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As filed with the Securities and Exchange Commission on March 7, 1997.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____________ to ______________
Commission file number: 0-26430
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: (213) 780-8250
Securities registered pursuant to Section 12(b) of the Act: Common Stock
Securities registered pursuant to Section 12(g) of the Act: None
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]
As of February 26, 1997, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was approximately $36,250,399, based upon the
closing price of the Common Stock on that date.
Number of shares of Common Stock of the registrant outstanding as of February
26, 1997: 6,552,276.
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TABLE OF CONTENTS
PAGE
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Item 1. BUSINESS.................................................................................................3
General ................................................................................................3
Business Strategy........................................................................................3
Products ................................................................................................4
Customers................................................................................................4
Design, Merchandising and Sales..........................................................................5
Sourcing and Distribution................................................................................6
Backlog ................................................................................................8
Management Fees..........................................................................................8
Import Restrictions......................................................................................8
Competition..............................................................................................9
Employees...............................................................................................10
Item 2. PROPERTIES..............................................................................................10
Item 3. LEGAL PROCEEDINGS.......................................................................................10
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.....................................................10
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.....................................................................................11
NASDAQ Listing..........................................................................................11
Dividend Policy.........................................................................................11
Item 6. SELECTED FINANCIAL DATA.................................................................................12
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...............................................................................13
General ...............................................................................................13
Factors That May Affect Future Results..................................................................13
Results of Operations ..................................................................................15
Quarterly Results of Operations.........................................................................18
Liquidity and Capital Resources.........................................................................18
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................................................19
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.....................................................................20
Item 10. DIRECTORS AND EXECUTIVE OFFICERS........................................................................20
Item 11. EXECUTIVE COMPENSATION..................................................................................20
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..............................................................................................20
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..........................................................20
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.........................................21
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PART I
ITEM 1. BUSINESS
GENERAL
Tarrant Apparel Group (the "Company"), a leading provider of private
label casual apparel, primarily serves both specialty retail and mass
merchandise store chains by designing, merchandising, contracting for the
manufacture of and selling casual, moderately-priced apparel, primarily for
women, under private label. Since 1988, when the Company began designing and
supplying private label denim jeans to a single specialty retail store chain, it
has successfully expanded its product lines and built a private label business
which during 1996 served over 20 customers. The Company's five major customers
are Lerner New York, Limited Stores, Target Stores, Lane Bryant and Express,
which together represented approximately 91.4% of the Company's net sales in
fiscal 1996. In addition, in fiscal 1996, the Company's net sales to divisions
of The Limited, Inc. ("The Limited"), including Lerner New York, Limited Stores,
Lane Bryant and Express aggregated approximately 67.1% of net sales. The
Company's current products are manufactured in a variety of woven and knit
fabrications and include jeanswear, casual pants, t-shirts, shorts, blouses,
shirts and other tops, dresses, leggings and jackets. Prior to its initial
public offering in July 1995, the Company conducted its U.S. business under the
name "Fashion Resource" and the Company has continued using that name in
connection with its domestic operations.
Over the past five years, the Company has achieved a compound annual
growth rate in net sales of approximately 16.6% from $124.4 million in 1992 to
$229.9 million in 1996. Gross profit margins during this period have
consistently exceeded 15% and operating margins have shown steady improvement,
particularly in the last three years. Pre-tax income has risen approximately
39.0% on a compound annual basis, from $3.9 million in 1992 to $14.6 million in
1996.
BUSINESS STRATEGY
The Company believes that there has been a trend over the last several
years toward consumer acceptance of casual, moderately-priced, private label
apparel. For example, more than half of the top twenty-five Fortune 500
companies have instituted "casual Fridays," and other companies are following
this trend. The Company also believes that the number of people who work at home
is increasing substantially and that outside of the workplace, people's social
activities are focusing more on family life and a more casual lifestyle. In
particular, the Company believes that baby boomers are now rearing children and
engaging in more recreational activities or are spending evenings at home. The
Company also believes that in recent years apparel consumers have become more
cost-conscious and are bypassing premium brand name or designer products in
favor of quality products at lower prices. In partial response, apparel
retailers have focused on "private label" apparel bearing the retailer's own
name or a proprietary label. Private label apparel generally provides higher
margins for the retailer than brand name or designer products, as a result of
the lower wholesale costs of such apparel. Suppliers are able to sell these
garments at lower wholesale prices due to the significant economies which they
realize, including lower advertising and promotional costs, lack of brand name
license fees and royalties and absence of "markdowns" and other risks and
expenses inherent in the brand name apparel industry.
Management believes that the Company has taken advantage of these
trends by developing and refining the following strategies:
Customer-Focused Teams and Design and Test-Marketing
Capabilities. The Company serves its major customers through integrated
teams of designers, merchandisers and support personnel, some of whom
serve on more than one team. The Company believes that this team
approach fosters strong relationships with each major customer's staff
and enables its employees to develop an in-depth understanding of the
fashion, fabric and pricing strategies of the customer. The Company
also assists many of its customers with the market testing of selected
designs through its ability to source small quantities of selected
items for production within a short time frame. The Company believes
that its design, sample-making and test run capabilities have enhanced
the likelihood (but does not ensure) that it will receive a significant
portion of bulk orders for merchandise designed independently by the
Company or in
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collaboration with its customers. Management also believes that its
design capability is a major competitive advantage.
International Sourcing Network. The Company and its senior
executives have developed long-standing relationships with a network of
contract manufacturers and suppliers, who are used by the Company to
fulfill most of the Company's manufacturing needs. The Company is
aggressively expanding this network both within the countries where it
currently sources goods and to other countries including those in which
it has not previously sourced goods. The Company believes that this
network has sufficient production capacity and flexibility to enable
the Company to accept large orders, work on short production schedules
and produce a broad range of garments at a variety of possible prices
depending on the lead times required by the customer. Certain of these
manufacturers also have the capability to produce small quantity test
runs for the market test programs of the Company's customers.
Product Capabilities That Respond to Changing Fashion Needs.
