise prices and
number of shares subject to the accelerated options were unchanged. The
acceleration was effective as of September 23, 2005. Had the acceleration of
these stock options not been undertaken, the future compensation expense we
would recognize in the fiscal years of 2006, 2007, 2008 and 2009 would be $1.4
million, $810,000, $10,000 and $3,000, respectively. Our decision to accelerate
the vesting of these stock options was based upon the accounting of this $2.2
million of compensation expense from disclosure-only in 2005 to being included
in our statement of operations in 2006 to 2009 based on our adoption of SFAS No.
123 (revised 2004) "Share-Based Payment" effective in January 2006.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Our pro forma
information follows:
F-14
2003 2004 2005
--------------- --------------- ---------------
Net income (loss) as reported ............... $ (35,884,660) $ (104,676,671) $ 993,344
Add stock-based employee compensation charges
reported in net loss ........................ $ 71,572 $ 161,038 $ 38,740
Pro forma compensation expense, net of tax .. $ (4,115,263) $ (3,852,990) $ (4,298,193)
--------------- --------------- ---------------
Pro forma net loss .......................... $ (39,928,351) $ (108,368,623) $ (3,266,109)
Net income (loss) per share
Basic (as restated, see Note 13) ............ $ (2.38) $ (3.64) $ 0.03
Add stock-based employee compensation charges
reported in net loss
Basic ....................................... $ 0.00 $ 0.01 $ 0.00
Pro forma compensation expense per share
Basic ....................................... $ (0.22) $ (0.14) $ (0.14)
--------------- --------------- ---------------
Pro forma loss per share
Basic (as restated, see Note 13) $ (2.60) $ (3.77) $ (0.11)
Net income (loss) per share
Diluted (as restated, see Note 13) .......... $ (2.38) $ (3.64) $ 0.03
Add stock-based employee compensation charges
reported in net loss
Diluted ..................................... $ 0.00 $ 0.01 $ 0.00
Pro forma compensation expense per share
Diluted ..................................... $ (0.22) $ (0.14) $ (0.14)
--------------- --------------- ---------------
Pro forma loss per share
Diluted (as restated, see Note 13) .......... $ (2.60) $ (3.77) $ (0.11)
OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) includes all changes in equity (net assets)
from non-owner sources such as foreign currency translation adjustments. We
account for other comprehensive income (loss) in accordance with SFAS 130,
"Reporting Comprehensive Income."
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment," which addresses the accounting for employee stock options. SFAS No.
123R eliminates the ability to account for share-based compensation transactions
using APB Opinion No. 25 and generally would require instead that such
transactions be accounted for using a fair value-based method. SFAS No. 123R
also requires that tax benefits associated with these share-based payments be
classified as financing activities in the statement of cash flow rather than
operating activities as currently permitted. SFAS No. 123R is effective as of
the beginning of our first annual or interim reporting period that begins after
June 15, 2005. On April 14, 2005, the Securities and Exchange Commission adopted
a new rule amending the effective date for Statement 123R for public companies.
Under the effective date provisions included in Statement 123R, registrants
would have been required to implement the Statement's requirements as of the
beginning of the first interim or annual period beginning after June 15, 2005,
or after December 15, 2005 for small business issuers. The new rule allows
registrants to implement Statement 123R at the beginning of their next fiscal
year, instead of the next interim period, that begins after June 15, 2005. SFAS
No. 123R offers alternative methods of adopting this final rule. We have not yet
determined which alternative method we will use. We have not completed the
process of evaluating the impact that will result from adopting SFAS No. 123R,
but believe the impact upon adoption will be an increase to compensation
expense.
In May 2005, the FASB issued SFAS No. 154, "Accounting for Changes and Error
Corrections." SFAS 154 establishes standards for the accounting and reporting
for changes in accounting principles. SFAS 154 replaces APB 20 "Accounting
Changes" and FASB Interpretation No. 20 ("FIN 20"), "Reporting Accounting
F-15
Changes under AICPA Statements of Position." The Statement requires
retrospective application for changes in accounting principle, unless it is
impracticable to determine either the cumulative effect or the period-specific
effects of the change. When it is impracticable to determine the period-specific
effects of an accounting change on one or more individual prior periods
presented, this Statement would require that the new accounting policy be
applied to the balances of assets and liabilities as of the beginning of the
earliest period for which retrospective application is practicable and that a
corresponding adjustment be made to the opening balance of retained earnings for
the period. When it is impracticable for an entity to determine the cumulative
effect of applying a change in accounting principle to all prior periods, this
Statement would require the new accounting principle to be applied as if it were
made prospectively from the earliest date practicable. SFAS 154 is effective as
of the beginning of our first annual reporting period that begins after December
15, 2005. The adoption of this new accounting pronouncement is not expected to
have a material impact on our consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments", which amends SFAS No. 133, "Accounting for Derivatives
Instruments and Hedging Activities" and SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities". SFAS 155
amends SFAS 133 to narrow the scope exception for interest-only and
principal-only strips on debt instruments to include only such strips
representing rights to receive a specified portion of the contractual interest
or principle cash flows. SFAS 155 also amends SFAS 140 to allow qualifying
special-purpose entities to hold a passive derivative financial instrument
pertaining to beneficial interests that itself is a derivative instrument. We
are currently evaluating the impact this new Standard, but believe that it will
not have a material impact on our financial position, results of operations or
cash flows.
CURRENCY RATE HEDGING
We manufacture in a number of countries throughout the world, including Hong
Kong, and, as a result, are exposed to movements in foreign currency exchange
rates. Periodically we will enter into various currency rate hedges. The primary
purpose of our foreign currency hedging activities is to manage the volatility
associated with foreign currency purchases of materials and equipment in the
normal course of business. We utilize forward exchange contracts with maturities
of one to three months. 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. As a result,
we mark to market all derivative instruments with the gain or loss included in
other income and expense. See Note 18 of the "Notes to Consolidated Financial
Statements." These instruments are intended to protect against exposure related
to financing transactions (equipment) and income from international operations.
There were no exchange contracts at December 31, 2004 and December 31, 2005.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
DECEMBER 31,
----------------------------
2004 2005
------------ ------------
U.S. trade accounts receivable ................. $ 3,248,887 $ 2,893,217
Foreign trade accounts receivable .............. 17,148,600 19,619,172
Factored accounts receivable ................... 19,452,756 33,222,354
Other receivables .............................. 346,965 1,815,450
Allowance for returns, discounts and bad debts . (2,437,865) (2,951,750)
------------ ------------
$ 37,759,343 $ 54,598,443
============ ============
Under the asset-based lending arrangement we had with GMAC before September 29,
2004, we factored trade receivables from clients with credit ratings below BBB.
GMAC did not advance any funds to us and only afforded us a credit insurance
coverage. We received funds from GMAC only after such funds were collected from
customers at their respective due dates. Effective as of September 29, 2004, the
asset based lending arrangement
F-16
was amended and converted to a factoring arrangement. At December 31, 2005,
substantially all trade receivables, irrespective of their debt ratings, were
factored and GMAC advances up to 90% of the invoice value to us immediately upon
the submission of invoices. See Note 8 of "Notes to Consolidated Financial
Statements."
3. INVENTORY
Inventory consists of the following:
DECEMBER 31,
---------------------------
2004 2005
----------- -----------
Raw materials, fabric and trim accessories ..... $ 1,164,977 $ 5,079,428
Finished goods shipments-in-transit ............ 9,283,022 8,800,014
Finished goods ................................. 8,696,106 17,749,518
----------- -----------
$19,144,105 $31,628,960
=========== ===========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
-----------------------------
2004 2005
------------ ------------
Land ........................................... $ 85,000 $ 85,000
Buildings ...................................... 819,372 819,372
Equipment ...................................... 5,966,453 6,249,487
Furniture and fixtures ......................... 2,228,375 2,308,537
Leasehold improvements ......................... 2,605,763 2,684,720
Vehicles ....................................... 330,564 322,487
------------ ------------
12,035,527 12,469,603
Less accumulated depreciation and amortization . (10,160,634) (10,766,763)
------------ ------------
$ 1,874,893 $ 1,702,840
============ ============
Depreciation expense, including amortization of assets recorded under capital
leases, totaled $15,663,000, $7,853,000 and $727,000 for the years ended
December 31, 2003, 2004 and 2005, respectively.
5. RESTRUCTURING AND SALE OF MEXICO OPERATIONS
Following our restructuring of our Mexican operations in 2003, and the resulting
reduction in our Mexican work force, we became the target of workers' rights
activists who have picketed our customers, stuffed electronic mailboxes with
inaccurate, protest e-mails, and threatened customers with retaliation for
continuing business with us. While we have defended our position to our
customers, some of our larger customers for Mexico-produced jeans wear have been
reluctant to place orders with us in response to actions taken and contemplated
by these activist groups. As a consequence, we experienced a significant decline
in revenue from sales of Mexico-produced merchandise during 2004. As a result of
this reduction in revenue from the sale of Mexico-produced merchandise, the
Board of Directors approved a resolution in July 2004 authorizing management to
sell the manufacturing operations in Mexico.
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," we evaluated the long-lived assets in Mexico for
recoverability and concluded that the book value of the asset group was
significantly higher than the expected future cash flows and that impairment had
occurred. Accordingly, we recognized a non-cash impairment loss of approximately
$78 million in the second quarter of 2004. The impairment
F-17
charge was the difference between the carrying value and fair value of the
impaired assets. Fair value was determined based on independent appraisals of
the property and equipment obtained in June 2004. There was no tax benefit
recorded with the impairment loss due to a full valuation allowance recorded
against the future tax benefit as of June 30, 2004. The entire impairment charge
was recorded in the Mexico geographic reporting segment.
In connection with our restructuring of our Mexico operations, we incurred $2.5
million, $1.1 million and $0 of severance costs in 2003, 2004 and 2005,
respectively, in the Mexico reportable segment. We did not relocate any
employees in connection with this restructuring and therefore did not incur any
relocation costs. In addition, we did not incur any contract termination costs.
There was no ending liability balance for the severance costs incurred in 2003
and 2004 since such amounts were all paid in 2003 and 2004. Severance costs
incurred in 2003 were included in costs of goods sold and such costs incurred in
2004 were included in general and administrative expenses in the accompanying
consolidated statements of operations.
In August 2004, through Tarrant Mexico, S. de R.L. de C.V., our majority owned
and controlled subsidiary in Mexico, 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 which include
equipment and facilities previously leased to Mr. Nacif's affiliates in October
2003, for an aggregate purchase price consisting of the following:
o $105,400 in cash and $3,910,000 by delivery of unsecured
promissory notes bearing interest at 5.5% per annum; and
o $40,204,000, by delivery of secured promissory notes bearing
interest at 4.5% per annum, maturing on December 31, 2014, and
payable in equal monthly installments of principal and
interest over the term of the notes.
Included in the $41.4 million notes receivable - related party on the
accompanying balance sheet as of December 31, 2005 was $1,317,000 of Mexico
valued added taxes on the real property component of this transaction. The
future maturities of the note receivable from the purchasers, including the
Mexican value added tax to be paid by the purchasers, is as follows:
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ -----------
2006 ................... $ 5,139,387
2007 ................... 4,866,963
2008 ................... 3,835,953
2009 ................... 3,898,575
2010 ................... 4,077,855
2011 and after.......... 19,589,100
-----------
Total .................. 41,407,833
Upon consummation of the sale, we entered into a purchase commitment agreement
with the purchasers, pursuant to which we have 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. This
agreement replaced a previously existing purchase commitment agreement whereby
we were obligated to purchase annually from Mr. Nacif's affiliates, 6 million
yards of fabric (or approximately $19.2 million of fabric at today's market
prices) manufactured at these same facilities through October 2009. The annual
future purchase commitments approximate the annual maturities of the notes
receivable from the related party and are allowed to be offset against annual
principal and interest requirements. Included in the current maturities balance
is $429,000 related to the 2005 balance due, which we believe is fully
collectible and are allowed to be offset against annual principal and interest
requirements. We expect to realize the note receivable from related party
through the receipt of fabric manufactured at these facilities over the maturity
period of the notes receivable.
