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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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
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TARRANT APPAREL GROUP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-4181026
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
3151 EAST WASHINGTON BOULEVARD
LOS ANGELES, CALIFORNIA 90023
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (323) 780-8250
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Number of shares of Common Stock of the registrant outstanding as of November
10, 2005: 30,553,763.
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TARRANT APPAREL GROUP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at September 30, 2005 (Unaudited)
and December 31, 2004 (Audited) .................................. 2
Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Three Months and Nine Months Ended
September 30, 2005 and September 30, 2004 ........................ 3
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2005 and September 30, 2004 .................. 4
Notes to Consolidated Financial Statements ....................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk ....... 34
Item 4. Controls and Procedures .......................................... 34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................ 35
Item 6. Exhibits ......................................................... 35
SIGNATURES ....................................................... 36
CAUTIONARY LEGEND REGARDING FORWARD-LOOKING STATEMENTS
Some of the information in this Quarterly Report on Form 10-Q may
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
both as amended. These forward-looking statements are subject to various risks
and uncertainties. The forward-looking statements include, without limitation,
statements regarding our future business plans and strategies and our future
financial position or results of operations, as well as other statements that
are not historical. You can find many of these statements by looking for words
like "will", "may", "believes", "expects", "anticipates", "plans" and
"estimates" and for similar expressions. Because forward-looking statements
involve risks and uncertainties, there are many factors that could cause the
actual results to differ materially from those expressed or implied. These
include, but are not limited to, economic conditions. This Quarterly Report on
Form 10-Q contains important cautionary statements and a discussion of many of
the factors that could materially affect the accuracy of Tarrant's
forward-looking statements and such statements and discussions are incorporated
herein by reference. Any subsequent written or oral forward-looking statements
made by us or any person acting on our behalf are qualified in their entirety by
the cautionary statements and factors contained or referred to in this section.
We do not intend or undertake any obligation to update any forward-looking
statements to reflect events or circumstances after the date of this document or
the date on which any subsequent forward-looking statement is made or to reflect
the occurrence of unanticipated events.
1
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- -------------
(Unaudited) (Audited)
ASSETS
Current assets:
Cash and cash equivalents .............................. $ 1,636,941 $ 1,214,944
Accounts receivable, net ............................... 64,859,916 37,759,343
Due from related parties ............................... 3,794,229 10,651,914
Inventory .............................................. 26,364,421 19,144,105
Current portion of notes receivable from related parties 5,323,733 5,323,733
Prepaid expenses ....................................... 1,292,308 1,251,684
Prepaid royalties ...................................... 2,162,450 2,257,985
Income taxes receivable ................................ 145,236 144,796
------------- -------------
Total current assets ..................................... 105,579,234 77,748,504
Property and equipment, net ............................ 1,745,910 1,874,893
Notes receivable - related party, net of current portion 38,728,558 40,107,337
Due from related parties ............................... 2,796,516 --
Equity method investment ............................... 2,140,228 1,880,281
Deferred financing cost, net ........................... 950,634 1,203,259
Other assets ........................................... 173,674 414,161
Goodwill, net .......................................... 8,582,845 8,582,845
------------- -------------
Total assets ............................................. $ 160,697,599 $ 131,811,280
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings ............................. $ 15,414,942 $ 17,951,157
Accounts payable ....................................... 28,028,676 24,394,553
Accrued expenses ....................................... 11,824,895 11,243,179
Income taxes ........................................... 17,597,599 16,826,383
Current portion of long-term obligations ............... 44,243,959 19,628,701
------------- -------------
Total current liabilities ................................ 117,110,071 90,043,973
Long-term obligations ..................................... 660,425 2,544,546
Convertible debentures, net ............................... 5,846,657 8,330,483
Deferred tax liabilities .................................. 152,233 213,784
Minority interest in UAV and PBG7 ......................... 163,577 --
Commitments and contingencies ............................. -- --
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized; no shares
(2005) and (2004) issued and outstanding ............ -- --
Common stock, no par value, 100,000,000 shares
authorized; 30,553,763 shares (2005) and 28,814,763
shares (2004) issued and outstanding ................. 114,977,465 111,515,091
Warrant to purchase common stock ....................... 2,846,833 2,846,833
Contributed capital .................................... 9,965,591 9,965,591
Accumulated deficit .................................... (88,715,524) (91,182,959)
Notes receivable from officer/shareholder .............. (2,309,729) (2,466,062)
------------- -------------
Total shareholders' equity ............................... 36,764,636 30,678,494
------------- -------------
Total liabilities and shareholders' equity ............... $ 160,697,599 $ 131,811,280
============= =============
The accompanying notes are an integral part of these consolidated financial
statements
2
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2005 2004 2005 2004
------------- ------------- ------------- -------------
Net sales ............................... $ 69,566,080 $ 38,102,733 $ 164,934,075 $ 118,746,577
Cost of sales ........................... 55,020,926 33,968,166 129,988,823 101,846,372
------------- ------------- ------------- -------------
Gross profit ............................ 14,545,154 4,134,567 34,945,252 16,900,205
Selling and distribution expenses ....... 2,846,445 2,081,389 7,812,476 7,110,002
General and administrative expenses ..... 7,398,722 5,494,741 20,270,148 25,564,599
Royalty expenses ........................ 1,288,634 125,000 2,181,325 417,873
Impairment of assets .................... -- -- -- 77,982,034
------------- ------------- ------------- -------------
Income (loss) from operations ........... 3,011,353 (3,566,563) 4,681,303 (94,174,303)
Interest expense ........................ (1,301,271) (700,451) (3,400,081) (2,194,080)
Interest income ......................... 505,913 94,067 1,575,727 281,292
Other income ............................ 168,176 383,899 753,894 6,994,834
Other expense ........................... (228) (194,391) (559) (623,719)
Minority interest ....................... (163,576) 180,264 (163,576) 15,196,733
------------- ------------- ------------- -------------
Income (loss) before provision for income
taxes ................................ 2,220,367 (3,803,175) 3,446,708 (74,519,243)
Provision for income taxes .............. 517,950 215,511 979,272 1,040,154
------------- ------------- ------------- -------------
Net income (loss) ....................... $ 1,702,417 $ (4,018,686) $ 2,467,436 $ (75,559,397)
============= ============= ============= =============
Net income (loss) per share:
Basic ................................ $ 0.06 $ (0.14) $ 0.08 $ (2.63)
============= ============= ============= =============
Diluted .............................. $ 0.06 $ (0.14) $ 0.08 $ (2.63)
============= ============= ============= =============
Weighted average common and common
equivalent shares:
Basic ................................ 30,365,502 28,814,763 29,451,054 28,705,274
============= ============= ============= =============
Diluted .............................. 30,785,797 28,814,763 29,517,251 28,705,274
============= ============= ============= =============
Net income (loss) ....................... $ 1,702,417 $ (4,018,686) $ 2,467,436 $ (75,559,397)
Foreign currency translation adjustment . -- 56,998 -- (2,908,207)
------------- ------------- ------------- -------------
Total comprehensive income (loss) ....... $ 1,702,417 $ (3,961,688) $ 2,467,436 $ (78,467,604)
============= ============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements
3
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED SEPTEMBER 30,
------------- -------------
2005 2004
------------- -------------
Operating activities:
Net income (loss) ......................................... $ 2,467,436 $ (75,559,397)
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Deferred taxes ......................................... (61,551) (31,992)
Depreciation and amortization .......................... 1,738,937 7,940,452
Asset impairment ....................................... -- 77,982,034
Unrealized gain on foreign currency .................... -- (362,159)
Compensation expense related to stock option ........... 38,740 161,037
Provision for returns and discounts .................... 372,805 (323,925)
(Gain) loss on sale of fixed assets .................... (113,968) 8,811
Income from investments ................................ (475,947) (723,450)
Minority interest ...................................... 163,577 (15,196,731)
Changes in operating assets and liabilities:
Restricted cash ...................................... -- 2,759,742
Accounts receivable .................................. (27,473,378) 17,296,369
Due to/from related parties .......................... 1,982,152 (1,792,814)
Inventory ............................................ (6,819,037) 9,561,962
Temporary quota rights ............................... -- (1,306,543)
Prepaid expenses and other receivables ............... 54,471 (127,714)
Accounts payable ..................................... 3,634,123 (5,152,284)
Accrued expenses and income tax payable .............. 1,689,190 795,242
------------- -------------
Net cash (used in) provided by operating activities .. (22,802,450) 15,928,640
Investing activities:
Net (purchase) sale of fixed assets .................... (452,930) 194,357
Proceeds from sale of fixed assets ..................... 119,506 3,086,350
Investment in equity investment method ................. -- (75,000)
Distribution from equity investment method ............. 216,000 --
Collection on notes receivable ......................... 977,500 --
Investment in joint venture ............................ -- (225,899)
Collection of advances from shareholders/officers ...... 2,456,334 20,778
------------- -------------
Net cash provided by investing activities ............ 3,316,410 3,000,586
Financing activities:
Short-term bank borrowings, net ........................ (2,536,215) (1,707,608)
Proceeds from long-term obligations .................... 167,099,510 89,259,375
Payment of long-term obligations and bank borrowings ... (144,655,258) (111,585,581)
Proceeds from issuance of common stock and warrant ..... -- 3,667,765
------------- -------------
Net cash provided by (used in) financing activities .. 19,908,037 (20,366,049)
Effect of exchange rate on cash ........................... -- (114,062)
------------- -------------
Decrease in cash and cash equivalents ..................... 421,997 (1,550,885)
Cash and cash equivalents at beginning of period .......... 1,214,944 3,319,964
------------- -------------
Cash and cash equivalents at end of period ................ $ 1,636,941 $ 1,769,079
============= =============
The accompanying notes are an integral part of these consolidated financial
statements
4
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. ORGANIZATION AND BASIS OF CONSOLIDATION
The accompanying financial statements consist of the consolidation of
Tarrant Apparel Group, a California corporation, and its majority owned
subsidiaries located primarily in the U.S., Mexico, and Asia. At September 30,
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. In August 2004, we entered into a purchase and sale
agreement to sell these facilities to affiliates of Mr. Nacif, which transaction
was consummated in the fourth quarter of 2004.
