UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 2
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to _______
Commission File Number: 0-26006
TARRANT APPAREL GROUP
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-4181026
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
3151 EAST WASHINGTON BOULEVARD
LOS ANGELES, CALIFORNIA 90023
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (323) 780-8250
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registration is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the Common Stock held by non-affiliates
of the Registrant is approximately $51,515,376 based upon the closing price of
the Common Stock on June 30, 2005.
Number of shares of Common Stock of the Registrant outstanding as of
March 30, 2006: 30,543,763.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A in
connection with the 2006 Annual Meeting of Shareholders are incorporated by
reference into Part III of this Report.
EXPLANATORY NOTE
We are filing this Amendment No. 2 to Annual Report on Form 10-K/A for
the year ended December 31, 2005 (the "Amended Annual Report"), to amend our
Annual Report on Form 10-K for the year ended December 31, 2005 originally filed
with the Securities and Exchange Commission (the "SEC") on March 31, 2006 and
previously amended by our Annual Report on Form 10-K/A filed with the SEC on
January 31, 2007 (as amended, the "Original Annual Report"). The Company is
filing this Amended Annual Report in response to comments received from the SEC.
The following Items amend the Original Annual Report, as permitted by the rules
and regulations of the SEC. Unless otherwise stated, all information contained
in this Amended Annual Report is as of March 31, 2006. All capitalized terms
used herein but not otherwise defined shall have the meanings ascribed to them
in the Original Annual Report.
PART II
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 15. Exhibits, Financial Statement Schedules" for our
financial statements, and the notes thereto, and the financial statement
schedules filed as part of this report.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Schedule. Reference is made to the
Index to Financial Statements and Schedule on page F-1 for a list of financial
statements and the financial statement schedule filed as part of this report.
All other schedules are omitted because they are not applicable or the required
information is shown in the Company's financial statements or the related notes
thereto.
(b) Exhibits.
EXHIBIT
NUMBER DESCRIPTION
------------ -------------------------------------------------------------------
23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP.
23.2 Consent of Grant Thornton LLP.
23.3 Consent of Singer Lewak Greenbaum & Goldstein LLP.
31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities and Exchange Act of 1934, as amended.
31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a)
under the Securities and Exchange Act of 1934, as amended.
32.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(b)
under the Securities and Exchange Act of 1934, as amended.
32.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(b)
under the Securities and Exchange Act of 1934, as amended.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
PAGE
----
Financial Statements
Report of Independent Registered Public Accounting Firm, Singer
Lewak Greenbaum & Goldstein LLP..........................................F-2
Report of Independent Registered Public Accounting Firm, Grant
Thornton LLP.............................................................F-3
Consolidated Balance Sheets--December 31, 2004 and 2005..................F-4
Consolidated Statements of Operations and Comprehensive Loss--
Three year period ended December 31, 2005................................F-5
Consolidated Statements of Shareholders' Equity--Three year
period ended December 31, 2005...........................................F-6
Consolidated Statements of Cash Flows--Three year period ended
December 31, 2005........................................................F-7
Notes to Consolidated Financial Statements...............................F-8
Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts..........................F-41
American Rag Combined Financial Statements for Year Ended
December 31, 2005.......................................................F-42
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Tarrant Apparel Group
Los Angeles, California
We have audited the consolidated balance sheet of Tarrant Apparel Group and
subsidiaries (collectively, the "Company") as of December 31, 2005, and the
related consolidated statement of operations, stockholders' equity and cash
flows for the year then ended. Our audit also included the financial statement
schedule of Tarrant Apparel Group, listed in Item 15(a). These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Tarrant Apparel Group and
subsidiaries as of December 31, 2005, and the results of its operations and its
cash flows for the year then ended in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements, taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Singer Lewak Greenbaum & Goldstein LLP
-------------------------------------------
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
March 15, 2006, except for Note 6,
as to which the date is October 3, 2007
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and
Shareholders of Tarrant Apparel Group
We have audited the accompanying consolidated balance sheet of Tarrant Apparel
Group (a California corporation) and subsidiaries as of December 31, 2004 and
the related consolidated statements of operations and comprehensive loss,
shareholders' equity, and cash flows for each of the two years in the period
ended December 31, 2004. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tarrant Apparel
Group as of December 31, 2004 and the results of its operations and its cash
flows for each of the two years in the period ended December 31, 2004 in
conformity with accounting principles generally accepted in the United States of
America.
We have also audited Schedule II of Tarrant Apparel Group for each of the two
years in the period ending December 31, 2004. In our opinion, this schedule
presents fairly, in all material respects, the information required to be set
forth therein.
/S/ GRANT THORNTON LLP
-----------------------------------
Grant Thornton LLP
Los Angeles, California
March 24, 2005, except for Note 19,
as to which the date is March 30, 2005, and
Note 13, as to which the date is May 31, 2005
F-3
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------------
2004 2005
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ........................................ $ 1,214,944 $ 1,641,768
Accounts receivable, net ......................................... 37,759,343 54,598,443
Due from related parties ......................................... 10,651,914 3,100,928
Inventory ........................................................ 19,144,105 31,628,960
Current portion of note receivable from related party ............ 5,323,733 5,139,387
Prepaid expenses ................................................. 1,251,684 1,292,441
Prepaid royalties ................................................ 2,257,985 1,123,531
Income taxes receivable .......................................... 144,796 25,468
------------- -------------
Total current assets ........................................... 77,748,504 98,550,926
Property and equipment, net ...................................... 1,874,893 1,702,840
Notes receivable - related party, net of current portion ......... 40,107,337 36,268,446
Due from related parties ......................................... -- 2,994,945
Equity method investment ......................................... 1,880,281 2,138,865
Deferred financing cost, net ..................................... 1,203,259 838,786
Other assets ..................................................... 414,161 164,564
Goodwill, net .................................................... 8,582,845 8,582,845
------------- -------------
Total assets ................................................... $ 131,811,280 $ 151,242,217
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings ....................................... $ 17,951,157 $ 13,833,532
Accounts payable ................................................. 24,394,553 33,278,959
Accrued expenses ................................................. 11,243,179 9,503,806
Income taxes ..................................................... 16,826,383 16,828,538
Current portion of long-term obligations and factoring arrangement 19,628,701 36,109,699
------------- -------------
Total current liabilities ...................................... 90,043,973 109,554,534
Long-term obligations .............................................. 2,544,546 239,935
Convertible debentures, net ........................................ 8,330,483 5,965,098
Deferred tax liabilities ........................................... 213,784 47,098
Minority interest in PBG7 .......................................... -- 75,241
Commitments and contingencies
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized;
no shares (2004) and no shares (2005) issued and outstanding .... -- --
Common stock, no par value, 100,000,000 shares authorized;
28,814,763 shares (2004) and 30,553,763 shares (2005) issued and
outstanding ..................................................... 111,515,091 114,977,465
Warrant to purchase common stock ................................... 2,846,833 2,846,833
Contributed capital ................................................ 9,965,591 10,004,331
Accumulated deficit ................................................ (91,182,959) (90,189,615)
Notes receivable from officer/shareholder .......................... (2,466,062) (2,278,703)
------------- -------------
Total shareholders' equity ..................................... 30,678,494 35,360,311
------------- -------------
Total liabilities and shareholders' equity ..................... $ 131,811,280 $ 151,242,217
============= =============
See accompanying notes.
F-4
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2003 2004 2005
------------- -------------- -------------
Net sales .................................... $ 320,422,850 $ 155,452,663 $ 214,648,218
Cost of sales ................................ 288,445,173 134,492,460 169,767,051
------------- ------------- -------------
Gross profit ................................. 31,977,677 20,960,203 44,881,167
Selling and distribution expenses ............ 11,329,414 9,290,819 10,726,425
General and administrative expenses .......... 31,767,122 32,083,637 26,864,789
Write-off of prepaid expenses ................ 2,771,989 -- --
Royalty expense .............................. 242,426 604,888 3,664,454
Impairment charges ........................... 19,504,521 77,982,034 --
Cumulative translation loss attributable to
liquidated Mexico operations .............. -- 22,786,125 --
------------- ------------- -------------
Income (loss) from operations ................ (33,637,795) (121,787,300) 3,625,499
Interest expense ............................. (5,602,556) (2,857,096) (4,624,590)
Interest income .............................. 424,518 377,587 2,081,456
Minority interest ............................ 3,461,243 15,331,171 (75,241)
Interest in income of equity method investee.. -- 769,706 559,634
Other income ................................. 4,784,479 6,366,637 354,347
Other expense ................................ (1,182,920) (529,257) (580)
------------- ------------- -------------
Income (loss) before provision for income
taxes ...................................... (31,753,031) (102,328,552) 1,920,525
Provision for income taxes ................... 4,131,629 2,348,119 927,181
------------- ------------- -------------
Net income (loss) ............................ $ (35,884,660) $(104,676,671) $ 993,344
============= ============= =============
Net income (loss) per share - Basic (as
restated, see Note 13): .................... $ (2.38) $ (3.64) $ 0.03
============= ============= =============
Net income (loss) per share - Diluted (as
restated, see Note 13) ..................... $ (2.38) $ (3.64) $ 0.03
============= ============= =============
Weighted average common and common equivalent
shares outstanding:
Basic ...................................... 18,215,071 28,732,796 29,728,997
============= ============= =============
Diluted .................................... 18,215,071 28,732,796 29,734,291
============= ============= =============
Net income (loss) ............................ $ (35,884,660) $(104,676,671) $ 993,344
Foreign currency translation adjustment ...... (9,945,727) -- --
------------- ------------- -------------
Total comprehensive income (loss) ............ $ (45,830,387) $(104,676,671) $ 993,344
============= ============= =============
See accompanying notes.
F-5
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005
PREFERRED NUMBER COMMON NUMBER
STOCK OF SHARES STOCK OF SHARES WARRANTS
------------- ------------- ------------- ------------- -------------
Balance at January 1, 2003 ................... $ 8,820,573 100,000 $ 69,368,239 15,846,315 $ --
Net loss .................................. -- -- -- -- --
Currency translation ...................... -- -- -- -- --
Comprehensive loss ........................ -- -- -- -- --
Conversion of preferred stock to
common stock ........................... (8,820,573) (100,000) 8,820,573 3,000,000 --
Issuance of preferred stock and
warrant, net ........................... 29,226,041 881,732 -- -- 1,798,733
Conversion of preferred stock to
common stock ........................... (29,226,041) (881,732) 29,226,041 8,817,320 --
Intrinsic value of beneficial conversion
associated with convertible preferred
stock .................................. -- -- -- -- --
Issuance of common stock .................. -- -- 788,000 200,000 --
Retirement of stock ....................... -- -- (311,427) (248,872) --
Compensation expense ...................... -- -- -- -- --
Repayment from shareholders ............... -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2003 (as restated,
see Note 13) ................................. -- -- 107,891,426 27,614,763 1,798,733
Currency translation ...................... -- -- -- -- --
Net loss .................................. -- -- -- -- --
Cumulative translation loss attributable to
liquidated Mexico operations ........... -- -- -- -- --
Compensation expense ...................... -- -- -- -- --
Issuance of common stock .................. -- -- 3,623,665 1,200,000 44,100
Issuance of warrants with debentures ...... -- -- -- -- 1,004,000
Intrinsic value of beneficial conversion
associated with convertible debentures . -- -- -- -- --
Repayment from shareholders ............... -- -- -- -- --
Reclassification of shareholders'
receivable to current asset ............ -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2004 ................. $ -- -- $ 111,515,091 28,814,763 $ 2,846,833
Net income ................................ -- -- -- -- --
Compensation expense ...................... -- -- -- -- --
Issuance of common stock .................. -- -- 375,000 195,313 --
Conversion of debentures .................. -- -- 3,087,374 1,543,687 --
Repayment from shareholders ............... -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2005 ................. $ -- -- $ 114,977,465 30,553,763 $ 2,846,833
============= ============= ============= ============= =============
RETAINED ACCUMULATED
EARNINGS OTHER TOTAL
CONTRIBUTED (ACCUMULATED COMPREHENSIVE NOTES FROM SHAREHOLDERS'
CAPITAL DEFICIT) INCOME (LOSS) SHAREHOLDERS EQUITY
------------- ------------- ------------- ------------- -------------
Balance at January 1, 2003 ................... 1,434,259 56,873,094 (9,733,458) (5,601,804) 121,160,903
Net loss .................................. -- (35,884,660) -- -- (35,884,660)
Currency translation ...................... -- -- (9,945,727) -- (9,945,727)
-------------
Comprehensive loss ........................ -- -- -- -- (45,830,387)
Conversion of preferred stock to
common stock ........................... -- -- -- -- --
Issuance of preferred stock and
warrant, net ........................... -- -- -- -- 31,024,774
Conversion of preferred stock to
common stock ........................... -- -- -- -- --
Intrinsic value of beneficial conversion
associated with convertible preferred
stock .................................. 7,494,722 (7,494,722) -- -- --
Issuance of common stock .................. -- -- -- -- 788,000
Retirement of stock ....................... -- -- -- -- (311,427)
Compensation expense ...................... 71,572 -- -- -- 71,572
Repayment from shareholders ............... -- -- -- 805,376 805,376
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2003 (as restated,
see Note 13) ................................. 9,000,553 13,493,712 (19,679,185) (4,796,428) 107,708,811
Currency translation ...................... -- -- (3,106,940) -- (3,106,940)
Net loss .................................. -- (104,676,671) -- -- (104,676,671)
Cumulative translation loss attributable to
liquidated Mexico operations ........... -- -- 22,786,125 -- 22,786,125
Compensation expense ...................... 161,038 -- -- -- 161,038
Issuance of common stock .................. -- -- -- -- 3,667,765
Issuance of warrants with debentures ...... -- -- -- -- 1,004,000
Intrinsic value of beneficial conversion
associated with convertible debentures . 804,000 -- -- -- 804,000
Repayment from shareholders ............... -- -- -- 30,366 30,366
Reclassification of shareholders'
receivable to current asset ............ -- -- -- 2,300,000 2,300,000
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2004 ................. $ 9,965,591 $ (91,182,959) $ -- $ (2,466,062) $ 30,678,494
Net income ................................ -- 993,344 -- -- 993,344
Compensation expense ...................... 38,740 -- -- -- 38,740
Issuance of common stock .................. -- -- -- -- 375,000
Conversion of debentures .................. -- -- -- -- 3,087,374
Repayment from shareholders ............... -- -- -- 187,359 187,359
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2005 ................. $ 10,004,331 $ (90,189,615) $ -- $ (2,278,703) $ 35,360,311
============= ============= ============= ============= =============
See accompanying notes
F-6
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
2003 2004 2005
------------ ----------- ------------
Operating activities:
Net Income (loss) ........................................... $ (35,884,660) $(104,676,671) $ 993,344
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Deferred taxes ........................................... (132,622) (61,345) (166,686)
Depreciation and amortization ............................ 16,097,595 8,337,946 2,126,585
Receipt of merchandise in lieu of interest on notes
receivable, related party .............................. -- -- (1,742,540)
Impairment charges ....................................... 22,276,510 77,982,034 --
Cumulative transaction loss attributable to the liquidated
Mexico operations ...................................... -- 22,786,125 --
Inventory write-down ..................................... 10,986,153 -- --
Prepaid royalties write-off .............................. -- -- 1,165,970
Income from equity method investment ..................... -- (769,706) (559,634)
Loss (gain) on sale of fixed assets ...................... 593,626 (15,272) (124,041)
Unrealized (gain) loss on foreign currency ............... 560,602 (367,262) --
Minority interest ........................................ (3,218,069) (15,331,171) 75,241
Gain on legal settlement ................................. (235,785) -- --
Compensation expense related to stock options ............ 71,572 161,038 38,740
Change in the provision for returns and discounts ........ (324,387) (1,747,060) (78,060)
Changes in operating assets and liabilities:
Restricted cash ....................................... (2,759,742) 2,759,742 --
Accounts receivable ................................... 7,856,700 21,224,454 (16,761,040)
Due to/from related parties ........................... (14,801,324) (122,389) 2,702,047
Inventory ............................................. 9,626,509 4,162,158 (8,503,086)
Prepaid expenses ...................................... 590,046 (1,860,955) 47,055
Other assets .......................................... 450,782 -- --
Accounts payable ...................................... (4,207,552) 687,758 9,248,667
Accrued expenses and income tax payable ............... 2,388,976 (981,196) (1,362,218)
------------- ------------- -------------
Net cash (used in) provided by operating activities ...... 9,934,930 12,168,228 (12,899,656)
Investing activities:
Purchase of fixed assets .................................... (368,113) (111,836) (559,081)
Proceeds from sale of fixed assets .......................... 209,788 1,219,904 130,552
Investment in equity investment method ...................... (1,434,375) (137,000) --
Distribution from equity investment method .................. -- 460,800 301,050
Collection on notes receivable, related party ............... -- -- 1,194,722
Investment in joint venture ................................. -- (211,963) --
Collection of advances from shareholders/officers ........... 88,723 30,366 2,487,360
------------- ------------- -------------
Net cash provided by (used in) investing activities ...... (1,503,977) 1,250,271 3,554,603
Financing activities:
Short-term bank borrowings, net ............................. (161,194) (11,342,166) (4,117,625)
Proceeds from long-term obligations ......................... 239,280,109 129,667,084 218,367,495
Payment of financing costs .................................. -- (1,124,668) --
Payment of long-term obligations and bank borrowings ........ (275,640,677) (146,375,987) (204,477,993)
Repayments of borrowings from shareholders/officers ......... (486,379) -- --
Proceeds from issuance of preferred stock and warrant ....... 31,024,774 3,623,665 --
Proceeds from convertible debentures, net ................... -- 10,000,000 --
Repurchase of shares ........................................ (311,427) -- --
------------- ------------- -------------
Net cash provided by (used in) financing activities ...... (6,294,794) (15,552,072) 9,771,877
Effect of exchange rate on cash ............................. (204,677) 28,553 --
------------- ------------- -------------
Increase (decrease) in cash and cash equivalents ............ 1,931,482 (2,105,020) 426,824
Cash and cash equivalents at beginning of year .............. 1,388,482 3,319,964 1,214,944
------------- ------------- -------------
Cash and cash equivalents at end of year .................... $ 3,319,964 $ 1,214,944 $ 1,641,768
============= ============= =============
See accompanying notes
F-7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF CONSOLIDATION
The accompanying financial statements consist of the consolidation of Tarrant
Apparel Group, a California corporation, and its majority owned Subsidiaries
located primarily in the U.S., Mexico, and Asia. At December 31, 2005, we own
50.1% of United Apparel Ventures ("UAV") and 75% of PBG7, LLC ("PBG7"). We
consolidate these entities and reflect the minority interests in earnings
(losses) of the ventures in the accompanying financial statements. All
inter-company amounts are eliminated in consolidation. The 49.9% minority
interest in UAV is owned by Azteca Production International, a corporation owned
by the brothers of our Chairman, Gerard Guez. The 25% minority interest in PBG7
is owned by BH7, LLC, an unrelated party.