The Company believes that it has established a reputation with its
customers as a "fashion resource" - a producer that is capable of
designing and producing a broad range of quality merchandise and
reacting rapidly to changing trends in fashion, fabrics and styles. In
management's view, this reputation has afforded the Company a
competitive advantage, because customers have been willing to place
orders with the Company for an expanding range of products not
previously sourced by the Company.
The Company believes that by employing these strategies, it can attract
new customers and increase sales to existing customers.
PRODUCTS
In 1988, the Company received its first orders for private label
women's denim jeans from Express, a division of The Limited. While women's jeans
have historically been, and continue to be, the Company's principal product, in
recent years the Company has expanded its sales of moderately-priced, women's
apparel to include casual, denim and non-denim woven tops and bottoms. The
Company's product lines currently include jeanswear, casual pants, t-shirts,
shorts, blouses, shirts and other tops, dresses, leggings and jackets. These
products are manufactured in petite, standard and large sizes and are sold at a
variety of wholesale prices generally ranging from less than $6.00 to over
$25.00 per garment.
Over the past two years, management's best estimate is that
approximately forty percent of net sales were derived from the sale of pants and
jeans, approximately fifteen percent of net sales were derived from the sale of
shorts and shirts accounted for approximately one-eighth of net sales. The
balance of net sales consisted of sales of dresses, jackets, leggings and other
products. These estimates do not include any information relating to fabric
sales, net sales of Tarrant Company Limited, a wholly-owned subsidiary ("Tarrant
HK"), or net sales to non-combined affiliates for which, in each case, the
Company does not have data segregated by apparel category.
The Company, in the ordinary course of its business, regularly
evaluates new markets and potential acquisitions and believes that numerous
opportunities exist due, in part, to the adverse effect on the earnings of many
apparel companies of the recent decline in retail sales generally. Such
opportunities could include transactions involving acquisitions or brand
affiliations. Although the Company currently is evaluating several brand
affiliations, there are no existing commitments with respect to any acquisition
or affiliation.
CUSTOMERS
For the year ended December 31, 1996, affiliated stores owned by The
Limited, including Lerner New York, Limited Stores and Lane Bryant, accounted
for 67.1% of the Company's net sales and Target Stores accounted for 24.3% of
the Company's net sales. No other customer accounted for more than 10% of the
Company's net sales in 1996. In the same period, the predominant portion of the
Company's sales were of private label apparel. The Company currently serves over
20 customers. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - General."
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The Company does not have long-term contracts with any of its customers
and, therefore, there can be no assurance that any customer will continue to
place orders with the Company of the same magnitude as it has in the past, or at
all. In addition, the apparel industry historically has been subject to
substantial cyclical variation, with consumer spending for purchases of apparel
and related goods tending to decline during recessionary periods. Various
retailers, including divisions of The Limited, have experienced sluggish sales
and declines in revenue and profits in recent periods. To the extent that these
financial difficulties continue or worsen, there can be no assurance that the
Company's financial condition and results of operations would not be adversely
affected. As a result of the importance of The Limited to the operations of the
Company, The Limited and its divisions have the ability to exert significant
influence over the Company's business decisions.
DESIGN, MERCHANDISING AND SALES
While many private label producers only arrange for the bulk production
of styles specified by their customers, the Company not only designs garments,
but also assists some of its customers in market testing new designs. The
Company believes that its design, sample-production and test-run capabilities
give it a competitive advantage in obtaining bulk orders from its customers. The
Company also often receives bulk orders for garments it has not designed because
many of its customers allocate bulk orders among more than one producer.
The Company has developed integrated teams of design, merchandising and
support personnel, some of whom serve on more than one team, that focus on
designing and producing merchandise that reflects the style and image of their
customers. These teams were initially created in 1992 to serve the specific
needs of each of Limited Stores and Lerner New York. Currently, in addition to
Limited Stores and Lerner New York, teams work with each of Target Stores,
Express and Lane Bryant.
Each team is responsible for all aspects of its customer's needs,
including designing products, developing product samples and test items,
obtaining orders, coordinating fabric choices and procurement, monitoring
production and delivering finished products. In particular, the team seeks to
identify prevailing fashion trends that meet its customer's retail strategies
and design garments incorporating those trends. The team also works with the
buyers of its customer to revise designs as necessary to better reflect the
style and image that the customer wishes to project to consumers. During the
production process, the team is responsible for informing the customer about the
progress of the order, including any difficulties that might affect the
timetable for delivery. In this way, the Company and its customer can make
appropriate arrangements regarding any delay or other change in the order. The
Company believes that this team approach enables its employees to develop an
understanding of the customer's distinctive styles and production requirements
in order to respond effectively to the customer's needs.
As part of the Company's merchandising strategy, the Company produces,
at its own expense, one or more samples of garments embodying new designs. The
Company produces samples at its facilities in Guangdong Province, China, Hong
Kong and Los Angeles. The Chinese facility, which has 130 employees, currently
furnishes a significant portion of the Company's sample requirements.
From time to time and at scheduled seasonal meetings, the Company
presents its samples to the customer's buyers, who determine which, if any, of
those samples will be produced on a test run or a bulk scale. Samples are often
presented in coordinated groupings or as part of a product line. Some customers,
particularly specialty retail stores such as divisions of The Limited, may
require that a product be "tested" before placing a bulk order. Testing involves
the production of as few as several hundred copies of a given sample in
different size, fabric and color combinations. The customer pays for these test
items, which are placed in selected stores to gauge consumer response. The
production of test items enables the Company's customers to identify garments
that may appeal to consumers and also provides the Company with important
information regarding the cost and feasibility of the bulk production of the
tested garment. If the test is determined to be successful, the Company
generally receives a significant percentage of the customer's total bulk order
of the tested item. In addition, as is typical in the private label business,
the Company receives bulk production orders to produce merchandise designed by
its competitors or other designers, since most customers allocate bulk orders
among a number of suppliers.
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SOURCING AND DISTRIBUTION
When bidding for or filling an order, the Company's international
sourcing network enables it to choose from among a number of suppliers and
manufacturers based on the customer's price requirements, product specifications
and delivery schedules. The Company maintains its primary sourcing office in
Hong Kong. The Company's senior management has historically had and continues to
have strong relationships with suppliers and manufacturers located in Hong Kong
and China. In recent years, the Company has expanded its network to include
suppliers and manufacturers located in a number of additional countries. See "-
International Sourcing." In 1996, approximately 15% of the Company's
merchandise, on the basis of the free on board cost at the supplier's plant
("FOB Basis"), was manufactured in the U.S., and approximately 85% was
manufactured in Asia and other parts of the world.
