--------------------------------------------------------------------------------
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 JUNE 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
----------
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|
Number of shares of Common Stock of the registrant outstanding as of August 10,
2005: 30,143,763.
--------------------------------------------------------------------------------
TARRANT APPAREL GROUP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at June 30, 2005 (Unaudited)
and December 31, 2004 (Restated Audited)...................... 3
Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Three Months and Six Months Ended
June 30, 2005 and June 30, 2004............................... 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2005 and June 30, 2004......................... 5
Notes to Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk ... 37
Item 4. Controls and Procedures....................................... 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 38
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds.... 38
Item 4. Submission of Matters to a Vote of Security Holders........... 38
Item 6. Exhibits...................................................... 39
SIGNATURES.................................................... 40
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.
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
2005 2004
------------- -------------
(Unaudited) (Restated)
ASSETS
Current assets:
Cash and cash equivalents .............................. $ 1,179,394 $ 1,214,944
Accounts receivable, net ............................... 58,430,536 37,759,343
Due from related parties ............................... 6,881,548 10,651,914
Inventory .............................................. 24,071,353 19,144,105
Current portion of notes receivable from related parties 5,323,733 5,323,733
Prepaid expenses ....................................... 958,158 1,251,684
Prepaid royalties ...................................... 3,299,370 2,257,985
Income taxes receivable ................................ 162,831 144,796
------------- -------------
Total current assets ..................................... 100,306,923 77,748,504
Property and equipment, net ............................ 1,645,459 1,874,893
Notes receivable - related party, net of current portion 39,508,855 40,107,337
Equity method investment ............................... 2,145,641 1,880,281
Deferred financing cost, net ........................... 1,029,851 1,203,259
Other assets ........................................... 180,175 414,161
Goodwill, net .......................................... 8,582,845 8,582,845
------------- -------------
Total assets ............................................. $ 153,399,749 $ 131,811,280
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings ............................. $ 19,337,111 $ 17,951,157
Accounts payable ....................................... 30,842,170 24,394,553
Accrued expenses ....................................... 10,811,768 11,243,179
Income taxes ........................................... 17,215,907 16,826,383
Current portion of long-term obligations ............... 32,875,427 19,628,701
------------- -------------
Total current liabilities ............................... 111,082,383 90,043,973
Long-term obligations ..................................... 1,496,886 2,544,546
Convertible debentures, net ............................... 6,493,276 8,330,483
Deferred tax liabilities .................................. 127,323 213,784
Minority interest in UAV and PBG7 ......................... -- --
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; 30,143,763 shares (2005) and 28,814,763
shares (2004) issued and outstanding ................. 114,157,465 111,515,091
Warrant to purchase common stock ....................... 2,846,833 2,846,833
Contributed capital .................................... 9,965,591 9,965,591
Accumulated deficit .................................... (90,417,940) (91,182,959)
Notes receivable from officer/shareholder .............. (2,352,068) (2,466,062)
------------- -------------
Total shareholders' equity ............................... 34,199,881 30,678,494
------------- -------------
Total liabilities and shareholders' equity ............... $ 153,399,749 $ 131,811,280
============= =============
The accompanying notes are an integral part of these consolidated financial
statements
3
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net sales ............................... $ 50,537,704 $ 38,488,938 $ 95,367,995 $ 80,643,843
Cost of sales ........................... 39,083,324 33,223,369 74,967,897 67,878,206
------------ ------------ ------------ ------------
Gross profit ............................ 11,454,380 5,265,569 20,400,098 12,765,637
Selling and distribution expenses ....... 2,404,177 2,386,214 4,966,031 5,028,613
General and administrative expenses ..... 7,015,603 9,290,707 12,871,426 20,069,857
Impairment of assets .................... -- 77,982,034 -- 77,982,034
------------ ------------ ------------ ------------
Income (loss) from operations ........... 2,034,600 (84,393,386) 2,562,641 (90,314,867)
Interest expense ........................ (1,285,624) (699,846) (2,098,809) (1,493,629)
Interest income ......................... 516,590 92,954 1,069,813 187,225
Other income ............................ 357,850 3,114,202 585,718 6,610,935
Other expense ........................... (592,418) (362,997) (893,022) (722,201)
Minority interest ....................... -- 14,135,921 -- 15,016,469
------------ ------------ ------------ ------------
Income (loss) before provision for income
taxes ................................ 1,030,998 (68,113,152) 1,226,341 (70,716,068)
Provision for income taxes .............. 160,159 454,029 461,322 824,643
------------ ------------ ------------ ------------
Net income (loss) ....................... $ 870,839 $(68,567,181) $ 765,019 $(71,540,711)
============ ============ ============ ============
Net income (loss) per share:
Basic ................................ $ 0.03 $ (2.39) $ 0.03 $ (2.50)
============ ============ ============ ============
Diluted .............................. $ 0.03 $ (2.39) $ 0.03 $ (2.50)
============ ============ ============ ============
Weighted average common and common
equivalent shares:
Basic ................................ 29,155,855 28,649,928 28,986,251 28,567,510
============ ============ ============ ============
Diluted .............................. 29,163,070 28,649,928 28,993,466 28,567,510
============ ============ ============ ============
Net income (loss) ....................... $ 870,839 $(68,567,181) $ 765,019 $(71,540,711)
Foreign currency translation adjustment . -- (3,902,068) -- (2,965,205)
------------ ------------ ------------ ------------
Total comprehensive income (loss) ....... $ 870,839 $(72,469,249) $ 765,019 $(74,505,916)
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements
4
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED JUNE 30,
----------------------------
2005 2004
------------ ------------
Operating activities:
Net income (loss) ......................................... $ 765,019 $(71,540,711)
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Deferred taxes ......................................... (86,461) (26,761)
Depreciation and amortization .......................... 1,251,439 7,558,836
Asset impairment ....................................... -- 77,982,034
Unrealized gain on foreign currency .................... -- (184,410)
Compensation expense related to stock option ........... -- 107,358
Provision for returns and discounts .................... 210,178 (244,066)
Gain on sale of fixed assets ........................... (113,852) --
Income from investments ................................ (346,360) (567,332)
Minority interest ...................................... -- (15,016,469)
Changes in operating assets and liabilities:
Restricted cash ...................................... -- 2,759,742
Accounts receivable .................................. (20,881,371) 7,558,900
Due to/from related parties .......................... 1,691,349 (1,529,319)
Inventory ............................................ (4,927,248) 2,392,037
Temporary quota rights ............................... -- (2,444,836)
Prepaid expenses and other receivables ............... (765,894) (59,523)
Accounts payable ..................................... 6,447,618 2,025,944
Accrued expenses and income tax payable .............. 333,113 3,644,010
------------ ------------
Net cash (used in) provided by operating activities .. (16,422,470) 12,415,434
Investing activities:
(Purchase) sale of fixed assets ........................ (79,690) 78,207
Investment in equity investment method ................. -- (75,000)
Distribution from equity investment method ............. 81,000 --
Collection on notes receivable ......................... 598,482 --
Investment in joint venture ............................ -- (225,898)
Collection of advances from shareholders/officers ...... 2,413,994 14,768
------------ ------------
Net cash provided by (used in) investing activities .. 3,013,786 (207,923)
Financing activities:
Short-term bank borrowings, net ........................ 1,385,954 (1,257,124)
Proceeds from long-term obligations .................... 98,905,667 52,683,171
Payment of long-term obligations and bank borrowings ... (86,918,487) (69,696,381)
Proceeds from issuance of common stock and warrant ..... -- 3,667,765
------------ ------------
Net cash provided by (used in) financing activities .. 13,373,134 (14,602,569)
Effect of exchange rate on cash ........................... -- (89,226)
------------ ------------
Decrease in cash and cash equivalents ..................... (35,550) (2,484,284)
Cash and cash equivalents at beginning of period .......... 1,214,944 3,319,964
------------ ------------
Cash and cash equivalents at end of period ................ $ 1,179,394 $ 835,680
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
5
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 June 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
restated audited financial statements which are included in our Annual Report on
Form 10-K for the year ended December 31, 2004, 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.