We serve specialty retail, mass merchandise and department store chains and
major international brands by designing, merchandising, contracting for the
manufacture of, and selling casual apparel for women, men and children under
private label. Commencing in 1999, we expanded our operations from sourcing
apparel to sourcing and operating our own vertically integrated manufacturing
facilities. In August 2003, we determined to abandon our strategy of being both
a trading and vertically integrated manufacturing company, and effective
September 1, 2003, we leased and outsourced operation of our manufacturing
facilities in Mexico to affiliates of Mr. Kamel Nacif, a shareholder at the time
of the transaction. See Note 7 and Note 15 of the "Notes to Consolidated
Financial Statements." In August 2004, we entered into a purchase and sale
agreement to sell these facilities to affiliates of Mr. Nacif, which transaction
consummated in the fourth quarter of 2004. See Note 5 of the "Notes to
Consolidated Financial Statements."
Historically, our operating results have been subject to seasonal trends when
measured on a quarterly basis. This trend is dependent on numerous factors,
including the markets in which we operate, holiday seasons, consumer demand,
climate, economic conditions and numerous other factors beyond our control.
Generally, the second and third quarters are stronger than the first and fourth
quarters. There can be no assurance that the historic operating patterns will
continue in future periods.
RISK AND UNCERTAINTIES - IRS EXAMINATION
As discussed in Note 10 of the "Notes to Consolidated Financial Statements," our
federal income tax returns for the years ended December 31, 1996 through 2002
are under examination by the Internal Revenue Service ("IRS"). The IRS has
proposed adjustments to increase our federal income tax payable for these years.
This adjustment would also result in additional state taxes, penalties and
interest. We believe that we have meritorious defenses to and intend to
vigorously contest the proposed adjustments made to our federal income tax
returns for the years ended 1996 through 2002. If the proposed adjustments are
upheld through the administrative and legal process, they could have a material
impact on our earnings and cash flow. The maximum amount of loss in excess of
the amount accrued in the financial statements is $7.7 million. If the amount of
any actual liability, however, exceeds our reserves, we would experience an
immediate adverse earnings impact in the amount of such additional liability,
which could be material. Additionally, we anticipate that the ultimate
resolution of these matters will require that we make significant cash payments
to the taxing authorities. Presently we do not have sufficient cash or borrowing
ability to make any future payments that may be required. No assurance can be
given that we will have sufficient surplus cash from operations to make the
required payments. Additionally, any cash used for these purposes will not be
available for other corporate purposes, which could have a material adverse
effect on our financial condition and results of operations. See Note 10 of the
"Notes to Consolidated Financial Statements" for a further discussion on the IRS
examination.
F-8
RISK AND UNCERTAINTIES - DEBT COVENANTS
As discussed in Note 8 of the "Notes to Consolidated Financial Statements," our
debt agreements require certain covenants including a minimum level of net
worth. If our results of operations erode and we are not able to obtain waivers
from the lenders, the debt would be in default and callable by our lenders. In
addition, due to cross-default provisions in our debt agreements, substantially
all of our long-term debt would become due in full if any of the debt is in
default. In anticipation of us not being able to meet the required covenants due
to various reasons, we either negotiate for changes in the relative covenants or
an advance waiver or reclassify the relevant debt as current. We also believe
that our lenders would provide waivers if necessary. However, our expectations
of future operating results and continued compliance with other debt covenants
cannot be assured and our lenders' actions are not controllable by us. If
projections of future operating results are not achieved and the debt is placed
in default, we would be required to reduce our expenses, including by curtailing
operations, and to raise capital through the sale of assets, issuance of equity
or otherwise, any of which could have a material adverse effect on our financial
condition and results of operations. See Note 8 of the "Notes to Consolidated
Financial Statements" for a further discussion of the credit facilities and
related debt covenants.
REVENUE RECOGNITION
Revenue is recognized at the point of shipment for all merchandise sold based on
FOB shipping point. For merchandise shipped on landed duty paid ("LDP") terms,
revenue is recognized at the point of either leaving Customs for direct
shipments or at the point of leaving our warehouse where title is transferred,
net of an estimate of returned merchandise and discounts. Customers are allowed
the rights of return or non-acceptance only upon receipt of damaged products or
goods with quality different from shipment samples. We do not undertake any
after-sale warranty or any form of price protection.
We often arrange, on behalf of manufacturers, for the purchase of fabric from a
single supplier. We have the fabric shipped directly to the cutting factory and
invoice the factory for the fabric. Generally, the factories pay us for the
fabric with offsets against the price of the finished goods.
SHIPPING AND HANDLING COSTS
Freight charges are included in selling and distribution expenses in the
statement of operations and amounted to $1,817,000, $783,000 and $667,000 for
the years ended December 31, 2003, 2004 and 2005, respectively. We did not bill
customers for shipping and handling costs for the years 2003 and 2004. In 2005,
we did some billing for freight to specialty stores although the amount was not
material.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of cash and highly liquid investments with an original
maturity of three months or less when purchased. Cash and cash equivalents held
in foreign financial institutions totaled $1,206,000 and $1,062,000 as of
December 31, 2004 and 2005, respectively. Cash is deposited with what we believe
are highly credited quality financial institutions and may exceed FDIC insured
limits.
ACCOUNTS RECEIVABLE--ALLOWANCE FOR RETURNS, DISCOUNTS AND BAD DEBTS
We evaluate the collectibility of accounts receivable and chargebacks (disputes
from the customer) based upon a combination of factors. In circumstances where
we are aware of a specific customer's inability to meet its financial
obligations (such as in the case of bankruptcy filings or substantial
downgrading of credit sources), a specific reserve for bad debts is taken
against amounts due to reduce the net recognized receivable to the amount
reasonably expected to be collected. For all other customers, we recognize
reserves for bad debts and uncollectible chargebacks based on our historical
collection experience. If collection experience deteriorates (for example, due
to an unexpected material adverse change in a major customer's ability to meet
its financial obligations to us), the estimates of the recoverability of amounts
due to us could be reduced by a material amount. As of December 31, 2004 and
2005, the balance of the allowance for returns, discounts and bad debts was $2.4
million and $3.0 million, respectively.
F-9
INVENTORIES
Inventories are stated (valued) at the lower of cost (first-in, first-out) or
market. Under certain market conditions, we use estimates and judgments
regarding the valuation of inventory to properly value inventory. Inventory
adjustments are made for the difference between the cost of the inventory and
the estimated market value and charged to operations in the period in which the
facts that give rise to the adjustments become known.
COST OF SALES
Cost of sales includes costs related to product costs, direct labor,
manufacturing overhead, duty, quota, freight in, and brokerage.
SELLING AND DISTRIBUTION EXPENSES
Selling and distribution expenses include expenses related to samples, travel
and entertainment, salaries, rent, warehouse handling and other office expenses,
professional fees, freight out, and selling commissions incurred in the sales
process.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include expenses related to research and
product development, travel and entertainment, salaries, rent and other office
expenses, depreciation and amortization, professional fees and bank charges.
ROYALTY EXPENSES
Royalty expenses consist of the royalty payments and marketing fund commitments
according to the various licensing agreements we have entered into. Royalty
expenses are calculated based on a certain percentage of net sales. All of these
agreements include minimum royalties. See Note 11 of the "Notes to Consolidated
Financial Statements" regarding various agreements we have entered into.
PRODUCT DESIGN, ADVERTISING AND SALES PROMOTION COSTS
Product design, advertising and sales promotion costs are expensed as incurred.
Product design, advertising and sales promotion costs included in selling,
general and administrative expenses in the accompanying statements of operations
(excluding the costs of manufacturing production samples) amounted to
approximately $1,306,000, $2,106,000 and $3,009,000 in 2003, 2004 and 2005,
respectively.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Additions and betterments are
capitalized while repair and maintenance costs are charged to operations as
incurred. Depreciation of property and equipment is provided for by the
straight-line method over their estimated useful lives. Leasehold improvements
are amortized using the straight-line method over the lesser of their estimated
useful lives or the term of the lease. Upon retirement or disposal of property
and equipment, the cost and related accumulated depreciation are eliminated from
the accounts and any gain or loss is reflected in the statement of operations.
The estimated useful lives of the assets are as follows:
Buildings 35 to 40 years
Equipment 7 to 15 years
Furniture and Fixtures 5 to 7 years
Vehicles 5 years
Leasehold Improvements Term of lease or Estimated useful life
F-10
IMPAIRMENT OF LONG-LIVED ASSETS
The carrying value of long-lived assets are reviewed when events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If it is determined that an impairment loss has occurred based on
the lowest level of identifiable expected future cash flow, then a loss is
recognized in the statement of operations using a fair value based model.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets." According to this
statement, goodwill and other intangible assets with indefinite lives are no
longer subject to amortization, but rather an assessment of impairment applied
on a fair-value-based test on an annual basis or more frequently if an event
occurs or circumstances change that would more likely than not reduce the fair
value of a reporting unit below its carrying amount.
We utilized the discounted cash flow methodology to estimate fair value. At
December 31, 2005, we have a goodwill balance of $8.6 million, and a net
property and equipment balance of $1.7 million, as compared to a goodwill
balance of $8.6 million and a net property and equipment balance of $1.9 million
at December 31, 2004. Our net property and equipment balance at December 31,
2004 reflects the disposal of our Mexico fixed assets of $123.3 million in the
fourth quarter of 2004. See Note 5 and Note 7 of the "Notes to Consolidated
Financial Statements."
Factors considered important that could trigger an impairment review include,
but are not limited to, the following:
o a significant underperformance relative to expected historical
or projected future operating results;
o a significant change in the manner of the use of the acquired
asset or the strategy for the overall business; or
o a significant negative industry or economic trend.
During the year ended December 31, 2005, we did not recognize any impairment
related to goodwill and property and equipment.
DEFERRED FINANCING COST
Deferred financing costs were $1,203,000 and $839,000 at December 31, 2004 and
2005, respectively. These costs of obtaining financing and issuance of
convertible debt instruments are being amortized on a straight-line basis over
the term of the related debt. Amortization expenses for deferred charges were
$408,000, $387,000 and $1,399,000 for the years ended December 31, 2003, 2004
and 2005, respectively.
INCOME TAXES
We utilize SFAS No. 109, "Accounting for Income Taxes," which prescribes the use
of the liability method to compute the differences between the tax basis of
assets and liabilities and the related financial reporting amounts using
currently enacted tax laws and rates. A valuation allowance is recorded to
reduce deferred taxes to the amount that is more likely than not to be realized.
Our Hong Kong corporate affiliates are taxed at an effective Hong Kong rate of
17.5%. As of December 31, 2005, no domestic tax provision has been provided for
$41.9 million of un-remitted retained earnings of these Hong Kong corporations,
as we intend to maintain these amounts outside of the U.S. on a permanent basis.
F-11
NET INCOME (LOSS) PER SHARE
Basic and diluted income (loss) per share has been computed in accordance with
SFAS No. 128, "Earnings Per Share". A reconciliation of the numerator and
denominator of basic loss per share and diluted loss per share is as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2003 2004 2005
------------- ------------- -------------
Basic EPS Computation:
Numerator:
Reported net income (loss) ................. $ (35,884,660) $(104,676,671) $ 993,344
Dividend to the preferred stockholders ..... (7,494,722) -- --
------------- ------------- -------------
Net income (loss) available to common
stockholders ............................. $ (43,379,382) $(104,676,671) $ 993,344
Denominator:
Weighted average common shares outstanding.. 18,215,071 28,732,796 29,728,997
Basic EPS .................................. $ (2.38) $ (3.64) $ 0.03
============= ============= =============
Diluted EPS Computation:
Numerator:
Reported net income (loss) ................. $ (35,884,660) $(104,676,671) $ 993,344
Dividend to the preferred stockholders ..... (7,494,722) -- --
------------- ------------- -------------
Net income (loss) available to common
stockholders ............................. $ (43,379,382) $(104,676,671) $ 993,344
Denominator:
Weighted average common shares outstanding.. 18,215,071 28,732,796 29,728,997
Incremental shares from assumed exercise of
warrants ................................... -- -- --
convertible debentures ..................... -- -- --
options .................................... -- -- 5,294
------------- ------------- -------------
Total shares ............................... 18,215,071 28,732,796 29,734,291
Diluted EPS ................................ $ (2.38) $ (3.64) $ 0.03
============= ============= =============
The following potentially dilutive securities were not included in the
computation of loss per share, because to do so would have been anti-dilutive:
2003 2004 2005
---------- ---------- ----------
Options ........................ 8,926,087 8,331,962 6,727,756
Warrants ....................... 881,732 2,361,732 2,361,732
Convertible debentures ......... -- 5,000,000 3,456,313
---------- ---------- ----------
Total ....................... 9,807,819 15,693,694 12,545,801
DIVIDENDS
We did not declare or pay any cash dividends in 2003, 2004 or 2005. We intend to
retain any future earnings for use in our business and, therefore, do not
anticipate declaring or paying any cash dividends in the foreseeable future. The
F-12
declaration and payment of any cash dividends in the future will depend upon our
earnings, financial condition, capital needs and other factors deemed relevant
by the Board of Directors. In addition, our credit agreements prohibit the
payment of dividends during the term of the agreements.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Mexico and Hong Kong subsidiaries are translated
at the rate of exchange in effect on the balance sheet date; income and expenses
are translated at the average rates of exchange prevailing during the year. The
functional currencies in which we transact business are the Hong Kong dollar and
the peso in Mexico.
Foreign currency gains and losses resulting from translation of assets and
liabilities are included in other comprehensive income (loss). Transaction gains
or losses, other than inter-company debt deemed to be of a long-term nature, are
included in net income (loss) in the period in which they occur. In 2004, we
substantially liquidated our Mexico subsidiaries following the sale of the fixed
assets in Mexico. The accumulated foreign currency translation adjustment
related to the Mexico subsidiaries of $22.8 million of loss was reclassified and
charged to income. The adjustment occurred in the fourth quarter of 2004. See
Note 5 of the "Notes to Consolidated Financial Statements."
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments is determined by reference to various
market data and other valuation techniques as appropriate. Considerable judgment
is required in estimating fair values. Accordingly, the estimates may not be
indicative of the amounts that we could realize in a current market exchange.
The carrying amounts of cash and cash equivalents, receivables and accounts
payable approximate fair values. The carrying amounts of our variable rate
borrowings under the various short-term borrowings and long-term debt
arrangements approximate fair value.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose us to concentration of credit
risk, consist primarily of cash equivalents, trade accounts receivable, related
party receivables and amounts due from factor.
Our products are primarily sold to mass merchandisers and specialty retail
stores. These customers can be significantly affected by changes in economic,
competitive or other factors. We make substantial sales to a relatively few,
large customers. In order to minimize the risk of loss, we assign certain of our
domestic accounts receivable to a factor without recourse or requires letters of
credit from our customers prior to the shipment of goods. For non-factored
receivables, account-monitoring procedures are utilized to minimize the risk of
loss. Collateral is generally not required. At December 31, 2004 and 2005,
approximately 19.6% and 22.5% of accounts receivable were due from two
customers, respectively. The following table presents the percentage of net
sales concentrated with certain customers.
PERCENTAGE OF NET SALES
------------------------
CUSTOMER 2003 2004 2005
----------------------------------------------------- ------ ------ ------
Kohl's .............................................. 6.6 16.4 13.5
Macy's Merchandising Group .......................... 5.2 10.3 13.4
Mervyn's ............................................ 5.9 15.4 11.2
Wal-Mart ............................................ 8.7 5.9 11.1
Lerner New York ..................................... 8.3 15.0 8.6
Lane Bryant ......................................... 12.1 2.0 4.9
The Limited (1) ..................................... 15.3 4.6 0.0
----------
(1) Includes Express and Limited stores.
We maintain demand deposits with several major banks. At times, cash balances
may be in excess of Federal Deposit Insurance Corporation or equivalent foreign
insurance limits.
F-13
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Significant estimates used by us in preparation of the
financial statements include allowance for returns, discounts and bad debts,
inventory, valuation of long-lived and intangible assets and goodwill, and tax
provision. Actual results could differ from those estimates.
EMPLOYEE STOCK OPTIONS
We account for employee stock options using the intrinsic value method rather
than the alternative fair-value accounting method. Under the intrinsic-value
method, if the exercise price of the employee's stock options equals the market
price of the underlying stock on the date of the grant, no compensation expense
is recognized. For the years ended December 31, 2003, 2004 and 2005, $72,000,
$161,000 and $39,000 were recorded as an expense related to our stock options,
respectively.