The use of contractors and the resulting lack of direct control could
subject the Company to difficulty in obtaining timely delivery of products of
acceptable quality. In addition, as is customary in the industry, the Company
does not have any long-term contracts with its fabric suppliers or product
manufacturers. The loss of any of its major contractors, particularly its
product manufacturers, could have a material adverse effect on the Company's
financial condition and results of operations until alternative supplier
arrangements are secured.
The Company believes that it has the ability, through its production
network, to operate on production schedules with lead times as short as 30 days.
Typically, the Company's specialty retail customers attempt to respond quickly
to changing fashion themes and are increasingly less willing to assume the risk
that goods ordered on long lead times will be out of fashion when delivered.
These retailers, including divisions of The Limited, frequently require
production schedules with lead times ranging from 30 to 120 days. Although mass
merchandisers, such as Target, are beginning to operate on shorter lead times,
they are occasionally able to estimate their needs as much as six months to one
year in advance for "program" business - basic products that do not change in
style significantly from season to season. The Company's ability to operate on
production schedules with a wide range of lead times helps it to meet its
customers' varying needs.
By allocating an order among different manufacturers, the Company can
fill the high-volume orders of its customers, while meeting their delivery
requirements. Upon receiving an order, the Company determines which of its
suppliers and manufacturers can best fill the order and meet the customer's
price, quality and delivery requirements. The Company considers, among other
things, the price charged by each manufacturer and the manufacturer's available
production capacity to complete the order, as well as the availability of quota
for the product from various countries and the manufacturer's ability to produce
goods on a timely basis subject to the customer's quality specifications. The
Company's personnel also consider the transportation lead times required to
deliver an order from a given manufacturer to the customer. In addition, some
customers prefer not to carry excess inventory and therefore require that the
Company stagger the delivery of products over several weeks.
The Company often purchases fabric to meet the specifications of the
customer's order. The Company has the fabric shipped directly to the factory and
invoices the factory for the fabric. Generally the factories pay the Company for
the fabric with offsets against the price of the finished goods. For its
longstanding program business, the Company may purchase fabric in advance of
receiving the order, but in accordance with the customer's specifications. The
Company's primary sources of working capital are cash flow from operations and
borrowings under the Company's bank credit agreements and factoring agreement.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
International Sourcing
The Company conducts and monitors the majority of its international
sourcing operations from its offices in Hong Kong. These offices comprise
approximately 36,250 square feet of leased office space. At January 31, 1997,
the Company had approximately 170 full-time employees in Hong Kong, many of whom
have extensive knowledge about and experience with sourcing and production in
Hong Kong and China, including purchasing, manufacturing and quality control.
Several times each year, members of the Company's senior management, including
those resident in Hong Kong and China, visit and inspect the facilities and
operations of the Company's international suppliers and manufacturers.
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The Company contracts with suppliers of raw materials and manufacturers
located primarily in Hong Kong, as well as in China, the U.S., Macau, Thailand
and the UAE among approximately twenty countries currently used by the Company
for sourcing. In 1996, the Company imported approximately 80% of its products
(on an FOB Basis) utilizing quota from Hong Kong and China, and approximately 5%
of its products (on an FOB Basis) were imported from other countries.
Foreign manufacturing is subject to a number of risk factors,
including, among other things, transportation delays and interruptions,
political instability, expropriation, currency fluctuations and the imposition
of tariffs, import and export controls and other non-tariff barriers (including
changes in the allocation of quotas). In addition to these risk factors, the
Company faces additional risks arising from the uncertainty regarding the future
status of Hong Kong after resumption of Chinese sovereignty on July 1, 1997, the
continuation of favorable trade relations between the U.S. and China (in
particular the continuation of China's Most Favored Nation ("MFN") status for
tariff purposes), and the continuation of economic reform programs in China
which encourage private economic activity. Each of these factors could have a
material adverse effect on the Company.
While the Company is in the process of establishing business
relationships with manufacturers and suppliers located in countries other than
Hong Kong, the Company still contracts with manufacturers and suppliers located
primarily in Hong Kong, and currently expects that it will continue to do so.
Any significant disruption in the Company's operations or its relationships with
its manufacturers and suppliers located in Hong Kong could have a material
adverse effect on the Company.
Domestic Sourcing
The Company conducts its domestic sourcing from its Los Angeles
facility. This facility comprises approximately 100,000 square feet of leased
office and warehouse space. In general, the Company intends to utilize domestic
sourcing to deliver products ordered on a short delivery schedule, when a
customer desires to sell products with a "Made in the USA" label or when it
otherwise determines that domestic manufacturing is appropriate.
The Company also manufactures samples at its Los Angeles facility.
Samples are produced at the Company's expense and embody a particular design
idea that can be presented to a customer as a means of soliciting an order. See
"Business - Design, Merchandising and Sales." Because of its local sample-making
capacity, the Company is capable of responding quickly to customers' requests
for revisions to samples. As a result, management believes that this capability
gives the Company a competitive advantage.
The Sourcing Process
As is customary in the industry, the Company does not have any
long-term contracts with its manufacturers. The Company typically contracts (on
the basis of a written purchase order) with one to three manufacturers to
produce a bulk order. The Company often arranges on behalf of these
manufacturers for the purchase of fabric from one supplier for the entire order,
in which case the Company deducts the cost of the fabric when paying the
manufacturer's invoice. By procuring fabric for an entire order from one source,
the Company believes that production costs per garment are reduced and customer
specifications as to fabric quality and color can be controlled. In 1996, an
aggregate of approximately $32.7 million (on an FOB Basis) or 46.3% of fabric
for the Company's imported products was purchased from three suppliers located
in Hong Kong with weaving mills in China, and approximately $60.4 million (on an
FOB Basis) or approximately 47.5% of the Company's imported products were
purchased from five manufacturers with facilities in Hong Kong.