F-18
6. 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. Private Brands also entered into a multi-year exclusive
distribution agreement with Federated Merchandising Group ("FMG"), the sourcing
arm of Federated Department Stores, to supply FMG with American Rag CIE, a new
casual sportswear collection for juniors and young men. Private Brands will
design and manufacture a full collection of American Rag apparel, which will be
distributed by FMG exclusively to Federated stores across the country. Beginning
in August 2003, the American Rag collection was available in approximately 100
select Macy's, the Bon Marche, Burdines, Goldsmith's, Lazarus and Rich's-Macy's
locations. The investment in American Rag CIE, LLC totaling $1.9 million and
$2.1 million at December 31, 2004 and 2005, respectively, 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 for 2005 was as follows:
Balance as of December 31, 2003 $ 1,434,375
Additional capital contribution 137,000
Share of income ............... 769,706
Distribution .................. (460,800)
-----------
Balance as of December 31, 2004 $ 1,880,281
Share of income ............... 559,634
Distribution .................. (301,050)
-----------
Balance as of December 31, 2005 $ 2,138,865
===========
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 entity is generating positive cash flow and net operating
profit from its retail stores. The royalty income paid by us to American Rag is
considered other income and is ancillary to the primary operations. Reported
revenue from the retail business in fiscal 2004 and 2005 was approximately $9
million and $10 million, respectively. The amount of royalty income paid by us
to American Rag in 2003, 2004 and 2005 was $250,000, $500,000 and $575,000,
respectively. 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 have not entered into any obligations to guarantee the entity's debt nor do
we expect to receive a guaranteed return on its investment. We determined that
we are not the primary beneficiary of American Rag and nothing has given rise to
a re-evaluation of the investment for consolidation under FIN 46. 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.
7. IMPAIRMENT OF ASSETS
IMPAIRMENT OF GOODWILL
Goodwill on the accompanying consolidated balance sheets represents the as
"excess of costs over fair value of net assets acquired in previous business
combination". SFAS No. 142, "Goodwill and Other Intangible Assets," requires
that goodwill and other intangibles be tested for impairment using a two-step
process. The first step is to determine the fair value of the reporting unit,
which may be calculated using a discounted cash flow methodology, and compare
this value to its carrying value. If the fair value exceeds the carrying value,
no further work is required and no impairment loss would be recognized. The
second step is an allocation of the fair value of the reporting unit to all of
the reporting unit's assets and liabilities under a hypothetical purchase price
allocation.
In 2003, we ceased directly operating a substantial majority of our equipment
and fixed assets in Mexico, and started
F-19
leasing a large portion of our manufacturing facilities and operations in Mexico
to affiliates of Mr. Kamel Nacif, a shareholder at the time of the transaction,
effective September 1, 2003. During 2003, we made an interim review of our
goodwill and intangible assets and wrote off all goodwill and intangible assets
affected by our strategic changes in Mexico. Write-offs included $9.1 million
and $2.7 million directly relating to Tarrant Mexico - Famian and Ajalpan
divisions, respectively, and another $7.5 million relating to of Rocky Apparel
LLC ("Rocky"). It was unlikely that Tommy Hilfiger, whose business we acquired
in the Rocky acquisition, would continue to purchase merchandise from UAV
following implementation of the restructuring in Mexico. In 2003, we had also
written off the remaining goodwill of $150,000 relating to the acquisition of
Jane Doe International, LLC due to litigation with the minority shareholder.
The following table displays the change in the gross carrying amount of goodwill
by reporting units for the years ended December 31, 2004 and 2005. The reporting
unit below is one level below the reportable segments included in Note 16,
"Operations by Geographic Areas". The reporting unit FR TCL-Chazz & MGI Division
was included within the United States geographical segment of Note 16 of the
"Notes to the Consolidated Financial Statements."
REPORTING UNITS
FR TCL - CHAZZZ
& MGI DIVISION
---------------
Balance as of January 1, 2004 . $ 8,582,845
Activities for the year ....... --
---------------
Balance as of December 31, 2004 $ 8,582,845
Activities for the year ....... --
---------------
Balance as of December 31, 2005 $ 8,582,845
===============
IMPAIRMENT OF OTHER ASSETS
On June 28, 2000, we signed an exclusive production agreement with Manufactures
Cheja ("Cheja") through February 2002. We had agreed on a new contract to extend
the agreement for an additional quantity of 6.4 million units beginning April 1,
2002, which was amended on November 8, 2002, for the manufacturing of 5.7
million units through September 30, 2004. In June 2003, we determined that we no
longer expected to recoup advances to Cheja related to the production agreement.
In June 2003, we wrote off $2.8 million of remaining advances to Cheja.
8. DEBT
Debt consists of the following:
DECEMBER 31,
------------------------------
2004 2005
------------ ------------
Short-term bank borrowings:
Import trade bills payable - UPS, DBS
Bank and Aurora Capital .................... $ 3,902,714 $ 4,165,306
Bank direct acceptances - UPS and DBS
Bank ....................................... 10,447,855 1,471,476
Other Hong Kong credit facilities -
UPS and DBS Bank ........................... 3,600,588 8,196,750
------------ ------------
$ 17,951,157 $ 13,833,532
============ ============
Long-term debt:
Vendor financing ........................... $ 135,145 $ --
Equipment financing ........................ 78,038 83,206
Term loan - UPS ............................ 5,000,000 2,708,333
Debt facility - GMAC ....................... 16,960,064 33,558,095
------------ ------------
22,173,247 36,349,634
Less current portion ....................... (19,628,701) (36,109,699)
------------ ------------
$ 2,544,546 $ 239,935
============ ============
F-20
IMPORT TRADE BILLS PAYABLE, BANK DIRECT ACCEPTANCES AND OTHER HONG KONG CREDIT
FACILITIES
On June 13, 2002, we entered into a letter of credit facility of $25 million
with UPS Capital Global Trade Finance Corporation ("UPS"). Under this facility,
we may arrange for the issuance of letters of credit and acceptances. The
facility is collateralized by the shares and debentures of all of our
subsidiaries in Hong Kong. In addition to the guarantees provided by Tarrant
Apparel Group and our subsidiaries, Fashion Resource (TCL) Inc. and Tarrant
Luxembourg Sarl, Gerard Guez, our Chairman, also signed a guarantee of $5
million in favor of UPS to secure this facility. This facility bore interest at
10.25% per annum at December 31, 2005. Under this facility, we were subject to
certain restrictive covenants, including that we maintain a specified tangible
net worth, fixed charge ratio, and leverage ratio. On June 27, 2005, we amended
the letter of credit facility with UPS to extend the expiration date of the
facility from June 30, 2005 to August 31, 2005 and to reduce the tangible net
worth requirement at June 30, 2005. On August 31, 2005, we amended the letter of
credit facility with UPS to further extend the expiration date of the facility
to October 31, 2005, immediately reduce the maximum amount of borrowings to
$14.5 million on September 1, 2005 and further reduced the maximum amount of
borrowing to $14.0 million on October 1, 2005. On October 31, 2005, we further
amended the letter of credit facility with UPS to extend the expiration date of
the facility to January 31, 2006 and amend the interest rate to "prime rate"
plus 3%. The facility amendment also provided for reduction in the maximum
amount of borrowings to $13.5 million commencing on November 1, 2005, to $13.0
million commencing on December 1, 2005, and to $12.5 million commencing on
January 1, 2006. Additionally, Gerard Guez, our Chairman, pledged to UPS 4.6
million shares of our common stock held by Mr. Guez to secure the obligations
under the credit facility. On January 27, 2006, we further amended the letter of
credit facility with UPS to extend the expiration date of the facility from
January 31, 2006 to July 31, 2006. The amendment provides for reduction of the
maximum amount of borrowings under the facility to $12.0 million commencing on
April 1, 2006, $11.5 million commencing on May 1, 2006, $11.0 million commencing
on June 1, 2006 and to $10.5 million commencing on July 1, 2006. Under the
amended letter of credit facility, we are subject to restrictive financial
covenants of maintaining tangible net worth of $25 million as of December 31,
2005 and the last day of each fiscal quarter thereafter. There is also a
provision capping maximum capital expenditures per quarter of $800,000. As of
December 31, 2005, we were in compliance with the covenants. As of December 31,
2005, $9.2 million was outstanding under this facility with UPS (classified
above as follows: $1.9 million in import trade bills payable; $1.0 million in
bank direct acceptances and $6.3 million in other Hong Kong credit facilities)
and an additional $2.5 million was available for future borrowings. In addition,
$1.3 million of open letters of credit was outstanding as of December 31, 2005.
Since March 2003, DBS Bank (Hong Kong) Limited (formerly known as Dao Heng Bank)
has made available a letter of credit facility of up to HKD 20 million
(equivalent to US $2.6 million) to our subsidiaries in Hong Kong. This is a
demand facility and is secured by the pledge of our office property, which is
owned by Gerard Guez, our Chairman, 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. As of December 31, 2005, $2.9
million was outstanding under this facility. In addition, $1.1 million of open
letters of credit was outstanding and $0 was available for future borrowings as
of December 31, 2005. In October 2005, a tax loan for HKD 6.233 million
(equivalent to US $804,000) was also made available to our Hong Kong
subsidiaries. As of December 31, 2005, $675,000 was outstanding under this tax
loan.
As of December 31, 2005, the total balance outstanding under the DBS Bank credit
facilities was $3.6 million (classified above as follows: $1.3 million in import
trade bills payable, $0.5 million in bank direct acceptances and $1.8 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 December 31, 2005, $1.0 million was outstanding
under this facility (classified above under import trade bills payable) and $7.1
million of letters of credit were open under this arrangement. We pay a
commission fee of 2.25% on all letters of credits issued under this arrangement.
LOAN FROM MAX AZRIA
On February 14, 2005, we borrowed $5.0 million from Max Azria, which amount bore
interest at the rate of 4% per annum and was payable in weekly installments of
$250,000 beginning on February 28, 2005. This was an unsecured loan. In early
August 2005, we repaid the remaining balance of this loan in its entirety.
F-21
EQUIPMENT FINANCING
We had three equipment loans outstanding at December 31, 2005 totaling $83,000.
One of these equipment loans bears interest at 6% payable in installments
through 2009, the second loan bears interest at 15.8% payable in installment
through 2007 and the third loan bears interest at 6.15% payable in installment
through 2007.
VENDOR FINANCING
During 2000, we financed equipment purchases for a manufacturing facility with
certain vendors. A total of $16.9 million was financed with five-year promissory
notes, which bear interest ranging from 7.0% to 7.5%, and were payable in
semiannual payments commencing in February 2000. All remaining balances under
these notes were paid off in February 2005. A portion of the debt was
denominated in Euros. Unrealized transaction (loss) gain associated with the
debt denominated in Euros totaled $(561,000), $367,000 and $0 for the years
ended December 31, 2003, 2004 and 2005, respectively. These amounts were
recorded in other income (expense) in the accompanying consolidated statements
of operations.
TERM LOAN - UPS
On December 31, 2004, our Hong Kong subsidiaries entered into a new loan
agreement with UPS pursuant to which UPS made a $5 million term loan, the
proceeds of which were used to repay $5 million of indebtedness owed to UPS
under the letter of credit of facility. The principal amount of this loan is due
and payable in 24 equal monthly installments of approximately $208,333 each,
plus interest equivalent to the "prime rate" plus 2% commencing on February 1,
2005. This facility bore interest at 9.25% per annum at December 31, 2005. On
June 27, 2005, we amended the loan agreement with UPS to reduce the tangible net
worth requirement at June 30, 2005. Under the amended loan agreement, we are
subject to restrictive financial covenants of maintaining tangible net worth of
$25 million at December 31, 2005 and the last day of each fiscal quarter
thereafter. There is also a provision capping maximum capital expenditure per
quarter at $800,000. As of December 31, 2005, we were in compliance with the
covenants. As of December 31, 2005, $2.7 million was outstanding. The
obligations under the loan agreement are collateralized by the same security
interests and guarantees provided under our letter of credit facility with UPS.
Additionally, the term loan is secured by two promissory notes payable to
Tarrant Luxembourg Sarl in the amounts of $2,550,000 and $1,360,000 and a pledge
by Gerard Guez, our Chairman, of 4.6 million shares of our common stock.