Pro forma information regarding net income and earnings per share is required by
SFAS 148, and has been determined as if we had accounted for our employee stock
options under the fair value method of that Statement. The fair value for these
options was estimated at the date of grant using a Black-Scholes option pricing
model with the following weighted-average assumptions: weighted-average
risk-free interest rate of 4% for 2003, 3% to 4% for 2004, 4% for 2005; dividend
yields of 0% for 2003, 2004 and 2005; weighted-average volatility factors of the
expected market price of our common stock of 0.65 for 2003, 0.51 to 0.55 for
2004 and 0.55 for 2005; and a weighted-average expected life of the option of
four years for 2003, 2004 and 2005.
On September 23, 2005, the Board of Directors approved the acceleration of
vesting of all our unvested stock options. In total, 1.7 million stock options
with an average exercise price of $3.69 and an average remaining contractual
life of 7.9 years were subject to this acceleration. The exercise prices and
number of shares subject to the accelerated options were unchanged. The
acceleration was effective as of September 23, 2005. Had the acceleration of
these stock options not been undertaken, the future compensation expense we
would recognize in the fiscal years of 2006, 2007, 2008 and 2009 would be $1.4
million, $810,000, $10,000 and $3,000, respectively. Our decision to accelerate
the vesting of these stock options was based upon the accounting of this $2.2
million of compensation expense from disclosure-only in 2005 to being included
in our statement of operations in 2006 to 2009 based on our adoption of SFAS No.
123 (revised 2004) "Share-Based Payment" effective in January 2006.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Our pro forma
information follows:
F-14
2003 2004 2005
-------------- -------------- --------------
Net income (loss) as reported ............... $ (35,884,660) $ (104,676,671) $ 993,344
Add stock-based employee compensation charges
reported in net loss ........................ $ 71,572 $ 161,038 $ 38,740
Pro forma compensation expense, net of tax .. $ (4,115,263) $ (3,852,990) $ (4,298,193)
-------------- -------------- --------------
Pro forma net loss .......................... $ (39,928,351) $ (108,368,623) $ (3,266,109)
Net income (loss) per share
Basic (as restated, see Note 13) ............ $ (2.38) $ (3.64) $ 0.03
Add stock-based employee compensation charges
reported in net loss
Basic ....................................... $ 0.00 $ 0.01 $ 0.00
Pro forma compensation expense per share
Basic ....................................... $ (0.22) $ (0.14) $ (0.14)
-------------- -------------- --------------
Pro forma loss per share
Basic (as restated, see Note 13) ............ $ (2.60) $ (3.77) $ (0.11)
Net income (loss) per share
Diluted (as restated, see Note 13) .......... $ (2.38) $ (3.64) $ 0.03
Add stock-based employee compensation charges
reported in net loss
Diluted ..................................... $ 0.00 $ 0.01 $ 0.00
Pro forma compensation expense per share
Diluted ..................................... $ (0.22) $ (0.14) $ (0.14)
-------------- -------------- --------------
Pro forma loss per share
Diluted (as restated, see Note 13) .......... $ (2.60) $ (3.77) $ (0.11)
OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) includes all changes in equity (net assets)
from non-owner sources such as foreign currency translation adjustments. We
account for other comprehensive income (loss) in accordance with SFAS 130,
"Reporting Comprehensive Income."
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment," which addresses the accounting for employee stock options. SFAS No.
123R eliminates the ability to account for share-based compensation transactions
using APB Opinion No. 25 and generally would require instead that such
transactions be accounted for using a fair value-based method. SFAS No. 123R
also requires that tax benefits associated with these share-based payments be
classified as financing activities in the statement of cash flow rather than
operating activities as currently permitted. SFAS No. 123R is effective as of
the beginning of our first annual or interim reporting period that begins after
June 15, 2005. On April 14, 2005, the Securities and Exchange Commission adopted
a new rule amending the effective date for Statement 123R for public companies.
Under the effective date provisions included in Statement 123R, registrants
would have been required to implement the Statement's requirements as of the
beginning of the first interim or annual period beginning after June 15, 2005,
or after December 15, 2005 for small business issuers. The new rule allows
registrants to implement Statement 123R at the beginning of their next fiscal
year, instead of the next interim period, that begins after June 15, 2005. SFAS
No. 123R offers alternative methods of adopting this final rule. We have not yet
determined which alternative method we will use. We have not completed the
process of evaluating the impact that will result from adopting SFAS No. 123R,
but believe the impact upon adoption will be an increase to compensation
expense.
In May 2005, the FASB issued SFAS No. 154, "Accounting for Changes and Error
Corrections." SFAS 154 establishes standards for the accounting and reporting
for changes in accounting principles. SFAS 154 replaces APB 20 "Accounting
Changes" and FASB Interpretation No. 20 ("FIN 20"), "Reporting Accounting
F-15
Changes under AICPA Statements of Position." The Statement requires
retrospective application for changes in accounting principle, unless it is
impracticable to determine either the cumulative effect or the period-specific
effects of the change. When it is impracticable to determine the period-specific
effects of an accounting change on one or more individual prior periods
presented, this Statement would require that the new accounting policy be
applied to the balances of assets and liabilities as of the beginning of the
earliest period for which retrospective application is practicable and that a
corresponding adjustment be made to the opening balance of retained earnings for
the period. When it is impracticable for an entity to determine the cumulative
effect of applying a change in accounting principle to all prior periods, this
Statement would require the new accounting principle to be applied as if it were
made prospectively from the earliest date practicable. SFAS 154 is effective as
of the beginning of our first annual reporting period that begins after December
15, 2005. The adoption of this new accounting pronouncement is not expected to
have a material impact on our consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments", which amends SFAS No. 133, "Accounting for Derivatives
Instruments and Hedging Activities" and SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities." SFAS 155
amends SFAS 133 to narrow the scope exception for interest-only and
principal-only strips on debt instruments to include only such strips
representing rights to receive a specified portion of the contractual interest
or principle cash flows. SFAS 155 also amends SFAS 140 to allow qualifying
special-purpose entities to hold a passive derivative financial instrument
pertaining to beneficial interests that itself is a derivative instrument. We
are currently evaluating the impact this new Standard, but believe that it will
not have a material impact on our financial position, results of operations or
cash flows.
CURRENCY RATE HEDGING
We manufacture in a number of countries throughout the world, including Hong
Kong, and, as a result, are exposed to movements in foreign currency exchange
rates. Periodically we will enter into various currency rate hedges. The primary
purpose of our foreign currency hedging activities is to manage the volatility
associated with foreign currency purchases of materials and equipment in the
normal course of business. We utilize forward exchange contracts with maturities
of one to three months. We do not enter into derivative financial instruments
for speculative or trading purposes. We enter into certain foreign currency
derivative instruments that do not meet hedge accounting criteria. As a result,
we mark to market all derivative instruments with the gain or loss included in
other income and expense. See Note 18 of the "Notes to Consolidated Financial
Statements." These instruments are intended to protect against exposure related
to financing transactions (equipment) and income from international operations.
There were no exchange contracts at December 31, 2004 and December 31, 2005.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
DECEMBER 31,
----------------------------
2004 2005
------------ ------------
U.S. trade accounts receivable ................. $ 3,248,887 $ 2,893,217
Foreign trade accounts receivable .............. 17,148,600 19,619,172
Factored accounts receivable ................... 19,452,756 33,222,354
Other receivables .............................. 346,965 1,815,450
Allowance for returns, discounts and bad debts . (2,437,865) (2,951,750)
------------ ------------
$ 37,759,343 $ 54,598,443
============ ============
Under the asset-based lending arrangement we had with GMAC before September 29,
2004, we factored trade receivables from clients with credit ratings below BBB.
GMAC did not advance any funds to us and only afforded us a credit insurance
coverage. We received funds from GMAC only after such funds were collected from
customers at their respective due dates. Effective as of September 29, 2004, the
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asset based lending arrangement was amended and converted to a factoring
arrangement. At December 31, 2005, substantially all trade receivables,
irrespective of their debt ratings, were factored and GMAC advances up to 90% of
the invoice value to us immediately upon the submission of invoices. See Note 8
of "Notes to Consolidated Financial Statements."
3. INVENTORY
Inventory consists of the following:
DECEMBER 31,
---------------------------
2004 2005
----------- -----------
Raw materials, fabric and trim accessories ..... $ 1,164,977 $ 5,079,428
Finished goods shipments-in-transit ............ 9,283,022 8,800,014
Finished goods ................................. 8,696,106 17,749,518
----------- -----------
$19,144,105 $31,628,960
=========== ===========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
----------------------------
2004 2005
------------ ------------
Land ........................................... $ 85,000 $ 85,000
Buildings ...................................... 819,372 819,372
Equipment ...................................... 5,966,453 6,249,487
Furniture and fixtures ......................... 2,228,375 2,308,537
Leasehold improvements ......................... 2,605,763 2,684,720
Vehicles ....................................... 330,564 322,487
------------ ------------
12,035,527 12,469,603
Less accumulated depreciation and amortization . (10,160,634) (10,766,763)
------------ ------------
$ 1,874,893 $ 1,702,840
============ ============
Depreciation expense, including amortization of assets recorded under capital
leases, totaled $15,663,000, $7,853,000 and $727,000 for the years ended
December 31, 2003, 2004 and 2005, respectively.
5. RESTRUCTURING AND SALE OF MEXICO OPERATIONS
Following our restructuring of our Mexican operations in 2003, and the resulting
reduction in our Mexican work force, we became the target of workers' rights
activists who have picketed our customers, stuffed electronic mailboxes with
inaccurate, protest e-mails, and threatened customers with retaliation for
continuing business with us. While we have defended our position to our
customers, some of our larger customers for Mexico-produced jeans wear have been
reluctant to place orders with us in response to actions taken and contemplated
by these activist groups. As a consequence, we experienced a significant decline
in revenue from sales of Mexico-produced merchandise during 2004. As a result of
this reduction in revenue from the sale of Mexico-produced merchandise, the
Board of Directors approved a resolution in July 2004 authorizing management to
sell the manufacturing operations in Mexico.
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," we evaluated the long-lived assets in Mexico for
recoverability and concluded that the book value of the asset group was
significantly higher than the expected future cash flows and that impairment had
occurred. Accordingly, we recognized a non-cash impairment loss of approximately
$78 million in the second quarter of 2004. The impairment charge was the
difference between the carrying value and fair value of the impaired assets.
Fair value was determined based on independent appraisals of the property and
equipment obtained in June 2004. There was no tax benefit recorded with the
impairment loss due to a full valuation allowance recorded against the future
tax benefit as of June 30, 2004. The entire impairment charge was recorded in
the Mexico geographic reporting segment.
F-17
In connection with our restructuring of our Mexico operations, we incurred $2.5
million, $1.1 million and $0 of severance costs in 2003, 2004 and 2005,
respectively, in the Mexico reportable segment. We did not relocate any
employees in connection with this restructuring and therefore did not incur any
relocation costs. In addition, we did not incur any contract termination costs.
There was no ending liability balance for the severance costs incurred in 2003
and 2004 since such amounts were all paid in 2003 and 2004. Severance costs
incurred in 2003 were included in costs of goods sold and such costs incurred in
2004 were included in general and administrative expenses in the accompanying
consolidated statements of operations.
In August 2004, through Tarrant Mexico, S. de R.L. de C.V., our majority owned
and controlled subsidiary in Mexico, we entered into an Agreement for Purchase
of Assets with affiliates of Mr. Kamel Nacif, a shareholder at the time of the
transaction, which agreement was amended in October 2004. Pursuant to the
agreement, as amended, on November 30, 2004, we sold to the purchasers
substantially all of our assets and real property in Mexico which include
equipment and facilities previously leased to Mr. Nacif's affiliates in October
2003, for an aggregate purchase price consisting of the following:
o $105,400 in cash and $3,910,000 by delivery of unsecured
promissory notes bearing interest at 5.5% per annum; and
o $40,204,000, by delivery of secured promissory notes bearing
interest at 4.5% per annum, maturing on December 31, 2014, and
payable in equal monthly installments of principal and
interest over the term of the notes.
Included in the $41.4 million notes receivable - related party on the
accompanying balance sheet as of December 31, 2005 was $1,317,000 of Mexico
valued added taxes on the real property component of this transaction. The
future maturities of the note receivable from the purchasers, including the
Mexican value added tax to be paid by the purchasers, is as follows:
YEAR ENDING DECEMBER 31, AMOUNT
------------------------------------------------- ------------
2006............................................. $ 5,139,387
2007............................................. 4,866,963
2008............................................. 3,835,953
2009............................................. 3,898,575
2010............................................. 4,077,855
2011 and after................................... 19,589,100
------------
Total............................................ $ 41,407,833
Upon consummation of the sale, we entered into a purchase commitment agreement
with the purchasers, pursuant to which we have agreed to purchase annually over
the ten-year term of the agreement, $5 million of fabric manufactured at our
former facilities acquired by the purchasers at negotiated market prices. This
agreement replaced a previously existing purchase commitment agreement whereby
we were obligated to purchase annually from Mr. Nacif's affiliates, 6 million
yards of fabric (or approximately $19.2 million of fabric at today's market
prices) manufactured at these same facilities through October 2009. The annual
future purchase commitments approximate the annual maturities of the notes
receivable from the related party and are allowed to be offset against annual
principal and interest requirements. Included in the current maturities balance
is $429,000 related to the 2005 balance due, which we believe is fully
collectible and are allowed to be offset against annual principal and interest
requirements. We expect to realize the note receivable from related party
through the receipt of fabric manufactured at these facilities over the maturity
period of the notes receivable.
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
F-18
the licensor of minimum royalties of $10.4 million over the initial 10-year term
of the agreement. Private Brands also entered into a multi-year exclusive
distribution agreement with Federated Merchandising Group ("FMG"), the sourcing
arm of Federated Department Stores, to supply FMG with American Rag CIE, a new
casual sportswear collection for juniors and young men. Private Brands will
design and manufacture a full collection of American Rag apparel, which will be
distributed by FMG exclusively to Federated stores across the country. Beginning
in August 2003, the American Rag collection was available in approximately 100
select Macy's, the Bon Marche, Burdines, Goldsmith's, Lazarus and Rich's-Macy's
locations. The investment in American Rag CIE, LLC totaling $1.9 million and
$2.1 million at December 31, 2004 and 2005, respectively, is accounted for under
the equity method and included in equity method investment on the accompanying
consolidated balance sheets. Income from the equity method investment is
recorded in the United States geographical segment. The change in investment in
American Rag for 2005 was as follows:
Balance as of December 31, 2003 $ 1,434,375
Additional capital contribution 137,000
Share of income ............... 769,706
Distribution .................. (460,800)
-----------
Balance as of December 31, 2004 $ 1,880,281
Share of income ............... 559,634
Distribution .................. (301,050)
-----------
Balance as of December 31, 2005 $ 2,138,865
===========
We hold a 45% member interest in American Rag. The remaining 55% owners are an
unrelated third party who contributed the American Rag trademark and other
assets and liabilities relating to two retail stores operating under the name of
"American Rag". The entity is generating positive cash flow and net operating
profit from its retail stores. The royalty income paid by us to American Rag is
considered other income and is ancillary to the primary operations. Reported
revenue from the retail business in fiscal 2004 and 2005 was approximately $9
million and $10 million, respectively. The amount of royalty income paid by us
to American Rag in 2003, 2004 and 2005 was $250,000, $500,000 and $575,000,
respectively. We do not have sole decision-making ability. Day to day management
of American Rag is effectively controlled by one of the 55% owners.
We have not entered into any obligations to guarantee the entity's debt nor do
we expect to receive a guaranteed return on its investment. We determined that
we are not the primary beneficiary of American Rag and nothing has given rise to
a re-evaluation of the investment for consolidation under FIN 46. Our variable
interest will not absorb a majority of the VIE's expected losses. We record its
proportionate share of income and losses but are not obligated nor do we intend
to absorb losses beyond its 45% investment interest. Additionally, we do not
expect to receive a majority of the entity's expected residual returns, other
than their 45% ownership interest.
The summarized combined financial information for American Rag for the year
ended December 31, 2005 was as follows:
BALANCE SHEET
Current assets ........ $ 1,889,389
Non-current assets .... 545,388
TOTAL ASSETS ...... 2,434,777
Current liabilities ... 641,350
Non-current liabilities 83,615
TOTAL LIABILITIES . $ 724,965
STATEMENT OF INCOME
Net sales ............. $10,125,563
Gross profit .......... 5,092,708
Income from operations 585,481
Net income ............ $ 1,152,431
F-19
7. IMPAIRMENT OF ASSETS
IMPAIRMENT OF GOODWILL
Goodwill on the accompanying consolidated balance sheets represents the as
"excess of costs over fair value of net assets acquired in previous business
combination". SFAS No. 142, "Goodwill and Other Intangible Assets," requires
that goodwill and other intangibles be tested for impairment using a two-step
process. The first step is to determine the fair value of the reporting unit,
which may be calculated using a discounted cash flow methodology, and compare
this value to its carrying value. If the fair value exceeds the carrying value,
no further work is required and no impairment loss would be recognized. The
second step is an allocation of the fair value of the reporting unit to all of
the reporting unit's assets and liabilities under a hypothetical purchase price
allocation.