During the manufacturing process, the Company's quality control
personnel visit each factory to inspect garments when the fabric is cut, as it
is being sewn and as the garment is being finished. Daily information on the
status of each order is transmitted from the various manufacturing facilities to
the Company's offices in Hong Kong and Los Angeles. The Company, in turn, keeps
its customers apprised, often through daily telephone calls and frequent written
reports. These calls and reports include candid assessments of the progress of a
customer's order, including a discussion of the difficulties, if any, that have
been encountered and the Company's plans to rectify them.
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BACKLOG
At February 15, 1997, the Company had unfilled customer orders of
approximately $81.6 million as compared to approximately $49.4 million as of
February 15, 1996. The Company believes that all of its backlog of orders as of
February 15, 1997 will be filled within the current fiscal year. Backlog is
based on the Company's estimates derived from internal management reports. The
amount of unfilled orders at a particular time is affected by a number of
factors, including the scheduling of manufacture and shipping of the product
which, in some instances, depends on the customer's demands. Accordingly, a
comparison of unfilled orders from period to period is not necessarily
meaningful and may not be indicative of eventual actual shipments. The Company's
experience has been that the cancellations, rejections or returns of orders have
not materially reduced the amount of sales realized from its backlog.
MANAGEMENT FEES
In 1992, the Company entered into a business arrangement with F.I.S.,
Inc. ("FIS"), a corporation which sourced and sold garments under the B.U.M.
Equipment label until it ceased operations in the second quarter of 1996. Under
this arrangement, the Company acted as a sourcing agent for and sold finished
garments to FIS. The price charged for these garments equaled the cost of the
goods (on an FOB Basis, including the cost of import quota) plus a 10%
commission. In addition, the Company provided FIS with certain management,
administrative and operations services, including, without limitation,
designing, merchandising, production and accounting services. In consideration
of the foregoing services, FIS paid the Company a fee based upon the net sales
of FIS.
IMPORT RESTRICTIONS
Quotas. The Company imported approximately 85% of its products (on an
FOB Basis) in 1996. Almost all of the products imported were manufactured in a
foreign jurisdiction (e.g., Hong Kong and China) with which the U.S. has entered
into a bilateral textile agreement that, among other restrictions, imposes
specific quantitative restraints, or "quotas," on the amounts of various
categories of textiles and apparel that can be imported into the U.S. from that
foreign jurisdiction during a particular quota year. These bilateral textile
agreements also include provisions which allow the U.S. to impose quotas on
categories of textiles and apparel not previously under quota or to "charge"
(i.e., impose deductions upon) the quotas for origin-related violations.
Accordingly, the Company's operations are subject to the restrictions imposed by
these bilateral agreements.
Until recently, the Arrangement Regarding International Trade in
Textiles, known as the Multifiber Arrangement ("MFA"), provided the
international framework for the global regulation of the textile and apparel
trade. Pursuant to the MFA, the U.S. entered into these bilateral textile
agreements for the purpose of imposing quotas on the imports of textiles and
apparel. However, under "The Final Act Embodying the Results of the Uruguay
Round of Multilateral Trade Negotiations" (the "Uruguay Round Agreement") which
was agreed to on a preliminary basis in December 1993 by 117 member nations of
the General Agreement on Tariffs and Trade ("GATT"), and enacted into U.S.
domestic law in December 1994 under the Uruguay Round Agreements Act (the
"URAA"), the MFA has been replaced by the World Trade Organization Agreement on
Textiles and Clothing (the "ATC"). Under the ATC, quotas implemented under the
MFA on the importation of textiles and apparel from countries that are members
of the World Trade Organization (the "WTO," which is the successor organization
to GATT under the Uruguay Round Agreement) will be phased out over a ten-year
period that commenced on January 1, 1995 (with the U.S. phasing out quotas on
most of the sensitive categories at the end of this period). However, a member
country may, under the Uruguay Round Agreement on Safeguards, re-impose quotas
on textiles and apparel under certain specified conditions.
China is a signatory to the MFA, but was not a member of GATT and,
therefore, was not a party to the Uruguay Round Agreement. China has not been
admitted as a member of the WTO, although it is in the process of trying to
negotiate its accession to the WTO at this time. Because China is not a member
of the WTO, its exports of textiles and apparel to the U.S. are not covered by
the ATC. Accordingly, the U.S. continues to control imports of textiles and
apparel from China under the existing bilateral agreement between the U.S. and
China. On January 17, 1994, the U.S. and China signed a three-year agreement
which set the 1994 textile and apparel quotas from China at their 1993 levels
and increased the quota by 1.0% for each of 1995 and 1996. A new agreement, to
replace the expiring 1994 Agreement, was signed in February, 1997. It will
become effective January 1, 1998 for a four year period and will continue to
permit some growth in most quota categories.
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In the event that China eventually becomes a member of the WTO, it will
be afforded the rights granted other members under the ATC, including the
phase-out of textile and apparel quotas over the ten-year period that commenced
on January 1, 1995. However, there can be no assurance that China will become a
member of the WTO, particularly since the U.S. has expressed dissatisfaction
with China's progress in opening its domestic market in a number of areas.
In 1996, products imported using Hong Kong quota accounted for
approximately 79.4% of the Company's imported net sales (on an FOB Basis). Under
the U.S. and Hong Kong rules of origin currently in effect, the Company conducts
certain, non-origin conferring manufacturing operations in China for a
significant portion of the products it imports using Hong Kong quota. As part of
the URAA, the U.S. implemented new rules of origin which become effective on
July 1, 1996. These new rules of origin had little actual impact on the country
of origin of the merchandise imported by the Company. The Company is
nevertheless attempting to diversify its sourcing network to reduce reliance on
Hong Kong sources, in part to minimize the potential effects of this change in
the rule of origin. It is also taking steps to obtain additional quota from
China in the event that these new rules of origin result in changing the origin
of the products presently subject to Hong Kong quota.
Duties and Tariffs. Merchandise imported by the Company into the U.S.
is subject to rates of duty established by U.S. statute. In general, these rates
vary, depending on the type of product, from 3.0% to 34.6% of the appraised
value of the product. In addition to duties, in the ordinary course of its
business, the Company, from time to time, may become subject to claims by the
U.S. Customs Service for penalties, liquidated damage claims and other charges
relating to import activities. Similarly, from time to time, the Company may be
entitled to refunds from the U.S. Customs Service due to the overpayment of
duties.