DEBT FACILITY AND FACTORING AGREEMENT - GMAC
We were previously party to a revolving credit, factoring and security agreement
(the "Debt Facility") with GMAC Commercial Credit, LLC ("GMAC"). This Debt
Facility provided a revolving facility of $90 million, including a letter of
credit facility not to exceed $20 million, and was scheduled to mature on
January 31, 2005. The Debt Facility also provided a term loan of $25 million,
which was being repaid in monthly installments of $687,500. The Debt Facility
provided for interest at LIBOR plus the LIBOR rate margin determined by the
Total Leverage Ratio (as defined in the Debt Facility agreements), and was
collateralized by our receivables, intangibles, inventory and various other
specified non-equipment assets. In May 2004, the maximum facility amount was
reduced to $45 million in total and we established new financial covenants with
GMAC for the fiscal year of 2004.
On October 1, 2004, we amended and restated the Debt Facility with GMAC by
entering into a new factoring agreement with GMAC. 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. Pursuant to the terms of the factoring agreement, we and
our subsidiaries agree to assign and sell to GMAC, 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, in its discretion, may make advances to us
up to the lesser of (a) up to 90% of our accounts on which GMAC has the risk of
loss and (b) $40 million, minus in each case, any amount owed by us to GMAC.
Pursuant to the terms of the PBG7 factoring agreement, PBG7 agreed to assign and
sell to GMAC, as factor, all accounts, which arise from PBG7's sale of
merchandise or rendition of services created on a going-forward basis. At PBG7's
request, GMAC, in its discretion, may make advances to PBG7 up to the lesser of
(a) up to 90% of PBG7's accounts on which GMAC has the risk of
F-22
loss, and (b) $5 million minus in each case, any amounts owed to GMAC by PBG7.
The facility bears interest at 7.385% per annum and the facility under PBG7, LLC
bears interest at 7.75% per annum at December 31, 2005. Restrictive covenants
under the revised facility include a limit on quarterly capital expenses of
$800,000 and tangible net worth of $25 million at December 31, 2005 and at the
end of each fiscal quarter thereafter. As of December 31, 2005, we were in
compliance with the covenants. A total of $30.6 million was outstanding with
respect to receivables factored under the GMAC facility at December 31, 2005.
In May 2005, we amended our factoring agreement with GMAC to permit our
subsidiaries party thereto and us, to borrow up to the lesser of $3 million or
fifty percent (50%) of the value of eligible inventory. In connection with this
amendment, we granted GMAC a lien on certain of our inventory located in the
United States. On January 23, 2006, we further amended our factoring agreement
with GMAC to increase the amount we may borrow against inventory to the lesser
of $5 million or 50% of the value of eligible inventory. The $5 million limit
will be reduced to $4 million on April 1, 2006 and will be further reduced to $3
million on July 1, 2006. The maximum borrowing availability under the factoring
agreement, based on the borrowing base formula remains at $40 million. A total
of $3.0 million was outstanding under the GMAC facility at December 31, 2005
with respect to collateralized inventory.
The credit facility with GMAC and the credit facility with UPS carry
cross-default clauses. A breach of a financial covenant set by GMAC or UPS
constitutes an event of default under the other credit facility, entitling both
financial institutions to demand payment in full of all outstanding amounts
under their respective debt and credit facilities.
Annual maturities for the long-term debt, convertible debentures and capital
lease obligations are $36.1 million (2006), $7.1 million (2007), $14,000 (2008),
and $5,000 (2009). The effective interest rate on short-term bank borrowing as
of December 31, 2003, 2004 and 2005 were 5.3%, 5.7% and 7.8%, respectively.
GUARANTEES
Guarantees had been issued since 2001 in favor of YKK, Universal Fasteners, and
RVL Inc. for $750,000, $500,000 and unspecified amount, respectively, to cover
trim purchased by Tag-It Pacific Inc. on our behalf. We have not reported a
liability for these guarantees. We issued the guarantees to cover trim purchased
by Tag-It in order to ensure our production in a timely manner. If Tag-It ever
defaults, we would have to pay the outstanding liability due to these vendors by
Tag-It for purchases made on our behalf. We have not had to perform under these
guarantees since inception. It is not predictable to estimate the fair value of
the guarantee; however, we do not anticipate that we will incur losses as a
result of these guarantees. In April 2005, we terminated these guarantees with
respect to Tag-It's obligations arising after the date of termination.
9. CONVERTIBLE DEBENTURES AND WARRANTS
On December 14, 2004, we completed a $10 million financing through the issuance
of (i) 6% Secured Convertible Debentures ("Debentures") and (ii) warrants to
purchase up to 1,250,000 shares of our common stock. Prior to maturity, the
investors may convert the Debentures into shares of our common stock at a price
of $2.00 per share. The warrants have a term of five years and an exercise price
of $2.50 per share. The warrants were valued at $866,000 using the Black-Scholes
option valuation model with the following assumptions: risk-free interest rate
of 4%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.55; and an expected life of four years. The Debentures
bear interest at a rate of 6% per annum and have a term of three years. We may
elect to pay interest on the Debentures in shares of our common stock if certain
conditions are met, including a minimum market price and trading volume for our
common stock. The Debentures contain customary events of default and permit the
holder thereof to accelerate the maturity if the full principal amount together
with interest and other amounts owing upon the occurrence of such events of
default. The Debentures are secured by a subordinated lien on certain of our
accounts receivable and related assets. The closing market price of our common
stock on the closing date of the financing was $1.96. The convertible debenture
was thus valued at $8,996,000, resulting in an effective conversion price of
$1.799 per share. The intrinsic value of the conversion option of $804,000 is
being amortized over the life of the loan. The value of the warrants of $866,000
and the intrinsic value of the conversion option of $804,000 were netted from
the $10 million presented as the convertible debentures, net on our accompanying
balance sheets at December 31, 2004.
F-23
The placement agent in the financing, received compensation for its services in
the amount of $620,000 in cash and issuance of five year warrants to purchase up
to 200,000 shares of our common stock at an exercise price of $2.50 per share.
The warrants to purchase 200,000 shares of our common stock were valued at
$138,000 using the Black-Scholes option valuation model with the following
assumptions: risk-free interest rate of 4%; dividend yields of 0%; volatility
factors of the expected market price of our common stock of 0.55; and an
expected life of four years. The $620,000 financing cost paid to the placement
agent and the value of the warrants to purchase 200,000 shares of our common
stock of $138,000 are included in the deferred financing cost, net on our
accompanying balance sheets and are amortized over the life of the loan.
In June 2005, holders of our Debentures converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock. The Debentures were converted at the option of the
holders at a price of $2.00 per share. Debt discount of $248,000 related to the
intrinsic value of the conversion option of $804,000 was expensed upon the
conversion. Of the $620,000 financing cost paid to the placement agent, $191,000
was expensed upon the conversion. The intrinsic value of the conversion option,
and the value of the warrant amortized in 2005 was $474,000. Total deferred
financing cost amortized in 2005 was $189,000. Total interest paid to the
holders of the Debentures in 2005 was $539,000. As of December 31, 2005, $6.0
million, net of $0.9 million of debt discount, remained outstanding under the
Debentures.
10. INCOME TAXES
The provision (credit) for domestic and foreign income taxes is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2003 2004 2005
----------- ----------- -----------
Current:
Federal ............... $ 2,400,000 $ 1,000,000 $ --
State ................. (241,948) 8,511 2,425
Foreign ............... 2,106,199 1,400,953 1,091,442
----------- ----------- -----------
4,264,251 2,409,464 1,093,867
Deferred:
Federal ............... -- -- --
State ................. -- -- --
Foreign ............... (132,622) (61,345) (166,686)
----------- ----------- -----------
(132,622) (61,345) (166,686)
----------- ----------- -----------
Total ................. $ 4,131,629 $ 2,348,119 $ 927,181
=========== =========== ===========
The source of loss before the provision for taxes and cumulative effect of
accounting change is as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2003 2004 2005
------------- ------------- -------------
Federal ............ $ (18,609,818) $ (14,271,441) $ (4,481,879)
Foreign ............ (13,143,213) (88,057,111) 6,402,404
------------- ------------- -------------
Total .............. $ (31,753,031) $(102,328,552) $ 1,920,525
============= ============= =============
F-24
Our effective tax rate differs from the statutory rate principally due to the
following reasons: (1) A full 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; (2) Although we have taxable losses in Mexico, it is subject to a minimum
tax; and (3) 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.
A reconciliation of the statutory federal income tax provision (benefit) to the
reported tax provision (benefit) on income is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------
2003 2004 2005
------------ ------------ ------------
Income tax (benefit) based on federal
statutory rate ........................... $(11,113,561) $(35,814,993) $ 672,184
State income taxes, net of federal benefit .. (157,266) 5,532 (246,978)
Effect of foreign income taxes .............. 2,862,550 2,749,376 (1,316,085)
Nondeductible goodwill impairment ........... 4,141,426 -- --
Nondeductible impairment of long-lived assets -- 30,463,663 --
Increase in tax reserve ..................... 2,400,000 1,000,000 --
Increase in valuation allowance
and other ................................ 5,998,480 3,944,541 1,818,060
------------ ------------ ------------
$ 4,131,629 $ 2,348,119 $ 927,181
============ ============ ============
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
deferred tax assets (liabilities) are as follows:
DECEMBER 31,
----------------------------
2004 2005
------------ ------------
Deferred tax assets:
Provision for doubtful accounts and unissued credits ........... $ 433,261 $ 117,979
Provision for other reserves ................................... 1,533,620 2,874,377
Domestic and foreign loss carry forwards and foreign tax credits 9,789,485 11,162,380
Goodwill impairment ............................................ 2,719,294 2,138,984
------------ ------------
Total deferred tax assets ...................................... 14,475,660 16,293,720
Deferred tax liabilities:
Other .......................................................... (213,784) (47,098)
------------ ------------
(213,784) (47,098)
Valuation allowance for deferred tax assets .................... (14,475,660) (16,293,720)
------------ ------------
Net deferred tax liabilities ................................... $ (213,784) $ (47,098)
============ ============
At December 31, 2005, we have $32.1 million of federal net operating loss
carryforwards expiring in 2024. We also have foreign tax credits carryforwards
totaling $833,000 that do not expire.
In January 2004, the Internal Revenue Service ("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. In March 2005, the IRS proposed an adjustment to our taxable income of
approximately $6 million related to similar issues identified in their audit of
the 1996
F-25
through 2001 federal income tax returns. The proposed adjustments to our 2002
federal income tax return would not result in additional tax due for that year
due to the tax loss reported in the 2002 federal return. However, it could
reduce the amount of net operating losses available to offset taxes due from the
preceding tax years. This adjustment would also result in additional state taxes
and interest. We believe that we have meritorious defenses to and intend to
vigorously contest the proposed adjustments. 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 included in the consolidated financial statements
under the caption "Income Taxes". The maximum amount of loss in excess of the
amount accrued in the financial statements is $7.7 million. 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.
11. COMMITMENTS AND CONTINGENCIES
We have entered into various non-cancelable operating lease agreements,
principally for executive office, warehousing facilities and production
facilities with unexpired terms in excess of one year. Certain of these leases
provided for scheduled rent increases. We record rent expense on a straight-line
basis over the term of the lease. The future minimum lease payments under these
non-cancelable operating leases are as follows:
2006 ...................................................... $1,188,000
2007 ...................................................... 710,000
2008 ...................................................... 585,000
2009 ...................................................... 600,000
2010 ...................................................... 627,000
Thereafter ................................................ 3,128,000
----------
Total future minimum lease payments ....................... $6,838,000
==========
Included in the future minimum lease payments, $420,000 payable to Lynx
International Limited, a Hong Kong corporation that is owned by Messrs. Guez and
Kay for leasing our warehouse and office space in Hong Kong. See Note 15 of the
"Notes to Consolidated Financial Statements."
Several of the operating leases contain provisions for additional rent based
upon increases in the operating costs, as defined, per the agreement. Total rent
expense under the operating leases amounted to approximately $3,101,000,
$2,128,000 and $1,295,000 for 2003, 2004 and 2005, respectively.