In 2003, we ceased directly operating a substantial majority of our equipment
and fixed assets in Mexico, and started leasing a large portion of our
manufacturing facilities and operations in Mexico to affiliates of Mr. Kamel
Nacif, a shareholder at the time of the transaction, effective September 1,
2003. During 2003, we made an interim review of our goodwill and intangible
assets and wrote off all goodwill and intangible assets affected by our
strategic changes in Mexico. Write-offs included $9.1 million and $2.7 million
directly relating to Tarrant Mexico - Famian and Ajalpan divisions,
respectively, and another $7.5 million relating to of Rocky Apparel LLC
("Rocky"). It was unlikely that Tommy Hilfiger, whose business we acquired in
the Rocky acquisition, would continue to purchase merchandise from UAV following
implementation of the restructuring in Mexico. In 2003, we had also written off
the remaining goodwill of $150,000 relating to the acquisition of Jane Doe
International, LLC due to litigation with the minority shareholder.
The following table displays the change in the gross carrying amount of goodwill
by reporting units for the years ended December 31, 2004 and 2005. The reporting
unit below is one level below the reportable segments included in Note 16,
"Operations by Geographic Areas". The reporting unit FR TCL. - Chazz & MGI
Division was included within the United States geographical segment of Note 16
of the "Notes to the Consolidated Financial Statements."
REPORTING UNITS
FR TCL - CHAZZZ
& MGI DIVISION
---------------
Balance as of January 1, 2004 . $8,582,845
Activities for the year ....... --
----------
Balance as of December 31, 2004 $8,582,845
Activities for the year ....... --
----------
Balance as of December 31, 2005 $8,582,845
==========
IMPAIRMENT OF OTHER ASSETS
On June 28, 2000, we signed an exclusive production agreement with Manufactures
Cheja ("Cheja") through February 2002. We had agreed on a new contract to extend
the agreement for an additional quantity of 6.4 million units beginning April 1,
2002, which was amended on November 8, 2002, for the manufacturing of 5.7
million units through September 30, 2004. In June 2003, we determined that we no
longer expected to recoup advances to Cheja related to the production agreement.
In June 2003, we wrote off $2.8 million of remaining advances to Cheja.
F-20
8. DEBT
Debt consists of the following:
DECEMBER 31,
----------------------------
2004 2005
------------ ------------
Short-term bank borrowings:
Import trade bills payable - UPS, DBS Bank and Aurora Capital $ 3,902,714 $ 4,165,306
Bank direct acceptances - UPS and DBS Bank .................. 10,447,855 1,471,476
Other Hong Kong credit facilities - UPS and DBS Bank ........ 3,600,588 8,196,750
------------ ------------
$ 17,951,157 $ 13,833,532
============ ============
Long-term debt:
Vendor financing ............................................ $ 135,145 $ --
Equipment financing ......................................... 78,038 83,206
Term loan - UPS ............................................. 5,000,000 2,708,333
Debt facility - GMAC ........................................ 16,960,064 33,558,095
------------ ------------
22,173,247 36,349,634
Less current portion ........................................ (19,628,701) (36,109,699)
------------ ------------
$ 2,544,546 $ 239,935
============ ============
IMPORT TRADE BILLS PAYABLE, BANK DIRECT ACCEPTANCES AND OTHER HONG KONG CREDIT
FACILITIES
On June 13, 2002, we entered into a letter of credit facility of $25 million
with UPS Capital Global Trade Finance Corporation ("UPS"). Under this facility,
we may arrange for the issuance of letters of credit and acceptances. The
facility is collateralized by the shares and debentures of all of our
subsidiaries in Hong Kong. In addition to the guarantees provided by Tarrant
Apparel Group and our subsidiaries, Fashion Resource (TCL) Inc. and Tarrant
Luxembourg Sarl, Gerard Guez, our Chairman, also signed a guarantee of $5
million in favor of UPS to secure this facility. This facility bore interest at
10.25% per annum at December 31, 2005. Under this facility, we were subject to
certain restrictive covenants, including that we maintain a specified tangible
net worth, fixed charge ratio, and leverage ratio. On June 27, 2005, we amended
the letter of credit facility with UPS to extend the expiration date of the
facility from June 30, 2005 to August 31, 2005 and to reduce the tangible net
worth requirement at June 30, 2005. On August 31, 2005, we amended the letter of
credit facility with UPS to further extend the expiration date of the facility
to October 31, 2005, immediately reduce the maximum amount of borrowings to
$14.5 million on September 1, 2005 and further reduced the maximum amount of
borrowing to $14.0 million on October 1, 2005. On October 31, 2005, we further
amended the letter of credit facility with UPS to extend the expiration date of
the facility to January 31, 2006 and amend the interest rate to "prime rate"
plus 3%. The facility amendment also provided for reduction in the maximum
amount of borrowings to $13.5 million commencing on November 1, 2005, to $13.0
million commencing on December 1, 2005, and to $12.5 million commencing on
January 1, 2006. Additionally, Gerard Guez, our Chairman, pledged to UPS 4.6
million shares of our common stock held by Mr. Guez to secure the obligations
under the credit facility. On January 27, 2006, we further amended the letter of
credit facility with UPS to extend the expiration date of the facility from
January 31, 2006 to July 31, 2006. The amendment provides for reduction of the
maximum amount of borrowings under the facility to $12.0 million commencing on
April 1, 2006, $11.5 million commencing on May 1, 2006, $11.0 million commencing
on June 1, 2006 and to $10.5 million commencing on July 1, 2006. Under the
amended letter of credit facility, we are subject to restrictive financial
covenants of maintaining tangible net worth of $25 million as of December 31,
2005 and the last day of each fiscal quarter thereafter. There is also a
provision capping maximum capital expenditures per quarter of $800,000. As of
December 31, 2005, we were in compliance with the covenants. As of December 31,
2005, $9.2 million was outstanding under this facility with UPS (classified
above as follows: $1.9 million in import trade bills payable; $1.0 million in
bank direct acceptances and $6.3 million in other Hong Kong credit facilities)
and an additional $2.5 million was available for future borrowings. In addition,
$1.3 million of open letters of credit was outstanding as of December 31, 2005.
Since March 2003, DBS Bank (Hong Kong) Limited (formerly known as Dao Heng Bank)
has made available a letter of credit facility of up to HKD 20 million
(equivalent to US $2.6 million) to our subsidiaries in Hong Kong. This is a
demand facility and is secured by the pledge of our office property, which is
owned by Gerard Guez, our Chairman, and Todd Kay, our Vice Chairman, and by our
guarantee. The letter of credit facility was increased to HKD 30 million
F-21
(equivalent to US $3.9 million) in June 2004. As of December 31, 2005, $2.9
million was outstanding under this facility. In addition, $1.1 million of open
letters of credit was outstanding and $0 was available for future borrowings as
of December 31, 2005. In October 2005, a tax loan for HKD 6.233 million
(equivalent to US $804,000) was also made available to our Hong Kong
subsidiaries. As of December 31, 2005, $675,000 was outstanding under this tax
loan.
As of December 31, 2005, the total balance outstanding under the DBS Bank credit
facilities was $3.6 million (classified above as follows: $1.3 million in import
trade bills payable, $0.5 million in bank direct acceptances and $1.8 million in
other Hong Kong credit facilities).
From time to time, we open letters of credit under an uncommitted line of credit
from Aurora Capital Associates which issues these letters of credits out of
Israeli Discount Bank. As of December 31, 2005, $1.0 million was outstanding
under this facility (classified above under import trade bills payable) and $7.1
million of letters of credit were open under this arrangement. We pay a
commission fee of 2.25% on all letters of credits issued under this arrangement.
LOAN FROM MAX AZRIA
On February 14, 2005, we borrowed $5.0 million from Max Azria, which amount bore
interest at the rate of 4% per annum and was payable in weekly installments of
$250,000 beginning on February 28, 2005. This was an unsecured loan. In early
August 2005, we repaid the remaining balance of this loan in its entirety.
EQUIPMENT FINANCING
We had three equipment loans outstanding at December 31, 2005 totaling $83,000.
One of these equipment loans bears interest at 6% payable in installments
through 2009, the second loan bears interest at 15.8% payable in installment
through 2007 and the third loan bears interest at 6.15% payable in installment
through 2007.
VENDOR FINANCING
During 2000, we financed equipment purchases for a manufacturing facility with
certain vendors. A total of $16.9 million was financed with five-year promissory
notes, which bear interest ranging from 7.0% to 7.5%, and were payable in
semiannual payments commencing in February 2000. All remaining balances under
these notes were paid off in February 2005. A portion of the debt was
denominated in Euros. Unrealized transaction (loss) gain associated with the
debt denominated in Euros totaled $(561,000), $367,000 and $0 for the years
ended December 31, 2003, 2004 and 2005, respectively. These amounts were
recorded in other income (expense) in the accompanying consolidated statements
of operations.
TERM LOAN - UPS
On December 31, 2004, our Hong Kong subsidiaries entered into a new loan
agreement with UPS pursuant to which UPS made a $5 million term loan, the
proceeds of which were used to repay $5 million of indebtedness owed to UPS
under the letter of credit of facility. The principal amount of this loan is due
and payable in 24 equal monthly installments of approximately $208,333 each,
plus interest equivalent to the "prime rate" plus 2% commencing on February 1,
2005. This facility bore interest at 9.25% per annum at December 31, 2005. On
June 27, 2005, we amended the loan agreement with UPS to reduce the tangible net
worth requirement at June 30, 2005. Under the amended loan agreement, we are
subject to restrictive financial covenants of maintaining tangible net worth of
$25 million at December 31, 2005 and the last day of each fiscal quarter
thereafter. There is also a provision capping maximum capital expenditure per
quarter at $800,000. As of December 31, 2005, we were in compliance with the
covenants. As of December 31, 2005, $2.7 million was outstanding. The
obligations under the loan agreement are collateralized by the same security
interests and guarantees provided under our letter of credit facility with UPS.
Additionally, the term loan is secured by two promissory notes payable to
Tarrant Luxembourg Sarl in the amounts of $2,550,000 and $1,360,000 and a pledge
by Gerard Guez, our Chairman, of 4.6 million shares of our common stock.
F-22
DEBT FACILITY AND FACTORING AGREEMENT - GMAC
We were previously party to a revolving credit, factoring and security agreement
(the "Debt Facility") with GMAC Commercial Credit, LLC ("GMAC"). This Debt
Facility provided a revolving facility of $90 million, including a letter of
credit facility not to exceed $20 million, and was scheduled to mature on
January 31, 2005. The Debt Facility also provided a term loan of $25 million,
which was being repaid in monthly installments of $687,500. The Debt Facility
provided for interest at LIBOR plus the LIBOR rate margin determined by the
Total Leverage Ratio (as defined in the Debt Facility agreements), and was
collateralized by our receivables, intangibles, inventory and various other
specified non-equipment assets. In May 2004, the maximum facility amount was
reduced to $45 million in total and we established new financial covenants with
GMAC for the fiscal year of 2004.
On October 1, 2004, we amended and restated the Debt Facility with GMAC by
entering into a new factoring agreement with GMAC. The amended and restated
agreement (the factoring agreement) extended the expiration date of the facility
to September 30, 2007 and added as parties our subsidiaries Private Brands, Inc
and No! Jeans, Inc. In addition, in connection with the factoring agreement, our
indirect majority-owned subsidiary PBG7, LLC entered into a separate factoring
agreement with GMAC. Pursuant to the terms of the factoring agreement, we and
our subsidiaries agree to assign and sell to GMAC, as factor, all accounts which
arise from our sale of merchandise or rendition of service created on a going
forward basis. At our request, GMAC, in its discretion, may make advances to us
up to the lesser of (a) up to 90% of our accounts on which GMAC has the risk of
loss and (b) $40 million, minus in each case, any amount owed by us to GMAC.
Pursuant to the terms of the PBG7 factoring agreement, PBG7 agreed to assign and
sell to GMAC, as factor, all accounts, which arise from PBG7's sale of
merchandise or rendition of services created on a going-forward basis. At PBG7's
request, GMAC, in its discretion, may make advances to PBG7 up to the lesser of
(a) up to 90% of PBG7's accounts on which GMAC has the risk of loss, and (b) $5
million minus in each case, any amounts owed to GMAC by PBG7. The facility bears
interest at 7.385% per annum and the facility under PBG7, LLC bears interest at
7.75% per annum at December 31, 2005. Restrictive covenants under the revised
facility include a limit on quarterly capital expenses of $800,000 and tangible
net worth of $25 million at December 31, 2005 and at the end of each fiscal
quarter thereafter. As of December 31, 2005, we were in compliance with the
covenants. A total of $30.6 million was outstanding with respect to receivables
factored under the GMAC facility at December 31, 2005.
In May 2005, we amended our factoring agreement with GMAC to permit our
subsidiaries party thereto and us, to borrow up to the lesser of $3 million or
fifty percent (50%) of the value of eligible inventory. In connection with this
amendment, we granted GMAC a lien on certain of our inventory located in the
United States. On January 23, 2006, we further amended our factoring agreement
with GMAC to increase the amount we may borrow against inventory to the lesser
of $5 million or 50% of the value of eligible inventory. The $5 million limit
will be reduced to $4 million on April 1, 2006 and will be further reduced to $3
million on July 1, 2006. The maximum borrowing availability under the factoring
agreement, based on the borrowing base formula remains at $40 million. A total
of $3.0 million was outstanding under the GMAC facility at December 31, 2005
with respect to collateralized inventory.
The credit facility with GMAC and the credit facility with UPS carry
cross-default clauses. A breach of a financial covenant set by GMAC or UPS
constitutes an event of default under the other credit facility, entitling both
financial institutions to demand payment in full of all outstanding amounts
under their respective debt and credit facilities.
Annual maturities for the long-term debt, convertible debentures and capital
lease obligations are $36.1 million (2006), $7.1 million (2007), $14,000 (2008),
and $5,000 (2009). The effective interest rate on short-term bank borrowing as
of December 31, 2003, 2004 and 2005 were 5.3%, 5.7% and 7.8%, respectively.
GUARANTEES
Guarantees had been issued since 2001 in favor of YKK, Universal Fasteners, and
RVL Inc. for $750,000, $500,000 and unspecified amount, respectively, to cover
trim purchased by Tag-It Pacific Inc. on our behalf. We have not reported a
liability for these guarantees. We issued the guarantees to cover trim purchased
by Tag-It in order to ensure our production in a timely manner. If Tag-It ever
defaults, we would have to pay the outstanding liability due to these vendors by
Tag-It for purchases made on our behalf. We have not had to perform under these
guarantees since inception. It is not predictable to estimate the fair value of
F-23
the guarantee; however, we do not anticipate that we will incur losses as a
result of these guarantees. In April 2005, we terminated these guarantees with
respect to Tag-It's obligations arising after the date of termination.
9. CONVERTIBLE DEBENTURES AND WARRANTS
On December 14, 2004, we completed a $10 million financing through the issuance
of (i) 6% Secured Convertible Debentures ("Debentures") and (ii) warrants to
purchase up to 1,250,000 shares of our common stock. Prior to maturity, the
investors may convert the Debentures into shares of our common stock at a price
of $2.00 per share. The warrants have a term of five years and an exercise price
of $2.50 per share. The warrants were valued at $866,000 using the Black-Scholes
option valuation model with the following assumptions: risk-free interest rate
of 4%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.55; and an expected life of four years. The Debentures
bear interest at a rate of 6% per annum and have a term of three years. We may
elect to pay interest on the Debentures in shares of our common stock if certain
conditions are met, including a minimum market price and trading volume for our
common stock. The Debentures contain customary events of default and permit the
holder thereof to accelerate the maturity if the full principal amount together
with interest and other amounts owing upon the occurrence of such events of
default. The Debentures are secured by a subordinated lien on certain of our
accounts receivable and related assets. The closing market price of our common
stock on the closing date of the financing was $1.96. The convertible debenture
was thus valued at $8,996,000, resulting in an effective conversion price of
$1.799 per share. The intrinsic value of the conversion option of $804,000 is
being amortized over the life of the loan. The value of the warrants of $866,000
and the intrinsic value of the conversion option of $804,000 were netted from
the $10 million presented as the convertible debentures, net on our accompanying
balance sheets at December 31, 2004.
The placement agent in the financing, received compensation for its services in
the amount of $620,000 in cash and issuance of five year warrants to purchase up
to 200,000 shares of our common stock at an exercise price of $2.50 per share.
The warrants to purchase 200,000 shares of our common stock were valued at
$138,000 using the Black-Scholes option valuation model with the following
assumptions: risk-free interest rate of 4%; dividend yields of 0%; volatility
factors of the expected market price of our common stock of 0.55; and an
expected life of four years. The $620,000 financing cost paid to the placement
agent and the value of the warrants to purchase 200,000 shares of our common
stock of $138,000 are included in the deferred financing cost, net on our
accompanying balance sheets and are amortized over the life of the loan.
In June 2005, holders of our Debentures converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock. The Debentures were converted at the option of the
holders at a price of $2.00 per share. Debt discount of $248,000 related to the
intrinsic value of the conversion option of $804,000 was expensed upon the
conversion. Of the $620,000 financing cost paid to the placement agent, $191,000
was expensed upon the conversion. The intrinsic value of the conversion option,
and the value of the warrant amortized in 2005 was $474,000. Total deferred
financing cost amortized in 2005 was $189,000. Total interest paid to the
holders of the Debentures in 2005 was $539,000. As of December 31, 2005, $6.0
million, net of $0.9 million of debt discount, remained outstanding under the
Debentures.