Products imported from China into the U.S. currently receive the same
preferential tariff treatment accorded goods from countries granted MFN status.
China's MFN status, which is granted on an annual basis, expires in July 1997.
China's MFN status has been a contentious political issue for several years
because of concerns regarding labor and human rights practices, weapons
proliferation, trade policies and failure to protect U.S. intellectual property
rights. Previous legislation attaching conditions to China's MFN status has been
passed by both houses of the Congress, but did not survive presidential vetoes.
There can be no assurance that the U.S. will not revoke China's MFN status
entirely or place greater conditions or restrictions on this status, but absent
a major deterioration in U.S.- China relations, it is anticipated that China
will maintain its MFN status. If China's MFN status were to terminate, and
Chinese origin products had to enter the U.S. without the benefit of MFN status,
such goods will be subject to significantly higher duties than at present. Any
such increased duties would increase the cost or reduce the supply of the
Company's goods imported from China. In 1996, products imported using China
quota accounted for approximately 11.5% of the Company's imported net sales (on
an FOB Basis). The Company is taking steps to diversify its sourcing network to
reduce its dependence on Chinese-origin products.
The Company's continued ability to source products from foreign
jurisdictions may be adversely affected by additional bilateral and multilateral
agreements, unilateral trade restrictions, changes in trade policy, significant
decreases in import quotas, embargoes, the disruption of trade from exporting
countries as a result of political instability or the imposition of additional
duties, taxes and other charges or restrictions on imports.
COMPETITION
There is intense competition in the sectors of the apparel industry in
which the Company participates. The Company competes with many other
manufacturers, many of which are larger and have greater resources than the
Company. The Company also faces competition from its own customers and potential
customers, many of which have established, or may establish, their own internal
product development and sourcing capabilities. For example, The Limited's
wholly-owned subsidiary, Mast Industries, Inc., competes with the Company and
other private label apparel suppliers for orders from divisions of The Limited.
The Company believes that it competes favorably on the basis of design and
sample capabilities, quality and value of its products, price, the production
flexibility that it enjoys as a result of its sourcing network and the long-term
customer relationships it has developed.
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EMPLOYEES
At January 31, 1997, the Company had approximately 110 full-time
employees in Los Angeles, 170 full-time employees in Hong Kong and 130 in China.
None of the Company's employees is subject to a collective bargaining agreement.
The Company considers its relations with its employees to be good.
ITEM 2. PROPERTIES
The Company currently conducts its operations from three facilities,
all of which are leased. The Company's executive offices and warehouse
facilities are located at 3151 East Washington Boulevard, Los Angeles,
California 90023. The Company leases this facility for an annual rent of
$567,000 from a California corporation which is owned by Gerard Guez and Todd
Kay, the Company's Chief Executive Officer and President (the "Original
Shareholders"). The base rent is subject to increase on January 1, 1998 and
every two years thereafter by an amount equal to at least five percent but no
greater than ten percent. The lease for this facility, under which the Company
is responsible for the payment of taxes, utilities and insurance, terminates in
December 2003 subject to a renewal option for five additional years. The Company
also leases approximately 36,250 square feet of warehouse and office space in
Hong Kong for an annual rent of $674,000 from a Hong Kong corporation that is
owned by the Original Shareholders. The base rent is subject to increase every
two years in accordance with market rates. The lease for this facility, under
which the Company is responsible for the payment of taxes, utilities and
insurance, expires in June 2004. See Note 9 of Notes to Consolidated Financial
Statements for additional information with respect to these leases.
The Company believes that its other existing facilities are well
maintained, in good operating condition and adequate to meet its current and
foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any pending or threatened legal
proceedings which the Company believes could reasonably be expected to have a
material adverse effect on the it's financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders
during the fourth quarter of fiscal 1996.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
NASDAQ LISTING
The Company's Common Stock began trading on The Nasdaq Stock Market's
National Market ("NASDAQ") under the symbol "TAGS" on July 24, 1995.
The following table sets forth, for the periods indicated, the range of
high and low sale prices for the Company's Common Stock as reported by NASDAQ.
1996 LOW HIGH
---- ----- ------
First Quarter ..................... $5.75 $ 8.25
Second Quarter .................... $7.50 $10.62
Third Quarter ..................... $7.25 $10.25
Fourth Quarter .................... $9.12 $14.75
1997 LOW HIGH
---- ------ ------
First Quarter (through February 26) $13.50 $18.25
On February 26, 1997, the last reported sale price of the Company's
Common Stock as reported on NASDAQ was $17.75. Shareholders are urged to obtain
current market quotations for the Common Stock. As of February 26, 1997, there
were approximately 16 shareholders of record of the Company.