Historically, our operating results have been subject to seasonal
trends when measured on a quarterly basis. This trend is dependent on numerous
factors, including the markets in which we operate, holiday seasons, consumer
demand, climate, economic conditions and numerous other factors beyond our
control. Generally, the second and third quarters are stronger than the first
and fourth quarters. There can be no assurance that the historic operating
patterns will continue in future periods.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("US GAAP") for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by US GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation of the results
of operations for the periods presented have been included.
The consolidated financial data at December 31, 2004 is derived from
audited financial statements which are included in our Annual Report on Form
10-K for the year ended December 31, 2004, as amended, and should be read in
conjunction with the audited financial statements and notes thereto. Interim
results are not necessarily indicative of results for the full year.
The accompanying unaudited consolidated financial statements include
all majority-owned subsidiaries in which we exercise control. Investments in
which we exercise significant influence, but which we do not control, are
accounted for under the equity method of accounting. The equity method of
accounting is used when we have a 20% to 50% interest in other entities, except
for variable interest entities for which we are considered the primary
beneficiary under Financial Accounting Standards Board ("FASB") Interpretation
No. 46, "Consolidation of Variable Interest Entities," an interpretation of ARB
No. 51. Under the equity method, original investments are recorded at cost and
adjusted by our share of undistributed earnings or losses of these entities. All
significant intercompany transactions and balances have been eliminated from the
consolidated financial statements.
The preparation of financial statements in conformity with US GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates used by
us in preparation of the consolidated financial statements include: (i)
allowance for returns, discounts and bad debts, (ii) inventory, (iii) valuation
of long lived and intangible assets and goodwill, and (iv) income taxes. Actual
results could differ from those estimates.
5
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 certain percentage of net sales. All of
these agreements include minimum royalties. See Note 14 of the "Notes to
Consolidated Financial Statements" regarding various agreements we have entered
into.
Certain 2004 amounts have been reclassified to conform to the 2005
presentation.
3. STOCK BASED COMPENSATION
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.
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.
For the three months ended September 30, 2005 and 2004, $39,000 and $54,000 were
recorded, respectively, as an expense related to our stock options. For the nine
months ended September 30, 2005 and 2004, $39,000 and $161,000 were recorded,
respectively, as an expense related to our stock options.
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:
6
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net income (loss) as reported ........... $ 1,702,417 $ (4,018,686) $ 2,467,436 $(75,559,397)
Add stock-based employee compensation
charges reported in net loss ......... 38,740 53,679 38,740 161,037
Pro forma compensation expense, net of
tax ................................... (3,248,221) (970,416) (4,298,193) (3,596,972)
------------ ------------ ------------ ------------
Pro forma net loss ...................... $ (1,507,064) $ (4,935,423) $ (1,792,017) $(78,995,332)
============ ============ ============ ============
Net income (loss) per share as reported -
Basic .................................. $ 0.06 $ (0.14) $ 0.08 $ (2.63)
Add stock-based employee compensation
charges reported in net loss - Basic .. -- -- -- --
Pro forma compensation expense per share
-- Basic .............................. (0.11) (0.03) (0.14) (0.12)
------------ ------------ ------------ ------------
Pro forma loss per share -- Basic ....... $ (0.05) $ (0.17) $ (0.06) $ (2.75)
============ ============ ============ ============
Net income (loss) per share as reported
-- Diluted ............................ $ 0.06 $ (0.14) $ 0.08 $ (2.63)
Add stock-based employee compensation
charges reported in net loss - Diluted -- -- -- --
Pro forma compensation expense per share
-- Diluted ............................ (0.11) (0.03) (0.14) (0.12)
------------ ------------ ------------ ------------
Pro forma loss per share -- Diluted ..... $ (0.05) $ (0.17) $ (0.06) $ (2.75)
============ ============ ============ ============
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 2005 and 2004: weighted-average volatility
factors of the expected market price of our common stock of 0.55 for the three
months and nine months ended September 30, 2005 and 2004, weighted-average
risk-free interest rates of 4% for the three months and nine months ended
September 30, 2005 and 2004, dividend yield of 0% and weighted-average expected
life of the options of 4 years. These pro forma results may not be indicative of
the future results for the full fiscal year due to potential grants, vesting and
other factors.
4. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------ ------------
U.S. trade accounts receivable ................. $ 6,717,320 $ 3,248,887
Foreign trade accounts receivable .............. 17,614,864 17,148,600
Factored accounts receivable ................... 41,357,978 19,452,756
Other receivables .............................. 2,197,742 346,965
Allowance for returns, discounts and bad debts . (3,027,988) (2,437,865)
------------ ------------
$ 64,859,916 $ 37,759,343
============ ============
5. INVENTORY
Inventory consists of the following:
SEPTEMBER 30, DECEMBER 31,
2005 2004
----------- -----------
Raw materials - fabric and trim accessories .... $ 2,392,647 $ 1,164,977
Finished goods shipments-in-transit ............ 7,184,557 9,283,022
Finished goods ................................. 16,787,217 8,696,106
----------- -----------
$26,364,421 $19,144,105
=========== ===========
7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 Macy's Merchandising Group,
LLC ("MMG"), the sourcing arm of Federated Department Stores, to supply MMG with
American Rag CIE, a casual sportswear collection for juniors and young men.