We entered into a new lease agreement in June 2005 in New York as our showroom
through June 2015. This is currently the location used for the private brands
sales, design and technical departments, which functions we moved from our Los
Angeles executive office.
We had open letters of credit of $5,976,000, $9,987,000 and $9,519,000 as of
December 31, 2003, 2004 and 2005, respectively.
We have two employment contracts dated January 1, 1998, and subsequently
amended, with two executives providing for base compensation and other
incentives. On April 1, 2004, we amended each of these contracts to extend the
term through March 31, 2006, and to provide one contract for base salary per
annum of $500,000 for the period from April 1, 2003 to March 31, 2006, and the
other contract for base salary per annum of $50,000 from April 1, 2003 to March
31, 2006. Additionally, we agreed to pay each of these executives an annual
bonus (the "Annual Bonus") for fiscal years ended December 31, 2003, 2004 and
2005 in an amount, if any, equal to ten percent (10%) of the amount by which our
actual pre-tax income for such fiscal year exceeds the amount of projected
pre-tax income set forth in our annual budget for the same fiscal year as
approved by our Board of Directors. No bonuses were paid to these executives for
the fiscal year ended December 31, 2003, 2004 and 2005.
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 in missy, juniors and large sizes. This agreement has
an initial three-year term, and provided we are in compliance with the terms of
the agreement, is
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renewable for one additional two-year term. Minimum net sales are $20 million in
year 1, $25 million in year 2 and $30 million in year 3. The agreement provides
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. As of December 31, 2005, we had an outstanding
advance of $1.1 million. In March 2006, we became involved in a dispute with the
licensor of the Jessica Simpson brands over our continued rights to these
brands.
On January 3, 2005, Private Brands, Inc, our wholly owned subsidiary, entered
into a term sheet exclusive licensing agreement with Beyond Productions, LLC and
Kids Headquarters to collaborate on the design, manufacturing and distribution
of women's contemporary, large sizes and junior apparel bearing the brand name
"House of Dereon", Couture, Kick and Soul. This agreement is a three-year
contract, and providing compliance with all terms of the license, is renewable
for one additional three-year term. Minimum net sales are $10 million in year 1,
$20 million in year 2 and $30 million in year 3. The agreement also provides
payment of royalty at the rate of 8% on net sales and 3% on net sales for
marketing fund commitments. In the first quarter of 2005, we advanced $1.2
million as payment for the first year's minimum royalty and marketing fund
commitment. We had applied $34,000 from the above advance against the royalty
and marketing expenses in 2005. In March 2006, we agreed to terminate our
agreement to design, market and sell House of Dereon by Tina Knowles branded
apparel and we agreed to sell all remaining inventory to the licensor or its
designee. As a result, we will no longer be involved in the sales of this
private brand. Prior to December 31, 2005, we had written off the capitalized
balance of $1.2 million related to agreement and recognized a loss accordingly
in 2005. The loss was classified as royalty expense on our consolidated
statements of operations.
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. At December 31, 2005, the total commitment on royalties
remaining on the term was $9.1 million.
On October 16, 2003, we entered into a lease with affiliates of Mr. Kamel Nacif,
a substantial portion of our manufacturing facilities and operations in Mexico
including real estate and equipment. The lease was effective as of September 1,
2003. We leased our twill mill in Tlaxcala, Mexico, and our sewing plant in
Ajalpan, Mexico, for a period of 6 years and for an annual rental fee of $11
million. Mr. Nacif was a stockholder at the time of transaction. In connection
with this transaction, we also entered into a management services agreement
pursuant to which Mr. Nacif's affiliates managed the operation of our remaining
facilities in Mexico in exchange for use of the remaining facilities. The term
of the management services agreement was also for a period of 6 years.
Additionally, we agreed to purchase annually, six million yards of fabric
manufactured at the facilities leased and/or operated by Mr. Nacif's affiliates
at market prices to be negotiated. See Note 15 of the "Notes to Consolidated
Financial Statements." Using current market prices, the purchase commitment
would be approximately $18 million per year.
In connection with the restructuring of our Mexican operations, and the
resulting reduction in our Mexican work force, we became the target of workers'
rights activists who have picketed our customers, stuffed electronic mailboxes
with inaccurate, protest e-mails, and threatened customers with retaliation for
continuing business with us. While we have defended our position to our
customers, some of our larger customers for Mexico-produced jeans wear have been
reluctant to place orders with us in response to actions taken and contemplated
by these activist groups. As a consequence of these actions, we experienced a
significant decline in revenue of approximately $75 million from sales of
Mexico-produced merchandise in 2004 as compared to 2003.
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 have 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. This agreement replaced an
existing
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purchase commitment agreement with Mr. Nacif's affiliates. In August 2004, upon
entering into an Agreement for Purchase of Assets, Mr. Nacif's affiliates agreed
to suspend our fabric purchase obligations under the existing purchase
commitment, and we agreed to suspend the affiliates of Mr. Nacif's lease payment
obligations under the lease agreements pursuant to which Mr. Nacif's affiliates
operated our manufacturing facilities in Mexico. See Note 15 of the "Notes to
Consolidated Financial Statements."
We are involved from time to time in routine legal matters incidental to our
business. In our opinion, resolution of such matters will not have a material
effect on our financial position or results of operations.
12. EQUITY
We have adopted the disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," an amendment of FASB Statement No. 123. This
pronouncement requires prominent disclosures in both annual and interim
financial statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We account
for stock compensation awards under the intrinsic value method of Accounting
Principles Board ("APB") Opinion No. 25, rather than the alternative fair-value
accounting method. Under the intrinsic-value method, if the exercise price of
the employee's stock options equals the market price of the underlying stock on
the date of the grant, no compensation expense is recognized.
Our Employee Incentive Plan, formerly the 1995 Stock Option Plan, as amended and
restated in May 1999 (the Plan), has authorized the grant of both incentive and
non-qualified stock options to officers, employees, directors and consultants of
the Company for up to 5,100,000 shares (as adjusted for a stock split effective
May 1998) of our common stock. The exercise price of incentive options must be
equal to 100% of fair market value of common stock on the date of grant and the
exercise price of non-qualified options must not be less than the par value of a
share of common stock on the date of grant. The Plan was also amended to expand
the types of awards, which may be granted pursuant thereto to include stock
appreciation rights, restricted stock and other performance-based benefits. At
December 31, 2005, no further options may be granted under the Plan.
In October 1998, we granted 1,000,000 non-qualified stock options not under the
Plan. The options were granted to our Chairman and Vice Chairman at $13.50 per
share, the closing sales price of the common stock on the day of the grant. The
options expire in 2008 and vest over four years. In May 2002, we granted
3,000,000 non-qualified stock options not under the Plan. The options were
granted to our Chairman, Vice Chairman and Mr. Kamel Nacif at $5.50 per share,
the closing sales price of the common stock on the day of the grant. The options
expire in 2012 and vest over three years. The 1,000,000 stock options granted to
Kamel Nacif were forfeited in 2005. In May 2003, we granted 2,000,000
non-qualified stock options not under the Plan to our Chairman and Vice
Chairman. The options were granted at $3.65 per share, the closing sales price
of the common stock on the day of the grant. The options expire in 2013 and vest
over four years. In December 2003, we granted 400,000 non-qualified stock
options not under the Plan to our President. The options were granted at $3.94
per share, the closing sales price of the common stock on the day of the grant.
The options expire in 2013 and vest over four years.
On September 23, 2005, the Board of Directors approved the acceleration of
vesting of all our unvested stock options. In total, 1.7 million stock options
with an average exercise price of $3.69 and an average remaining contractual
life of 7.9 years were subject to this acceleration. The exercise prices and
number of shares subject to the accelerated options were unchanged. The
acceleration was effective as of September 23, 2005. Had the acceleration of
these stock options not been undertaken, the future compensation expense we
would recognize in the fiscal years of 2006, 2007, 2008 and 2009 would be $1.4
million, $810,000, $10,000 and $3,000, respectively. Our decision to accelerate
the vesting of these stock options was based upon the accounting of this $2.2
million of compensation expense from disclosure-only in 2005 to being included
in our statement of operations in 2006 to 2009 based on our anticipated adoption
of SFAS No. 123 (revised 2004) "Share-Based Payment" effective in January 2006.
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A summary of our stock option activity, and related information is as follows:
2003 2004 2005
---------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- -------- --------- -------- ---------- --------
Options outstanding at
beginning of year 6,376,487 $ 8.89 8,926,087 $ 7.13 8,331,962 $ 7.22
Granted 3,288,100 3.67 83,000 3.04 42,000 2.44
Exercised -- -- -- -- -- --
Forfeited (738,500) 6.91 (677,125) 5.43 (1,573,300) 11.40
Expired -- -- -- -- (67,612) 4.50
--------- --------- ----------
Outstanding at end of
year 8,926,087 $ 7.13 8,331,962 $ 7.22 6,733,050 $ 6.25
========= ========= ==========
Exercisable at end of
Year 4,028,487 $ 10.56 5,251,250 $ 9.04 6,733,050 $ 6.25
Weighted average per
option fair value
of options granted
during the year $ 1.92 $ 1.36 $ 1.13
The following table summarizes information about stock options outstanding at
December 31, 2005:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ -------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life Price Exercisable Price
----------------- ----------- ----------- -------- ----------- --------
$ 1.39 - $ 2.84 56,000 8.1 $ 2.41 56,000 $ 2.41
$ 3.60 - $ 3.68 2,388,050 7.5 3.64 2,388,050 3.64
$ 3.94 - $ 5.09 763,000 7.2 4.30 763,000 4.30
$ 5.50 2,004,000 6.3 5.50 2,004,000 5.50
$ 5.55 - $ 9.97 444,500 2.4 7.05 444,500 7.05
$ 13.50 - $15.50 1,011,000 2.7 13.51 1,011,000 13.51
$ 18.44 - $18.50 23,000 2.7 18.50 23,000 18.50
$ 33.13 - $39.97 41,500 3.1 39.31 41,500 39.31
$ 45.50 2,000 3.2 45.50 2,000 45.50
----------- -----------
$ 1.39 - $45.50 6,733,050 6.0 $ 6.25 6,733,050 $ 6.25
=========== ===========
13. EQUITY TRANSACTIONS
In October 2003, we sold an aggregate of 881,732 shares of the Series A
Convertible Preferred Stock, at $38 per share, to a group of institutional
investors and high net worth individuals and raised an aggregate of
approximately $31 million, after payment of commissions and expenses. We used
the proceeds of this offering to pay down vendors and reduce debts. The
preferred stock was converted into an aggregate of 8,817,320 shares of common
stock following a special meeting of shareholders held on December 4, 2003 in
accordance with the original conversion terms. We have registered the shares of
common stock issued upon conversion of the Series A Preferred Stock with the
Securities and Exchange Commission for resale by the investors. In conjunction
with the private placement transaction, we issued a warrant to purchase 881,732
shares of common stock to the placement agent. The warrants are exercisable
beginning April 17, 2004 through October 17, 2008 and have a per share exercise
price of $4.65. Warrants were valued using the Black-Scholes option valuation
model with the following assumptions:
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risk-free interest rate of 4%; dividend yields of 0%; volatility factors of the
expected market price of our common stock of 0.51; and an expected life of four
years.
As previously disclosed, following a review of the accounting treatment of our
October 2003 private placement of convertible preferred stock, we revised our
accounting treatment for this transaction to record a beneficial conversion
feature in accordance with Emerging Issues Task Force ("EITF") No. 98-5 and to
restate our financial statements for the fiscal years ended December 31, 2003
and 2004 to reflect the beneficial conversion feature of the convertible
preferred stock. We restated our 2003 and 2004 financial statements to reflect
the recording of the beneficial conversion feature of approximately $7.5 million
in the fourth quarter of 2003 relating to the issuance of 881,732 shares of
Series A convertible preferred stock. The beneficial conversion feature of the
preferred shares in the amount of $7.5 million was recorded in the fourth
quarter of 2003, resulting in an increase in loss per share to common
shareholders for the year ended December 31, 2003 to $(2.38) per share from the
previously reported $(1.97) per share. The beneficial conversion feature did not
change our reported earnings (loss) per share for the year ended December 31,
2004. The effect of recording the beneficial conversion feature on the December
31, 2004 financial statements was an increase in the accumulated deficit of $7.5
million and an offsetting increase in contributed capital. The restatement did
not change total shareholders' equity at December 31, 2003 or 2004.