6
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. For the three
months ended June 30, 2005 and 2004, $0 and $54,000 was 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:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------- -------------------------------
2005 2004 2005 2004
-------------- -------------- -------------- --------------
Net income (loss) as reported ............ $ 870,839 $ (68,567,181) $ 765,019 $ (71,540,711)
Add stock-based employee compensation
charges reported in net loss ........... -- 53,679 -- 107,358
Pro forma compensation expense, net of
tax .................................... (973,463) (1,282,484) (1,049,972) (2,626,556)
-------------- -------------- -------------- --------------
Pro forma net loss ....................... $ (102,624) $ (69,795,986) $ (284,953) $ (74,059,909)
============== ============== ============== ==============
Net income (loss) per share as reported -
Basic ................................... $ 0.03 $ (2.39) $ 0.03 $ (2.50)
Add stock-based employee compensation
charges reported in net loss - Basic ... -- -- -- --
Pro forma compensation expense per share -
Basic .................................. (0.03) (0.05) (0.04) (0.09)
-------------- -------------- -------------- --------------
Pro forma loss per share - Basic ........ $ (0.00) $ (2.44) $ (0.01) $ (2.59)
============== ============== ============== ==============
Net income (loss) per share as reported -
Diluted ................................ $ 0.03 $ (2.39) $ 0.03 $ (2.50)
Add stock-based employee compensation
charges reported in net loss - Diluted . -- -- -- --
Pro forma compensation expense per share -
Diluted ................................ (0.03) (0.05) (0.04) (0.09)
-------------- -------------- -------------- --------------
Pro forma loss per share -- Diluted ...... $ (0.00) $ (2.44) $ (0.01) $ (2.59)
============== ============== ============== ==============
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 and 0.51 for
the three months ended June 30, 2005 and 2004, respectively, weighted-average
risk-free interest rates of 4% and 3% for the three months ended June 30, 2005
and 2004, respectively, 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.
7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
4. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
JUNE 30, DECEMBER 31,
2005 2004
------------ ------------
U.S. trade accounts receivable ................. $ 5,138,138 $ 3,248,887
Foreign trade accounts receivable .............. 25,715,007 17,148,600
Factored accounts receivable ................... 28,986,138 19,452,756
Other receivables .............................. 1,441,838 346,965
Allowance for returns, discounts and bad debts . (2,850,585) (2,437,865)
------------ ------------
$ 58,430,536 $ 37,759,343
============ ============
5. INVENTORY
Inventory consists of the following:
JUNE 30, DECEMBER 31,
2005 2004
----------- -----------
Raw materials - fabric and trim accessories ...... $ 620,415 $ 1,164,977
Finished goods shipments-in-transit .............. 8,234,531 9,283,022
Finished goods ................................... 15,216,407 8,696,106
----------- -----------
$24,071,353 $19,144,105
=========== ===========
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 June 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
six month ended June 30, 2005 was as follows:
Balance as of December 31, 2004 ..... $ 1,880,281
Share of income ..................... 346,360
Distribution ........................ (81,000)
-------------
Balance as of June 30, 2005 ......... $ 2,145,641
=============
8
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
7. DEBT
Short-term bank borrowings consist of the following:
JUNE 30, DECEMBER 31,
2005 2004
----------- -----------
Import trade bills payable - UPS, DBS Bank and Aurora Capital $ 9,261,022 $ 3,902,714
Bank direct acceptances - UPS and DBS Bank .................. 2,294,098 10,447,855
Other Hong Kong credit facilities - UPS and DBS Bank ........ 7,781,991 3,600,588
----------- -----------
$19,337,111 $17,951,157
=========== ===========
Long-term obligations consist of the following:
JUNE 30, DECEMBER 31,
2005 2004
------------ ------------
Vendor financing ................... $ -- $ 135,145
Loan from Max Azria ................ 1,500,000 --
Equipment financing ................ 70,237 78,038
Term loan - UPS .................... 3,988,099 5,000,000
Debt facility - GMAC ............... 28,813,977 16,960,064
------------ ------------
34,372,313 22,173,247
Less current portion ............... (32,875,427) (19,628,701)
------------ ------------
$ 1,496,886 $ 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 bears interest at
7.0% per annum at June 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. 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
June 30, 2005, $13.8 million was outstanding under this facility with UPS
(classified above as follows: $5.1 million in import trade bills payable; $2.3
million in bank direct acceptances and $6.4 million in other Hong Kong
facilities) and an additional $3,000 was available for future borrowings. In
addition, $1.2 million of open letters of credit was outstanding as of June 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 June 30, 2005, $3.5 million
was outstanding under this facility. In addition, $0.9 million of open letters
of credit was outstanding and none was available for future borrowings as of
June 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 June
30, 2005, $423,000 was outstanding under this loan.
As of June 30, 2005, the total balance outstanding under the DBS Bank
credit facilities was $3.9 million (classified above as follows: $2.6 million in
import trade payable and $1.3 million in other Hong Kong facilities).