DIVIDEND POLICY
The Company intends to retain future earnings for use in its business
and therefore does not anticipate declaring or paying any cash dividends in the
foreseeable future. The declaration and payment of any cash dividends in the
future will depend upon the Company's earnings, financial condition, capital
needs and other factors deemed relevant by the Board of Directors.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is qualified in its
entirety by, and should be read in conjunction with, the other information and
financial statements, including the notes thereto, appearing elsewhere herein.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1992 1993 1994 1995 1996
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Net sales ................................................ $ 124,448 $ 147,017 $ 177,108 $ 205,174 $ 229,861
Cost of sales ............................................ 105,648 121,971 148,740 172,959 192,288
--------- --------- --------- --------- ---------
Gross profit ........................................ 18,800 25,046 28,368 32,215 37,573
Selling and distribution expenses ........................ 3,128 5,360 6,118 6,761 7,124
General and administrative expenses ...................... 8,088 11,636 12,359 13,493 13,990
Officers' bonus(1) ....................................... 2,061 3,000 -- -- --
LDA Option(2) ............................................ -- -- -- 1,734 --
--------- --------- --------- --------- ---------
Income from operations .............................. 5,523 5,050 9,891 10,227 16,459
Interest expense ......................................... (2,328) (3,410) (3,696) (4,003) (1,865)
Interest income .......................................... 580 210 78 773 337
Other income / (expense)(3) .............................. 112 2,359 1,367 1,274 (302)
--------- --------- --------- --------- ---------
Income before provision for income taxes and
cumulative effect of accounting change............ 3,887 4,209 7,640 8,271 14,629
Provision for income taxes(4) ............................ (474) (478) (597) (961) (4,627)
--------- --------- --------- --------- ---------
Income before cumulative effect of accounting change 3,413 3,731 7,043 7,310 10,002
Cumulative effect of accounting change(5) ................ -- -- 94 -- --
--------- --------- --------- --------- ---------
Net income .......................................... $ 3,413 $ 3,731 $ 7,137 $ 7,310 $ 10,002
========= ========= ========= ========= =========
PRO FORMA DATA(6):
Pro forma net income...................................... $ 2,845 $ 3,033 $ 5,358 $ 7,408(7) $ 10,002
Pro forma net income per common share .................... $ 0.63 $ 0.67 $ 1.19(7) $ 1.38(7) $ 1.53
Pro forma weighted average shares outstanding(8) ......... 4,500 4,500 4,500(9) 5,353 6,548
AS OF DECEMBER 31,
----------------------------------------------------------------
1992 1993 1994 1995 1996
--------- --------- --------- --------- ---------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital.......................................... $ 3,206 $ 3,242 $ 2,594 $ 23,003 $ 34,029
Total assets............................................. 52,109 44,376 44,017 57,840 63,420
Bank borrowings and long-term obligations................ 29,297 20,371 19,313 15,940 6,810
Shareholders' equity..................................... 7,093 7,163 7,848 26,416 36,953
- ------------------------
(1) Consists of bonuses paid to enable the Original Shareholders to pay
their income taxes, including personal income taxes resulting from the
Company's S Corporation status.
(2) On the effective date of its initial public offering, the Company
incurred a non-recurring charge to earnings related to a grant by the
Original Shareholders to Limited Direct Associates, L.P., an affiliate
of The Limited, Inc., of a four-year option (the "LDA Option") to
purchase an aggregate of 649,999 shares, or 10% of the Company's Common
Stock, at an exercise price equal to $7.20 per share.
(3) Major components of Other income/(expense) (as presented above) include
fees paid by affiliate entities for management and administrative
services provided by the Company and royalty income. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations ."
(4) For federal and state tax purposes, Tarrant Apparel Group and certain
of the companies included in the historical results of operations were
treated as S corporations under Subchapter S of the Internal Revenue
Code of 1986, as amended, and comparable provisions of state income tax
laws.
(5) See Note 1 to Consolidated Financial Statements.
(6) Reflects an income tax provision which is the sum of (i) U.S. income
taxes computed as if the Company had been taxed as a C Corporation at
an effective tax rate of 40% for federal and state tax purposes for the
period it was an S Corporation and (ii) the historical tax provision of
the Company and its non-U.S. consolidated subsidiaries for all other
periods. Fiscal 1996 has no adjustments since the Company was a C
Corporation for the full year.
(7) The 1994 amount has been adjusted from the $1.09 per share previously
reported in the Registration Statement on Form S-1, as amended, dated
May 4, 1995 (File No. 33-91874) (the "Form S-1") to reflect the
elimination of a 400,000 share adjustment, as described in Note 9 to
this table. The 1995 amounts reflect a $1.7 million adjustment related
to the grant of the LDA Option. The pro forma net income and pro forma
net income per common share amounts reflecting only the adjustment for
pro forma income taxes for 1995 would be $5.7 million and $1.06,
respectively. See "Consolidated Statements of Income," page F-5.
(8) Adjusted to give effect to a stock dividend of 14,999 shares for each
outstanding share and the sale by the Company of 2,000,000 shares in
its initial public offering (the "Offering") in July 1995.
(9) The 1994 amount has been adjusted from the 4,900,000 shares previously
reported in the Form S-1 due to the elimination of a 400,000 share
adjustment originally made to account for the capital in excess of
earnings which was withdrawn by the Original Shareholders prior to the
Offering. Additional earnings recorded subsequent to the Offering have
necessitated that this adjustment be eliminated.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company primarily serves both specialty retail and mass merchandise
store chains by designing, merchandising, contracting for the manufacture of and
selling casual, moderately-priced apparel, primarily for women, under private
label. The Company's major customers include specialty retailers, such as Lerner
New York, Limited Stores, Lane Bryant and Express, all of which are divisions of
The Limited, and mass merchandisers, such as Target Stores. The Company's
products are manufactured in a variety of woven and knit fabrications and
include jeanswear, casual pants, t-shirts, shorts, blouses, shirts and other
tops, dresses, leggings and jackets.
On July 28, 1995, the Company closed an initial public offering (the
"Offering") of 2,000,000 shares of the Company's Common Stock at a price of
$9.00 per share. The proceeds to the Company, net of underwriting discounts and
commissions and offering expenses, were $14.8 million. Concurrent with the
closing of the Offering, the Company changed its tax status from an S
Corporation to a C Corporation for income tax purposes.
Concurrent with the closing of the Offering, the Original Shareholders
granted a four-year option (the "LDA Option") to Limited Direct Associates, L.P.
("LDA"), a limited partnership, the general and limited partners of which are
subsidiaries of The Limited, and the Company granted registration rights to LDA
pertaining to the option shares. Historically, sales to divisions of The Limited
have represented a significant portion of the Company's sales. Subject to
certain anti-dilution provisions, the LDA Option grants LDA the right to
purchase an aggregate of approximately 9.9% (649,999 shares) of the Company's
outstanding Common Stock at a price per share of $7.20. For accounting purposes,
even though the LDA Option was granted by shareholders, and will not cover any
shares of the Company's unissued Common Stock, the LDA Option has been treated
as though it was granted by the Company. Accordingly, in the quarter ended
September 30, 1995, the Company recorded a non-recurring charge to earnings, in
the amount of $1.7 million, which equals the $1.4 million estimated fair market
value of the LDA Option plus the $300,000 estimated value of the expenses of
registration of the offer and sale of the option shares. The $1.4 million
component of this charge was offset by an equal credit to contributed capital
because the Company's capital structure was not affected by the grant of the LDA
Option. The $300,000 component of this charge was recorded as an accrued
expense. Because of the credit to contributed capital, the net impact of this
charge on shareholders' equity was $300,000.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Report on Form 10-K contains forward-looking statements which are
subject to a variety of risks and uncertainties. The Company's actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below.