In November 2003, we issued an aggregate of 200,000 shares of common stock to
Antonio Haddad Haddad, Miguel Angel Haddad Yunes, Mario Alberto Haddad Yunes,
and Marco Antonio Haddad Yunes in partial settlement of the balance of
approximately $2.5 million in obligations owed these parties arising from our
acquisition of their factories in 1998. The fair value of the common stock
issued on the date of issuance was $3.94 per share, resulting in a reduction of
our obligation by $788,000.
During the year of 2003, we retired a total of 248,872 shares of common stock
relating to shares repurchased but uncancelled before 2001 and shares
repurchased in 2003 from Gabe Zeitouni, upon exercising his put option under an
agreement dated July 10, 2000.
In January 2004, we sold an aggregate of 1,200,000 shares of our common stock at
a price of $3.35 per share, for aggregate proceeds to us of approximately $3.7
million after payment of placement agent fees and other offering expenses. We
used the proceeds of this offering for working capital purposes. The securities
sold in the offering were registered under the Securities Act of 1933, as
amended, pursuant to our effective shelf registration statement. In conjunction
with this public offering, we issued a warrant to purchase 30,000 shares of our
common stock to the placement agent. This warrant has an exercise price of $3.35
per share, is fully vested and exercisable and has a term of five years. The
warrant was valued using the Black-Scholes option valuation model with the
following assumptions: risk-free interest rate of 3%; dividend yields of 0%;
volatility factors of the expected market price of warrants of 0.51; and an
expected life of four years.
In March 2005, in connection with a settlement of a dispute involving a former
employee named Nicolas Nunez, we agreed to compensate Mr. Nunez in the total
amount of $875,000. In April 2005, we issued 195,313 shares of our common stock
(having a value of $375,000) to Mr. Nunez pursuant to the terms of an agreement
and plan of reorganization and paid Mr. Nunez $500,000 in settlement of all
remaining claims by Mr. Nunez against us.
In June 2005, holders of our Debentures converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock. See Note 9 of the "Notes to Consolidated Financial
Statements."
In November 2003, our board of directors adopted a shareholders rights plan.
Pursuant to the plan, we issued a dividend of one right for each share of our
common stock held by shareholders of record as of the close of business on
December 12, 2003. Each right initially entitled shareholders to purchase a
fractional share of our Series B Preferred Stock for $25.00. However, the rights
are not immediately exercisable and will become exercisable only upon the
occurrence of certain events. Generally, if a person or group acquires, or
announces a tender or exchange offer that would result in the acquisition of 15%
or more of our common stock while the shareholder rights plan remains in place,
then, unless the rights are redeemed by us for $0.001 per right, the rights will
become exercisable, by all rights holders other than the acquiring person or
group, for our shares or shares of the third party acquirer having a value of
twice the right's then-current exercise price. The shareholder rights plan is
designed to guard against partial tender offers and other coercive tactics to
gain control of our company without offering a fair and
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adequate price and terms to all of our shareholders. The plan was not adopted in
response to any efforts to acquire our company, and we are not aware of any such
efforts.
Our credit agreement prohibits the payment of dividends during the term of the
agreement.
14. SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31,
----------------------------------------
2003 2004 2005
---------- ---------- ----------
Cash paid for interest ............ $2,856,000 $1,796,000 $3,335,000
========== ========== ==========
Cash paid for income taxes ........ $ 378,000 $1,196,000 $ 875,000
========== ========== ==========
In 1999, we acquired Industrial Exportadora Famian from the Haddad family. In
accordance with the acquisition agreement, we had to pay certain amount of
earnouts to the vendors annually. As of October 31, 2003, total earnouts accrued
but not paid amounted to about $2.5 million. In November 2003, we entered into
an agreement with the Haddad family to satisfy the amount owed by issuing to
four family members a total of 200,000 shares of common stock, with a fair value
of $788,000. In addition, we gave them 400,000 yards of our stock fabric,
100,000 pairs of pants, and a fleet of old vehicles, with an aggregate book
value of approximately $1.5 million. Included in other income was a gain of
$236,000 resulting from this settlement in 2003.
In 2003, we reduced a shareholder receivable for $722,000 from Mr. Kamel Nacif
against vendor payables owed to entities controlled by Mr. Nacif.
In 2004, as consideration for the sale of our assets and real property in
Mexico, we received $45.4 million of notes receivable. See Note 5 of "Notes to
Consolidated Financial Statements."
On December 14, 2004, we completed a $10 million financing through the issuance
of 6% Secured Convertible Debentures ("Debentures"), we issued warrants to
purchase up to 1,250,000 shares of our common stock. The warrants were valued at
$866,000 using the Black-Scholes option valuation model. The placement agent in
the financing, for its services were paid $620,000 in cash and issued five year
warrants to purchase up to 200,000 shares of our common stock at an exercise
price of $2.50 per share. The 200,000 warrants were valued at $138,000 using the
Black-Scholes option valuation model.
In March 2005, in connection with a settlement of a dispute involving a former
employee named Nicolas Nunez, we agreed to compensate Mr. Nunez in the total
amount of $875,000. In April 2005, we issued 195,313 shares of our common stock
(having a value of $375,000) to Mr. Nunez pursuant to the terms of an agreement
and plan of reorganization and paid Mr. Nunez $500,000 in settlement of all
remaining claims by Mr. Nunez against us.
In June 2005, holders of our Debentures converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock.
In 2005, we purchased $6.4 million of fabric from Acabados y Terminados, of
which $2.4 million was paid in cash and $4.0 million was offset against the
notes receivable principal and accrued interest on the note receivable from the
affiliates of Mr. Kamel Nacif.
F-31
15. RELATED-PARTY TRANSACTIONS
Related-party transactions, consisting primarily of purchases and sales of
finished goods and raw materials, are as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------
2003 2004 2005
----------- ----------- -----------
Sales to related parties .......... $22,296,000 $ 3,598,000 $ 88,000
Purchases from related parties .... $72,329,000 $17,875,000 $ 6,987,000
As of December 31, 2004 and 2005, related party affiliates were indebted to us
in the amounts of $13.1 million and $8.4 million, respectively. These include
amounts due from Gerard Guez, our Chairman of $2.5 million and $2.3 million at
December 31, 2004 and 2005, respectively, which have been shown as reductions to
shareholders' equity in the accompanying financial statements. Total interest
paid by Mr. Guez was $374,000, $370,000 and $209,000 for the years ended
December 31, 2003, 2004 and 2005, respectively.
From time to time in the past, we borrowed funds from, and advanced funds to,
Mr. Guez. The greatest outstanding balance of such advances to Mr. Guez during
2005 was approximately $4,766,000. At December 31, 2005, the entire balance due
from Mr. Guez totaling $2.3 million was reflected as a reduction of
shareholders' equity. All advances to, and borrowings from, Mr. Guez bore
interest at the rate of 7.75% during the period. Total interest paid by Mr. Guez
was $374,000, $370,000 and $209,000 for the years ended December 31, 2003, 2004
and 2005, respectively. Mr. Guez paid expenses on our behalf of approximately
$400,000 and $397,000 for the years ended December 31, 2004 and 2005,
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 officers or directors of Tarrant.
In February 2004, our Hong Kong subsidiary entered into a 50/50 joint venture
with Auto Enterprises Limited, an unrelated third party, to source products for
Seven Licensing Company, LLC and our private brands subsidiary in mainland
China. On May 31, 2004, after realizing an accumulated loss from the venture of
approximately $200,000 (our share being half), we sold our interest for $1 to
Asia Trading Limited, a company owned by Jacqueline Rose, wife of Gerard Guez.
The venture owed us $221,000 as of December 31, 2004. This amount was repaid in
the first quarter of 2005.
On July 1, 2001, we formed an entity to jointly market, share certain risks and
achieve economics of scale with Azteca Production International, Inc.
("Azteca"), a corporation owned by the brothers of Gerard Guez, our Chairman,
called United Apparel Ventures, LLC ("UAV"). This entity was created to
coordinate the production of apparel for a single customer of our branded
business. UAV is owned 50.1% by Tag Mex, Inc., our wholly owned subsidiary, and
49.9% by Azteca. Results of the operation of UAV have been consolidated into our
results since July 2001 with the minority partner's share of gain and losses
eliminated through the minority interest line in our financial statements. Due
to the restructuring of our Mexico operations, we discontinued manufacturing for
UAV customers in the second quarter of 2004. UAV makes purchases from two
related parties in Mexico, an affiliate of Azteca and Tag-It Pacific, Inc.
Since June 2003, United Apparel Venture, LLC had been selling to Seven Licensing
Company, LLC ("Seven Licensing"), jeans wear bearing the brand "Seven7", which
is ultimately purchased by Express. Seven Licensing is beneficially owned by
Gerard Guez. In the third quarter of 2004, in order to strengthen our own
private brand business, we decided to discontinue sourcing for Seven7. Total
sales to Seven Licensing during the years ended December 31, 2003, 2004 and 2005
were $8.1 million, $2.6 million and $0, respectively. In 1998, a California
limited liability company owned by our Chairman and Vice Chairman purchased
2,300,000 shares of the common stock of Tag-It Pacific, Inc. ("Tag-It") (or
approximately 37% of such common stock then outstanding). Tag-It is a provider
of brand identity programs to manufacturers and retailers of apparel and
accessories. Starting from 1998, Tag-It assumed the responsibility for
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managing and sourcing all trim and packaging used in connection with products
manufactured by or on behalf of us in Mexico. We believe that the terms of this
arrangement, which is subject to the acceptance of our customers, are no less
favorable to us than could be obtained from unaffiliated third parties. Due to
the restructuring of our Mexico operations, Tag-It no longer manages our trim
and packaging requirements. We purchased $16.8 million, $1.0 million and
$450,000 of trim inventory from Tag-It for the years ended December 31, 2003,
2004 and 2005, respectively. We also sold to Tag-It $1.5 million from our trim
and fabric inventory for the year ended December 31, 2003. We purchased $37.1
million, $11.5 million and $135,000 of finished goods and service from Azteca
and its affiliates for the years ended December 31, 2003, 2004 and 2005,
respectively. Azteca is owned by the brothers of our Chairman, Gerard Guez, and
is the minority member of our subsidiary, United Apparel Ventures, LLC. Our
total sales of fabric and service to Azteca in 2003, 2004 and 2005 were $9.9
million, $1.0 million and $88,000, respectively. Two and one half percent of
gross sales as management fees were paid in 2003, 2004 and 2005 to each of the
members of UAV, per the operating agreement. The amount paid to Azteca, the
minority member of UAV, totaled $1.7 million, $179,000 and $0 in 2003, 2004 and
2005, respectively. Net amounts due from these related parties as of December
31, 2004 and 2005 were $7.8 million and $5.5 million, respectively.
On October 16, 2003, we entered into a lease with affiliates of Mr. Kamel Nacif,
a substantial portion of our manufacturing facilities and operations in Mexico
including real estate and equipment. The lease was effective as of September 1,
2003. We leased our twill mill in Tlaxcala, Mexico, and our sewing plant in
Ajalpan, Mexico, for a period of 6 years and for an annual rental fee of $11
million. Mr. Nacif was a shareholder at the time of the transaction. In
connection with this transaction, we also entered into a management services
agreement pursuant to which Mr. Nacif's affiliates managed the operation of our
remaining facilities in Mexico. The term of the management services agreement
was also for a period of 6 years. Additionally, we entered into a purchase
commitment agreement with Mr. Nacif's affiliates to purchase annually, six
million yards of fabric manufactured at the facilities leased and/or operated by
Mr. Nacif's affiliates at market prices to be negotiated. See Note 11
"Commitments and Contingencies", of the "Notes to Consolidated Financial
Statements." Using current market prices, the purchase commitment would be
approximately $18 million per year. We agreed to pay $1 for each yard of fabric
that we fail to purchase under the agreement. We purchased $3.6 million and $5.3
million of fabric from Acabados y Terminados under this agreement in 2003 and
2004, 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,
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 have 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. This agreement replaced a
previously existing purchase commitment agreement with Mr. Nacif's affiliates.