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 June 30, 2005, $1.6 million was outstanding
under
9
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
this facility (classified above under import trade bills payable) and $3.6
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 bears interest at the rate of 4% per annum and is payable in weekly
installments of $250,000 beginning on February 28, 2005 and continuing each
Monday until July 11, 2005. This is an unsecured loan. As of June 30, 2005, $1.5
million remained outstanding under this loan. In early August 2005, we repaid
the loan in its entirety.
EQUIPMENT FINANCING
We had two equipment loans outstanding at June 30, 2005 totaling
$70,000 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. 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 June 30, 2005, $4.0 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
10
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
PBG7. This facility bears interest at 6.237% per annum at June 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 June 30, 2005, we were in compliance with the covenants. A
total of $28.8 million was outstanding with respect to receivables factored
under the GMAC facility at June 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 $2.1
million was outstanding under the GMAC facility at June 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.
GUARANTEES
Guarantees have been issued since 2001 in favor of YKK, Universal
Fasteners, and RVL Inc. for $750,000, $500,000 and an unspecified amount,
respectively, to cover trim purchased by Tag-It Pacific Inc. on our behalf. We
have not reported a liability for these guarantees. We issued the guarantees to
cover trim purchased by Tag-It in order to ensure our production in a timely
manner. If Tag-It ever defaults, we would have to pay the outstanding liability
due to these vendors by Tag-It for purchases made on our behalf. We have not had
to perform under these guarantees since inception. It is not predictable to
estimate the fair value of the guarantee; however, we do not anticipate that we
will incur losses as a result of these guarantees. In April 2005, we terminated
these guarantees with respect to Tag-It's obligations arising after the date of
termination.
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.
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
11
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. The Debentures
were converted at the option of the holders at a price of $2.00 per share. Debt
discount of $182,000 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, $141,000 was expensed upon the conversion. The intrinsic
value of the conversion option, and the value of the warrant amortized in the
first six months of 2005 was $248,000. Total deferred financing cost amortized
in the first six months of 2005 was $103,000. Total interest paid to the holders
of the Debentures in the first six months of 2005 was $326,000. As of June 30,
2005, $6.5 million, net of $1.2 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. 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 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.
12
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. 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 JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Basic EPS Computation:
Numerator ..................... $ 870,839 $(68,567,181) $ 765,019 $(71,540,711)
Denominator:
Weighted average common shares
outstanding ................... 29,155,855 28,649,928 28,986,251 28,567,510
------------ ------------ ------------ ------------
Basic EPS ..................... $ 0.03 $ (2.39) $ 0.03 $ (2.50)
============ ============ ============ ============
Diluted EPS Computation:
Numerator ..................... $ 870,839 $(68,567,181) $ 765,019 $(71,540,711)
Denominator:
Weighted average common share
outstanding ................... 29,155,855 28,649,928 28,986,251 28,567,510
Incremental shares from assumed
exercise of options ........... 7,215 -- 7,215 --
------------ ------------ ------------ ------------
Total shares .................. 29,163,070 28,649,928 28,993,466 28,567,510
------------ ------------ ------------ ------------
Diluted EPS ................... $ 0.03 $ (2.39) $ 0.03 $ (2.50)
============ ============ ============ ============
13
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Basic and diluted loss per share has been computed in accordance with
SFAS No. 128, "Earnings Per Share".
The following table presents potentially dilutive securities. For
options and warrants outstanding as of June 30, 2005, only 7,215 shares of
outstanding options and warrants were included in the computation of income per
share in the six months ended June 30, 2005 as the exercise prices of the
remaining shares were greater than the average market price for the six months
ended June 30, 2005. All options and warrants were excluded from the computation
of loss per share in the six months ended June 30, 2004, as the impact would be
anti-dilutive.
Basic and Diluted EPS Computation: SIX MONTHS ENDED JUNE 30,
---------------------------
2005 2004
--------- ---------
Options .................. 6,857,687 8,828,362
Warrants ................. 2,361,732 911,732
--------- ---------
Total .................... 9,219,419 9,740,094
========= =========
13. RELATED PARTY TRANSACTIONS
As of June 30, 2005, related party affiliates were indebted to us in
the amounts of $9.2 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 second quarter of 2005 was approximately $2,432,000. At June 30,
2005, the entire balance due from Mr. Guez totaling $2.4 million is payable on
demand and had 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 $46,000 and $93,000 for the three
months ended June 30, 2005 and 2004, respectively. Mr. Guez paid expenses on our
behalf of approximately $126,000 and $106,000 for the three months ended June
30, 2005 and 2004, respectively, which amounts were applied to reduce accrued
interest and principal on Mr. Guez's loan. Since the enactment of the
Sarbanes-Oxley Act in 2002, no further personal loans (or amendments to existing
loans) have been or will be made to officers or directors of Tarrant.
On July 1, 2001, we formed an entity to jointly market, share certain
risks and achieve 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 June 30, 2005 and 2004 were $0 and $1.1 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 $34,000 and $503,000 of trim inventory
from Tag-It in the three months ended June 30, 2005 and 2004, respectively. We
purchased $0 and $1.5 million of finished goods and service from Azteca and its
affiliates in the three months ended June 30, 2005 and 2004, respectively. Our
total sales of fabric and service to Azteca in the three months ended June 30,
2005 and 2004 were $0 and $436,000, 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 June 30, 2005 was $6.2 million.
14
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 $44.8 million notes receivable - related party on the accompanying balance
sheet as of June 30, 2005 was $1.3 million of Mexico value added taxes on the
real property component of this transaction. The future maturities of the note
receivable from the purchasers, including the Mexican value added tax to be paid
by the purchasers. 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 $954,000 and $2.8 million of fabric from Acabados y
Terminados in the three months ended June 30, 2005 and 2004. Net amount due from
these parties as of June 30, 2005 was $294,000.
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 June 30, 2005 and 2004,
respectively, for office and warehouse facilities. We currently lease both
facilities on a month-to-month basis.
We reimbursed Mr. Guez, our Chairman, for fuel and related expenses
incurred by 477 Aviation LLC, a company owned by Mr. Guez, when our executives
used this company's aircraft for business purposes.
At June 30, 2005, we had various employee receivables totaling $388,000
included in due from related parties.
In the second quarter of 2003, we acquired a 45% equity interest in the
owner of the trademark "American Rag CIE" and the operator of American Rag
retail stores for $1.4 million, and our subsidiary, Private Brands, Inc.,
acquired a license to certain exclusive rights to this trademark. The investment
in American Rag Cie, LLC totaling $2.1 million at June 30, 2005 was accounted
for under the equity method and included in equity method of investment on the
accompanying consolidated balance sheets.