Under this arrangement, Private Brands designs and manufactures American Rag
apparel, which is distributed by MMG exclusively to Federated stores across the
country. Beginning in August 2003, the American Rag collection was available in
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
$2.1 million at September 30, 2005, is accounted for under the equity method and
included in equity method investment on the accompanying consolidated balance
sheets. Income from the equity method investment is recorded in the United
States geographical segment. The change in investment in American Rag during the
nine month ended September 30, 2005 was as follows:
Balance as of December 31, 2004 ............ $ 1,880,281
Share of income ............................ 475,947
Distribution ............................... (216,000)
-----------
Balance as of September 30, 2005 .......... $ 2,140,228
===========
7. DEBT
Short-term bank borrowings consist of the following:
SEPTEMBER 30, DECEMBER 31,
2005 2004
----------- -----------
Import trade bills payable - UPS, DBS Bank
and Aurora Capital .......................... $ 6,457,570 $ 3,902,714
Bank direct acceptances - UPS and DBS Bank ..... 3,000,480 10,447,855
Other Hong Kong credit facilities - UPS and
DBS Bank .................................... 5,956,892 3,600,588
----------- -----------
$15,414,942 $17,951,157
=========== ===========
Long-term obligations consist of the following:
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------ ------------
Vendor financing ................... $ 26,789 $ 135,145
Equipment financing ................ 66,031 78,038
Term loan - UPS .................... 3,125,000 5,000,000
Debt facility - GMAC ............... 41,686,564 16,960,064
------------ ------------
44,904,384 22,173,247
Less current portion ............... (44,243,959) (19,628,701)
------------ ------------
$ 660,425 $ 2,544,546
============ ============
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
7.75% per annum at September 30, 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,
8
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 extend the
expiration date of the facility from August 31, 2005 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 from
October 31, 2005 to January 31, 2006 and amend the interest rate to "prime rate"
plus 3%. The most recent facility amendment also provides for reduction in the
maximum amount of borrowings to $13.5 million commencing on November 1, 2005, to
$13 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. Under the amended letter of credit facility, we are
subject to restrictive financial covenants of maintaining tangible net worth of
$22 million at December 31, 2004, March 31, 2005 and June 30, 2005, and $25
million as of the last day of each fiscal quarter thereafter. There is also a
provision capping maximum capital expenditures per quarter of $800,000. As of
September 30, 2005, we were in compliance with the covenants. As of September
30, 2005, $11.3 million was outstanding under this facility with UPS (classified
above as follows: $3.9 million in import trade bills payable; $3.0 million in
bank direct acceptances and $4.4 million in other Hong Kong credit facilities)
and an additional $0.8 million was available for future borrowings. In addition,
$2.4 million of open letters of credit was outstanding as of September 30, 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 September 30, 2005, $2.9
million was outstanding under this facility. In addition, $0.8 million of open
letters of credit was outstanding and $91,000 was available for future
borrowings as of September 30, 2005. In October 2004, a tax loan for HKD 7.725
million (equivalent to US $977,000) was also made available to our Hong Kong
subsidiaries. As of September 30, 2005, $171,000 was outstanding under this
loan.
As of September 30, 2005, the total balance outstanding under the DBS
Bank credit facilities was $3.1 million (classified above as follows: $1.5
million in import trade bills payable, $0.1 million in bank direct acceptances
and $1.5 million in other Hong Kong credit facilities).
From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates which issues these letters of credits
out of Israeli Discount Bank. As of September 30, 2005, $1.0 million was
outstanding under this facility (classified above under import trade bills
payable) and $5.1 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 loan in its entirety.
EQUIPMENT FINANCING
We had two equipment loans outstanding at September 30, 2005 totaling
$66,000 bearing interest at 6% payable in installments through 2009.
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 8.75% per annum at September 30, 2005. On
June 27, 2005, we amended the loan agreement
9
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 $22 million at December 31, 2004, March 31,
2005 and June 30, 2005, and $25 million as of the last day of each fiscal
quarter thereafter. There is also a provision capping maximum capital
expenditure per quarter at $800,000. As of September 30, 2005, we were in
compliance with the covenants. As of September 30, 2005, $3.1 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- 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 loss, and (b) $5
million minus in each case, any amounts owed to GMAC by PBG7. The facility bears
interest at 6.86% per annum and the facility under PBG7, LLC bears interest at
7.25% per annum at September 30, 2005. Restrictive covenants under the revised
facility include a limit on quarterly capital expenses of $800,000 and tangible
net worth of $20 million at September 30, 2004, $22 million at December 31, 2004
and March 31, 2005 and $25 million at the end of each fiscal quarter thereafter
beginning on June 30, 2005. On June 29, 2005, GMAC agreed to reduce the tangible
net worth requirement at June 30, 2005 from $25 million to $22 million. The
tangible net worth requirement of $25 million resumes at September 30, 2005 and
at the end of each fiscal quarter thereafter. As of September 30, 2005, we were
in compliance with the covenants. A total of $38.7 million was outstanding with
respect to receivables factored under the GMAC facility at September 30, 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. The maximum borrowing
availability under the factoring agreement, based on a borrowing base formula,
remained $40 million. In connection with this amendment, we granted GMAC a lien
on certain of our inventory located in the United States. A total of $3.0
million was outstanding under the GMAC facility at September 30, 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.
10
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. 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.
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 the first nine months of 2005
was $355,000. Total deferred financing cost amortized in the first nine months
of 2005 was $142,000. Total interest paid to the holders of the Debentures in
the first nine months of 2005 was $435,000. As of September 30, 2005, $5.8
million, net of $1.1 million of debt discount, remained outstanding under the
Debentures.
9. EQUITY TRANSACTIONS
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 8 of the "Notes to Consolidated
Financial Statements."
10. 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
11
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
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 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.
11. INCOME TAXES
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, we are 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.
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 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 $12.6
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.
12
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
12. NET INCOME (LOSS) PER SHARE
A reconciliation of the numerator and denominator of basic earnings
(loss) per share and diluted earnings (loss) per share is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Basic EPS Computation:
Numerator ..................... $ 1,702,417 $ (4,018,686) $ 2,467,436 $(75,559,397)
Denominator:
Weighted average common shares
outstanding ................... 30,365,502 28,814,763 29,451,054 28,705,274
------------ ------------ ------------ ------------
Basic EPS ..................... $ 0.06 $ (0.14) $ 0.08 $ (2.63)
============ ============ ============ ============
Diluted EPS Computation:
Numerator ..................... $ 1,702,417 $ (4,018,686) $ 2,467,436 $(75,559,397)
Denominator:
Weighted average common share
outstanding ................... 30,365,502 28,814,763 29,451,054 28,705,274
Incremental shares from assumed
exercise of warrant ........... 403,266 -- 59,040 --
Incremental shares from assumed
exercise of options ........... 17,029 -- 7,157 --
------------ ------------ ------------ ------------
Total shares .................. 30,785,797 28,814,763 29,517,251 28,705,274
------------ ------------ ------------ ------------
Diluted EPS ................... $ 0.06 $ (0.14) $ 0.08 $ (2.63)
============ ============ ============ ============
Basic and diluted loss per share has been computed in accordance with
SFAS No. 128, "Earnings Per Share".
For options and warrants outstanding as of September 30, 2005, only
7,157 and 59,040 shares of outstanding options and warrants, respectively, were
included in the computation of income per share in the nine months ended
September 30, 2005 as the exercise prices of the remaining shares were greater
than the average market price for the nine months ended September 30, 2005. All
options and warrants were excluded from the computation of loss per share in the
nine months ended September 30, 2004, as the impact would be anti-dilutive. The
effect of applying "IF Converted Method" to the convertible debenture was
anti-dilutive, therefore, it was excluded from the computation of income per
share in the nine months ended September 30, 2005. The following table presents
outstanding options, warrants and convertible debentures.
AS OF SEPTEMBER 30,
-------------------------
2005 2004
---------- ----------
Options ........................ 6,745,175 8,759,862
Warrants ....................... 2,361,732 911,732
Convertible debentures ......... 3,456,313 --
---------- ----------
Total .......................... 12,563,220 9,671,594
========== ==========
13
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
13. RELATED PARTY TRANSACTIONS
As of September 30, 2005, related party affiliates were indebted to us
in the amounts of $8.9 million. These include amounts due from Gerard Guez, our
Chairman. 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 in the third quarter of 2005 was approximately $2,352,000. At September 30,
2005, the entire balance due from Mr. Guez totaling $2.3 million is payable on
demand and has been shown as reductions to 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 $45,000 and $92,000 for the three
months ended September 30, 2005 and 2004, respectively. Total interest paid by
Mr. Guez was $165,000 and $278,000 for the nine months ended September 30, 2005
and 2004, respectively. Mr. Guez paid expenses on our behalf of approximately
$87,000 and $98,000 for the three months ended September 30, 2005 and 2004,
respectively, which amounts were applied to reduce accrued interest and
principal on Mr. Guez's loan. Mr. Guez paid expenses on our behalf of
approximately $321,000 and $299,000 for the nine months ended September 30, 2005
and 2004, respectively, which amounts were applied to reduce accrued interest
and principal on Mr. Guez's loan. These amounts included fuel and related
expenses incurred by 477 Aviation, LLC, a company owned by Mr. Guez, when our
executives used this company's aircraft for business purposes. Since the
enactment of the Sarbanes-Oxley Act in 2002, no further personal loans (or
amendments to existing loans) have been or will be made to our executive
officers or directors.