We purchased $6.4 million of fabric, of which $2.4 million was paid in cash and
$4.0 million was offset against the notes receivable principal and accrued
interest on the note receivable from the affiliates of Mr. Kamel Nacif in 2005.
Net amount due from these related parties as of December 31, 2005 was $236,000
We lease our executive offices in Los Angeles, California from GET, a
corporation which is owned by Gerard Guez and Todd Kay, our Chairman and Vice
Chairman, respectively. Additionally, we lease our warehouse and office space in
Hong Kong from Lynx International Limited, a Hong Kong corporation that is owned
by Messrs. Guez and Kay. We paid $1,330,000 in rent annually in each of 2003 and
2004 and $1,019,000 in 2005 for office and warehouse facilities. Our Los Angeles
offices and warehouse is leased on a month to month basis. On January 1, 2006,
we entered into a one year lease agreement with Lynx International Limited for
our office space in Hong Kong.
We reimbursed Mr. Guez, our Chairman, for 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.
At December 31, 2004 and 2005, we had various employees receivable totaling
$403,000 and $370,000, respectively, included in due from related parties.
F-33
We entered into lease agreements with the former owners of Industrial
Exportadora Famian and our former employees. Under theses leases, we paid
$943,000 in 2003, for rent for sewing and washing facilities in Tehuacan,
Mexico. All these lease agreements were cancelled in November 2003.
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. The investment in American Rag
Cie, LLC totaling $2.1 million at December 31, 2005 was accounted for under the
equity method and included in equity method of investment on the accompanying
consolidated balance sheets.
We believe the 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.
F-34
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 four geographic regions: the
United States, Asia, Mexico and Luxembourg. 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, Asia, Mexico and Luxembourg is presented below.
Inter-company revenues and assets have been eliminated to arrive at the
consolidated amounts.
ADJUSTMENTS
AND
UNITED STATES ASIA MEXICO LUXEMBOURG ELIMINATIONS TOTAL
------------- ------------- -------------- ------------- -------------- --------------
2003
---------------------------
Sales...................... $ 291,993,000 $ 7,359,000 $ 21,071,000 $ -- $ -- $ 320,423,000
Inter-company sales........ 33,441,000 112,481,000 75,716,000 -- (221,638,000) --
------------- ------------- -------------- ------------- -------------- --------------
Total revenue.............. $ 325,434,000 $ 119,840,000 $ 96,787,000 $ -- $ (221,638,000) $ 320,423,000
============= ============= ============== ============= ============== ==============
Income (loss) from operations $(11,078,000) $ 7,556,000 $ (30,116,000) $ -- $ -- $ (33,638,000)
============= ============= ============== ============= ============== ==============
Interest income............ $ 419,000 $ 725,000 $ 6,000 $ -- $ (725,000) $ 425,000
============= ============= ============== ============= ============== ==============
Interest expense........... $ 5,215,000 $ 41,000 $ 347,000 $ 725,000 $ (725,000) $ 5,603,000
============= ============= ============== ============= ============== ==============
Provision for depreciation
and amortization.......... $ 1,547,000 $ 261,000 $ 14,290,000 $ -- $ -- $ 16,098,000
============= ============= ============== ============= ============== ==============
Capital expenditures....... $ 94,000 $ 84,000 $ 190,000 $ -- $ -- $ 368,000
============= ============= ============== ============= ============== ==============
Total assets............... $ 128,058,000 $ 117,783,000 $ 201,050,000 $ 213,051,000 $ (406,837,000) $ 253,105,000
============= ============= ============== ============= ============== ==============
2004
---------------------------
Sales...................... $ 149,568,000 $ 1,838,000 $ 4,047,000 $ -- $ -- $ 155,453,000
Inter-company sales........ -- 80,420,000 7,453,000 -- (87,873,000) --
------------- ------------- -------------- ------------- -------------- --------------
Total revenue.............. $ 149,568,000 $ 82,258,000 $ 11,500,000 $ -- $ (87,873,000) $ 155,453,000
============= ============= ============== ============= ============== ==============
Income (loss) from operations $ (13,231,000) $ 3,663,000 $ (89,400,000) $ (33,000) $ (22,786,000) $ (121,787,000)
============= ============= ============== ============ ============== ==============
Interest income............ $ 378,000 $ 856,000 $ -- $ -- $ (856,000) $ 378,000
============== ============= ============== ============= ============== ==============
Interest expense........... $ 2,766,000 $ 55,000 $ 38,000 $ 854,000 $ (856,000) $ 2,857,000
============= ============= ============== ============= ============== ==============
Provision for depreciation
and amortization.......... $ 1,283,000 $ 219,000 $ 6,836,000 $ -- $ -- $ 8,338,000
============= ============= ============== ============= ============== ==============
Capital expenditures....... $ 48,000 $ 64,000 $ -- $ -- $ -- $ 112,000
============= ============= ============== ============= ============== ==============
Total assets............... $ 113,046,000 $ 121,007,000 $ 31,603,000 $ 212,165,000 $ (346,010,000) $ 131,811,000
============= ============= ============== ============= =============== ==============
2005
---------------------------
Sales...................... $ 213,205,000 $ 1,282,000 $ 161,000 $ -- $ -- $ 214,648,000
Inter-company sales........ -- 135,531,000 -- -- (135,531,000) --
-------------- ------------- -------------- ------------- -------------- --------------
Total revenue.............. $ 213,205,000 $ 136,813,000 $ 161,000 $ -- $ (135,531,000) $ 214,648,000
============= ============= ============== ============= ============== ==============
Income (loss) from operations $ (928,000) $ 5,071,000 $ (470,000) $ (48,000) $ -- $ 3,625,000
============= ============= ============== ============= ============= ==============
Interest income............ $ 223,000 $ 1,955,000 $ -- $ 1,856,000 $ (1,953,000) $ 2,081,000
============== ============= ============== ============= ============== ==============
Interest expense........... $ 4,219,000 $ 403,000 $ 2,000 $ 1,954,000 $ (1,953,000) $ 4,625,000
============= ============= ============== ============= ============== ==============
Provision for depreciation
and amortization.......... $ 2,025,000 $ 102,000 $ -- $ -- $ -- $ 2,127,000
============= ============= ============== ============= ============== ==============
Capital expenditures....... $ 335,000 $ 224,000 $ -- $ -- $ -- $ 559,000
============= ============= ============== ============= ============== ==============
Total assets............... $ 115,327,000 $ 129,737,000 $ 15,782,000 $ 212,019,000 $ (321.623.000) $ 151,242,000
============= ============= ============== ============= ============== ==============
F-35
17. EMPLOYEE BENEFIT PLANS
On August 1, 1992, Tarrant Hong Kong established a defined contribution
retirement plan covering all of its Hong Kong employees whose period of service
exceeds 12 months. Plan assets are monitored by a third-party investment manager
and are segregated from those of Tarrant Hong Kong. Participants may contribute
up to 5% of their salary to the plan. We make annual matching contributions.
Costs of the plan charged to operations for 2003, 2004 and 2005 amounted to
approximately $157,000, $131,000 and $160,000, respectively.
On July 1, 1994, we established a defined contribution retirement plan covering
all of our U.S. employees whose period of service exceeds 12 months. Plan assets
are monitored by a third-party investment manager and are segregated from those
of ours. Participants may contribute from 1% to 15% of their pre-tax
compensation up to effective limitations specified by the Internal Revenue
Service. Our contributions to the plan are based on a 50% (100% effective July
1, 1995) matching of participants' contributions, not to exceed 6% (5% effective
July 1, 1995) of the participants' annual compensation. In addition, we may also
make a discretionary annual contribution to the plan. Costs of the plan charged
to operations for 2003, 2004 and 2005 amounted to approximately $256,000,
$226,000 and $199,000, respectively.
On December 27, 1995, we established a deferred compensation plan for executive
officers. Participants may contribute a specific portion of their salary to such
plan. We do not contribute to the Plan.
18. OTHER INCOME AND EXPENSE
Other income and expense consists of the following:
YEAR ENDED DECEMBER 31,
-----------------------------------
2003 2004 2005
---------- ---------- ----------
Rental income ........................... $3,957,365 $5,854,698 $ 193,127
Gain on sale of fixed assets ............ -- -- 124,041
Unrealized gain on foreign currency ..... -- 367,262 --
Realized gain on foreign currency ....... 304,060 -- --
Gain on legal settlement ................ 235,785 -- --
Other items ............................. 287,269 144,677 37,179
---------- ---------- ----------
Total other income ...................... $4,784,479 $6,366,637 $ 354,347
========== ========== ==========
Unrealized loss on foreign currency ..... 560,602 -- --
Realized loss on foreign currency ....... -- 511,586 --
Loss on sale of fixed assets ............ 593,626 -- --
Other items ............................. 28,692 17,671 580
---------- ---------- ----------
Total other expense ..................... $1,182,920 $ 529,257 $ 580
========== ========== ==========
19. LEGAL PROCEEDINGS
1. PATRICK BENSIMON
On April 12, 2000, we formed a company, Jane Doe International, LLC ("JDI") for
the sole purpose of purchasing the assets of Needletex, Inc., owner of the Jane
Doe brand. JDI was owned 51% by Fashion Resource (TCL), Inc., our subsidiary,
and 49% by Needletex, Inc. In connection with the establishment of JDI, JDI
entered into an employment agreement with Patrick Bensimon, the principal
shareholder of Needletex, Inc., which provided for the payment of a salary to
Patrick Bensimon and a bonus tied to the new company's sales performance.
Thereafter a dispute arose as to whether Patrick Bensimon had performed in
accordance with his terms of employment set forth in the Employment Agreement.
When an amicable resolution of this dispute could not be achieved, Patrick
Bensimon commenced an arbitration preceding against his employer, JDI, Fashion
Resource (TCL), Inc., the managing member of Jane Doe International and us. On
April 7, 2003, the arbitration panel issued a final award in
F-36
favor of Patrick Bensimon of $1,425,655 for salary and bonus, plus interest
accrued and his costs and attorneys fees in the amount of $489,640. In January
2004, we settled the employment litigation with Patrick Bensimon for $1.2
million in cash and forgiveness of approximately $859,000 in debts owed by
Needletex Inc. As part of the settlement, we received the remaining 49% interest
in JDI. We also settled with our insurance carrier for a cash payment of
$330,000. An additional expense of approximately $379,000 was made in the fourth
quarter of 2003 to cover the forgiveness of debts.
2. NICOLAS NUNEZ
In March 2005, we reached a settlement of a dispute involving a former employee
named Nicolas Nunez. Mr. Nunez was employed by us pursuant to a written
employment agreement until he was terminated in or about November 2000. In
connection to this employment, we agreed to acquire Nunez' company by merger.
Mr. Nunez claimed to be entitled to shares of our common stock up to a value of
$500,000 assuming we did not otherwise have valid defenses to such claims. In
connection with the settlement, we agreed to compensate Mr. Nunez in the total
amount of $875,000. The full amount of $875,000 had been accrued and included in
accrued liabilities in the accompanying balance sheet at December 31, 2004. All
parties to both proceedings have agreed to exchange full mutual releases of any
and all claims, known or unknown, and will dismiss both proceedings with
prejudice, without admitting any liability.
In April 2005, we issued 195,313 shares of our common stock (having a value of
$375,000) to Mr. Nunez pursuant to the terms of an agreement and plan of
reorganization and paid Mr. Nunez $500,000 in settlement of all remaining claims
by Mr. Nunez against us.