We believe the each of the transactions described above has been
entered into on terms no less favorable to us than could have been obtained from
unaffiliated third parties.
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, large sizes and junior 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 June 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 royalty 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. As of June 30, 2005, we have advanced $2.2 million as payment for the
first year's minimum royalties.
15
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In the second quarter of 2003, we acquired a 45% equity interest in the
owner of the trademark "American Rag CIE" and the operator of American Rag
retail stores for $1.4 million, and our subsidiary, Private Brands, Inc.,
acquired a license to certain exclusive rights to this trademark. We have
guaranteed the payment to the licensor of minimum royalties of $10.4 million
over the initial 10-year term of the agreement. At June 30, 2005, the total
commitment on royalties remaining on the term was $9.4 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
$954,000 of fabric under this agreement in the three months ended June 30, 2005.
16
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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
JUNE 30, 2005
Sales ....................... $ 50,205,000 $ 246,000 $ 87,000 $ -- $ 50,538,000
Inter-company sales ......... -- 35,165,000 -- (35,165,000) --
------------ ------------ ------------ ------------ ------------
Total revenue ............... $ 50,205,000 $ 35,411,000 $ 87,000 $(35,165,000) $ 50,538,000
============ ============ ============ ============ ============
Income (loss) from operations $ 448,000 $ 1,743,000 $ (156,000) $ -- $ 2,035,000
============ ============ ============ ============ ============
THREE MONTHS ENDED
JUNE 30, 2004
Sales ....................... $ 36,617,000 $ 220,000 $ 1,652,000 $ -- $ 38,489,000
Inter-company sales ......... -- 20,431,000 2,242,000 (22,673,000) --
------------ ------------ ------------ ------------ ------------
Total revenue ............... $ 36,617,000 $ 20,651,000 $ 3,894,000 $(22,673,000) $ 38,489,000
============ ============ ============ ============ ============
Income (loss) from
operations (1) ............ $ (3,473,000) $ 1,522,000 $(82,442,000) $ -- $(84,393,000)
============ ============ ============ ============ ============
SIX MONTHS ENDED
JUNE 30, 2005
Sales ....................... $ 94,805,000 $ 470,000 $ 93,000 $ -- $ 95,368,000
Inter-company sales ......... -- 62,000,000 -- (62,000,000) --
------------ ------------ ------------ ------------ ------------
Total revenue ............... $ 94,805,000 $ 62,470,000 $ 93,000 $(62,000,000) $ 95,368,000
============ ============ ============ ============ ============
Income (loss) from operations $ 47,000 $ 2,876,000 $ (360,000) $ -- $ 2,563,000
============ ============ ============ ============ ============
SIX MONTHS ENDED
JUNE 30, 2004
Sales ....................... $ 75,779,000 $ 1,017,000 $ 3,848,000 $ -- $ 80,644,000
Inter-company sales ......... -- 38,599,000 6,660,000 (45,259,000) --
------------ ------------ ------------ ------------ ------------
Total revenue ............... $ 75,779,000 $ 39,616,000 $ 10,508,000 $(45,259,000) $ 80,644,000
============ ============ ============ ============ ============
Income (loss) from
operations (1) ............ $ (5,199,000) $ 2,562,000 $(87,678,000) $ -- $(90,315,000)
============ ============ ============ ============ ============
(1) Included in Income (loss) from operations an impairment charge of $78.0
million in Mexico region.
16. RESTATEMENT OF FINANCIAL RESULTS
As a result of a review by Securities and Exchange Commission in
connection with our filing of a registration statement, we reviewed our
accounting treatment of our private placement transaction in October 2003 in
which we sold shares of convertible preferred stock. As a result, in May 2005 we
revised our accounting treatment for that transaction to record a beneficial
conversion feature in accordance with EITF No. 98-5. We initially reviewed the
transaction in light of EITF No. 98-5 and concluded in good faith that the
convertible preferred stock issued did not contain a beneficial conversion
feature that should be recognized and measured separately. However, based on
further guidance from the SEC, we have concluded that the convertible preferred
security contained an embedded conversion feature that was not recorded in 2003.
We determined to restate our financial statements for the fiscal years ended
December 31, 2003 and 2004 to reflect a beneficial conversion feature of $7.4
million relating to the issuance of 881,732 shares of Series A convertible
17
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
preferred stock in fiscal 2003. The beneficial conversion feature of the
preferred shares in the amount of $7.4 million was recorded in the fourth
quarter of 2003, resulting in an increase in loss per share to common
shareholders for the year ended December 31, 2003 to $(2.38) per share from the
previously reported $(1.97) per share. The beneficial conversion feature did not
change our reported earnings (loss) per share for the year ended December 31,
2004 and will not change any subsequent period. The effect of recording the
beneficial conversion feature on the December 31, 2004 financial statements was
an increase in the accumulated deficit of $7.4 million and an offsetting
increase in contributed capital. The restatement did not change total
shareholders' equity at December 31, 2004 or June 30, 2005. The revised
financial statements were filed on May 31, 2005.
18
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, JS by Jessica Simpson, Princy by Jessica Simpson, House of
Dereon by Beyonce 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 first quarter
of 2005, we also began shipping Gear 7 to 1,500 Kmart stores, and shipped plus
sizes of the Alain Weiz collection to over 150 Dillard's Department Stores. We
have entered into apparel licensing agreements to design, produce and sell
apparel under the Jessica Simpson and House of Dereon by Beyonce Knowles brands.
We made our first shipments of JS by Jessica Simpson brand apparel in late June
2005, resulting in sales for this brand of $0.9 million in the second quarter of
2005. We expect Princy by Jessica Simpson and House of Dereon brands to be
available in retail stores commencing in the second half of 2005.
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 six months of
2005.
RESTATEMENT OF FINANCIAL RESULTS
As a result of a review by Securities and Exchange Commission in
connection with our filing of a registration statement, we reviewed our
accounting treatment of our private placement transaction in October 2003 in
which we sold shares of convertible preferred stock. As a result, in May 2005,
we revised our accounting treatment for that transaction to record a beneficial
conversion feature in accordance with EITF No. 98-5. We initially reviewed the
transaction in light of EITF No. 98-5 and concluded in good faith that the
convertible preferred stock issued did not contain a beneficial conversion
feature that should be recognized and measured separately. However, based on
further guidance from the SEC, we have concluded that the convertible preferred
security contained an embedded conversion feature that was not recorded in 2003.