F-24
10. INCOME TAXES
The provision (credit) for domestic and foreign income taxes is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2003 2004 2005
----------- ----------- -----------
Current:
Federal ............. $ 2,400,000 $ 1,000,000 $ --
State ............... (241,948) 8,511 2,425
Foreign ............. 2,106,199 1,400,953 1,091,442
----------- ----------- -----------
4,264,251 2,409,464 1,093,867
Deferred:
Federal ............. -- -- --
State ............... -- -- --
Foreign ............. (132,622) (61,345) (166,686)
----------- ----------- -----------
(132,622) (61,345) (166,686)
----------- ----------- -----------
Total ............. $ 4,131,629 $ 2,348,119 $ 927,181
=========== =========== ===========
The source of loss before the provision for taxes and cumulative effect of
accounting change is as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------------
2003 2004 2005
------------- ------------- -------------
Federal ............... $ (18,609,818) $ (14,271,441) $ (4,481,879)
Foreign ............... (13,143,213) (88,057,111) 6,402,404
------------- ------------- -------------
Total ........ $ (31,753,031) $(102,328,552) $ 1,920,525
============= ============= =============
Our effective tax rate differs from the statutory rate principally due to the
following reasons: (1) A full valuation allowance has been provided for deferred
tax assets as a result of the operating losses in the United States and Mexico,
since recoverability of those assets has not been assessed as more likely than
not; (2) Although we have taxable losses in Mexico, it is subject to a minimum
tax; and (3) The earnings of our Hong Kong subsidiary are taxed at a rate of
17.5% versus the 35% U.S. federal rate. The impairment charge in Mexico did not
result in a tax benefit due to an increase in the valuation allowance against
the future tax benefit. We believe it is more likely than not that the tax
benefit will not be realized based on our future business plans in Mexico.
A reconciliation of the statutory federal income tax provision (benefit) to the
reported tax provision (benefit) on income is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------
2003 2004 2005
------------ ------------ ------------
Income tax (benefit) based on federal
statutory rate ........................... $(11,113,561) $(35,814,993) $ 672,184
State income taxes, net of federal benefit .. (157,266) 5,532 (246,978)
Effect of foreign income taxes .............. 2,862,550 2,749,376 (1,316,085)
Nondeductible goodwill impairment ........... 4,141,426 -- --
Nondeductible impairment of long-lived assets -- 30,463,663 --
Increase in tax reserve ..................... 2,400,000 1,000,000 --
Increase in valuation allowance
and other ................................ 5,998,480 3,944,541 1,818,060
------------ ------------ ------------
$ 4,131,629 $ 2,348,119 $ 927,181
============ ============ ============
F-25
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
deferred tax assets (liabilities) are as follows:
DECEMBER 31,
----------------------------
2004 2005
------------ ------------
Deferred tax assets:
Provision for doubtful accounts and unissued credits $ 433,261 $ 117,979
Provision for other reserves ....................... 1,533,620 2,874,377
Domestic and foreign loss carry forwards and foreign
tax credits ..................................... 9,789,485 11,162,380
Goodwill impairment ............................. 2,719,294 2,138,984
------------ ------------
Total deferred tax assets ....................... 14,475,660 16,293,720
Deferred tax liabilities:
Other .............................................. (213,784) (47,098)
------------ ------------
(213,784) (47,098)
Valuation allowance for deferred tax assets ........... (14,475,660) (16,293,720)
------------ ------------
Net deferred tax liabilities .......................... $ (213,784) $ (47,098)
============ ============
At December 31, 2005, we have $32.1 million of federal net operating loss
carryforwards expiring in 2024. We also have foreign tax credits carryforwards
totaling $833,000 that do not expire.
In January 2004, the Internal Revenue Service ("IRS") completed its examination
of our Federal income tax returns for the years ended December 31, 1996 through
2001. The IRS has proposed adjustments to increase our income tax payable for
the six years under examination. In addition, in July 2004, the IRS initiated an
examination of our Federal income tax return for the year ended December 31,
2002. In March 2005, the IRS proposed an adjustment to our taxable income of
approximately $6 million related to similar issues identified in their audit of
the 1996 through 2001 federal income tax returns. The proposed adjustments to
our 2002 federal income tax return would not result in additional tax due for
that year due to the tax loss reported in the 2002 federal return. However, it
could reduce the amount of net operating losses available to offset taxes due
from the preceding tax years. This adjustment would also result in additional
state taxes and interest. We believe that we have meritorious defenses to and
intend to vigorously contest the proposed adjustments. If the proposed
adjustments are upheld through the administrative and legal process, they could
have a material impact on our earnings and cash flow. We believe we have
provided adequate reserves for any reasonably foreseeable outcome related to
these matters on the consolidated balance sheets included in the consolidated
financial statements under the caption "Income Taxes". The maximum amount of
loss in excess of the amount accrued in the financial statements is $7.7
million. We do not believe that the adjustments, if any, arising from the IRS
examination, will result in an additional income tax liability beyond what is
recorded in the accompanying consolidated balance sheets.
11. COMMITMENTS AND CONTINGENCIES
We have entered into various non-cancelable operating lease agreements,
principally for executive office, warehousing facilities and production
facilities with unexpired terms in excess of one year. Certain of these leases
provided for scheduled rent increases. We record rent expense on a straight-line
basis over the term of the lease. The future minimum lease payments under these
non-cancelable operating leases are as follows:
2006................................................... $ 1,188,000
2007................................................... 710,000
2008................................................... 585,000
2009................................................... 600,000
2010................................................... 627,000
Thereafter............................................. 3,128,000
-----------
Total future minimum lease payments................ $ 6,838,000
===========
F-26
Included in the future minimum lease payments, $420,000 payable to Lynx
International Limited, a Hong Kong corporation that is owned by Messrs. Guez and
Kay for leasing our warehouse and office space in Hong Kong. See Note 15 of the
"Notes to Consolidated Financial Statements."
Several of the operating leases contain provisions for additional rent based
upon increases in the operating costs, as defined, per the agreement. Total rent
expense under the operating leases amounted to approximately $3,101,000,
$2,128,000 and $1,295,000 for 2003, 2004 and 2005, respectively.
We entered into a new lease agreement in June 2005 in New York as our showroom
through June 2015. This is currently the location used for the private brands
sales, design and technical departments, which functions we moved from our Los
Angeles executive office.
We had open letters of credit of $5,976,000, $9,987,000 and $9,519,000 as of
December 31, 2003, 2004 and 2005, respectively.
We have two employment contracts dated January 1, 1998, and subsequently
amended, with two executives providing for base compensation and other
incentives. On April 1, 2004, we amended each of these contracts to extend the
term through March 31, 2006, and to provide one contract for base salary per
annum of $500,000 for the period from April 1, 2003 to March 31, 2006, and the
other contract for base salary per annum of $50,000 from April 1, 2003 to March
31, 2006. Additionally, we agreed to pay each of these executives an annual
bonus (the "Annual Bonus") for fiscal years ended December 31, 2003, 2004 and
2005 in an amount, if any, equal to ten percent (10%) of the amount by which our
actual pre-tax income for such fiscal year exceeds the amount of projected
pre-tax income set forth in our annual budget for the same fiscal year as
approved by our Board of Directors. No bonuses were paid to these executives for
the fiscal year ended December 31, 2003, 2004 and 2005.
On October 17, 2004, Private Brands, Inc entered into an agreement with J. S.
Brand Management to design, manufacture and distribute Jessica Simpson branded
jeans and casual apparel in missy, juniors and large sizes. This agreement has
an initial three-year term, and provided we are in compliance with the terms of
the agreement, is renewable for one additional two-year term. Minimum net sales
are $20 million in year 1, $25 million in year 2 and $30 million in year 3. The
agreement provides for payment of a sales royalty and advertising commitment at
the rate of 8% and 3%, respectively, of net sales, for a total minimum payment
obligation of $8.3 million over the initial term of the agreement. On July 19,
2005, Camuto Consulting Group replaced J.S. Brand Management as the master
licensor. In December 2004, we advanced $2.2 million as payment for the first
year's minimum royalties. We applied $1.1 million from the above advance against
the royalty and marketing expenses in 2005. As of December 31, 2005, we had an
outstanding advance of $1.1 million. In March 2006, we became involved in a
dispute with the licensor of the Jessica Simpson brands over our continued
rights to these brands.
On January 3, 2005, Private Brands, Inc, our wholly owned subsidiary, entered
into a term sheet exclusive licensing agreement with Beyond Productions, LLC and
Kids Headquarters to collaborate on the design, manufacturing and distribution
of women's contemporary, large sizes and junior apparel bearing the brand name
"House of Dereon", Couture, Kick and Soul. This agreement is a three-year
contract, and providing compliance with all terms of the license, is renewable
for one additional three-year term. Minimum net sales are $10 million in year 1,
$20 million in year 2 and $30 million in year 3. The agreement also provides
payment of royalty at the rate of 8% on net sales and 3% on net sales for
marketing fund commitments. In the first quarter of 2005, we advanced $1.2
million as payment for the first year's minimum royalty and marketing fund
commitment. We had applied $34,000 from the above advance against the royalty
and marketing expenses in 2005. In March 2006, we agreed to terminate our
agreement to design, market and sell House of Dereon by Tina Knowles branded
apparel and we agreed to sell all remaining inventory to the licensor or its
designee. As a result, we will no longer be involved in the sales of this
private brand. Prior to December 31, 2005, we had written off the capitalized
balance of $1.2 million related to agreement and recognized a loss accordingly
in 2005. The loss was classified as royalty expense on our consolidated
statements of operations.
In the second quarter of 2003, we acquired a 45% equity interest in the owner of
the trademark "American Rag CIE" and the operator of American Rag retail stores
for $1.4 million, and our subsidiary, Private Brands, Inc., acquired a license
to certain exclusive rights to this trademark. We have guaranteed the payment to
the licensor of minimum royalties of $10.4 million over the initial 10-year term
of the agreement. At December 31, 2005, the total commitment on royalties
remaining on the term was $9.1 million.
F-27
On October 16, 2003, we entered into a lease with affiliates of Mr. Kamel Nacif,
a substantial portion of our manufacturing facilities and operations in Mexico
including real estate and equipment. The lease was effective as of September 1,
2003. We leased our twill mill in Tlaxcala, Mexico, and our sewing plant in
Ajalpan, Mexico, for a period of 6 years and for an annual rental fee of $11
million. Mr. Nacif was a stockholder at the time of transaction. In connection
with this transaction, we also entered into a management services agreement
pursuant to which Mr. Nacif's affiliates managed the operation of our remaining
facilities in Mexico in exchange for use of the remaining facilities. The term
of the management services agreement was also for a period of 6 years.
Additionally, we agreed to purchase annually, six million yards of fabric
manufactured at the facilities leased and/or operated by Mr. Nacif's affiliates
at market prices to be negotiated. See Note 15 of the "Notes to Consolidated
Financial Statements." Using current market prices, the purchase commitment
would be approximately $18 million per year.
In connection with the restructuring of our Mexican operations, and the
resulting reduction in our Mexican work force, we became the target of workers'
rights activists who have picketed our customers, stuffed electronic mailboxes
with inaccurate, protest e-mails, and threatened customers with retaliation for
continuing business with us. While we have defended our position to our
customers, some of our larger customers for Mexico-produced jeans wear have been
reluctant to place orders with us in response to actions taken and contemplated
by these activist groups. As a consequence of these actions, we experienced a
significant decline in revenue of approximately $75 million from sales of
Mexico-produced merchandise in 2004 as compared to 2003.
In August 2004, we entered into an Agreement for Purchase of Assets with
affiliates of Mr. Kamel Nacif, a shareholder at the time of the transaction,
with agreement was amended in October 2004. Pursuant to the agreement, as
amended, on November 30, 2004, we sold to the purchasers substantially all of
our assets and real property in Mexico, including the equipment and facilities
we previously leased to Mr. Nacif's affiliates. Upon consummation of the sale,
we entered into a purchase commitment agreement with the purchasers, pursuant to
which we have agreed to purchase annually over the ten-year term of the
agreement, $5 million of fabric manufactured at our former facilities acquired
by the purchasers at negotiated market prices. This agreement replaced an
existing purchase commitment agreement with Mr. Nacif's affiliates. In August
2004, upon entering into an Agreement for Purchase of Assets, Mr. Nacif's
affiliates agreed to suspend our fabric purchase obligations under the existing
purchase commitment, and we agreed to suspend the affiliates of Mr. Nacif's
lease payment obligations under the lease agreements pursuant to which Mr.
Nacif's affiliates operated our manufacturing facilities in Mexico. See Note 15
of the "Notes to Consolidated Financial Statements."
We are involved from time to time in routine legal matters incidental to our
business. In our opinion, resolution of such matters will not have a material
effect on our financial position or results of operations.
12. EQUITY
We have adopted the disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," an amendment of FASB Statement No. 123. This
pronouncement requires prominent disclosures in both annual and interim
financial statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We account
for stock compensation awards under the intrinsic value method of Accounting
Principles Board ("APB") Opinion No. 25, rather than the alternative fair-value
accounting method. Under the intrinsic-value method, if the exercise price of
the employee's stock options equals the market price of the underlying stock on
the date of the grant, no compensation expense is recognized.
Our Employee Incentive Plan, formerly the 1995 Stock Option Plan, as amended and
restated in May 1999 (the Plan), has authorized the grant of both incentive and
non-qualified stock options to officers, employees, directors and consultants of
the Company for up to 5,100,000 shares (as adjusted for a stock split effective
May 1998) of our common stock. The exercise price of incentive options must be
equal to 100% of fair market value of common stock on the date of grant and the
exercise price of non-qualified options must not be less than the par value of a
share of common stock on the date of grant. The Plan was also amended to expand
the types of awards, which may be granted pursuant thereto to include stock
appreciation rights, restricted stock and other performance-based benefits. At
December 31, 2005, no further options may be granted under the Plan.
F-28
In October 1998, we granted 1,000,000 non-qualified stock options not under the
Plan. The options were granted to our Chairman and Vice Chairman at $13.50 per
share, the closing sales price of the common stock on the day of the grant. The
options expire in 2008 and vest over four years. In May 2002, we granted
3,000,000 non-qualified stock options not under the Plan. The options were
granted to our Chairman, Vice Chairman and Mr. Kamel Nacif at $5.50 per share,
the closing sales price of the common stock on the day of the grant. The options
expire in 2012 and vest over three years. The 1,000,000 stock options granted to
Kamel Nacif were forfeited in 2005. In May 2003, we granted 2,000,000
non-qualified stock options not under the Plan to our Chairman and Vice
Chairman. The options were granted at $3.65 per share, the closing sales price
of the common stock on the day of the grant. The options expire in 2013 and vest
over four years. In December 2003, we granted 400,000 non-qualified stock
options not under the Plan to our President. The options were granted at $3.94
per share, the closing sales price of the common stock on the day of the grant.
The options expire in 2013 and vest over four years.
On September 23, 2005, the Board of Directors approved the acceleration of
vesting of all our unvested stock options. In total, 1.7 million stock options
with an average exercise price of $3.69 and an average remaining contractual
life of 7.9 years were subject to this acceleration. The exercise prices and
number of shares subject to the accelerated options were unchanged. The
acceleration was effective as of September 23, 2005. Had the acceleration of
these stock options not been undertaken, the future compensation expense we
would recognize in the fiscal years of 2006, 2007, 2008 and 2009 would be $1.4
million, $810,000, $10,000 and $3,000, respectively. Our decision to accelerate
the vesting of these stock options was based upon the accounting of this $2.2
million of compensation expense from disclosure-only in 2005 to being included
in our statement of operations in 2006 to 2009 based on our anticipated adoption
of SFAS No. 123 (revised 2004) "Share-Based Payment" effective in January 2006.
F-29
A summary of our stock option activity, and related information is as follows:
2003 2004 2005
--------------------------- -------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------------- ------------ ------------- ----------- -------------- ------------
Options outstanding at
beginning of year 6,376,487 $ 8.89 8,926,087 $ 7.13 8,331,962 $ 7.22
Granted 3,288,100 3.67 83,000 3.04 42,000 2.44
Exercised -- -- -- -- -- --
Forfeited (738,500) 6.91 (677,125) 5.43 (1,573,300) 11.40
Expired -- -- -- -- (67,612) 4.50
--------- --------- ---------
Outstanding at end of
year 8,926,087 $ 7.13 8,331,962 $ 7.22 6,733,050 $ 6.25
========= ========= =========
Exercisable at end of
year 4,028,487 $10.56 5,251,250 $ 9.04 6,733,050 $ 6.25
Weighted average per
option fair value
of options granted
during the year $ 1.92 $ 1.36 $ 1.13
The following table summarizes information about stock options outstanding at
December 31, 2005:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
----------------------------------------------------------------------------------------------------------
$ 1.39 - $ 2.84 56,000 8.1 $ 2.41 56,000 $ 2.41
$ 3.60 - $ 3.68 2,388,050 7.5 3.64 2,388,050 3.64
$ 3.94 - $ 5.09 763,000 7.2 4.30 763,000 4.30
$ 5.50 2,004,000 6.3 5.50 2,004,000 5.50
$ 5.55 - $ 9.97 444,500 2.4 7.05 444,500 7.05
$13.50 - $15.50 1,011,000 2.7 13.51 1,011,000 13.51
$18.44 - $18.50 23,000 2.7 18.50 23,000 18.50
$33.13 - $39.97 41,500 3.1 39.31 41,500 39.31
$45.50 2,000 3.2 45.50 2,000 45.50
----------- -----------
$ 1.39 - $45.50 6,733,050 6.0 $ 6.25 6,733,050 $ 6.25
=========== ===========
13. EQUITY TRANSACTIONS
In October 2003, we sold an aggregate of 881,732 shares of the Series A
Convertible Preferred Stock, at $38 per share, to a group of institutional
investors and high net worth individuals and raised an aggregate of
approximately $31 million, after payment of commissions and expenses. We used
the proceeds of this offering to pay down vendors and reduce debts. The
preferred stock was converted into an aggregate of 8,817,320 shares of common
stock following a special meeting of shareholders held on December 4, 2003 in
accordance with the original conversion terms. We have registered the shares of
common stock issued upon conversion of the Series A Preferred Stock with the
Securities and Exchange Commission for resale by the investors. In conjunction
with the private placement transaction, we issued a warrant to purchase 881,732
shares of common stock to the placement agent. The warrants are exercisable
beginning April 17, 2004 through October 17, 2008 and have a per share exercise
price of $4.65. Warrants were valued using the Black-Scholes option valuation
F-30
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 0.51; and an expected life of four years.