3. MR. BENJAMIN DOMINGUEZ GONZALEZ
On December 10, 2004 and December 14, 2004, Mr. Benjamin Dominguez Gonzalez
brought suits against our Mexico Subsidiary, Tarrant Mexico, S. de R.L. de C.V.,
in Puebla, Puebla, Mexico: (a) "Juicio Ejecutivo Mercantil 887/2004, Juzgado
Dicimo de lo Civil del Estado de Puebla, Puebla, Mexico, Dominguez Gonzalez
Benjamin vs. Tarrant Mexico S. de R.L. de C.V. e Inmobiliaria Cuadros S.A. de
C.V."; and (b) "Juicio Ejecutivo Mercantil 889/2004, Juzgado Noveno de lo Civil
del Estado de Puebla, Puebla, Mexico, Dominguez Gonzalez Benjamin vs. Tarrant
Mexico S. de R.L. de C.V. e Inmobiliaria Cuadros S.A. de C.V.", for the
non-payment of approximately $14 million in principal amount and accrued
interest on two promissory notes, which Mr. Gonzalez asserts were issued by
Tarrant Mexico. The amounts Mr. Gonzalez claimed were due and owing under the
notes previously had been paid in full. In April 2005, Mr. Gonzalez agreed to
dismiss his claims, which agreement has been approved by the court.
4. BAZAK INTERNATIONAL CORPORATION
Shortly before May 2004, Bazak International Corp. commenced an action against
us in the New York County Supreme Court claiming that we breached an oral
contract to sell a quantity of close-out goods, as a consequence of which Bazak
was damaged to the extent of $1.3 million. Bazak International Corp. claimed
that our liability exists under a theory of breach of contract or unjust
enrichment. This case is currently pending in the United States District Court
for the Southern District of New York and is scheduled for trial on December 18,
2006. We will continue to vigorously defend against the breach of contract and
unjust enrichment claim.
F-37
20. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
QUARTER ENDED
---------------------------------------------
MAR. 31 JUN. 30 SEP. 30 DEC. 31
-------------------------------- -------- -------- -------- --------
2004 (In thousands, except per share data)
Net sales ...................... $ 42,155 $ 38,489 $ 38,102 $ 36,707
Gross profit ................... 7,500 5,266 4,135 4,060
Operating loss ................. (5,963) (84,585) (3,626) (27,613)
Net loss ....................... $ (2,974) $(68,567) $ (4,019) $(29,117)
Net loss per common share:
Basic ........................ $ (0.10) $ (2.39) $ (0.14) $ (1.01)
Diluted ...................... $ (0.10) $ (2.39) $ (0.14) $ (1.01)
Weighted average shares
outstanding:
Basic ........................ 28,485 28,649 28,815 28,815
Diluted ...................... 28,485 28,649 28,815 28,815
2005
Net sales ...................... $ 44,830 $ 50,538 $ 69,566 $ 49,714
Gross profit ................... 8,946 11,454 14,545 9,936
Operating income ............... 233 1,437 3,011 (1,056)
Net income (loss) .............. $ (106) $ 871 $ 1,702 $ (1,474)
Net loss per common share:
Basic ........................ $ (0.00) $ 0.03 $ 0.05 $ (0.05)
Diluted ...................... $ (0.00) $ 0.03 $ 0.05 $ (0.05)
Weighted average shares
outstanding:
Basic ........................ 28,815 29,156 30,366 30,554
Diluted ...................... 28,815 29,163 30,786 30,554
F-38
21. SUBSEQUENT EVENTS
On January 19, 2006, we borrowed $4 million from Max Azria pursuant to the terms
of a promissory note, which amount bears interest at the rate of 5.5% per annum
and is payable in weekly installments of $200,000 beginning on March 1, 2006.
This is an unsecured loan.
On January 23, 2006, we further amended our factoring agreement with GMAC to
increase the amount we may borrow against inventory to the lesser of $5 million
or 50% of the value of eligible inventory. The $5 million limit will be reduced
to $4 million on April 1, 2006 and will be further reduced to $3 million on July
1, 2006. The maximum borrowing availability under the factoring agreement, based
on the borrowing base formula remains at $40 million.
On January 27, 2006, we further amended the letter of credit facility with UPS
to extend the expiration date of the facility from January 31, 2006 to July 31,
2006. The amendment provides for reduction of the maximum amount of borrowings
under the facility to $12.0 million commencing on April 1, 2006, $11.5 million
commencing on May 1, 2006, $11.0 million commencing on June 1, 2006 and to $10.5
million commencing on July 1, 2006. Under the amended letter of credit facility,
we are subject to restrictive financial covenants of maintaining tangible net
worth of $25 million as of December 31, 2005 and the last day of each fiscal
quarter thereafter. There is also a provision capping maximum capital
expenditures per quarter of $800,000.
In March 2006, we terminated our license agreement for the brand House of Dereon
by Tina Knowles branded apparel, and sold our remaining inventory to the
licensor. As a result, we will no longer be involved in the sales of this
private brand. Prior to December 31, 2005, we had written off the capitalized
balance of $1.2 million related to agreement and recognized a loss accordingly
in 2005. The loss was classified as royalty expense on our consolidated
statements of operations.
In March 2006, we became involved in a dispute with the master licensor of the
JS by Jessica Simpson, Princy and Sweet Kisses brands over our continued rights
to these brands. Accordingly, we do not anticipate sales of Jessica Simpson
branded apparel after the first quarter of 2006 unless and until we successfully
resolve our dispute with the licensor. Net sales of Jessica Simpson and Princy
by Jessica Simpson totaled $12.6 million in 2005.
F-39
SCHEDULE II
TARRANT APPAREL GROUP
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS ADDITIONS
BALANCE AT CHARGED TO CHARGED BALANCE
BEGINNING COSTS AND TO OTHER AT END
OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR
----------- ----------- ------------ ----------- -----------
For the year ended December 31, 2003
Allowance for returns and discounts... $ 3,134,768 $ -- $ -- $ (324,387) $ 2,810,381
Allowance for bad debt ............... $ 1,181,853 $ 234,149 $ -- $ -- $ 1,416,002
Inventory reserve .................... $ -- $10,986,153 $ -- $ -- $10,986,153
=========== =========== ============ =========== ===========
For the year ended December 31, 2004
Allowance for returns and discounts .. $ 2,810,381 $ 738,326 $ -- $(2,485,386) $ 1,063,321
Allowance for bad debt ............... $ 1,416,002 $ 476,016 $ -- $ (517,474) $ 1,374,544
Inventory reserve .................... $10,986,153 $ -- $ -- $(9,869,491) $ 1,116,662
=========== =========== ============ =========== ===========
For the year ended December 31, 2005
Allowance for returns and discounts .. $ 1,063,321 $ 871,208 $ -- $ (949,268) $ 985,261
Allowance for bad debt ............... $ 1,374,544 $ 637,210 $ -- $ (45,265) $ 1,966,489
Inventory reserve .................... $ 1,116,662 $ -- $ -- $(1,032,836) $ 83,826
=========== =========== ============ =========== ===========
F-40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /S/ GERARD GUEZ
------------------------------------
Gerard Guez
Chairman of the Board
POWER OF ATTORNEY
The undersigned directors and officers of Tarrant Apparel Group do
hereby constitute and appoint Gerard Guez and Corazon Reyes, and each of them,
with full power of substitution and resubstitution, as their true and lawful
attorneys and agents, to do any and all acts and things in our name and behalf
in our capacities as directors and officers and to execute any and all
instruments for us and in our names in the capacities indicated below, which
said attorney and agent, may deem necessary or advisable to enable said
corporation to comply with the Securities Exchange Act of 1934, as amended and
any rules, regulations and requirements of the Securities and Exchange
Commission, in connection with this Annual Report on Form 10-K, including
specifically but without limitation, power and authority to sign for us or any
of us in our names in the capacities indicated below, any and all amendments
(including post-effective amendments) hereto, and we do hereby ratify and
confirm all that said attorneys and agents, or either of them, shall do or cause
to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
---------------------- ------------------------ --------------
Chairman of the Board March 31, 2006
/S/ GERARD GUEZ of Directors
----------------------
Gerard Guez
/S/ TODD KAY Vice Chairman of the March 31, 2006
---------------------- Board of Directors
Todd Kay
/S/ BARRY AVED Chief Executive Officer March 31, 2006
---------------------- and Director (Principal
Barry Aved Executive Officer)
/S/ CORAZON REYES Chief Financial Officer, March 31, 2006
---------------------- Treasurer and Director
Corazon Reyes (Principal Financial and
Accounting Officer)
/S/ MILTON KOFFMAN Director March 31, 2006
----------------------
Milton Koffman
/S/ STEPHANE FAROUZE Director March 31, 2006
----------------------
Stephane Farouze
/S/ MITCHELL SIMBAL Director March 31, 2006
----------------------
Mitchell Simbal
/S/ JOSEPH MIZRACHI Director March 31, 2006
----------------------
Joseph Mizrachi
Director March 31, 2006
----------------------
Simon Mani
S-1
TARRANT APPAREL GROUP
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
-------- --------------------------------------------------------------------
3.1 Restated Articles of Incorporation. (1)
3.1.1 Certificate of Amendment of Restated Articles of Incorporation. (7)
3.1.2 Certificate of Amendment of Restated Articles of Incorporation. (7)
3.1.3 Certificate of Amendment of Restated Articles of Incorporation. (14)
3.2 Restated Bylaws. (1)
4.1 Specimen of Common Stock Certificate. (2)
4.2 Rights Agreement dated as of November 21, 2003, between Tarrant
Apparel Group and Computershare Trust Company, as Rights Agent,
including the Form of Rights Certificate and the Summary of Rights
to Purchase Preferred Stock, attached thereto as Exhibits B and C,
respectively. (13)
4.3 Certificate of Determination of Preferences, Rights and Limitations
of Series B Preferred Stock. (15)
4.4 Form of 6% Secured Convertible Debenture. (22)
10.1 Tarrant Apparel Group Employee Incentive Plan.* (19)
10.2 Services Agreement dated as of October 1, 1994, by and between the
Company and Lynx International Limited. (1)
10.3 Indemnification Agreement dated as of March 14, 1995, by and among
Tarrant Apparel Group, Gerard Guez and Todd Kay. (2)
10.4 Employment Agreement effective January 1, 1998, by and between
Tarrant Apparel Group and Gerard Guez.* (4)
10.4.1 First amendment to Employment Agreement dated as of January 10, 2000
by and between Gerard Guez and Tarrant Apparel Group.* (6)
10.4.2 Second Amendment to Employment Agreement dated April 1, 2003 between
Tarrant Apparel Group and Gerard Guez.* (10)
10.4.3 Third Amendment to Employment Agreement, effective as of April 1,
2004, between Tarrant Apparel Group and Gerard Guez.* (20)
10.5 Employment Agreement effective January 1, 1998, by and between
Tarrant Apparel Group and Todd Kay.* (4)
10.5.1 First Amendment to Employment Agreement dated as of January 10, 2000
by and between Todd Kay and Tarrant Apparel Group.* (6)
10.5.2 Second Amendment to Employment Agreement dated April 1, 2003 between
Tarrant Apparel Group and Todd Kay.* (10)
10.5.3 Third Amendment to Employment Agreement, effective as of April 1,
2004, between Tarrant Apparel Group and Todd Kay.* (20)
EX-1
EXHIBIT
NUMBER DESCRIPTION
-------- --------------------------------------------------------------------
10.6 Buying Agency Agreement executed as of April 4, 1995, by Azteca
Production International, Inc. and Tarrant Company Ltd., with
Tarrant Apparel Group acknowledging as to certain matters. (2)
10.7 Form of Indemnification Agreement with directors and certain
executive officers. (3)
10.8 Factoring Agreement dated as of September 29, 2004 by and among GMAC
Commercial Finance LLC and Tarrant Apparel Group, Fashion Resource
(TCL), Inc., TAG Mex, Inc., United Apparel Ventures, LLC, Private
Brands, Inc. and NO! Jeans, Inc. (20)
10.8.1 First Amendment Factoring Agreement dated as of May 9, 2005 by and
among GMAC Commercial Finance LLC and Tarrant Apparel Group, Fashion
Resource (TCL), Inc., TAG Mex, Inc., United Apparel Ventures, LLC,
Private Brands, Inc. and NO! Jeans, Inc. (25)
10.8.2 Inventory Security Agreement by and among GMAC Commercial Finance
LLC and Tarrant Apparel Group, Fashion Resource (TCL), Inc., TAG
Mex, Inc., United Apparel Ventures, LLC, Private Brands, Inc. and
NO! Jeans, Inc. (25)
10.9 Promissory note dated February 28, 2001 in the amount of US
$4,119,545.06 to pay to the order of Standard Chartered Bank (5)
10.10 Amended and Restated Limited Liability Company Operating Agreement
of United Apparel Ventures, dated as of October 1, 2002, between
Azteca Production International, Inc. and Tag Mex, Inc. (9)
10.11 Guaranty Agreement dated as of May 30, 2002 by and between UPS
Capital Global Trade Finance Corporation and Tarrant Apparel Group
and Fashion Resource (TCL), Inc. (7)
10.11.1 Conditional Consent Agreement dated December 31, 2002, between UPS
Capital Global Trade Finance Corporation and Fashion Resource (TCL),
Inc. (8)
10.12 Guaranty Agreement dated as of May 30, 2002 by and between UPS
Capital Global Trade Finance Corporation and Gerard Guez. (7)
10.13 Syndicated Letter of Credit Facility dated June 13, 2002 by and
between Tarrant Company Limited, Marble Limited and Trade Link
Holdings Limited as Borrowers and UPS Capital Global Trade Finance
Corporation as Agent and Issuer and Certain Banks and Financial
Institutions as Banks. (7)
10.13.1 Charge Over Shares dated June 13, 2002 by Fashion Resource (TCL),
Inc. in favor of UPS Capital Global Trade Finance Corporation. (7)
10.13.2 Syndicated Composite Guarantee and Debenture dated June 13, 2002
between Tarrant Company Limited, Marble Limited and Trade link
Holdings Limited and UPS Capital Global Trade Finance Corporation.