We determined to restate our financial statements for the fiscal years ended
December 31, 2003 and 2004 to reflect a beneficial conversion feature of $7.4
million relating to the issuance of 881,732 shares of Series A convertible
preferred stock in fiscal 2003. The beneficial conversion feature of the
preferred shares in the amount of $7.4 million was recorded in the fourth
quarter of 2003, resulting in an increase in loss per share to common
shareholders for the year ended December 31, 2003 to $(2.38) per share from the
previously reported $(1.97) per share. The beneficial conversion feature did not
change our reported earnings (loss) per share for the year ended December 31,
2004 and will not change any subsequent period. The effect of recording the
beneficial conversion feature on the December 31, 2004 financial statements was
an increase in the accumulated deficit of $7.4 million and an offsetting
increase in contributed capital. The restatement did not change total
shareholders' equity at December 31, 2004 or June 30, 2005. The revised
financial statements were filed on May 31, 2005.
19
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.
EXCHANGE TRANSACTION
In April 2005, we entered into a letter of intent with Qorus.com, Inc.
("Qorus"), to exchange all the outstanding shares of our wholly-owned
subsidiary, Private Brands, Inc., for shares of Qorus. Qorus is a publicly
traded company quoted on the Over-the-Counter Bulletin Board under the symbol
QRUS. Under the terms of the proposed transaction, in exchange for all of the
outstanding capital stock of Private Brands, Qorus would have issued shares of
its convertible preferred stock to us in such amount so that, upon completion of
the transaction, we would own in the aggregate 97% of the issued and outstanding
shares of common stock of Qorus on a fully diluted and as-converted basis. In
June 2005, the parties mutually agreed to terminate the letter of intent and
abandoned discussions regarding an exchange transaction.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosures
of contingent assets and liabilities. We are required to make assumptions about
matters, which are highly uncertain at the time of the estimate. Different
estimates we could reasonably have used or changes in the estimates that are
reasonably likely to occur could have a material effect on our financial
condition or result of operations. Estimates and assumptions about future events
and their effects cannot be determined with certainty. On an ongoing basis, we
evaluate estimates, including those related to returns, discounts, bad debts,
inventories, intangible assets, income taxes, and contingencies and litigation.
We base our estimates on historical experience and on various assumptions
believed to be applicable and reasonable under the circumstances. These
estimates may change as new events occur, as additional information is obtained
and as our operating environment changes. In addition, management is
periodically faced with uncertainties, the outcomes of which are not within its
control and will not be known for prolonged period of time.
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.
20
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 June 30, 2005, the balance in the allowance for returns,
discounts and bad debts reserves was $2.9 million.
INVENTORY
Our inventories are valued at the lower of cost or market. Under
certain market conditions, we use estimates and judgments regarding the
valuation of inventory to properly value inventory. Inventory adjustments are
made for the difference between the cost of the inventory and the estimated
market value and charged to operations in the period in which the facts that
give rise to the adjustments become known.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We assess the impairment of identifiable intangibles, long-lived assets
and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include, but are not limited to, the following:
o a significant underperformance relative to expected historical
or projected future operating results;
o a significant change in the manner of the use of the acquired
asset or the strategy for the overall business; or
o a significant negative industry or economic trend.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets." According to this
statement, goodwill and other intangible assets with indefinite lives are no
longer subject to amortization, but rather an assessment of impairment applied
on a fair-value-based test on an annual basis or more frequently if an event
occurs or circumstances change that would more likely than not reduce the fair
value of a reporting unit below its carrying amount.
We utilized the discounted cash flow methodology to estimate fair
value. As of June 30, 2005, we have a goodwill balance of $8.6 million, and a
net property and equipment balance of $1.6 million.
INCOME TAXES
As part of the process of preparing our consolidated financial
statements, 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
21
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."
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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------- ----------------
2005 2004 2005 2004
------ ------ ------ ------
Net sales .............................. 100.0% 100.0% 100.0% 100.0%
Cost of sales .......................... 77.3 86.3 78.6 84.2
------ ------ ------ ------
Gross profit ........................... 22.7 13.7 21.4 15.8
Selling and distribution expenses ...... 4.8 6.2 5.2 6.2
General and administration
expenses ............................ 13.9 24.1 13.5 24.9
Impairment of assets ................... 0.0 202.6 0.0 96.7
------ ------ ------ ------
Income (loss) from operations .......... 4.0 (219.2) 2.7 (112.0)
Interest expense ....................... (2.5) (1.8) (2.2) (1.9)
Interest Income ........................ 1.0 0.2 1.1 0.2
Other income ........................... 0.7 8.1 0.6 8.2
Other expense .......................... (1.2) (0.9) (0.9) (0.8)
Minority interest ...................... 0.0 36.7 0.0 18.6
------ ------ ------ ------
Income (loss) before taxes ............. 2.0 (176.9) 1.3 (87.7)
Income taxes ........................... 0.3 1.2 0.5 1.0
------ ------ ------ ------
Net income (loss) ...................... 1.7% (178.1)% 0.8% (88.7)%
====== ====== ====== ======
SECOND QUARTER 2005 COMPARED TO SECOND QUARTER 2004
Net sales increased by $12.0 million, or 31.3%, to $50.5 million in the
second quarter of 2005 from $38.5 million in the second quarter of 2004. The
increase in net sales in the second quarter of 2005 was primarily due to
increased sales of Private Brands, which was $11.5 million in the
22
second quarter of 2005 compared to $4.7 million in the same period of 2004. Gear
7, Alain Weiz, and Jessica Simpson recorded significant sales contributions in
the second quarter of 2005. Private Label sales for the second quarter of 2005
were $39.0 million compared to $33.8 million in the second quarter of 2004, with
the increase resulting primarily from increased sales to Chico's and Mothers
Work and a decrease in the sale of close-out inventory and fabric of $2.5
million in the second quarter of 2004 compared to $1.2 million in the second
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 $6.2 million to $11.5 million in the second quarter of
2005 from $5.3 million in the second 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 13.7% in the second quarter
of 2004 to 22.7% in the second 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, and the
reduction of close-out inventory and fabric sales in the second quarter of 2005.
Selling and distribution expenses increased by $18,000, or 0.8%, to
$2.4 million in the second quarter of 2005 from $2.39 million in the second
quarter of 2004. As a percentage of net sales, these expenses decreased to 4.8%
in the second quarter of 2005 from 6.2% in the second quarter of 2004 due to
increased sales during the second quarter of 2005.