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 made purchases from two related
parties in Mexico, an affiliate of Azteca and Tag-It Pacific, Inc.
Commencing in June 2003, UAV began selling to Seven Licensing Company,
LLC ("Seven Licensing"), jeans wear bearing the brand "Seven7", which was
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 Seven7
in the three months ended September 30, 2005 and 2004 were $0 and $42,000,
respectively. Total sales to Seven7 in the nine months ended September 30, 2005
and 2004 were $0 and $3.4 million, 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.
Commencing in 1998, Tag-It assumed the responsibility for managing and sourcing
all trim and packaging used in connection with products manufactured by or on
behalf of us in Mexico. Due to the restructuring of our Mexico operations,
Tag-It no longer manages our trim and packaging requirements. We purchased
$20,000 and $465,000 of trim inventory from Tag-It in the three months ended
September 30, 2005 and 2004, respectively. We purchased $55,000 and $1.2 million
of trim inventory from Tag-It in the nine months ended September 30, 2005 and
2004, respectively. We purchased $0 and $2.0 million of finished goods and
service from Azteca and its affiliates in the three months ended September 30,
2005 and 2004, respectively. We purchased $135,000 and $7.5 million of finished
goods and service from Azteca and its affiliates in the nine months ended
September 30, 2005 and 2004, respectively. Our total sales of fabric and service
to Azteca in the three months ended September 30, 2005 and 2004 were $0. Our
total sales of fabric and service to Azteca in the nine months ended September
30, 2005 and 2004 were $63,000 and $1.0 million, respectively. Pursuant to the
operating agreement for UAV, two and one half percent of gross sales of UAV were
paid to each of the members of UAV as management fees. Net amount due from these
related parties as of September 30, 2005 was $6.0 million. Of this amount, $5.2
million was due from Azteca. We have received a commitment from Azteca to make
payments of $200,000 per month starting in October 2005 to repay this balance.
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
14
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
of the transaction, which agreement was amended in October 2004. Pursuant
to the agreement, as amended, on November 30, 2004, we sold to the purchasers
substantially all of our assets and real property in Mexico, including the
equipment and facilities we previously leased to Mr. Nacif's affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and $3,910,000 by delivery of unsecured promissory notes bearing interest at
5.5% per annum; and b) $40,204,000, by delivery of secured promissory notes
bearing interest at 4.5% per annum, maturing on December 31, 2005 and every year
thereafter until December 31, 2014. The secured promissory notes are payable in
partial or total amounts anytime prior to the maturity of each note. Included in
the $44.1 million notes receivable - related party on the accompanying balance
sheet as of September 30, 2005 was $1.3 million of Mexico value added taxes on
the real property component of this transaction. 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. We purchased $2.3 million and
$1.1 million of fabric from Acabados y Terminados in the three months ended
September 30, 2005 and 2004, respectively. We purchased $4.1 million and $5.3
million of fabric from Acabados y Terminados in the nine months ended September
30, 2005 and 2004, respectively. Net amount due from these parties as of
September 30, 2005 was $238,000.
Under lease agreements we entered into between two entities, GET and
Lynx International Limited, owned by our Chairman and Vice Chairman, we paid
$255,000 and $332,000 in the three months ended September 30, 2005 and 2004,
respectively, for office and warehouse facilities. We paid $764,000 and $996,000
in the nine months ended September 30, 2005 and 2004, respectively, for office
and warehouse facilities. The lease with Lynx International Limited for our Hong
Kong facility expires on December 31, 2005. We currently lease our Los Angeles
facility from GET on a month-to-month basis.
At September 30, 2005, we had various employee receivables totaling
$380,000 included in due from related parties.
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.
14. COMMITMENTS AND CONTINGENCIES
On January 3, 2005, Private Brands, Inc, our wholly owned subsidiary,
entered into an agreement with Beyond Productions, LLC and Kids Headquarters to
collaborate on the design, manufacturing and distribution of women's
contemporary apparel bearing the brand name "House of Dereon", Couture, Kick and
Soul. This agreement has an initial three-year term, and provided we are in
compliance with the terms of the agreement, 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 provides for royalty payments of
8% on net sales, and a marketing fund commitment of 3% of net sales, for a total
minimum payment obligation of $6.6 million over the initial term of the
agreement. As of September 30, 2005, we have advanced $1.2 million as payment
for the first year's minimum royalty and marketing fund commitment.
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 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. As of September 30, 2005, we had advanced
$2.2 million as payment for the first year's minimum royalties. We had applied
$1.2 million from the advance against the royalty and marketing expenses in the
nine months ended September 30, 2005.
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
15
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
of $10.4 million over the initial 10-year term of the agreement. At September
30, 2005, the total commitment on royalties remaining on the term was $9.2
million.
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. We purchased
$2.3 million and $3.2 million of fabric under this agreement in the three months
and nine months ended September 30, 2005, respectively.
15. 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 three geographic
regions: the United States, Asia and Mexico. 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, and Mexico is presented below.
Inter-company revenues and assets have been eliminated to arrive at the
consolidated amounts.
ADJUSTMENTS
AND
UNITED STATES ASIA MEXICO ELIMINATIONS TOTAL
------------- ------------- ------------- ------------- -------------
THREE MONTHS ENDED
SEPTEMBER 30, 2005
Sales ....................... $ 69,023,000 $ 536,000 $ 7,000 $ -- $ 69,566,000
Inter-company sales ......... -- 43,576,000 -- (43,576,000) --
------------- ------------- ------------- ------------- -------------
Total revenue ............... $ 69,023,000 $ 44,112,000 $ 7,000 $ (43,576,000) $ 69,566,000
============= ============= ============= ============= =============
Income (loss) from operations $ 275,000 $ 2,568,000 $ 168,000 $ -- $ 3,011,000
============= ============= ============= ============= =============
THREE MONTHS ENDED
SEPTEMBER 30, 2004
Sales ....................... $ 37,263,000 $ 696,000 $ 144,000 $ -- $ 38,103,000
Inter-company sales ......... -- 17,644,000 780,000 (18,424,000) --
------------- ------------- ------------- ------------- -------------
Total revenue ............... $ 37,263,000 $ 18,340,000 $ 924,000 $ (18,424,000) $ 38,103,000
============= ============= ============= ============= =============
Income (loss) from operations $ (3,234,000) $ 554,000 $ (887,000) $ -- $ (3,567,000)
============= ============= ============= ============= =============
NINE MONTHS ENDED
SEPTEMBER 30, 2005
Sales ....................... $ 163,828,000 $ 1,006,000 $ 100,000 $ -- $ 164,934,000
Inter-company sales ......... -- 105,576,000 -- (105,576,000) --
------------- ------------- ------------- ------------- -------------
Total revenue ............... $ 163,828,000 $ 106,582,000 $ 100,000 $(105,576,000) $ 164,934,000
============= ============= ============= ============= =============
Income (loss) from operations $ (571,000) $ 5,444,000 $ (192,000) $ -- $ 4,681,000
============= ============= ============= ============= =============
NINE MONTHS ENDED
SEPTEMBER 30, 2004
Sales ....................... $ 113,042,000 $ 1,713,000 $ 3,992,000 $ -- $ 118,747,000
Inter-company sales ......... -- 56,243,000 7,440,000 (63,683,000) --
------------- ------------- ------------- ------------- -------------
Total revenue ............... $ 113,042,000 $ 57,956,000 $ 11,432,000 $ (63,683,000) $ 118,747,000
============= ============= ============= ============= =============
Income (loss) from
operations (1) $ (8,725,000) $ 3,116,000 $ (88,565,000) $ -- $ (94,174,000)
============= ============= ============= ============= =============
(1) Included in Income (loss) from operations an impairment charge of $78.0
million in Mexico region.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
BUSINESS OVERVIEW AND RECENT DEVELOPMENTS
We are a design and sourcing company for private label and private
brand casual apparel serving mass merchandisers, department stores, branded
wholesalers and specialty chains located primarily in the United States. Our
major customers include leading retailers, such as Chico's, Macy's Merchandising
Group, the Avenue, Lane Bryant, Lerner New York, J.C. Penney, K-Mart, Kohl's,
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. Our private brands include
American Rag Cie, Jessica Simpson, Princy by Jessica Simpson, House of Dereon by
Tina Knowles, No! Jeans, Alain Weiz, and Gear 7.