As previously disclosed, following a review of the accounting treatment of our
October 2003 private placement of convertible preferred stock, we revised our
accounting treatment for this transaction to record a beneficial conversion
feature in accordance with Emerging Issues Task Force ("EITF") No. 98-5 and to
restate our financial statements for the fiscal years ended December 31, 2003
and 2004 to reflect the beneficial conversion feature of the convertible
preferred stock. We restated our 2003 and 2004 financial statements to reflect
the recording of the beneficial conversion feature of approximately $7.5 million
in the fourth quarter of 2003 relating to the issuance of 881,732 shares of
Series A convertible preferred stock. The beneficial conversion feature of the
preferred shares in the amount of $7.5 million was recorded in the fourth
quarter of 2003, resulting in an increase in loss per share to common
shareholders for the year ended December 31, 2003 to $(2.38) per share from the
previously reported $(1.97) per share. The beneficial conversion feature did not
change our reported earnings (loss) per share for the year ended December 31,
2004. The effect of recording the beneficial conversion feature on the December
31, 2004 financial statements was an increase in the accumulated deficit of $7.5
million and an offsetting increase in contributed capital. The restatement did
not change total shareholders' equity at December 31, 2003 or 2004.
In November 2003, we issued an aggregate of 200,000 shares of common stock to
Antonio Haddad Haddad, Miguel Angel Haddad Yunes, Mario Alberto Haddad Yunes,
and Marco Antonio Haddad Yunes in partial settlement of the balance of
approximately $2.5 million in obligations owed these parties arising from our
acquisition of their factories in 1998. The fair value of the common stock
issued on the date of issuance was $3.94 per share, resulting in a reduction of
our obligation by $788,000.
During the year of 2003, we retired a total of 248,872 shares of common stock
relating to shares repurchased but uncancelled before 2001 and shares
repurchased in 2003 from Gabe Zeitouni, upon exercising his put option under an
agreement dated July 10, 2000.
In January 2004, we sold an aggregate of 1,200,000 shares of our common stock at
a price of $3.35 per share, for aggregate proceeds to us of approximately $3.7
million after payment of placement agent fees and other offering expenses. We
used the proceeds of this offering for working capital purposes. The securities
sold in the offering were registered under the Securities Act of 1933, as
amended, pursuant to our effective shelf registration statement. In conjunction
with this public offering, we issued a warrant to purchase 30,000 shares of our
common stock to the placement agent. This warrant has an exercise price of $3.35
per share, is fully vested and exercisable and has a term of five years. The
warrant was valued using the Black-Scholes option valuation model with the
following assumptions: risk-free interest rate of 3%; dividend yields of 0%;
volatility factors of the expected market price of warrants of 0.51; and an
expected life of four years.
In March 2005, in connection with a settlement of a dispute involving a former
employee named Nicolas Nunez, we agreed to compensate Mr. Nunez in the total
amount of $875,000. In April 2005, we issued 195,313 shares of our common stock
(having a value of $375,000) to Mr. Nunez pursuant to the terms of an agreement
and plan of reorganization and paid Mr. Nunez $500,000 in settlement of all
remaining claims by Mr. Nunez against us.
In June 2005, holders of our Debentures converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock. See Note 9 of the "Notes to Consolidated Financial
Statements."
In November 2003, our board of directors adopted a shareholders rights plan.
Pursuant to the plan, we issued a dividend of one right for each share of our
common stock held by shareholders of record as of the close of business on
December 12, 2003. Each right initially entitled shareholders to purchase a
fractional share of our Series B Preferred Stock for $25.00. However, the rights
are not immediately exercisable and will become exercisable only upon the
occurrence of certain events. Generally, if a person or group acquires, or
announces a tender or exchange offer that would result in the acquisition of 15%
or more of our common stock while the shareholder rights plan remains in place,
then, unless the rights are redeemed by us for $0.001 per right, the rights will
become exercisable, by all rights holders other than the acquiring person or
group, for our shares or shares of the third party acquirer having a value of
twice the right's then-current exercise price. The shareholder rights plan is
designed to guard against partial tender offers and other coercive tactics to
gain control of our company without offering a fair and adequate price and terms
to all of our shareholders. The plan was not adopted in response to any efforts
to acquire our company, and we are not aware of any such efforts.
F-31
Our credit agreement prohibits the payment of dividends during the term of the
agreement.
14. SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31,
----------------------------------------
2003 2004 2005
---------- ---------- ----------
Cash paid for interest ............ $2,856,000 $1,796,000 $3,335,000
========== ========== ==========
Cash paid for income taxes ........ $ 378,000 $1,196,000 $ 875,000
========== ========== ==========
In 1999, we acquired Industrial Exportadora Famian from the Haddad family. In
accordance with the acquisition agreement, we had to pay certain amount of
earnouts to the vendors annually. As of October 31, 2003, total earnouts accrued
but not paid amounted to about $2.5 million. In November 2003, we entered into
an agreement with the Haddad family to satisfy the amount owed by issuing to
four family members a total of 200,000 shares of common stock, with a fair value
of $788,000. In addition, we gave them 400,000 yards of our stock fabric,
100,000 pairs of pants, and a fleet of old vehicles, with an aggregate book
value of approximately $1.5 million. Included in other income was a gain of
$236,000 resulting from this settlement in 2003.
In 2003, we reduced a shareholder receivable for $722,000 from Mr. Kamel Nacif
against vendor payables owed to entities controlled by Mr. Nacif.
In 2004, as consideration for the sale of our assets and real property in
Mexico, we received $45.4 million of notes receivable. See Note 5 of "Notes to
Consolidated Financial Statements."
On December 14, 2004, we completed a $10 million financing through the issuance
of 6% Secured Convertible Debentures ("Debentures"), we issued warrants to
purchase up to 1,250,000 shares of our common stock. The warrants were valued at
$866,000 using the Black-Scholes option valuation model. The placement agent in
the financing, for its services were paid $620,000 in cash and issued five year
warrants to purchase up to 200,000 shares of our common stock at an exercise
price of $2.50 per share. The 200,000 warrants were valued at $138,000 using the
Black-Scholes option valuation model.
In March 2005, in connection with a settlement of a dispute involving a former
employee named Nicolas Nunez, we agreed to compensate Mr. Nunez in the total
amount of $875,000. In April 2005, we issued 195,313 shares of our common stock
(having a value of $375,000) to Mr. Nunez pursuant to the terms of an agreement
and plan of reorganization and paid Mr. Nunez $500,000 in settlement of all
remaining claims by Mr. Nunez against us.
In June 2005, holders of our Debentures converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock.
In 2005, we purchased $6.4 million of fabric from Acabados y Terminados, of
which $2.4 million was paid in cash and $4.0 million was offset against the
notes receivable principal and accrued interest on the note receivable from the
affiliates of Mr. Kamel Nacif.
F-32
15. RELATED-PARTY TRANSACTIONS
Related-party transactions, consisting primarily of purchases and sales of
finished goods and raw materials, are as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------
2003 2004 2005
----------- ----------- -----------
Sales to related parties .......... $22,296,000 $ 3,598,000 $ 88,000
Purchases from related parties .... $72,329,000 $17,875,000 $ 6,987,000
As of December 31, 2004 and 2005, related party affiliates were indebted to us
in the amounts of $13.1 million and $8.4 million, respectively. These include
amounts due from Gerard Guez, our Chairman of $2.5 million and $2.3 million at
December 31, 2004 and 2005, respectively, which have been shown as reductions to
shareholders' equity in the accompanying financial statements. Total interest
paid by Mr. Guez was $374,000, $370,000 and $209,000 for the years ended
December 31, 2003, 2004 and 2005, respectively.
From time to time in the past, we borrowed funds from, and advanced funds to,
Mr. Guez. The greatest outstanding balance of such advances to Mr. Guez during
2005 was approximately $4,766,000. At December 31, 2005, the entire balance due
from Mr. Guez totaling $2.3 million was reflected as a reduction of
shareholders' equity. All advances to, and borrowings from, Mr. Guez bore
interest at the rate of 7.75% during the period. Total interest paid by Mr. Guez
was $374,000, $370,000 and $209,000 for the years ended December 31, 2003, 2004
and 2005, respectively. Mr. Guez paid expenses on our behalf of approximately
$400,000 and $397,000 for the years ended December 31, 2004 and 2005,
respectively, which amounts were applied to reduce accrued interest and
principal on Mr. Guez's loan. These amounts included fuel and related expenses
incurred by 477 Aviation, LLC, a company owned by Mr. Guez, when our executives
used this company's aircraft for business purposes. Since the enactment of the
Sarbanes-Oxley Act in 2002, no further personal loans (or amendments to existing
loans) have been or will be made to officers or directors of Tarrant.
In February 2004, our Hong Kong subsidiary entered into a 50/50 joint venture
with Auto Enterprises Limited, an unrelated third party, to source products for
Seven Licensing Company, LLC and our private brands subsidiary in mainland
China. On May 31, 2004, after realizing an accumulated loss from the venture of
approximately $200,000 (our share being half), we sold our interest for $1 to
Asia Trading Limited, a company owned by Jacqueline Rose, wife of Gerard Guez.
The venture owed us $221,000 as of December 31, 2004. This amount was repaid in
the first quarter of 2005.
On July 1, 2001, we formed an entity to jointly market, share certain risks and
achieve economics of scale with Azteca Production International, Inc.
("Azteca"), a corporation owned by the brothers of Gerard Guez, our Chairman,
called United Apparel Ventures, LLC ("UAV"). This entity was created to
coordinate the production of apparel for a single customer of our branded
business. UAV is owned 50.1% by Tag Mex, Inc., our wholly owned subsidiary, and
49.9% by Azteca. Results of the operation of UAV have been consolidated into our
results since July 2001 with the minority partner's share of gain and losses
eliminated through the minority interest line in our financial statements. Due
to the restructuring of our Mexico operations, we discontinued manufacturing for
UAV customers in the second quarter of 2004. UAV makes purchases from two
related parties in Mexico, an affiliate of Azteca and Tag-It Pacific, Inc.
Since June 2003, United Apparel Venture, LLC had been selling to Seven Licensing
Company, LLC ("Seven Licensing"), jeans wear bearing the brand "Seven7", which
is ultimately purchased by Express. Seven Licensing is beneficially owned by
Gerard Guez. In the third quarter of 2004, in order to strengthen our own
private brand business, we decided to discontinue sourcing for Seven7. Total
sales to Seven Licensing during the years ended December 31, 2003, 2004 and 2005
were $8.1 million, $2.6 million and $0, respectively. In 1998, a California
limited liability company owned by our Chairman and Vice Chairman purchased
2,300,000 shares of the common stock of Tag-It Pacific, Inc. ("Tag-It") (or
approximately 37% of such common stock then outstanding). Tag-It is a provider
of brand identity programs to manufacturers and retailers of apparel and
accessories. Starting from 1998, Tag-It assumed the responsibility for managing
and sourcing all trim and packaging used in connection with products
manufactured by or on behalf of us in Mexico. We believe that the terms of this
arrangement, which is subject to the acceptance of our customers, are no less
F-33
favorable to us than could be obtained from unaffiliated third parties. Due to
the restructuring of our Mexico operations, Tag-It no longer manages our trim
and packaging requirements. We purchased $16.8 million, $1.0 million and
$450,000 of trim inventory from Tag-It for the years ended December 31, 2003,
2004 and 2005, respectively. We also sold to Tag-It $1.5 million from our trim
and fabric inventory for the year ended December 31, 2003. We purchased $37.1
million, $11.5 million and $135,000 of finished goods and service from Azteca
and its affiliates for the years ended December 31, 2003, 2004 and 2005,
respectively. Azteca is owned by the brothers of our Chairman, Gerard Guez, and
is the minority member of our subsidiary, United Apparel Ventures, LLC. Our
total sales of fabric and service to Azteca in 2003, 2004 and 2005 were $9.9
million, $1.0 million and $88,000, respectively. Two and one half percent of
gross sales as management fees were paid in 2003, 2004 and 2005 to each of the
members of UAV, per the operating agreement. The amount paid to Azteca, the
minority member of UAV, totaled $1.7 million, $179,000 and $0 in 2003, 2004 and
2005, respectively. Net amounts due from these related parties as of December
31, 2004 and 2005 were $7.8 million and $5.5 million, respectively.
On October 16, 2003, we entered into a lease with affiliates of Mr. Kamel Nacif,
a substantial portion of our manufacturing facilities and operations in Mexico
including real estate and equipment. The lease was effective as of September 1,
2003. We leased our twill mill in Tlaxcala, Mexico, and our sewing plant in
Ajalpan, Mexico, for a period of 6 years and for an annual rental fee of $11
million. Mr. Nacif was a shareholder at the time of the transaction. In
connection with this transaction, we also entered into a management services
agreement pursuant to which Mr. Nacif's affiliates managed the operation of our
remaining facilities in Mexico. The term of the management services agreement
was also for a period of 6 years. Additionally, we entered into a purchase
commitment agreement with Mr. Nacif's affiliates to purchase annually, six
million yards of fabric manufactured at the facilities leased and/or operated by
Mr. Nacif's affiliates at market prices to be negotiated. See Note 11
"Commitments and Contingencies," of the "Notes to Consolidated Financial
Statements." Using current market prices, the purchase commitment would be
approximately $18 million per year. We agreed to pay $1 for each yard of fabric
that we fail to purchase under the agreement. We purchased $3.6 million and $5.3
million of fabric from Acabados y Terminados under this agreement in 2003 and
2004, respectively.
In August 2004, we entered into an Agreement for Purchase of Assets with
affiliates of Mr. Kamel Nacif, a shareholder at the time of the transaction,
with agreement was amended in October 2004. Pursuant to the agreement, as
amended, on November 30, 2004, we sold to the purchasers substantially all of
our assets and real property in Mexico, including the equipment and facilities
we previously leased to Mr. Nacif's affiliates. Upon consummation of the sale,
we entered into a purchase commitment agreement with the purchasers, pursuant to
which we have agreed to purchase annually over the ten-year term of the
agreement, $5 million of fabric manufactured at our former facilities acquired
by the purchasers at negotiated market prices. This agreement replaced a
previously existing purchase commitment agreement with Mr. Nacif's affiliates.
We purchased $6.4 million of fabric, of which $2.4 million was paid in cash and
$4.0 million was offset against the notes receivable principal and accrued
interest on the note receivable from the affiliates of Mr. Kamel Nacif in 2005.
Net amount due from these related parties as of December 31, 2005 was $236,000.
We lease our executive offices in Los Angeles, California from GET, a
corporation which is owned by Gerard Guez and Todd Kay, our Chairman and Vice
Chairman, respectively. Additionally, we lease our warehouse and office space in
Hong Kong from Lynx International Limited, a Hong Kong corporation that is owned
by Messrs. Guez and Kay. We paid $1,330,000 in rent annually in each of 2003 and
2004 and $1,019,000 in 2005 for office and warehouse facilities. Our Los Angeles
offices and warehouse is leased on a month to month basis. On January 1, 2006,
we entered into a one year lease agreement with Lynx International Limited for
our office space in Hong Kong.
We reimbursed Mr. Guez, our Chairman, for fuel and related expenses incurred by
477 Aviation LLC, a company owned by Mr. Guez, when our executives used this
company's aircraft for business purposes.
At December 31, 2004 and 2005, we had various employees receivable totaling
$403,000 and $370,000, respectively, included in due from related parties.
We entered into lease agreements with the former owners of Industrial
Exportadora Famian and our former employees. Under theses leases, we paid
$943,000 in 2003, for rent for sewing and washing facilities in Tehuacan,
Mexico. All these lease agreements were cancelled in November 2003.
F-34
In the second quarter of 2003, we acquired a 45% equity interest in the owner of
the trademark "American Rag CIE" and the operator of American Rag retail stores
for $1.4 million, and our subsidiary, Private Brands, Inc., acquired a license
to certain exclusive rights to this trademark. The investment in American Rag
Cie, LLC totaling $2.1 million at December 31, 2005 was accounted for under the
equity method and included in equity method of investment on the accompanying
consolidated balance sheets.
We believe the each of the transactions described above has been entered into on
terms no less favorable to us than could have been obtained from unaffiliated
third parties.
F-35
16. OPERATIONS BY GEOGRAPHIC AREAS
Our predominant business is the design, distribution and importation of private
label and private brand casual apparel. Substantially all of our revenues are
from the sales of apparel. We are organized into four geographic regions: the
United States, Asia, Mexico and Luxembourg. We evaluate performance of each
region based on profit or loss from operations before income taxes not including
the cumulative effect of change in accounting principles. Information about our
operations in the United States, Asia, Mexico and Luxembourg is presented below.
Inter-company revenues and assets have been eliminated to arrive at the
consolidated amounts.