General and administrative expenses decreased by $2.3 million, or
24.5%, to $7.0 million in the second quarter of 2005 from $9.3 million in the
second quarter of 2004. The decrease was primarily due to the depreciation and
amortization of our Mexico assets of $3.3 million in the second quarter of 2004
as compared to no such expense in the second quarter of 2005 after disposition
of those assets in late 2004. As a percentage of net sales, these expenses
decreased to 13.9% in the second quarter of 2005 from 24.1% in the second
quarter of 2004.
Impairment of assets expense was $0 in the second quarter of 2005,
compared to $78.0 million in the second quarter of 2004. This expense in the
second quarter 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 in the second quarter of 2005 was $2.0 million, or
4.0% of net sales, compared to operating loss of $84.4 million, or (219.2)% of
net sales, in the comparable period of 2004, because of the factors discussed
above.
Interest expense increased by $586,000 or 83.7%, to $1.3 million in the
second quarter of 2005 from $700,000 in the second quarter of 2004. As a
percentage of net sales, this expense increased to 2.5% in the second quarter of
2005 from 1.8% in the second quarter of 2004. The increase was primarily due to
interest expenses of $577,000 in the second 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 second
quarter of 2004. Interest income increased by $424,000 or 1.1% of net sales, to
$517,000 in the second quarter of 2005 from $93,000 in the second 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 $469,000 during
the second quarter of 2005, compared to no such income in the second quarter of
2004. Other income was $358,000 in the second quarter of 2005, compared to $3.1
million in the second quarter of 2004. This reduction in other income was due
primarily to $2.8 million of lease income received for the lease of our
facilities and equipment in Mexico in the second quarter of 2004, compared to no
such income in the second quarter of 2005 due to the sale of our Mexico
operations in the fourth quarter of 2004. Other expense was $592,000 in the
second quarter of 2005, compared to $363,000 in the second quarter of 2004.
Losses allocated to minority interests in the second quarter of 2004
were $14.1 million, representing the minority partner's share of profit in UAV
totaling $66,000, and the minority shareholder's share of losses in Tarrant
Mexico totaling $14.2 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.
Loss from the equity method investments, UAV and PBG7, totaled approximately
$21,000 for the second quarter of 2005. None of the loss in the equity method
investments was allocated to the minority members because we absorbed losses in
excess of the minority members' investment.
23
FIRST SIX MONTHS OF 2005 COMPARED TO FIRST SIX MONTHS OF 2004
Net sales increased by $14.7 million, or 18.3%, to $95.4 million in the
first six months of 2005 from $80.6 million in the first six months of 2004. The
increase in net sales in the first six months of 2005 was primarily due to
increased sales of Private Brands, which was $22.8 million in the first six
months of 2005 compared to $11.5 million in the same period of 2004. Gear 7,
Alain Weiz, and Jessica Simpson recorded significant sales contributions in the
first six months of 2005. Private Label sales for the first six months of 2005
were $72.6 million compared to $69.1 million in the first six months of 2004,
with the increase resulting primarily from increased sales to Chico's and
Mothers Work and a decrease in the sale of close-out inventory and fabric of
$7.6 million in the first six months of 2004 compared to $1.7 million in the
first six months of 2005.
Gross profit increased by $7.6 million to $20.4 million in the first
six months of 2005 from $12.8 million in the first six 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
15.8% in the first six months of 2004 to 21.4% in the first six 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 six months of 2005 as compared to the prior year period.
Selling and distribution expenses decreased by $63,000, or 1.2%, to
$4.97 million in the first six months of 2005 from $5.0 million in the first six
months of 2004. As a percentage of net sales, these expenses decreased from 6.2%
for the first six months of 2004 to 5.2% for the first six months of 2005.
General and administrative expenses decreased by $7.2 million, or
35.9%, to $12.9 million in the first six months of 2005 from $20.1 million in
the first six 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 six months of 2004 as
compared to no such expense in the first six months of 2005 after disposition of
our fixed assets in Mexico in late 2004. As a percentage of net sales, these
expenses decreased to 13.5% in the first six months of 2005 from 24.9% in the
first six months of 2004.
Impairment of assets expense was $0 in the first six months of 2005,
compared to $78.0 million in the first six months of 2004. This expense in the
first six 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 six months of 2005 was $2.6 million, or
2.7% of net sales, compared to operating loss of $90.3 million, or (112.0)% of
net sales, in the comparable prior period of 2004 as a result of the factors
discussed above.
Interest expense increased by $605,000, or 40.5%, to $2.1 million in
the first six months of 2005 from $1.5 million in the first six months of 2004.
As a percentage of net sales, this expense increased to 2.2% in the first six
months of 2005 from 1.9% in the first six months of 2004. The increase was
primarily due to interest expenses of $756,000 in the first six 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 six months of 2004. Interest income increased by $883,000 or 1.1%
of net sales, to $1.1 million in the first six months of 2005 from $187,000 in
the first six 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 $946,000 during the first six months of 2005, compared to no such
income in the first six months of 2004. Other income was $586,000 in the first
six months of 2005, compared to $6.6 million in the first six 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
six months of 2004, compared to no such income in the first six months of 2005
due to the sale of our Mexico operations in the fourth quarter of 2004. Other
expense was $893,000 in the first six months of 2005, compared to $722,000 in
the first six months of 2004.
Losses allocated to minority interests in the first six months of 2004
were $15.0 million, representing the minority partner's share of losses in UAV
totaling $157,000, 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
24
incurred for the write down of fixed assets in Mexico. Earnings from the equity
method investments, UAV and PBG7, totaled approximately $35,000 for the first
six months of 2005. None of the profit in the equity method investments was
allocated to the minority members because we previously absorbed losses in
excess of the minority members' investment.
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
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 six months ended June 30, 2005 and 2004 were as
follows (dollars in thousands):
CASH FLOWS: 2005 2004
-------- --------
Net cash provided by (used in) operating activities .... $(16,422) $ 12,415
Net cash provided by (used in) investing activities .... $ 3,014 $ (208)
Net cash provided by (used in) financing activities .... $ 13,373 $(14,603)
During the first six months of 2005, net cash used in operating
activities was $16.4 million, as compared to net cash provided by operating
activities of $12.4 million for the same period in 2004. Net cash used in
operating activities in the first six months of 2005 resulted primarily from a
net income of $765,000, reduced by increases of $20.9 million in accounts
receivable and $4.9 million in inventory, partially offset by depreciation and
amortization expense of $1.3 million, an increase of $6.4 million in account
payable and decrease of $1.7 million due to/from related parties. The increase
in accounts receivable, inventory and accounts payable in the first six months
of 2005 was primarily due to increase in sales volume.