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 300 stores. During the third quarter
of 2005, we were informed by K-Mart that it would discontinue with the Gear 7
brand. While we are pursuing other relationships for the Gear 7 brand, there
will be a decline in sales for this brand in the fourth quarter of 2005 as a
result of the discontinuance. Alain Weiz continues to be exclusive to Dillard's
Department Stores. Sales of Jessica Simpson and Princy by Jessica Simpson
totaled $10.7 million in the third quarter of 2005. We began shipping House of
Dereon by Tina Knowles in the fourth quarter of 2005. The Jessica Simpson brand
was originally launched as a denim line with Charming Shoppes. However, Charming
Shoppes is not going forward with the line, and we are currently in discussion
with other large volume, middle market retailers who would support the brand as
a multi-category collection. During the third quarter of 2005, the master
license for Jessica Simpson was changed to the Camuto Consulting Group. We
expect this relationship to add a great deal of value to the Jessica Simpson
related brands.
The success of our Private Brands collections has created new
opportunities within the Private 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 the first nine months of
2005.
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 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 $12.6
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
17
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.
We believe our financial statements are fairly stated in accordance
with accounting principles generally accepted in the United States of America
and provide a meaningful presentation of our financial condition and results of
operations.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. For a further discussion on the application of these and
other accounting policies, see Note 1 of the "Notes to Consolidated Financial
Statements" included in our Annual Report on Form 10-K for the year ended
December 31, 2004.
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
experience. If our collection experience deteriorates (for example, due to an
unexpected material adverse change in a major customer's ability to meet its
financial obligations to us), the estimates of the recoverability of amounts due
us could be reduced by a material amount.
As of September 30, 2005, the balance in the allowance for returns,
discounts and bad debts reserves was $3.0 million.
INVENTORY
Our inventories are valued at the lower of cost or market. Under
certain market conditions, we use estimates and judgments regarding the
valuation of inventory to properly value inventory. Inventory adjustments are
made for the difference between the cost of the inventory and the estimated
market value and charged to operations in the period in which the facts that
give rise to the adjustments become known.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We assess the impairment of identifiable intangibles, long-lived assets
and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include, but are not limited to, the following:
o a significant underperformance relative to expected historical
or projected future operating results;
o a significant change in the manner of the use of the acquired
asset or the strategy for the overall business; or
o a significant negative industry or economic trend.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets." According to this
statement, goodwill and other intangible assets with indefinite lives are no
longer subject to amortization, but rather an assessment of impairment applied
on a fair-value-based test on
18
an annual basis or more frequently if an event occurs or circumstances change
that would more likely than not reduce the fair value of a reporting unit below
its carrying amount.
We utilized the discounted cash flow methodology to estimate fair
value. As of September 30, 2005, we have a goodwill balance of $8.6 million, and
a net property and equipment balance of $1.7 million.
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 sheet. Management records a valuation allowance to reduce
our net 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 11 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 7 of the "Notes to Consolidated Financial
Statements." If our results of operations erode and we are not able to obtain
waivers from the lenders, the debt would be in default and callable by our
lenders. In addition, due to cross-default provisions in our debt agreements,
substantially all of our long-term debt would become due in full if any of the
debt is in default. In anticipation of us not being able to meet the required
covenants due to various reasons, we either negotiate for changes in the
relative covenants or obtain an advance waiver or reclassify the relevant debt
as current. We also believe that our lenders would provide waivers if necessary.
However, our expectations of future operating results and continued compliance
with other debt covenants cannot be assured and our lenders' actions are not
controllable by us. If projections of future operating results are not achieved
and the debt is placed in default, we would be required to reduce our expenses,
by curtailing operations, and to raise capital through the sale of assets,
issuance of equity or otherwise, any of which could have a material adverse
effect on our financial condition and results of operations.
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 10 of the "Notes to Consolidated Financial
Statements."
19
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in our consolidated statements of operations as a percentage of net sales:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2005 2004 2005 2004
----- ----- ----- -----
Net sales .............................. 100.0% 100.0% 100.0% 100.0%
Cost of sales .......................... 79.1 89.1 78.8 85.8
----- ----- ----- -----
Gross profit ........................... 20.9 10.9 21.2 14.2
Selling and distribution expenses ...... 4.1 5.5 4.7 6.0
General and administration
expenses ............................ 10.6 14.4 12.3 21.5
Royalty and marketing allowance expenses 1.9 0.4 1.3 0.4
Impairment of assets ................... 0.0 -- 0.0 65.6
----- ----- ----- -----
Income (loss) from operations .......... 4.3 (9.4) 2.9 (79.3)
Interest expense ....................... (1.9) (1.8) (2.1) (1.8)
Interest Income ........................ 0.7 0.3 1.0 0.2
Other income ........................... 0.3 1.0 0.4 5.9
Other expense .......................... (0.0) (0.5) (0.0) (0.5)
Minority interest ...................... (0.2) 0.5 (0.1) 12.8
----- ----- ----- -----
Income (loss) before taxes ............. 3.2 (9.9) 2.1 (62.7)
Income taxes ........................... 0.7 0.6 0.6 0.9
----- ----- ----- -----
Net income (loss) ...................... 2.5% (10.5)% 1.5% (63.6)%
===== ===== ===== =====
THIRD QUARTER 2005 COMPARED TO THIRD QUARTER 2004
Net sales increased by $31.5 million, or 82.6%, to $69.6 million in the
third quarter of 2005 from $38.1 million in the third quarter of 2004. The
increase in net sales in the third quarter of 2005 was primarily due to
increased sales of Private Brands, which was $22.6 million in the third quarter
of 2005 compared to $2.8 million in the same period of 2004. Gear 7, Jessica
Simpson and Princy by Jessica Simpson recorded significant sales contributions
in the third quarter of 2005, as compared to no sales for these brands in the
third quarter of 2004. We expect sales of these brands to decline significantly
in the fourth quarter of 2005 due to the discontinuance by Gear 7 line by K-Mart
and Charming Shoppes' decision not to continue with the Jessica Simpson line.
Private Label sales for the third quarter of 2005 were $47.0 million compared to
$35.3 million in the third quarter of 2004, with the increase resulting
primarily from increased sales to Chico's, Sears and Wal-Mart in the third
quarter of 2005.
Gross profit consists of net sales less product costs, direct labor,
manufacturing overhead, duty, quota, freight in, brokerage, and warehousing.
Gross profit increased by $10.4 million to $14.5 million in the third quarter of
2005 from $4.1 million in the third quarter of 2004. The increase in gross
profit occurred primarily because of an increase in sales and gross margin. As a
percentage of net sales, gross profit increased from 10.9% in the third quarter
of 2004 to 20.9% in the third quarter of 2005. 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 margin using Private Brand
product developments.
Selling and distribution expenses increased by $765,000, or 36.8%, to
$2.8 million in the third quarter of 2005 from $2.1 million in the third quarter
of 2004. As a percentage of net sales, these expenses decreased to 4.1% in the
third quarter of 2005 from 5.5% in the third quarter of 2004 due to increased
sales during the third quarter of 2005.
General and administrative expenses increased by $1.9 million, or
34.7%, to $7.4 million in the third quarter of 2005 from $5.5 million in the
third quarter of 2004. The increase was primarily due to the costs associated
with developing multiple new lines in the Private Brands business, primarily
personnel. As a percentage of net sales, these expenses decreased to 10.6% in
the third quarter of 2005 from 14.4% in the third quarter of 2004.
20
Royalty and marketing allowance expenses increased by $1.2 million, or
930.9%, to $1.3 million in the third quarter of 2005 from $125,000 in the third
quarter of 2004. The increase was primarily due to our sales under the Alain
Weiz, and Jessica Simpson brands. As a percentage of net sales, these expenses
increased to 1.9% in the third quarter of 2005 from 0.4% in the third quarter of
2004.
Operating income in the third quarter of 2005 was $3.0 million, or 4.3%
of net sales, compared to operating loss of $3.6 million, or 9.4% of net sales,
in the comparable period of 2004, because of the factors discussed above.