ADJUSTMENTS
AND
UNITED STATES ASIA MEXICO LUXEMBOURG ELIMINATIONS TOTAL
------------- ------------- -------------- ------------- -------------- -------------
2003
Sales...................... $ 291,993,000 $ 7,359,000 $ 21,071,000 $ -- $ -- $ 320,423,000
Inter-company sales........ 33,441,000 112,481,000 75,716,000 -- (221,638,000) --
------------- ------------- -------------- ------------- -------------- -------------
Total revenue.............. $ 325,434,000 $ 119,840,000 $ 96,787,000 $ -- $(221,638,000) $ 320,423,000
============= ============= ============== ============= ============= =============
Income (loss) from operations $(11,078,000) $ 7,556,000 $ (30,116,000) $ -- $ -- $ (33,638,000)
============ ============= ============== ============= ============= =============
Interest income............ $ 419,000 $ 725,000 $ 6,000 $ -- $ (725,000) $ 425,000
============= ============= ============== ============= ============= =============
Interest expense........... $ 5,215,000 $ 41,000 $ 347,000 $ 725,000 $ (725,000) $ 5,603,000
============= ============= ============== ============= ============= =============
Provision for depreciation
and amortization.......... $ 1,547,000 $ 261,000 $ 14,290,000 $ -- $ -- $ 16,098,000
============= ============= ============== ============= ============= =============
Capital expenditures....... $ 94,000 $ 84,000 $ 190,000 $ -- $ -- $ 368,000
============= ============= ============== ============= ============= =============
Total assets............... $ 128,058,000 $ 117,783,000 $ 201,050,000 $ 213,051,000 $(406,837,000) $ 253,105,000
============= ============= ============== ============= ============= =============
2004
Sales...................... $ 149,568,000 $ 1,838,000 $ 4,047,000 $ -- $ -- $ 155,453,000
Inter-company sales........ -- 80,420,000 7,453,000 -- (87,873,000) --
-------------- ------------- -------------- ------------- ------------- -------------
Total revenue.............. $ 149,568,000 $ 82,258,000 $ 11,500,000 $ -- $ (87,873,000) $ 155,453,000
============= ============= ============== ============= ============= =============
Income (loss) from operations $ (13,231,000) $ 3,663,000 $ (89,400,000) $ (33,000) $ (22,786,000) $(121,787,000)
============= ============= ============== ============= ============= =============
Interest income............ $ 378,000 $ 856,000 $ -- $ -- $ (856,000) $ 378,000
============== ============= ============== ============= ============= =============
Interest expense........... $ 2,766,000 $ 55,000 $ 38,000 $ 854,000 $ (856,000) $ 2,857,000
============= ============= ============== ============= ============= =============
Provision for depreciation
and amortization.......... $ 1,283,000 $ 219,000 $ 6,836,000 $ -- $ -- $ 8,338,000
============= ============= ============== ============= ============= =============
Capital expenditures....... $ 48,000 $ 64,000 $ -- $ -- $ -- $ 112,000
============= ============= ============== ============= ============= =============
Total assets............... $ 113,046,000 $ 121,007,000 $ 31,603,000 $ 212,165,000 $(346,010,000) $ 131,811,000
============= ============= ============= ============= ============= =============
2005
Sales...................... $ 213,205,000 $ 1,282,000 $ 161,000 $ -- $ -- $ 214,648,000
Inter-company sales........ -- 135,531,000 -- -- (135,531,000) --
------------- ------------- -------------- ------------- ------------- -------------
Total revenue.............. $ 213,205,000 $ 136,813,000 $ 161,000 $ -- $(135,531,000) $ 214,648,000
============= ============= ============== ============= ============= =============
Income (loss) from operations $ (928,000) $ 5,071,000 $ (470,000) $ (48,000) $ -- $ 3,625,000
============= ============= ============== ============= ============= =============
Interest income............ $ 223,000 $ 1,955,000 $ -- $ 1,856,000 $ (1,953,000) $ 2,081,000
============= ============= ============== ============= ============= =============
Interest expense........... $ 4,219,000 $ 403,000 $ 2,000 $ 1,954,000 $ (1,953,000) $ 4,625,000
============= ============= ============== ============= ============= =============
Provision for depreciation
and amortization.......... $ 2,025,000 $ 102,000 $ -- $ -- $ -- $ 2,127,000
============= ============= ============== ============= ============= =============
Capital expenditures....... $ 335,000 $ 224,000 $ -- $ -- $ -- $ 559,000
============= ============= ============== ============= ============= =============
Total assets............... $ 115,327,000 $ 129,737,000 $ 15,782,000 $ 212,019,000 $(321,623,000) $ 151,242,000
============= ============= ============== ============= ============= =============
F-36
17. EMPLOYEE BENEFIT PLANS
On August 1, 1992, Tarrant Hong Kong established a defined contribution
retirement plan covering all of its Hong Kong employees whose period of service
exceeds 12 months. Plan assets are monitored by a third-party investment manager
and are segregated from those of Tarrant Hong Kong. Participants may contribute
up to 5% of their salary to the plan. We make annual matching contributions.
Costs of the plan charged to operations for 2003, 2004 and 2005 amounted to
approximately $157,000, $131,000 and $160,000, respectively.
On July 1, 1994, we established a defined contribution retirement plan covering
all of our U.S. employees whose period of service exceeds 12 months. Plan assets
are monitored by a third-party investment manager and are segregated from those
of ours. Participants may contribute from 1% to 15% of their pre-tax
compensation up to effective limitations specified by the Internal Revenue
Service. Our contributions to the plan are based on a 50% (100% effective July
1, 1995) matching of participants' contributions, not to exceed 6% (5% effective
July 1, 1995) of the participants' annual compensation. In addition, we may also
make a discretionary annual contribution to the plan. Costs of the plan charged
to operations for 2003, 2004 and 2005 amounted to approximately $256,000,
$226,000 and $199,000, respectively.
On December 27, 1995, we established a deferred compensation plan for executive
officers. Participants may contribute a specific portion of their salary to such
plan. We do not contribute to the Plan.
18. OTHER INCOME AND EXPENSE
Other income and expense consists of the following:
YEAR ENDED DECEMBER 31,
------------------------------------
2003 2004 2005
---------- ---------- ----------
Rental income ........................... $3,957,365 $5,854,698 $ 193,127
Gain on sale of fixed assets ............ -- -- 124,041
Unrealized gain on foreign currency ..... -- 367,262 --
Realized gain on foreign currency ....... 304,060 -- --
Gain on legal settlement ................ 235,785 -- --
Other items ............................. 287,269 144,677 37,179
---------- ---------- ----------
Total other income ...................... $4,784,479 $6,366,637 $ 354,347
========== ========== ==========
Unrealized loss on foreign currency ..... 560,602 -- --
Realized loss on foreign currency ....... -- 511,586 --
Loss on sale of fixed assets ............ 593,626 -- --
Other items ............................. 28,692 17,671 580
---------- ---------- ----------
Total other expense ..................... $1,182,920 $ 529,257 $ 580
========== ========== ==========
19. LEGAL PROCEEDINGS
1. PATRICK BENSIMON
On April 12, 2000, we formed a company, Jane Doe International, LLC ("JDI") for
the sole purpose of purchasing the assets of Needletex, Inc., owner of the Jane
Doe brand. JDI was owned 51% by Fashion Resource (TCL), Inc., our subsidiary,
and 49% by Needletex, Inc. In connection with the establishment of JDI, JDI
entered into an employment agreement with Patrick Bensimon, the principal
shareholder of Needletex, Inc., which provided for the payment of a salary to
Patrick Bensimon and a bonus tied to the new company's sales performance.
Thereafter a dispute arose as to whether Patrick Bensimon had performed in
accordance with his terms of employment set forth in the Employment Agreement.
When an amicable resolution of this dispute could not be achieved, Patrick
Bensimon commenced an arbitration preceding against his employer, JDI, Fashion
Resource (TCL), Inc., the managing member of Jane Doe International and us. On
April 7, 2003, the arbitration panel issued a final award in favor of Patrick
F-37
Bensimon of $1,425,655 for salary and bonus, plus interest accrued and his costs
and attorneys fees in the amount of $489,640. In January 2004, we settled the
employment litigation with Patrick Bensimon for $1.2 million in cash and
forgiveness of approximately $859,000 in debts owed by Needletex Inc. As part of
the settlement, we received the remaining 49% interest in JDI. We also settled
with our insurance carrier for a cash payment of $330,000. An additional expense
of approximately $379,000 was made in the fourth quarter of 2003 to cover the
forgiveness of debts.
2. NICOLAS NUNEZ
In March 2005, we reached a settlement of a dispute involving a former employee
named Nicolas Nunez. Mr. Nunez was employed by us pursuant to a written
employment agreement until he was terminated in or about November 2000. In
connection to this employment, we agreed to acquire Nunez' company by merger.
Mr. Nunez claimed to be entitled to shares of our common stock up to a value of
$500,000 assuming we did not otherwise have valid defenses to such claims. In
connection with the settlement, we agreed to compensate Mr. Nunez in the total
amount of $875,000. The full amount of $875,000 had been accrued and included in
accrued liabilities in the accompanying balance sheet at December 31, 2004. All
parties to both proceedings have agreed to exchange full mutual releases of any
and all claims, known or unknown, and will dismiss both proceedings with
prejudice, without admitting any liability.
In April 2005, we issued 195,313 shares of our common stock (having a value of
$375,000) to Mr. Nunez pursuant to the terms of an agreement and plan of
reorganization and paid Mr. Nunez $500,000 in settlement of all remaining claims
by Mr. Nunez against us.
3. MR. BENJAMIN DOMINGUEZ GONZALEZ
On December 10, 2004 and December 14, 2004, Mr. Benjamin Dominguez Gonzalez
brought suits against our Mexico Subsidiary, Tarrant Mexico, S. de R.L. de C.V.,
in Puebla, Puebla, Mexico: (a) "Juicio Ejecutivo Mercantil 887/2004, Juzgado
Dicimo de lo Civil del Estado de Puebla, Puebla, Mexico, Dominguez Gonzalez
Benjamin vs. Tarrant Mexico S. de R.L. de C.V. e Inmobiliaria Cuadros S.A. de
C.V."; and (b) "Juicio Ejecutivo Mercantil 889/2004, Juzgado Noveno de lo Civil
del Estado de Puebla, Puebla, Mexico, Dominguez Gonzalez Benjamin vs. Tarrant
Mexico S. de R.L. de C.V. e Inmobiliaria Cuadros S.A. de C.V.", for the
non-payment of approximately $14 million in principal amount and accrued
interest on two promissory notes, which Mr. Gonzalez asserts were issued by
Tarrant Mexico. The amounts Mr. Gonzalez claimed were due and owing under the
notes previously had been paid in full. In April 2005, Mr. Gonzalez agreed to
dismiss his claims, which agreement has been approved by the court.
4. BAZAK INTERNATIONAL CORPORATION
Shortly before May 2004, Bazak International Corp. commenced an action against
us in the New York County Supreme Court claiming that we breached an oral
contract to sell a quantity of close-out goods, as a consequence of which Bazak
was damaged to the extent of $1.3 million. Bazak International Corp. claimed
that our liability exists under a theory of breach of contract or unjust
enrichment. This case is currently pending in the United States District Court
for the Southern District of New York and is scheduled for trial on December 18,
2006. We will continue to vigorously defend against the breach of contract and
unjust enrichment claim.
F-38
20. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
QUARTER ENDED
--------------------------------------------
MAR. 31 JUN. 30 SEP. 30 DEC. 31
-------- -------- -------- --------
(In thousands, except per share data)
2004
Net sales .......................... $ 42,155 $ 38,489 $ 38,102 $ 36,707
Gross profit ....................... 7,500 5,266 4,135 4,060
Operating loss ..................... (5,963) (84,585) (3,626) (27,613)
Net loss ........................... $ (2,974) $(68,567) $ (4,019) $(29,117)
Net loss per common share:
Basic ........................... $ (0.10) $ (2.39) $ (0.14) $ (1.01)
Diluted ......................... $ (0.10) $ (2.39) $ (0.14) $ (1.01)
Weighted average shares outstanding:
Basic ........................... 28,485 28,649 28,815 28,815
Diluted ......................... 28,485 28,649 28,815 28,815
2005
Net sales .......................... $ 44,830 $ 50,538 $ 69,566 $ 49,714
Gross profit ....................... 8,946 11,454 14,545 9,936
Operating income ................... 233 1,437 3,011 (1,056)
Net income (loss) .................. $ (106) $ 871 $ 1,702 $ (1,474)
Net loss per common share:
Basic ........................... $ (0.00) $ 0.03 $ 0.05 $ (0.05)
Diluted ......................... $ (0.00) $ 0.03 $ 0.05 $ (0.05)
Weighted average shares outstanding:
Basic ........................... 28,815 29,156 30,366 30,554
Diluted ......................... 28,815 29,163 30,786 30,554
F-39
21. SUBSEQUENT EVENTS
On January 19, 2006, we borrowed $4 million from Max Azria pursuant to the terms
of a promissory note, which amount bears interest at the rate of 5.5% per annum
and is payable in weekly installments of $200,000 beginning on March 1, 2006.
This is an unsecured loan.
On January 23, 2006, we further amended our factoring agreement with GMAC to
increase the amount we may borrow against inventory to the lesser of $5 million
or 50% of the value of eligible inventory. The $5 million limit will be reduced
to $4 million on April 1, 2006 and will be further reduced to $3 million on July
1, 2006. The maximum borrowing availability under the factoring agreement, based
on the borrowing base formula remains at $40 million.
On January 27, 2006, we further amended the letter of credit facility with UPS
to extend the expiration date of the facility from January 31, 2006 to July 31,
2006. The amendment provides for reduction of the maximum amount of borrowings
under the facility to $12.0 million commencing on April 1, 2006, $11.5 million
commencing on May 1, 2006, $11.0 million commencing on June 1, 2006 and to $10.5
million commencing on July 1, 2006. Under the amended letter of credit facility,
we are subject to restrictive financial covenants of maintaining tangible net
worth of $25 million as of December 31, 2005 and the last day of each fiscal
quarter thereafter. There is also a provision capping maximum capital
expenditures per quarter of $800,000.
In March 2006, we terminated our license agreement for the brand House of Dereon
by Tina Knowles branded apparel, and sold our remaining inventory to the
licensor. As a result, we will no longer be involved in the sales of this
private brand. Prior to December 31, 2005, we had written off the capitalized
balance of $1.2 million related to agreement and recognized a loss accordingly
in 2005. The loss was classified as royalty expense on our consolidated
statements of operations.
In March 2006, we became involved in a dispute with the master licensor of the
JS by Jessica Simpson, Princy and Sweet Kisses brands over our continued rights
to these brands. Accordingly, we do not anticipate sales of Jessica Simpson
branded apparel unless and until we successfully resolve our dispute with the
licensor. Net sales of Jessica Simpson and Princy by Jessica Simpson totaled
$12.6 million in 2005.
F-40
SCHEDULE II
TARRANT APPAREL GROUP
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS ADDITIONS
BALANCE AT CHARGED TO CHARGED BALANCE
BEGINNING COSTS AND TO OTHER AT END
OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR
----------- ----------- ----------- ----------- -----------
For the year ended December 31, 2003
Allowance for returns and discounts... $ 3,134,768 $ -- $ -- $ (324,387) $ 2,810,381
Allowance for bad debt ............... $ 1,181,853 $ 234,149 $ -- $ -- $ 1,416,002
Inventory reserve .................. $ -- $10,986,153 $ -- $ -- $10,986,153
=========== =========== =========== =========== ===========
For the year ended December 31, 2004
Allowance for returns and discounts .. $ 2,810,381 $ 738,326 $ -- $(2,485,386) $ 1,063,321
Allowance for bad debt ............... $ 1,416,002 $ 476,016 $ -- $ (517,474) $ 1,374,544
Inventory reserve .................. $10,986,153 $ -- $ -- $(9,869,491) $ 1,116,662
=========== =========== =========== =========== ===========
For the year ended December 31, 2005
Allowance for returns and discounts .. $ 1,063,321 $ 871,208 $ -- $ (949,268) $ 985,261
Allowance for bad debt ............... $ 1,374,544 $ 637,210 $ -- $ (45,265) $ 1,966,489
Inventory reserve .................. $ 1,116,662 $ -- $ -- $(1,032,836) $ 83,826
=========== =========== =========== =========== ===========
F-41
AMERICAN RAG
COMBINED FINANCIAL STATEMENTS
FOR THE YEAR ENDED
DECEMBER 31, 2005
F-42
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
American Rag
Montebello, California
We have audited the accompanying combined balance sheet of American Rag (the
"Company") and its combined affiliate as of December 31, 2005 and the related
combined statements of income, stockholders' equity/members' equity and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of American Rag and its
combined affiliate as of December 31, 2005 and the results of their operations
and their cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States of America.
As described in Note 2 to the financial statements, the accompanying combined
financial statements for the year ended December 31, 2005 have been restated.
/s/ Singer Lewak Greenbaum & Goldstein LLP
------------------------------------------
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
September 26, 2007
F-43
AMERICAN RAG
COMBINED BALANCE SHEET
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents .................................... $ 149,136
Accounts receivable .......................................... 43,654
Accounts receivable from member .............................. 41,000
Note receivable from member .................................. 75,000
Inventory, net ............................................... 1,571,458
Prepaid expenses and other current assets .................... 9,141
----------
Total current assets ................................... 1,889,389
PROPERTY AND EQUIPMENT, net of accumulated
depreciation and amortization ................................ 480,540
DEPOSITS ........................................................ 64,848
----------
TOTAL ASSETS .................................................... $2,434,777
==========
LIABILITIES AND STOCKHOLDERS' EQUITY/MEMBERS' EQUITY
CURRENT LIABILITIES
Accounts payable ............................................. $ 282,748
Accrued expenses ............................................. 209,143
Unearned revenue ............................................. 22,816
Deferred rent - current portion .............................. 4,232
Notes payable ................................................ 114,629
Current maturities on obligations under capital lease ........ 7,782
----------
Total current liabilities .............................. 641,350
OBLIGATIONS UNDER CAPITAL LEASE, LESS CURRENT MATURITIES ........ 19,462
DEFERRED RENT - LONG TERM PORTION ............................... 64,153
----------
Total liabilities ...................................... 724,965
STOCKHOLDERS' EQUITY/MEMBERS' EQUITY
American Rag Compagnie, Inc. ................................. 316,910
American Rag CIE, LLC ........................................ 1,392,902
----------
Total stockholders' equity/members' equity ........... 1,709,812
----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY/MEMBERS' EQUITY ...... $2,434,777
==========
The accompanying notes are an integral part of these financial statements
F-44
AMERICAN RAG
COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NET SALES ................................................... $10,125,563
COST OF SALES ............................................... 5,032,855
-----------
GROSS PROFIT ................................................ 5,092,708
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ................ 4,507,227
-----------
INCOME FROM OPERATIONS ...................................... 585,481
INTEREST EXPENSE ............................................ 17,433
OTHER INCOME (EXPENSE) ...................................... 602,449
-----------
INCOME BEFORE INCOME TAXES .................................. 1,170,497
INCOME TAXES ................................................ 18,066
-----------
NET INCOME .................................................. $ 1,152,431
===========
The accompanying notes are an integral part of these financial statements
F-45
AMERICAN RAG
COMBINED STATEMENT OF STOCKHOLDERS' EQUITY/MEMBERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2005
RESTATED
------------------------------------------------------------------------------------------------------------------
American
Rag CIE,
LLC American Rag Compagnie, Inc.