During the first six months of 2005, net cash provided by investing
activities was $3.0 million, as compared to net cash used in investing
activities of $208,000 for the same period in 2004. Net cash provided by
investing activities in the first six months 2005 included approximately $2.4
million of collection of advances from our Chairman.
25
During the first six months of 2005, net cash provided by financing
activities was $13.4 million, as compared to net cash used in financing
activities of $14.6 million for the same period in 2004. Net cash provided by
financing activities in six months of 2005 included $1.4 million net repayment
of our short-term bank borrowings, $10.5 million net proceeds from our credit
facilities and $1.5 million net proceeds from Max Azria.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Following is a summary of our contractual obligations and commercial
commitments available to us as of June 30, 2005 (in millions):
PAYMENTS DUE BY PERIOD
------------------------------------------
Less Between Between After
CONTRACTUAL OBLIGATIONS than 2-3 4-5 5
Total 1 Year Years Years Years
----------------------------------- ------ ------ ------ ------ ------
Long-term debt (1) ................ $ 34.4 $ 32.9 $ 1.5 $ -- $ --
Convertible debentures, net ....... 7.7 -- 7.7 -- --
Operating leases .................. 0.4 0.2 0.2 -- --
Minimum royalties ................. 25.2 4.1 13.9 2.0 5.2
Purchase commitment ............... 49.0 4.0 10.0 10.0 25.0
------ ------ ------ ------ ------
Total Contractual Cash Obligations $116.7 $ 41.2 $ 33.3 $ 12.0 $ 30.2
(1) Excludes interest on long-term debt obligations. Based on outstanding
borrowings as of June 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 $3.2 million.
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 .................. $ 63.9 $ 63.9 $ -- $ -- $ --
Letters of credit (within lines of
credit) ....................... $ 18.9 $ 18.9 $ -- $ -- $ --
Total commercial commitments ..... $ 63.9 $ 63.9 $ -- $ -- $ --
On June 13, 2002, we entered into a letter of credit facility of $25
million with UPS Capital Global Trade Finance Corporation ("UPS"). Under this
facility, we may arrange for the issuance of letters of credit and acceptances.
The facility is collateralized by the shares and debentures of all of our
subsidiaries in Hong Kong. In addition to the guarantees provided by Tarrant
Apparel Group and our subsidiaries, Fashion Resource (TCL) Inc. and Tarrant
Luxembourg Sarl, Gerard Guez, our Chairman, also signed a guarantee of $5
million in favor of UPS to secure this facility. This facility bears interest at
7.0% per annum at June 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. 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
June 30, 2005, $13.8 million was outstanding under this facility with UPS and an
additional $3,000 was available for future borrowings. In addition, $1.2 million
of open letters of credit was outstanding as of June 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. 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 June 30, 2005, $4.0 million was outstanding. The
26
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 June 30, 2005, $3.5 million
was outstanding under this facility. In addition, $0.9 million of open letters
of credit was outstanding and none was available for future borrowings as of
June 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 June
30, 2005, $423,000 was outstanding under this loan.
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. This facility
bears interest at 6.237% per annum at June 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 June
30, 2005, we were in compliance with the covenants. A total of $28.8 million was
outstanding with respect to receivables factored under the GMAC facility at June
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 $2.1
million was outstanding under the GMAC facility at June 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
27
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 $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. The Debentures
were converted at the option of the holders at a price of $2.00 per share. Debt
discount of $182,000 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, $141,000 was expensed upon the conversion. The intrinsic
value of the conversion option, and the value of the warrant amortized in the
first six months of 2005 was $248,000. Total deferred financing cost amortized
in the first six months of 2005 was $103,000. Total interest paid to the holders
of the Debentures in the first six months of 2005 was $326,000. As of June 30,
2005, $6.5 million, net of $1.2 million of debt discount, remained outstanding
under the Debentures.
On February 14, 2005, we borrowed $5.0 million from Max Azria, which
amount bears interest at the rate of 4% per annum and is payable in weekly
installments of $250,000 beginning on February 28, 2005 and continuing each
Monday until July 11, 2005. This is an unsecured loan. As of June 30, 2005, $1.5
million remained outstanding under this loan. In early August 2005, we repaid
the loan in its entirety.
We had two equipment loans outstanding at June 30, 2005 totaling
$70,000 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 June 30, 2005, $1.6 million was outstanding
under this facility and $3.6 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.
28
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.
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. We are
currently leasing both of these facilities on a month-to-month basis. We paid
$255,000 and $332,000 in the three months ended June 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 $44.8 million notes receivable - related party on the accompanying balance
sheet as of June 30, 2005 was $1.3 million of Mexico value added taxes on the
real property component of this transaction. The future maturities of the note
receivable from the purchasers, including the Mexican value added tax to be paid
by the purchasers. 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 $954,000 and $2.8 million of fabric from Acabados y
Terminados in the three months ended June 30, 2005 and 2004. Net amount due from
these parties as of June 30, 2005 was $294,000.
29
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 second quarter of 2005 was approximately $2,432,000. Mr. Guez paid
our expenses of approximately $126,000 and $106,000 for the three months ended
June 30, 2005 and 2004, respectively, which amounts were applied to reduce
accrued interest and principle on Mr. Guez's loan. The balance of $2.4 million
is payable on demand and had been shown as reductions to shareholders' equity as
of June 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
$46,000 and $93,000 for the three months ended June 30, 2005 and 2004,
respectively. Since the enactment of the Sarbanes-Oxley Act in 2002, no further
personal loans (or amendments to existing loans) have been or will be made to
officers or directors of Tarrant.
On July 1, 2001, we formed an entity to jointly market, share certain
risks and achieve economies of scale with Azteca Production International, Inc.
("Azteca"), called United Apparel Ventures, LLC ("UAV"). Azteca is owned by
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
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 $54,000 in the three months ended June 30, 2005 and 2004,
respectively. We purchased $0 and $1.5 million of finished goods and service
from Azteca and its affiliates in the three months ended June 30, 2005 and 2004,
respectively. Our total sales of fabric and service to Azteca in the three
months ended June 30, 2005 and 2004 were $0 and $436,000, 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 June 30, 2005 and 2004 were $0 and $1.1 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 $34,000 and $503,000
of trim inventory from Tag-It in the three months ended June 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.