Interest expense increased by $601,000 or 85.8%, to $1.3 million in the
third quarter of 2005 from $700,000 in the third quarter of 2004. As a
percentage of net sales, this expense increased to 1.9% in the third quarter of
2005 from 1.8% in the third quarter of 2004. The increase was partly due to
interest expenses of $283,000 in the third quarter of 2005 related to interest
payments to holders of Debentures and amortization of debt discount arising from
issuing convertible debentures, compared to no such expense in the third quarter
of 2004. Interest income increased by $412,000 to $506,000 in the third quarter
of 2005 from $94,000 in the third quarter of 2004. The increase was primarily
due to the interest earned from the notes receivable related to the sale of our
fixed assets in Mexico of $460,000 during the third quarter of 2005, compared to
no such income in the third quarter of 2004.
Income from the equity method investments, UAV and PBG7, totaled
approximately $164,000 for the third quarter of 2005. Losses allocated to
minority interests in the third quarter of 2004 were $180,000, representing the
minority partner's share of losses in each of UAV and PBG7.
FIRST NINE MONTHS OF 2005 COMPARED TO FIRST NINE MONTHS OF 2004
Net sales increased by $46.2 million, or 38.9%, to $164.9 million in
the first nine months of 2005 from $118.7 million in the first nine months of
2004. The increase in net sales in the first nine months of 2005 was primarily
due to increased sales of Private Brands, which was $45.4 million in the first
nine months of 2005 compared to $14.3 million in the same period of 2004. Gear
7, Alain Weiz, Jessica Simpson and Princy by Jessica Simpson recorded
significant sales contributions in the first nine months of 2005. We expect
sales of these brands to decline significantly in the fourth quarter of 2005 due
to the discontinuance by Gear 7 line by K-Mart and Charming Shoppes' decision
not to continue with the Jessica Simpson line. Private Label sales for the first
nine months of 2005 were $119.5 million compared to $104.4 million in the first
nine months of 2004, with the increase resulting primarily from increased sales
to Chico's, Mothers Work, Sears and Wal-Mart and a decrease in the sale of
close-out inventory and fabric from $7.7 million in the first nine months of
2004 compared to $1.4 million in the first nine months of 2005.
Gross profit increased by $18.0 million to $34.9 million in the first
nine months of 2005 from $16.9 million in the first nine months of 2004. The
increase in gross profit occurred primarily because of an increase in sales and
improved gross margin. As a percentage of net sales, gross profit increased from
14.2% in the first nine months of 2004 to 21.2% in the first nine months of
2005. 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, and the reduction of close-out inventory and fabric
sales in the first nine months of 2005 as compared to the prior year period.
Selling and distribution expenses increased by $702,000, or 15.0%, to
$7.8 million in the first nine months of 2005 from $7.1 million in the first
nine months of 2004. As a percentage of net sales, these expenses decreased from
6.0% for the first nine months of 2004 to 4.7% for the first nine months of 2005
due to increased sales in the first nine months of 2005.
General and administrative expenses decreased by $5.3 million, or
20.7%, to $20.3 million in the first nine months of 2005 from $25.6 million in
the first nine months of 2004. The decrease was primarily due to the
depreciation and amortization of our Mexico assets of $6.7 million and $1.1
million of severance paid to the Mexican workers in the first nine months of
2004 as compared to no such expense in the first nine months of 2005 after
disposition of our fixed assets in Mexico in late 2004. As a percentage of net
sales, these expenses decreased to 12.3% in the first nine months of 2005 from
21.5% in the first nine months of 2004.
21
Royalty and marketing allowance expenses increased by $1.8 million, or
422.0%, to $2.2 million in the first nine months of 2005 from $418,000 in the
first nine months of 2004. The increase was primarily due to our sales under the
Alain Weiz and Jessica Simpson brands. As a percentage of net sales, these
expenses increased to 1.3% in the first nine months of 2005 from 0.4% in the
first nine months of 2004.
Impairment of assets expense was $0 in the first nine months of 2005,
compared to $78.0 million in the first nine months of 2004. This expense in the
first nine months of 2004 was a consequence of our write-down of the book value
of our fixed assets in Mexico to their fair value in accordance with SFAS 144.
Operating income for the first nine months of 2005 was $4.7 million, or
2.9% of net sales, compared to operating loss of $94.2 million, or 79.3% of net
sales, in the comparable prior period of 2004 as a result of the factors
discussed above.
Interest expense increased by $1.2 million, or 55.0%, to $3.4 million
in the first nine months of 2005 from $2.2 million in the first nine months of
2004. As a percentage of net sales, this expense increased to 2.1% in the first
nine months of 2005 from 1.8% in the first nine months of 2004. The increase was
primarily due to interest expenses of $1.0 million in the first nine months of
2005 related to interest payments to holders of Debentures and amortization of
debt discount arising from issuing convertible debenture, compared to no such
expense in the first nine months of 2004. Interest income increased by $1.3
million, to $1.6 million in the first nine months of 2005 from $281,000 in the
first nine months of 2004. The increase was primarily due to the interest earned
from the notes receivable related to the sale of our fixed assets in Mexico of
$1.4 million during the first nine months of 2005, compared to no such income in
the first nine months of 2004. Other income was $754,000 in the first nine
months of 2005, compared to $7.0 million in the first nine months of 2004. This
reduction in other income was due primarily to $5.5 million of lease income
received for the lease of our facilities and equipment in Mexico in the first
nine months of 2004, compared to no such income in the first nine months of 2005
due to the sale of our Mexico operations in the fourth quarter of 2004.
Earnings from the equity method investments, UAV and PBG7, totaled
approximately $164,000 for the first nine months of 2005. Losses allocated to
minority interests in the first nine months of 2004 were $15.2 million,
representing the minority partner's share of losses in UAV and PBG7 totaling
$337,000, and the minority shareholder's share of losses in Tarrant Mexico
totaling $14.9 million, of which $13.7 million is this shareholder's 25% share
of the charge we incurred for the write down of fixed assets in Mexico.
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 and sales of equity and debt securities
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
22
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.
Cash flows for the nine months ended September 30, 2005 and 2004 were
as follows (dollars in thousands):
CASH FLOWS: 2005 2004
------------------------------------------ -------- --------
Net cash provided by (used in)
operating activities .................. $(22,802) $ 15,929
Net cash provided by investing
activities ............................ $ 3,316 $ 3,001
Net cash provided by (used in)
financing activities .................. $ 19,908 $(20,366)
During the first nine months of 2005, net cash used in operating
activities was $22.8 million, as compared to net cash provided by operating
activities of $15.9 million for the same period in 2004. Net cash used in
operating activities in the first nine months of 2005 resulted primarily from a
net income of $2.5 million, reduced by increases of $27.5 million in accounts
receivable and $6.8 million in inventory, partially offset by depreciation and
amortization expense of $1.7 million, an increase of $3.6 million in account
payable and decrease of $2.0 million due to/from related parties. The increase
in accounts receivable, inventory and accounts payable in the first nine months
of 2005 was primarily due to increase in sales volume in the current year
period.
During the first nine months of 2005, net cash provided by investing
activities was $3.3 million, as compared to net cash provided by investing
activities of $3.0 million for the same period in 2004. Net cash provided by
investing activities in the first nine months of 2005 included approximately
$2.5 million of collection of advances from our Chairman and $1.0 million of
collection on notes receivable.
During the first nine months of 2005, net cash provided by financing
activities was $19.9 million, as compared to net cash used in financing
activities of $20.4 million for the same period in 2004. Net cash provided by
financing activities in nine months of 2005 included $2.5 million net repayment
of our short-term bank borrowings and $22.4 million net proceeds from our credit
facilities.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Following is a summary of our contractual obligations and commercial
commitments available to us as of September 30, 2005 (in millions):
PAYMENTS DUE BY PERIOD
-----------------------------------------------------
Between Between
Less than 2-3 4-5 After
CONTRACTUAL OBLIGATIONS Total 1 year years years 5 years
---------------------------------- -------- -------- -------- -------- --------
Long-term debt(1) ................ $ 44.9 $ 44.2 $ 0.7 $ -- $ --
Convertible debentures, net ...... 6.9 -- 6.9 -- --
Operating leases ................. 6.5 0.7 1.3 1.2 3.3
Minimum royalties ................ 23.8 4.5 12.3 2.1 4.9
Purchase commitment .............. 46.8 5.5 10.0 10.0 21.3
-------- -------- -------- -------- --------
Total Contractual Cash Obligations $ 128.9 $ 54.9 $ 31.2 $ 13.3 $ 29.5
(1) Excludes interest on long-term debt obligations. Based on outstanding
borrowings as of September 30, 2005, and assuming all such indebtedness
remained outstanding and the interest rates remained unchanged, we
estimate that our interest cost on long-term debt would be
approximately $4.0 million.