----------- ---------------------------------------------------- Total
Members' Common Stock (a) Stockholders'
Equity ------------------------- Additional Equity
----------- Shares Paid-in Retained /Members'
Amount Outstanding Amount Capital Earnings Equity
----------- ----------- ----------- ----------- ----------- -----------
Balance at January 1, 2005 . $ 1,216,807 10,870 $ 100,000 $ 2,618 $ 215,914 $ 1,535,339
Distributions .............. (977,958) -- -- -- -- (977,958)
Net income (loss) .......... 1,154,053 -- -- -- (1,622) 1,152,431
----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 2005 $ 1,392,902 10,870 $ 100,000 $ 2,618 $ 214,292 $ 1,709,812
=========== =========== =========== =========== =========== ===========
(a) Common stock, no par value, 500,000 shares authorized and 10,870 shares
issued at January 1, 2005 and December 31, 2005.
The accompanying notes are an integral part of these financial statements
F-46
AMERICAN RAG
COMBINED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income ............................................... $ 1,152,431
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
Depreciation and amortization ..................... 76,241
CHANGES IN ASSETS AND LIABILITIES
(INCREASE) DECREASE IN ASSETS
Accounts receivable ............................... (11,983)
Accounts receivable from members .................. 60,495
Inventory ......................................... (356,472)
Prepaid expenses and other current assets ......... 6,820
Deposits .......................................... (30,813)
INCREASE (DECREASE) IN LIABILITIES
Accounts payable .................................. (96,740)
Accrued expenses .................................. 74,461
Deferred Rent ..................................... 68,385
Unearned revenue .................................. 22,816
-----------
Net cash provided by operating activities ...... 965,641
CASH FLOWS (USED IN) INVESTING ACTIVITIES
Payments to acquire property and equipment ............... (22,111)
-----------
Net cash used in investing activities .......... (22,111)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Note receivable from member .............................. 300,000
Payments on capital lease obligations .................... (6,370)
Payments on notes payable ................................ (149,239)
Distributions to members ................................. (977,958)
-----------
Net cash used in financing activities .......... (833,567)
-----------
NET INCREASE IN CASH .......................................... 109,963
CASH, beginning of year ....................................... 39,173
-----------
CASH, end of year ............................................. $ 149,136
===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid ............................................ $ 17,433
===========
Taxes paid ............................................... $ 13,390
===========
The accompanying notes are an integral part of these financial statements
F-47
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 1 - NATURE OF BUSINESS, OWNERSHIP AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
NATURE OF BUSINESS
BUSINESS ACTIVITY
The Company imports and operates retail men's and women's Avante-Garde
lifestyle clothing, including emerging designers, jeans wear, shoes,
accessories, home furnishings, vintage clothing, CDs and other related
items, in its Los Angeles and San Francisco stores.
PRINCIPLES OF COMBINATION AND BASIS OF PRESENTATION
The combined financial statements include the accounts of American Rag
CIE, LLC and American Rag Compagnie, Inc., collectively referred to as
"American Rag" or the "Company," which are affiliated by virtue of
common ownership. All significant intercompany transactions and related
party balances have been eliminated in combination.
OWNERSHIP
American Rag CIE, LLC is a California limited liability company that
was formed on June 19, 2003, with a term through December 15, 2080. 55%
of American Rag CIE, LLC is owned by American Rag CIE II, Inc. and 45%
owned by Tarrant Apparel Group.
American Rag Compagnie, Inc. was incorporated on July 6, 1984, and is a
C Corporation.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FAIR VALUE
Unless otherwise indicated, the fair values of all reported assets and
liabilities, which represent financial instruments, none of which are
held for trading purposes, approximate carrying values of such amounts.
USE OF ESTIMATES
The preparation of combined financial statements in conformity with
generally accepted accounting principles 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 combined financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
REVENUE RECOGNITION
The Company recognizes revenue upon the sale of retail merchandise, net
of returns and discounts.
COST OF SALES
Cost of sales includes cost related to product costs, and freight in.
F-48
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 1 - NATURE OF BUSINESS OWNERSHIP AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses include expenses related
to salaries, rent, insurance, bank charges, travel and entertainment,
professional fees, depreciation and amortization, and other office
expenses.
UNEARNED REVENUE
The Company records unearned revenue in the accompanying balance sheet
on gift cards sold but not redeemed by customers at the end of the
year.
DEFERRED RENT
The Company records rent expense related to its non-cancelable
operating leases on a straight line basis over the initial term of the
lease. The difference between the average rental amount charged to
expense and amounts payable under the lease is included in deferred
rent in the accompanying balance sheet.
ADVERTISING
The Company expenses advertising costs, consisting primarily of
placement in multiple publications, along with design and printing
costs of sales materials.
Advertising expense for the year ended December 31, 2005 amounted to
$6,792.
CASH AND CASH EQUIVALENTS
The Company maintains its cash balances in high credit quality
financial institutions; balances, at times, may exceed federally
insured limits. The Company has not experienced any losses in such
accounts. For purposes of reporting the statement of cash flows, the
Company considers all cash accounts, which are not subject to
withdrawal restrictions or penalties, and all highly liquid debt
instruments purchased with a maturity of three months or less to be
cash equivalents.
INVENTORY
Inventory is valued at the lower of cost or market on a first-in,
first-out basis. Inventory consists of men's and women's Avante-Garde
lifestyle clothing, including emerging designers, jeans wear, shoes,
accessories, home furnishings, vintage clothing, CDs and other related
items.
ACCOUNTS RECEIVABLE
Accounts receivable are receivables outstanding from commercial buyers.
Accounts receivable are evaluated on an item-by-item basis and are
written-off if deemed uncollectible.
F-49
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 1 - NATURE OF BUSINESS OWNERSHIP AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation and amortization
are provided by the use of straight-line and accelerated methods over
the estimated useful lives of the assets. Leasehold improvements are
amortized using the straight-line method over the lesser of their
estimated useful lives or the term of the lease.
INCOME TAXES
American Rag Compagnie, Inc. is a California C Corporation with a
fiscal year-end of December 31.
The Company recognizes deferred tax assets and liabilities with respect
to the tax consequences attributable to the differences between the
financial statements carrying values and tax bases of assets and
liabilities. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in
which these temporary differences are expected to be recovered or
settled. Further, the effect on deferred tax assets and liabilities of
a change in tax rates is recognized in income in the period that
includes the enactment date. Deferred tax assets and liabilities are
immaterial.
The Company has a California net operating loss carry forward of
$50,034 which expires in 2013.
American Rag CIE, LLC, and its members, elected income tax status as a
limited liability company from its inception. Under this election,
members of the American Rag CIE, LLC are personally liable for federal
and state income taxes. American Rag CIE, LLC is liable for its state
taxes based on revenues.
F-50
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 2 - RESTATED FINANCIAL STATEMENTS
The Company has restated its financial statements as of the year ended
December 31, 2005 and the related notes to the financial statements.
This restatement is to correct errors identified in: (a) the revenue
recognition related to gift cards sold that were recorded as revenue
rather than an unearned revenue. The revenue has been corrected to
reflect recognition of the revenue as the gift cards are used. (b) the
Company had not record its operating lease expense on a straight-line
basis as required under GAAP. The statements have been restated to
correct this accounting treatment.
The following table shows the impact of these restatements on the
financial statements as of and for the year ended December 31, 2005.
PREVIOUSLY
REPORTED RESTATED
DECEMBER 31, DECEMBER 31,
2005 ADJUSTMENTS 2005
----------- ----------- -----------
BALANCE SHEET
Deferred rent - current portion ............ $ -- $ 4,232 $ 4,232
Deferred rent - long term portion .......... -- 64,153 64,153
Unearned revenue ........................... -- 22,816 22,816
TOTAL LIABILITIES ................. 633,764 91,201 724,965
American Rag Compangnie, Inc. .............. 322,981 (6,071) 316,910
American Rag CIE, LLC ...................... 1,478,032 (85,130) 1,392,902
TOTAL STOCKHOLDER'S EQUITY ........ $ 1,801,013 $ (91,201) $ 1,709,812
STATEMENT OF CASH FLOWS
Deferred rent .............................. $ -- $ 68,385 $ 68,385
Unearned revenue ........................... $ -- $ 22,816 $ 22,816
STATEMENT OF INCOME
Net sales .................................. $10,148,379 $ (22,816) $10,125,563
Selling, general and administrative expenses 4,438,842 68,385 4,507,227
Net income ................................. $ 1,243,632 $ (91,201) $ 1,152,431
F-51
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 3 - ACCOUNT RECEIVABLE FROM MEMBER
As of December 31, 2005, there was an outstanding, non-interest bearing
advance to one of the members for $41,000. The advance was to be repaid
before the end of the following year.
NOTE 4 - NOTE RECEIVABLE FROM MEMBER
Effective June 19, 2003, American Rag CIE, LLC received a capital
contribution and a note receivable in the amount of $1,000,000 from a
member who has a 45% ownership in American Rag CIE, LLC. Payments
totaling $925,000 were received through December 31, 2005. At December
31, 2005, the balance on the note receivable was $75,000. The final
payment is due March 31, 2006 with interest at 4% per annum. The note
is secured by the member's interest in American Rag CIE, LLC.
NOTE 5 - INVENTORY
Inventory consists of men's and women's Avante-Garde lifestyle
clothing, including emerging designers, jeans wear, shoes, accessories,
home furnishings, vintage clothing, CDs and other related items.
NOTE 6 - PROPERTY AND EQUIPMENT
A summary is as follows:
Furniture and equipment ...................... $ 912,508
Leasehold improvements ....................... 764,029
Automobiles .................................. 114,359
Hydraulic press and forklift ................. 31,085
----------
1,821,981
Less accumulated depreciation and amortization 1,341,441
----------
$ 480,540
==========
Depreciation and amortization for the year ended December 31, 2005 was
$76,241.
NOTE 7 - DEPOSIT
The Company paid security deposits on leased facilities. At December
31, 2005, the Company had paid $64,848.
F-52
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 8 - NOTE PAYABLE
The Company may borrow up to $250,000 under a revolving line of credit
agreement expiring June 3, 2006. Interest is payable monthly at prime
plus 1%. At December 31, 2005, the Company had borrowings of $88,045.
The Company entered into a note for $300,000 bearing interest at prime
plus 1% and is due on May 8, 2006. Monthly payments of $9,037 include
variable interest, as charged on the outstanding debt, with the
remaining portion of the payment consisting of principal. At December
31, 2005, the Company had borrowings of $26,584.
The notes are secured by all assets of the Company and by personal
guaranties from the majority stockholders.
A summary is as follows:
Line of credit ... $ 88,045
Note payable, bank 26,584
--------
$114,629
========
NOTE 9 - OBLIGATION UNDER CAPITAL LEASE
The Company leases an automobile from an unrelated party under terms of
a capital lease at an annual interest rate of 6.85% payable in
installments through 2009. The lease is secured by the related
automobile costing $40,122 with accumulated depreciation of $15,625 at
December 31, 2005. Interest expense on the capital lease amounted to
$2,176 for the year ended December 31, 2005.
The following is a schedule by years of future minimum principal
payments required under the capital lease:
Year ending December 31,
2006 $ 9,027
2007 9,027
2008 9,027
2009 1,699
--------
Total minimum lease payments 28,780
Less amounts representing interest 1,536
--------
Present value of minimum lease payments 27,244
Less current maturities 7,782
--------
$ 19,462
========
F-53
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 10 - RELATED PARTY
The Company rents office space from HKW Partners on a month to month
basis at a rate of $2,500. HKW Partners is beneficially owned by one of
the members.
NOTE 11 - LICENSING AGREEMENT
On April 1, 2003, the Company entered into an agreement to license the
use of the American Rag trademark to Tarrant Apparel Group's related
company, allowing the licensee to manufacture and sell apparel and
accessories under this trademark. The term of the license is from April
1, 2003 to December 31, 2013, and the licensee may elect to renew for
three consecutive ten-year periods on the same terms and conditions.
The license calls for the licensee to make royalty payments to the
Company of 2.05% of net sales of all licensee products in the United
States, Canada, Mexico, and Bermuda, and 4% of net sales of all
licensed products worldwide, except Japan, with guaranteed minimum
annual royalty payments as follows:
GUARANTEED
YEAR MINIMUM ROYALTY
---- ---------------
2006 $ 661,250
2007 760,438
2008 874,504
2009 1,005,680
2010 1,156,532
2011 1,330,012
2012 1,529,514
2013 1,750,000
---------------
Total $ 9,067,930
===============
Annually thereafter $ 1,750,000
===============
Royalty income amounted to the minimum guaranteed royalty payment of
$575,000 for the year ended December 31, 2005.
F-54
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTE 12 - COMMITMENTS
The Company conducts its operations in leased facilities under
operating leases expiring at various dates. Certain of these leases
contain base rent escalation as well as renewal provisions. When a
lease requires fixed escalation of the minimum lease payments, rental
expense is recognized on a straight line basis over the initial term of
the lease, and the difference between the average rental amount charged
to expense and amounts payable under the lease is included in deferred
amount. The following is a schedule by years based on cash payments on
future minimum rental payments required under the operating leases that
have non-cancelable lease terms in excess of one year as of December
31, 2005:
OPERATING SUBLEASE
LEASES INCOME TOTAL
----------- ---------- -----------
Year ending December 31,
2006 $ 726,625 $ 54,500 $ 672,125
2007 737,950 - 737,950
2008 658,440 - 658,440
2009 493,016 - 493,016
2010 376,499 - 376,499
After 2010 2,164,871 - 2,164,871
----------- ---------- -----------
$ 5,157,401 $ 54,500 $ 5,102,901
=========== ========== ===========
Rent is adjusted annually based on increases in the Consumer Price
Index, if any, and payments of certain additional expenses including
utilities, property taxes and other operating expenses is required.
Certain leases provide for renewal options.
Rent expense charged to operations amounted to $842,398 for the year
ended December 31, 2005. As of December 31, 2005, deferred rent of
$68,385 was recorded in the Company's combined balance sheet.
Sublease rental income amounted to $101,012 for the year ended December
31, 2005.
The Company also rents office space from HKW Partners on a month to
month basis at a rate of $2,500. HKW Partners is beneficially owned by
one of the members.
F-55
AMERICAN RAG
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 2005
RESTATED
--------------------------------------------------------------------------------
NOTES 13 - SUBSEQUENT EVENTS
NEW STORE LOCATION
In September 2006, the Company opened a new store in the Fashion Island
shopping center in Newport Beach, California.
LEASE AMENDMENT
In June 2007, the Company amended the lease for its Fashion Island
location. The Company will pay rent at the rate of 12% of sales
effective March 1, 2007. The difference between that amount and the
prior rental rate will be deferred until the store achieves annualized
sales that exceed $5,500,000.
BANK LINE OF CREDIT / NOTES PAYABLE - CALIFORNIA UNITED BANK
In June 2006, the Company negotiated a new bank line and note facility.
The terms are summarized as follows:
Line of credit facility of $500,000, secured by substantially all of
the Company's assets, payable in full on maturity date April 15, 2007
at 8% per annum;
Note payable facility of $500,000, secured by substantially all of the
Company's assets, payable in equal monthly installments of $13,889 plus
interest of 8.50% through maturity of December 15, 2009;
Note payable facility of $500,000, secured by substantially all of the
Company's assets, payable in equal monthly installments of $13,889,
commencing July 15, 2007, plus interest of 8.50% through maturity at
June 15, 2010.
The Company is in the process of renewing the line of credit facility.
F-56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TARRANT APPAREL GROUP
By: /S/ GERARD GUEZ
---------------------------------------
Gerard Guez
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
Chief Executive Officer October 10, 2007
/S/ GERARD GUEZ and Chairman of the Board
-------------------------------- of Directors (Principal
Gerard Buez Executive Officer)
/S/ DAVID BURKE Chief Financial Officer October 10, 2007
-------------------------------- (Principal Financial
David Burke and Accounting Officer)
* Vice Chairman of the Board October 10, 2007
-------------------------------- of Directors
Todd Kay
* Director October 10, 2007
--------------------------------
Milton Koffman
* Director October 10, 2007
--------------------------------
Stephane Farouze
* Director October 10, 2007
--------------------------------
Mitchell Simbal
* Director October 10, 2007
--------------------------------
Joseph Mizrachi
* Director October 10, 2007
--------------------------------
Simon Mani
* By: /S/ GERARD GUEZ
--------------------------------
Gerard Guez, As Attorney-In-Fact
S-1