30
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 16.4% and 15.6% of our net sales for the first six
months of 2005 and 2004, respectively. Mervyn's accounted for 11.1% and 16.2% of
our net sales for the first six months of 2005 and 2004, respectively. Lerner
New York accounted for 9.1% and 11.5% of our net sales for the first six months
of 2005 and 2004, respectively. Affiliated department stores owned by Federated
Department Stores accounted for approximately 13.4% and 9.9% of our net sales
for the first six months of 2005 and 2004, respectively. Wal-Mart accounted for
approximately 9.9% and 7.1% of our net sales for the first six 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
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.
31
FAILURE TO MANAGE OUR RESTRUCTURING IN MEXICO COULD IMPAIR OUR BUSINESS.
We determined to cease directly operating a substantial majority of our
equipment and fixed assets in Mexico, and to lease a large portion of our
facilities and operations in Mexico to a related third party, which we
consummated effective September 1, 2003. Subsequently, in August 2004, we
entered into a purchase and sale agreement to sell substantially all of our
assets and real property in Mexico, including the equipment and facilities
previously leased to Mr. Nacif's affiliates, which transaction was consummated
in the fourth quarter of 2004. As a consequence, we have become primarily a
trading company, relying on third party manufacturers to produce the merchandise
we sell to our customers and as a result assume the risks associated with
contracting these services.
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, quotas, 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.
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
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
32
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 and quotas 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 could result in safeguard measures such as
duties or embargo of China country of origin products, which may be disruptive
or have a negative impact on margins.
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.
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OUR BUSINESS IS SUBJECT TO RISKS OF OPERATING IN A FOREIGN COUNTRY AND TRADE
RESTRICTIONS.
Approximately 89% of our products sold in the second 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;
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.
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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 June 30, 2005, our executive officers and directors and their
affiliates owned approximately 43.3% of the outstanding shares of our common
stock. Gerard Guez, our Chairman, and Todd Kay, our Vice Chairman, alone own
approximately 33.6% and 8.5%, respectively, of the outstanding shares of our
common stock at June 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
35
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. At times we use forward
exchange contracts to reduce the effect of fluctuations of foreign currencies on
purchases and commitments. These short-term assets and commitments are
principally related to trade payables positions and fixed asset purchase
obligations. We do not utilize derivative financial instruments for trading or
other speculative purposes. We actively evaluate the creditworthiness of the
financial institutions that are counter parties to derivative financial
instruments, and we do not expect any counter parties to fail to meet their
obligations.
INTEREST RATE RISK. Because our obligations under our various credit
agreements bear interest at floating rates (primarily 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 June 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 second quarter of 2005, we adopted new policies and
procedures for accounting for instruments with convertible features.
Specifically, our Chief Financial Officer, who was hired in the third quarter of
2004, will review and approve the appropriate accounting for convertible
instruments and determine whether any embedded beneficial conversion feature is
required to be recognized and measured separately. This change was made in
response to the conclusion by management and Grant Thornton LLP, our independent
accountants, that a material weakness existed in our internal control over
financial reporting in light of the restatement of our consolidated financial
statements for the years ended December 31, 2003 and 2004. See Note 16 of the
"Notes to Consolidated Financial Statements" for a discussion of the
restatement.
Other than as described above, during the second 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 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS.
From June 22, 2005 through August 2 2005, holders of our outstanding 6%
convertible secured debentures converted an aggregate of $361,000 of
indebtedness under the debentures into 180,500 shares our common stock. The
debentures are convertible at the option of the holders into shares of our
common stock at a price of $2.00 per share. These shares were issued to certain
holders of the debentures as of the following dates:
o 100,000 shares on June 22, 2005
o 20,500 shares on June 28, 2005
o 60,000 shares on August 2, 2005
The issuance of these shares was exempt from the registration and
prospectus delivery requirements of the Securities Act pursuant to Section
3(a)(9) of the Securities Act.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On May 26, 2005, we held our 2005 Annual Meeting of Shareholders. At
the annual meeting, there were 28,814,763 shares entitled to vote, and
25,715,746 shares (89.25%) were represented at the meeting in person or by
proxy. Immediately prior to and following the meeting, the Board of Directors
was comprised of Gerard Guez, Todd Kay, Barry Aved, Corazon Reyes, Joseph
Mizrachi, Mitchell Simbal, Milton Koffman, Stephane Farouze and Simon Mani.
The following summarizes vote results for those matters submitted to
our shareholders for action at the annual meeting:
1. Proposal to elect Barry Aved, Stephane Farouze, Milton Koffman
and Mtichell Simbal to serve as our Class II directors for two years and until
their successors has been elected.
DIRECTOR FOR WITHHELD
Barry Aved 25,573,224 142,522
Stephane Farouze 25,690,971 24,775
Milton Koffman 25,690,971 24,775
Mitchell Simbal 25,690,971 24,775
2. Proposal to ratify the appointment of Grant Thornton LLP as
the Company's independent public accountants for the year ended December 31,
2005.
FOR AGAINST ABSTAIN BROKER NON-VOTES
25,692,570 11,675 11,500 1
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ITEM 6. EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
------- --------------------------------------------------------
10.11.1 First Amendment Factoring Agreement dated as of May 9,
2005 by and among GMAC Commercial Finance LLC and
Tarrant Apparel Group, Fashion Resource (TCL), Inc., TAG
Mex, Inc., United Apparel Ventures, LLC, Private Brands,
Inc. and NO! Jeans, Inc.
10.11.2 Inventory Security Agreement by and among GMAC
Commercial Finance LLC and Tarrant Apparel Group,
Fashion Resource (TCL), Inc., TAG Mex, Inc., United
Apparel Ventures, LLC, Private Brands, Inc. and NO!
Jeans, Inc.
10.16.17 Eleventh Deed of Variation to Syndicated Letter of
Credit Facility effective as of February 14, 2005 among
Tarrant Company Limited, Marble Limited and Trade Link
Holdings Limited and UPS Capital Global Trade Finance
Corporation.
10.16.18 Twelfth Deed of Variation to Syndicated Letter of
Credit Facility effective as of June 27, 2005 among
Tarrant Company Limited, Marble Limited and Trade Link
Holdings Limited and UPS Capital Global Trade Finance
Corporation.
10.16.19 First Deed of Variation to Loan Agreement effective as
of June 27, 2005 among Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited and UPS Capital
Global Trade Finance Corporation.
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: August 11, 2005 By: /s/ Corazon Reyes
--------------------------
Corazon Reyes,
Chief Financial Officer
Date: August 11, 2005 By: /s/ Barry Aved
--------------------------
Barry Aved,
Chief Executive Officer
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