23
AMOUNT OF COMMITMENT EXPIRATION
PER PERIOD
TOTAL -----------------------------------------
AMOUNTS LESS BETWEEN BETWEEN
COMMERCIAL COMMITMENTS COMMITTED THAN 2-3 4-5 AFTER
AVAILABLE TO US TO US 1 YEAR YEARS YEARS 5 YEARS
----------------------------------- -------- -------- -------- -------- --------
Lines of credit .................. $ 61.4 $ 61.4 $ -- $ -- $ --
Letters of credit (within lines of
credit) ....................... $ 18.9 $ 18.9 $ -- $ -- $ --
Total commercial commitments ..... $ 61.4 $ 61.4 $ -- $ -- $ --
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
7.75% per annum at September 30, 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 extend the expiration date of the facility from
August 31, 2005 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 from October 31, 2005 to January 31, 2006 and amend the
interest rate to "prime rate" plus 3%. The most recent facility amendment also
provides for reduction in the maximum amount of borrowings to $13.5 million
commencing on November 1, 2005, to $13 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. Under the amended
letter of credit facility, we are subject to restrictive financial covenants of
maintaining tangible net worth of $22 million at December 31, 2004, March 31,
2005 and June 30, 2005, and $25 million as of the last day of each fiscal
quarter thereafter. There is also a provision capping maximum capital
expenditures per quarter of $800,000. As of September 30, 2005, we were in
compliance with the covenants. As of September 30, 2005, $11.3 million was
outstanding under this facility with UPS and an additional $0.8 million was
available for future borrowings. In addition, $2.4 million of open letters of
credit was outstanding as of September 30, 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 8.75% per annum at September 30, 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
$22 million at December 31, 2004, March 31, 2005 and June 30, 2005, and $25
million as of the last day of each fiscal quarter thereafter. There is also a
provision capping maximum capital expenditure per quarter at $800,000. As of
September 30, 2005, we were in compliance with the covenants. As of September
30, 2005, $3.1 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 September 30, 2005, $2.9
million was outstanding under this facility. In addition, $0.8 million of open
letters of credit was outstanding and $91,000 was available for future
borrowings as of September 30, 2005. In October 2004, a tax loan for HKD 7.725
million
24
(equivalent to US $977,000) was also made available to our Hong Kong
subsidiaries. As of September 30, 2005, $171,000 was outstanding under this
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) has an expiration date of September 30, 2007. 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 6.86% per annum and
the facility under PBG7, LLC bears interest at 7.25% at September 30, 2005.
Restrictive covenants under the revised facility include a limit on quarterly
capital expenses of $800,000 and tangible net worth of $20 million at September
30, 2004, $22 million at December 31, 2004 and March 31, 2005 and $25 million at
the end of each fiscal quarter thereafter beginning on June 30, 2005. On June
29, 2005, GMAC agreed to reduce the tangible net worth requirement at June 30,
2005 from $25 million to $22 million. The tangible net worth requirement of $25
million resumes at September 30, 2005 and at the end of each fiscal quarter
thereafter. As of September 30, 2005, we were in compliance with the covenants.
A total of $38.7 million was outstanding with respect to receivables factored
under the GMAC facility at September 30, 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. The maximum borrowing
availability under the factoring agreement, based on a borrowing base formula,
remained $40 million. In connection with this amendment, we granted GMAC a lien
on certain of our inventory located in the United States. A total of $3.0
million was outstanding under the GMAC facility at September 30, 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.
The amount we can borrow under the new 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
25
$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 the first nine months of 2005
was $355,000. Total deferred financing cost amortized in the first nine months
of 2005 was $142,000. Total interest paid to the holders of the Debentures in
the first nine months of 2005 was $435,000. As of September 30, 2005, $5.8
million, net of $1.1 million of debt discount, remained outstanding under the
Debentures.
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. As of September 30, 2005, $0 remained outstanding under this loan. In
early August 2005, we repaid the loan in its entirety.
We had two equipment loans outstanding at September 30, 2005 totaling
$66,000 bearing interest at 6% payable in installments through 2009.
From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates who issues these letters of credits out
of Israeli Discount Bank. As of September 30, 2005, $1.0 million was outstanding
under this facility and $5.1 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.
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), the proceeds from the exercise of stock
options and from time to time shareholder advances. Our short-term funding
relies very heavily on our major customers, banks, suppliers and major
shareholders. 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 $12.6
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.
26
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.
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. The lease with
Lynx International Limited for our Hong Kong facility expires on December 31,
2005. We are currently leasing our Los Angeles facility from GET on a
month-to-month basis. We paid $255,000 and $332,000 in the three months ended
September 30, 2005 and 2004, respectively, for office and warehouse facilities.
We paid $764,000 and $996,000 in the nine months ended September 30, 2005 and
2004, respectively, for office and warehouse facilities.
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, including the
equipment and facilities we previously leased to Mr. Nacif's affiliates in
October 2003, for an aggregate purchase price consisting of: a) $105,400 in cash
and $3,910,000 by delivery of unsecured promissory notes bearing interest at
5.5% per annum; and b) $40,204,000, by delivery of secured promissory notes
bearing interest at 4.5% per annum, maturing on December 31, 2005 and every year
thereafter until December 31, 2014. The secured promissory notes are payable in
partial or total amounts anytime prior to the maturity of each note. Included in
the $44.1 million notes receivable - related party on the accompanying balance
sheet as of September 30, 2005 was $1.3 million of Mexico value added taxes on
the real property component of this transaction. 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. We purchased $2.3 million and
$1.1 million of fabric from Acabados y Terminados in the three months ended
September 30, 2005 and 2004, respectively. We purchased $4.1 million and $5.3
million of fabric from Acabados y Terminados in the nine months ended September
30, 2005 and 2004, respectively. Net amount due from these parties as of
September 30, 2005 was $238,000.
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 in the third quarter of 2005 was approximately $2,352,000. Mr. Guez paid
our expenses of approximately $87,000 and $98,000 for the three months ended
September 30, 2005 and 2004, respectively, which amounts were applied to reduce
accrued interest and principle on Mr. Guez's loan. Mr. Guez paid expenses on our
behalf of approximately $165,000 and $278,000 for the nine months ended
September 30, 2005 and 2004, respectively, which amounts were applied to reduce
accrued interest and principal on Mr. Guez's loan. The balance of $2.3 million
is payable on demand and has been shown as reductions to shareholders' equity as
of September 30, 2005. 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 $45,000 and $92,000 for the three months ended September 30, 2005 and 2004,
respectively. Total interest paid by Mr. Guez was $321,000 and $299,000 for the
nine months ended September 30, 2005 and 2004, respectively. These amounts
included fuel and related expenses incurred by 477 Aviation, LLC, a company
owned by Mr. Guez, when our executives used this company's aircraft for business
purposes. Since the enactment of the Sarbanes-Oxley Act in 2002, no further
personal loans (or amendments to existing loans) have been or will be made to
our executive officers or directors.
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
Hubert Guez, the brother 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
27
results since July 2001 with the minority partner's share of all gains 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. Two and one half
percent of gross sales as management fees were paid to each of the members of
UAV, per the operating agreement. The amount paid to Azteca, the minority member
of UAV, totaled $0 and $0 in the three months ended September 30, 2005 and 2004,
respectively. We purchased $0 and $2.0 million of finished goods and service
from Azteca and its affiliates in the three months ended September 30, 2005 and
2004, respectively. We purchased $135,000 and $7.5 million of finished goods and
service from Azteca and its affiliates in the nine months ended September 30,
2005 and 2004, respectively. Our total sales of fabric and service to Azteca in
the three months ended September 30, 2005 and 2004 were $0. Our total sales of
fabric and service to Azteca in the nine months ended September 30, 2005 and
2004 were $63,000 and $1.0 million, respectively.
Commencing in June 2003, UAV began selling to Seven Licensing Company,
LLC ("Seven Licensing"), jeans wear bearing the brand "Seven7", which was
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 Seven7
in the three months ended September 30, 2005 and 2004 were $0 and $42,000,
respectively. Total sales to Seven7 in the nine months ended September 30, 2005
and 2004 were $0 and $3.4 million, respectively.