Variability of Quarterly Results. The Company has experienced, and
expects to continue to experience, a substantial variation in its net sales and
operating results from quarter to quarter. The Company believes that the factors
which influence this variability of quarterly results include the timing of the
Company's introduction of new product lines, the level of consumer acceptance of
each new product line, general economic and industry conditions that affect
consumer spending and retailer purchasing, the availability of manufacturing
capacity, the seasonality of the markets in which the Company participates, the
timing of trade shows, the product mix of customer orders, the timing of the
placement or cancellation of customer orders, the occurrence of chargebacks in
excess of reserves and the timing of expenditures in anticipation of increased
sales and actions of competitors. Accordingly, a comparison of the Company's
results of operations from period to period is not necessarily meaningful, and
the Company's results of operations for any period are not necessarily
indicative of future performance.
Economic Conditions. The apparel industry historically has been subject
to substantial cyclical variation, and a recession in the general economy or
uncertainties regarding future economic prospects that affect consumer spending
habits have in the past had, and may in the future have, a materially adverse
effect on the Company results of operations. In addition, certain retailers,
including some of the Company customers, have experienced in the past, and may
experience in the future, financial difficulties which increase the risk of
extending credit to such retailers. These retailers have attempted to improve
their own operating efficiencies by concentrating their purchasing power
13
14
among a narrowing group of vendors. There can be no assurance that the Company
will remain a preferred vendor for its existing customers. A decrease in
business from or loss of a major customer could have a material adverse effect
on the Company's results of operations. The Company has entered into a
non-recourse accounts receivable factoring agreement. There can be no assurance
that the Company's factor will approve the extension of credit to certain retail
customers in the future. If a customer's credit is not approved by the factor,
the Company could either assume the collection risk on sales to the customer
itself, require that the customer provide a letter of credit or choose not to
make sales to the customer.
Reliance on Key Customers. In 1996, affiliated stores owned by The
Limited, including Lerner New York, Limited Stores and Lane Bryant, accounted
for 67.1% of the Company's net sales and Target Stores accounted for 24.3% of
the Company's net sales. The loss of any such customer could have a material
adverse effect on the Company's results of operations. From time to time,
certain of the Company's major customers have experienced financial
difficulties. The Company does not have long-term contracts with any of its
customers and, accordingly, there can be no assurance that any customer will
continue to place orders with the Company to the same extent it has in the past,
or at all. In addition, the Company's results of operations will depend to a
significant extent upon the commercial success of its major customers.
Dependence on Contract Manufacturers. All of the Company's products,
with the exception of certain test runs and samples, are manufactured by
independent cutting, sewing and finishing contractors. The use of contract
manufacturers and the resulting lack of direct control over the production of
its products could result in the Company's failure to receive timely delivery of
products of acceptable quality. Although the Company believes that alternative
sources of cutting, sewing and finishing services are readily available, the
loss of one or more contract manufacturers could have a materially adverse
effect on the Company's results of operations until an alternative source is
located and has commenced producing the Company's products.
Price and Availability of Raw Materials. Cotton fabric is the principal
raw material used in the Company's apparel. Although the Company believes that
its suppliers will continue to be able to procure a sufficient supply of cotton
fabric for its production needs, the price and availability of cotton may
fluctuate significantly depending on supply, world demand, and currency
fluctuations, each of which may affect the price and availability of cotton
fabric. There can be no assurance that fluctuations in the price and
availability of cotton fabric or other raw materials used by the Company will
not have a material adverse effect on the Company's results of operations.
Management of Growth. Since its inception, the Company has experienced
rapid growth in sales. No assurance can be given that the Company will be
successful in maintaining or increasing its sales in the future. Any future
growth in sales will require additional working capital and may place a
significant strain on the Company's management, management information systems,
inventory management, production capability, distribution facilities and
receivables management. Any disruption in the Company's order processing,
sourcing or distribution systems could cause orders to be shipped late, and
under industry practices, retailers generally can cancel orders or refuse to
accept goods due to late shipment. Such cancellations and returns would result
in a reduction in revenue, increased administrative and shipping costs and a
further burden on the Company distribution facilities. In addition, the failure
to timely enhance the Company's operating systems, or unexpected difficulties in
implementing such enhancements, could have a material adverse effect on the
Company's results of operations.
Foreign Manufacturing. Approximately 85% of the Company products were
imported in 1996. As a result, the Company's operations are subject to the
customary risks of doing business abroad, including, among other things,
transportation delays, economic or political instability, currency fluctuations,
restrictions on the transfer of funds and the imposition of tariffs, export
duties, quotas and other trade restrictions.
14
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in the Company's consolidated statements of income as a percentage of net
sales and as adjusted in the pro forma manner set forth in the footnotes to the
table:
YEAR ENDED DECEMBER 31,
-----------------------------
1994 1995 1996
----- ----- -----
Net sales ................................. 100.0% 100.0% 100.0%
Cost of sales ............................. 84.0 84.3 83.7
----- ----- -----
Gross profit .............................. 16.0 15.7 16.3
Selling and distribution expenses ......... 3.4 3.3 3.1
General and administration expenses ....... 7.0 6.6 6.1
Non-recurring charge related
to LDA Option(1) ........................ -- 0.8 --
----- ----- -----
Operating income .......................... 5.6 5.0 7.1
Interest expense .......................... (2.1) (2.0) (0.8)
Other income .............................. 0.8 1.0 0.0
----- ----- -----
Income before income taxes ................ 4.3 4.0 6.3
Income taxes(2) ........................... (1.4) (1.3) (2.0)
Adoption of FASB 115 ...................... 0.1 -- --
----- ----- -----
Net income ................................ 3.0% 2.7% 4.3%
===== ===== =====
- --------------------
(1) On the effective date of the Offering, the Company incurred a
non-recurring charge to earnings related to a grant by the Original
Shareholders to Limited Direct Associates, L.P., an affiliate of The
Limited, Inc., of a four-year option to purchase an aggregate of 649,999
shares, or approximately 10% of the Company's then outstanding Common
Stock, at an exercise price equal to $7.20 per share.