(7)
10.13.3 Charge Over Shares dated February 26, 2003, between Machrima
Luxembourg International Sarl and UPS Global Trade Finance
Corporation. (9)
10.13.4 Fourth Deed of Variation to Syndicated Letter of Credit Facility
dated June 18, 2003 among Tarrant Company Limited, Marble Limited
and Trade Link Holdings Limited and UPS Capital Global Trade Finance
Corporation. (10)
10.13.5 Letter Agreement dated September 1, 2003, among Tarrant Company
Limited, Marble Limited, Trade Link Holdings Limited and UPS Capital
Global Trade Finance Corporation. (12)
EX-2
EXHIBIT
NUMBER DESCRIPTION
-------- --------------------------------------------------------------------
10.13.6 Fifth Deed of Variation to Syndicated Letter of Credit Facility
dated December 23, 2003 among Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited and UPS Capital Global Trade
Finance Corporation. (17)
10.13.7 Sixth Deed of Variation to Syndicated Letter of Credit Facility
dated March 17, 2004 among Tarrant Company Limited, Marble Limited
and Trade Link Holdings Limited and UPS Capital Global Trade Finance
Corporation. (18)
10.13.8 Seventh Deed of Variation to Syndicated Letter of Credit Facility
dated May 5, 2004 among Tarrant Company Limited, Marble Limited and
Trade Link Holdings Limited and UPS Capital Global Trade Finance
Corporation. (19)
10.13.9 Eighth Deed of Variation to Syndicated Letter of Credit Facility
effective as of May 10, 2004 among Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited and UPS Capital Global Trade
Finance Corporation. (19)
10.13.10 Ninth Deed of Variation to Syndicated Letter of Credit Facility
effective as of September 30, 2004 among Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited and UPS Capital
Global Trade Finance Corporation. (20)
10.13.11 Tenth Deed of Variation to Syndicated Letter of Credit Facility
effective as of December 31, 2004 among Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited and UPS Capital
Global Trade Finance Corporation. (23)
10.13.12 Loan Agreement dated December 31, 2004 by and among Tarrant Company
Limited, Marble Limited and Trade Link Holdings Limited and UPS
Capital Global Trade Finance Corporation. (23)
10.13.13 Amendment Agreement to Syndicated Composite Guarantee and Debenture
dated December 31, 2004, by and among Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited and UPS Capital
Global Trade Finance Corporation. (23)
10.13.14 Guaranty and Security Agreement dated December 31, 2004 by and among
Tarrant Apparel Group, Fashion Resource (TCL), Inc. and UPS Capital
Global Trade Finance Corporation. (23)
10.13.15 Guaranty and Security Agreement dated December 31, 2004 by and
between Tarrant Luxembourg Sarl and UPS Capital Global Trade Finance
Corporation. (23)
10.13.16 Amendment Agreement to Charge Over Shares dated December 31, 2004 by
and between Tarrant Luxembourg Sarl and UPS Capital Global Trade
Finance Corporation. (23)
10.13.17 Eleventh Deed of Variation to Syndicated Letter of Credit Facility
effective as of _______ among Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited and UPS Capital Global Trade
Finance Corporation. (25)
10.13.18 Twelfth Deed of Variation to Syndicated Letter of Credit Facility
effective as of June 27, 2005 among Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited and UPS Capital Global Trade
Finance Corporation. (25)
10.13.19 First Deed of Variation to Loan Agreement effective as of June 27,
2005 among Tarrant Company Limited, Marble Limited and Trade Link
Holdings Limited and UPS Capital Global Trade Finance Corporation.
(25)
10.13.20 Second Deed of Variation to Loan Agreement effective as of July
29, 2005 among Tarrant Company Limited, Marble Limited and Trade
Link Holdings Limited and UPS Capital Global Trade Finance
Corporation. (26)
EX-3
EXHIBIT
NUMBER DESCRIPTION
-------- --------------------------------------------------------------------
10.13.21 Thirteenth Deed of Variation to Syndicated Letter of Credit Facility
effective as of July 29, 2005 among Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited and UPS Capital Global Trade
Finance Corporation. (26)
10.13.22 Fourteenth Deed of Variation to Syndicated Letter of Credit Facility
effective as of August 31, 2005 among Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited and UPS Capital
Global Trade Finance Corporation. (26)
10.13.23 Fifteenth Deed of Variation to Syndicated Letter of Credit Facility
effective as of October 31, 2005 among Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited and UPS Capital
Global Trade Finance Corporation.
10.14 Assignment of Promissory Note by Tarrant Apparel Group to Tarrant
Company Limited and to Trade Link Holdings Company dated December
26, 2001. (7)
10.15 Exclusive Distribution Agreement dated April 1, 2003, between
Federated Merchandising Group, an unincorporated division of
Federated Department Stores, and Private Brands, Inc. (9)
10.15.1 Amendment No. 1 to Exclusive Distribution Agreement dated as of June
22, 2004, between Federated Merchandising Group, an unincorporated
division of Federated Department Stores, and Private Brands, Inc.
(19)
10.15.2 Amendment No. 2 to Exclusive Distribution Agreement dated as of
March 7, 2005, between Macy's Merchandising Group, LLC and Private
Brands, Inc. (24)
10.15.3 Trademark Sublicense Agreement dated as of March 3, 2005, between
Macy's Merchandising Group, LLC and Private Brands, Inc. (24) 10.16
Unconditional Guaranty of Performance dated April 1, 2003, by
Tarrant Apparel Group. (9)
10.17 Promissory Note dated May 31, 2003 made by Gerard Guez in favor of
Tarrant Apparel Group. (10)
10.18 Indemnification Agreement dated April 10, 2003 between Tarrant
Apparel Group and Seven Licensing Company, LLC. (10)
10.19 Registration Rights Agreement dated October 17, 2003, by and among
Tarrant Apparel Group and Sanders Morris Harris Inc. as agent and
attorney-in-fact for the Purchasers identified therein. (11)
10.20 Common Stock Purchase Warrant dated October 17, 2003, by and between
Tarrant Apparel Group and Sanders Morris Harris Inc. (11)
10.21 Employment Agreement, effective as of September 1, 2003, between the
Company and Barry Aved. (12)
10.22 Employment Agreement, dated September 16, 2005, between Tarrant
Company Limited and Henry Chu. (26)
10.23 Common Stock Purchase Warrant dated January 26, 2004 between Tarrant
Apparel Group and Sanders Morris Harris Inc. (16)
10.24 Agreement for Purchase of Assets dated August 13, 2004 among Tarrant
Mexico S. de R.L. de C.V., Acabados Y Cortes Textiles S.A. de C.V.
and Construcciones Solticio S.A. de C.V. (20)
10.24.1 Amendment No. 1 to Agreement for Purchase of Assets dated October
29, 2004 among Tarrant Mexico S. de R.L. de C.V., Acabados Y Cortes
Textiles S.A. de C.V. and Construcciones Solticio S.A. de C.V. (20)
EX-4
EXHIBIT
NUMBER DESCRIPTION
-------- --------------------------------------------------------------------
10.25 Termination Agreement dated August 13, 2004 among Tarrant Mexico, S.
de R.L. de C.V., Inmobiliaria Cuadros, S.A., de C.V. and Acabados y
Cortes Textiles S.A. de C.V. (20)
10.26 Securities Purchase Agreement dated December 6, 2004, by and between
Tarrant Apparel Group and the investors listed on the signature
pages thereto. (21)
10.27 Registration Rights Agreement dated December 14, 2004, by and among
Tarrant Apparel Group and the investors listed on the signature
pages thereto. (22)
10.28 Security Agreement dated December 14, 2004, by and among Tarrant
Apparel Group and the investors listed on the signature pages
thereto. (22)
10.29 Intercreditor Agreement dated December 14, 2004 by and among Tarrant
Apparel Group, GMAC Commercial Finance, LLC, UPS Capital Global
Trade Finance Corporation and T.R. Winston & Company, LLC. (22)
10.30 Common Stock Purchase Warrant dated December 14, 2004 issued by
Tarrant Apparel Group in favor of T.R. Winston & Company, LLC. (22)
10.31 Form of Common Stock Purchase Warrant. (22)
10.32 Promissory Note in the principal amount of $5,000,000 dated as of
February 15, 2005, issued by Tarrant Apparel Group in favor of Max
Azria. (24)
10.33 Tenancy Agreement, dated July 1, 2005, between Tarrant Company
Limited and Lynx International Limited. (26)
14.1 Code of Ethical Conduct. (17)
21.1 Subsidiaries.
23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP.
23.2 Consent of Grant Thornton LLP.
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.
----------
* Management contract or compensatory plan or arrangement.
(1) Filed as an exhibit to the Company's Registration Statement on Form
S-1 filed with the Securities and Exchange Commission on May 4, 1995
(File No. 33-91874).
(2) Filed as an exhibit to Amendment No. 1 to Registration Statement on
Form S-1 filed with the Securities and Exchange Commission on July
15, 1995.
(3) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997.
(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for
the year ended December 31, 1998.
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for
the year ending December 31, 2000.
(6) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ending March 31, 2001.
EX-5
(7) Filed as an exhibit to the Company's Quarterly Report on Form 10Q
for the quarter ending June 30, 2002.
(8) Filed as an exhibit to the Company's Annual Report on Form 10K for
the year ending December 31, 2002.
(9) Filed as an exhibit to the Company's Quarterly Report on Form 10Q
for the quarter ending March 31, 2003.
(10) Filed as an exhibit to the Company's Quarterly Report on Form 10Q
for the quarter ending June 30, 2003.
(11) Filed as an exhibit to the Company's Current Report on Form 8-K
dated October 16, 2003.
(12) Filed as an exhibit to the Company's Quarterly Report on Form 10Q
for the quarter ending September 30, 2003.
(13) Filed as an exhibit to the Company's Current Report on Form 8-K
dated November 12, 2003.
(14) Filed as an exhibit to the Company's Current Report on Form 8-K
dated December 4, 2003.
(15) Filed as an exhibit to the Company's Amendment to Current Report on
Form 8-K/A, filed December 12, 2003.
(16) Filed as an exhibit to the Company's Current Report on Form 8-K
dated January 23, 2004.
(17) Filed as an exhibit to the Company's Annual Report on Form 10-K for
year ending December 31, 2003.
(18) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ending March 31, 2004.
(19) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ending June 30, 2004.
(20) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ending September 30, 2004.
(21) Filed as an exhibit to the Company's Current Report on Form 8-K
dated December 6, 2004.
(22) Filed as an exhibit to the Company's Current Report on Form 8-K
dated December 14, 2004.
(23) Filed as an exhibit to the Company's Annual Report on Form 10-K for
the year ending December 31, 2004.
(24) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ending March 31, 2005.
(25) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ending June 30, 2005.
(26) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ending September 30, 2005.
EX-6