At December 31, 2004, Messrs. Guez and Kay beneficially owned 961,000
and 1,003,500 shares, respectively, of common stock of Tag-It Pacific, Inc.
("Tag-It"), collectively representing 10.8% of Tag-It Pacific's common stock at
December 31, 2004. Tag-It is a provider of brand identity programs to
manufacturers and retailers of apparel and accessories. Commencing in 1998,
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. Due to the restructuring of our Mexico operations, Tag-It no longer
manages our trim and packaging requirements. We purchased $20,000 and $465,000
of trim inventory from Tag-It in the three months ended September 30, 2005 and
2004, respectively. We purchased $55,000 and $1.2 million of trim inventory from
Tag-It in the nine months ended September 30, 2005 and 2004, respectively. From
time to time we have guaranteed the indebtedness of Tag-It for the purchase of
trim on our behalf. See Note 7 of the "Notes to Consolidated Financial
Statements."
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. 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.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report on Form 10-Q contains forward-looking statements,
which are subject to a variety of risks and uncertainties. Our actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below.
RISKS RELATED TO OUR BUSINESS
WE DEPEND ON A GROUP OF KEY CUSTOMERS FOR A SIGNIFICANT PORTION OF OUR SALES. A
SIGNIFICANT ADVERSE CHANGE IN A CUSTOMER RELATIONSHIP OR IN A CUSTOMER'S
FINANCIAL POSITION COULD HARM OUR BUSINESS AND FINANCIAL CONDITION.
Kohl's accounted for 13.5% and 16.6% of our net sales for the first
nine months of 2005 and 2004, respectively. Mervyn's accounted for 9.8% and
16.5% of our net sales for the first nine months of 2005 and 2004, respectively.
Lerner New York accounted for 9.3% and 13.0% of our net sales for the first nine
months of 2005 and 2004, respectively. Affiliated department stores owned by
Federated Department Stores accounted for approximately 11.5% and 8.9% of our
net sales for the first nine months of 2005 and 2004, respectively. Wal-Mart
accounted for approximately 12.0% and 7.0% of our net sales for the first nine
months of 2005 and 2004, respectively. 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
28
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. There
can be no assurances of, and we have no control over a return to timely
deliveries. 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 effect our results of
operations.
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.
29
THE FINANCIAL CONDITION OF OUR CUSTOMERS COULD AFFECT OUR RESULTS OF OPERATIONS.
Certain retailers, including some of our customers, have experienced in
the past, and may experience in the future, financial difficulties, which
increase the risk of extending credit to such retailers and the risk that
financial failure will eliminate a customer entirely. These retailers have
attempted to improve their own operating efficiencies by concentrating their
purchasing power among a narrowing group of vendors. There can be no assurance
that we will remain a preferred vendor for our existing customers. A decrease in
business from or loss of a major customer could have a material adverse effect
on our results of operations. There can be no assurance that our factor will
approve the extension of credit to certain retail customers in the future. If a
customer's credit is not approved by the factor, we could assume the collection
risk on sales to the customer itself, require that the customer provide a letter
of credit, or choose not to make sales to the customer.
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
vendor credit, cash on hand and cash available through our bank credit
facilities, issuance of long-term debt, proceeds from sale of debt or equity
securities, and proceeds from the exercise of stock options to fund existing
operations for the foreseeable future. However, in the future we may need to
raise additional funds through equity or debt financings or collaborative
relationships. This additional funding may not be available or, if available, it
may not be available on economically reasonable terms. In addition, any
additional funding may result in significant dilution to existing shareholders.
If adequate funds are not available, we may be required to curtail our
operations or obtain funds through collaborative partners that may require us to
release material rights to our products.
OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS.
Substantially all of our import operations are subject to tariffs
imposed on imported products, safeguards and growth targets imposed by trade
agreements. In addition, the countries in which our products are manufactured or
imported may from time to time impose additional new duties, tariffs or other
restrictions on our imports or adversely modify existing restrictions. Adverse
changes in these import costs and restrictions, or our suppliers' failure to
comply with customs or similar laws, could harm our business. We cannot assure
that future trade agreements will not provide our competitors with an advantage
over us, or increase our costs, either of which could have an adverse effect on
our business and financial condition.
Our operations are also subject to the effects of international trade
agreements and regulations such as the North American Free Trade Agreement, and
the activities and regulations of the World Trade Organization. Generally, these
trade agreements benefit our business by reducing or eliminating the duties
assessed on products manufactured in a particular country. However, trade
agreements can also impose requirements that adversely affect our business, such
as limiting the countries from which we can purchase raw materials and setting
duties or restrictions on products that may be imported into the United States
from a particular country. In addition, the World Trade Organization may
commence a new round of trade negotiations that liberalize textile trade by
further eliminating or reducing tariffs. The elimination of quotas on World
Trade Organization member countries in 2005 has resulted in explosive growth in
textile imports from China, and subsequent safeguard measures including embargo
of certain China country of origin products, which has been disruptive, and has
a negative impact on margins. Such disruption may continue to affect our
products to some extent in the future.
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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 their apparel
manufacturers, including us, with applicable labor laws and visit our facilities
often. There can be no assurance that the violation of applicable labor laws by
one of our contractors will not have a material adverse effect on our
relationship with our customers.
OUR BUSINESS IS SUBJECT TO RISKS OF OPERATING IN A FOREIGN COUNTRY AND TRADE
RESTRICTIONS.
Approximately 95% of our products sold in the third quarter of 2005
were imported from outside the U.S. 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;
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o developing innovative, high-quality products in sizes, colors
and styles that appeal to consumers of varying age groups and
tastes;
o competitively pricing our products and achieving customer
perception of value; and
o the need to provide strong and effective marketing support.
WE MUST SUCCESSFULLY GAUGE FASHION TRENDS AND CHANGING CONSUMER PREFERENCES TO
SUCCEED.
Our success is largely dependent upon our ability to gauge the fashion
tastes of our customers and to provide merchandise that satisfies retail and
customer demand in a timely manner. The apparel business fluctuates according to
changes in consumer preferences dictated in part by fashion and season. To the
extent we misjudge the market for our products, 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 $12.6 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 September 30, 2005, our executive officers and directors and
their affiliates owned approximately 42.8% 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
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at September 30, 2005. Accordingly, our executive officers and 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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
FOREIGN CURRENCY RISK. Our earnings are affected by fluctuations in the
value of the U.S. dollar as compared to foreign currencies as a result of doing
business in foreign jurisdictions. As a result, we bear the risk of exchange
rate gains and losses that may result in the future.
INTEREST RATE RISK. Because our obligations under our various credit
agreements bear interest at floating rates (primarily LIBOR 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 4. 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 September 30, 2005, the end of the period covered
by this report. 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
During the third quarter of 2005 there were no significant changes in
our internal controls or in other factors known to the Chief Executive Officer
or the Chief Financial Officer that materially affected, or are reasonably
likely to materially effect, our internal control over financial reporting.
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PART II -- OTHER INFORMATION
ITEM 1. 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 6. EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
------- -------------------------------------------------------
10.16.20 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.
10.16.21 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.
10.16.22 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.
10.31 Employment Agreement, dated September 16, 2005, between
Tarrant Company Limited and Henry Chu.
10.44 Tenancy Agreement, dated July 1, 2005, between Tarrant
Company Limited and Lynx International Limited.
31.1 Certificate of Chief Executive Officer pursuant to Rule
13a-14(a) under the Securities and Exchange Act of
1934, as amended.
31.2 Certificate of Chief Financial Officer pursuant to Rule
13a-14(a) under the Securities and Exchange Act of
1934, as amended.
32.1 Certificate of Chief Executive Officer pursuant to Rule
13a-14(b) under the Securities and Exchange Act of
1934, as amended.
32.2 Certificate of Chief Financial Officer pursuant to Rule
13a-14(b) under the Securities and Exchange Act of
1934, as amended.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TARRANT APPAREL GROUP
Date: November 14, 2005 By: /s/ Corazon Reyes
--------------------------------
Corazon Reyes,
Chief Financial Officer
Date: November 14, 2005 By: /s/ Barry Aved
--------------------------------
Barry Aved,
Chief Executive Officer
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