(2) 1994 and 1995 amounts reflect a pro forma income tax provision which is
the sum of (i) U.S. income taxes computed as if the Company had been
taxed as a C Corporation at an effective tax rate of 40% for federal and
state tax purposes for the period it was an S Corporation and (ii) the
historical tax provision of the Company and its non-U.S. consolidated
subsidiaries for all other periods.
COMPARISON OF 1996 TO 1995
Net sales increased by $24.7 million, or 12.0%, from $205.2 million in
1995 to $229.9 million in 1996. The increase in net sales included an aggregate
increase in sales of $40.7 million to divisions of The Limited and $27.9 million
to Target, which were offset in part by a decrease of $35.1 million in sales to
Kmart.
Certain of the Company's customers, including divisions of The Limited,
experienced sluggish sales and declines in revenue and profits in 1996. To the
extent that these financial difficulties continue or worsen, the Company's
revenues and gross profit margins could be adversely affected.
Gross profit (which consists of net sales less product costs, duties
and direct costs attributable to production) for 1996 was $37.6 million, or
16.3% of net sales, compared to $32.2 million, or 15.7% of net sales, in 1995,
an increase of 16.6%. The increase in the gross profit margin primarily resulted
from the reduction of low margin sales to Kmart. The increase in the absolute
amount of gross profit was primarily due to the increase in net sales.
Selling and distribution expenses increased from $6.8 million in 1995
to $7.1 million in 1996. As a percentage of net sales, these expenses declined
from 3.3% in 1995 to 3.1% in 1996. This percentage decrease is primarily due to
a decrease in commission expenses.
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General and administrative expenses increased from $13.5 million in
1995 to $14.0 million in 1996. As a percentage of net sales, these expenses
declined from 6.6% in 1995 to 6.1% in 1996. This percentage decrease was
primarily due to a decrease in the provision for bad debt, which includes an
estimated provision for returns and discounts as well as bad debt expense. The
estimated provision for returns and discounts is primarily based on a percentage
of receivables which increases with the age of the receivables, but is not a
reflection on the credit worthiness of the customer. The decrease in the
estimated provision for returns and discounts during 1996 was $180,000, or 0.1%
of net sales, compared to an increase in such provision of $314,000, or 0.2% of
net sales, during 1995. The most significant portions of the decrease in the
estimated provision for returns and discounts resulted from changes in the
amount and aging of accounts receivable. An additional favorable variance in the
provision for bad debt resulted from $179,000 of bad debt expense in 1996
compared to $532,000 of such expense in 1995. After adjusting for the decrease
in the provision for bad debt of $847,000, general and administrative expenses
increased by $1.3 million and were 6.2% of net sales in 1995 as compared to 6.1%
in 1996.
Operating income was $10.2 million in 1995, or 5.0% of net sales,
compared to $16.5 million in 1996, or 7.1% of net sales, due to the factors
described above. After adjusting for the decrease in the provision for bad debt
expense and the $1.7 million non-recurring charge related to the grant of the
LDA Option during 1995, operating income as a percentage of net sales increased
from 6.2% in 1995 to 7.1% in 1996. This increase in operating income as a
percentage of net sales was due to the increase in the gross profit margin,
which amounted to 0.6% of net sales, a decrease in selling and distribution
expenses, which amounted to 0.2% of net sales and a decrease in general and
administrative expenses, which amounted to 0.1% of net sales.
Other income decreased from $2.0 million, or 1.0% of net sales, in 1995
to $35,000 in 1996. This decrease is primarily the result of interest income of
$337,000 in 1996 compared to $773,000 in 1995, management fee income of $60,000
in 1996 compared to $1.1 million in 1995 and a non-operating expense accrual of
$400,000 in 1996 compared to no similar accrual in 1995. (See Note 9 to
Consolidated Financial Statements.) Management fee income was derived from an
agreement with FIS which sourced and sold garments under the B.U.M. Equipment
label until it ceased operations in the second quarter of 1996.
Income before income taxes was $8.3 million in 1995 and $14.6 million
in 1996, representing 4.0% and 6.3% of net sales, respectively. After adjusting
for the decrease in the provision for bad debt expense and the $1.7 million
non-recurring charge related to the grant of the LDA Option during 1995, income
before income taxes as a percentage of net sales increased from 5.2% in 1995 to
6.3% in 1996. This increase in income before taxes as a percentage of net sales
was due to the increase in the gross profit margin, which amounted to 0.6% of
net sales, a decrease in selling and distribution expenses, which amounted to
0.2% of net sales, a decrease in general and administrative expenses, which
amounted to 0.1% of net sales, and the decrease in interest expense, which
amounted to 1.2% of net sales, as offset by the decrease in other income, which
amounted to 1.0% of net sales.
COMPARISON OF 1995 TO 1994
Net sales increased by $28.1 million, or 15.8%, from $177.1 million in
1994 to $205.2 million in 1995. The increase in net sales included an increase
in sales of $31.3 million to Kmart and an aggregate increase of $5.3 million to
divisions of The Limited, which were offset in part by a one-time bulk sale of
$11.6 million in 1994 of two product items to a marketer of promotional items.
Gross profit (which consists of net sales less product costs, duties
and direct costs attributable to production) for 1995 was $32.2 million, or
15.7% of net sales, compared to $28.4 million, or 16.0% of net sales, in 1994,
an increase of 13.6%. The decrease in the gross profit margin resulted from a
doubling of sales to mass merchandiser customers (from $34.9 million in 1994 to
$70.1 million in 1995) at lower margins which were offset by an increase in
margins on sales to The Limited. The increase in the absolute amount of gross
profit was due to the increase in net sales.
Selling and distribution expenses increased from $6.1 million in 1994
to $6.8 million in 1995. As a percentage of net sales, these expenses declined
from 3.4% in 1994 to 3.3% in 1995. This percentage decrease is primarily due to
a decrease in freight charges.
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General and administrative expenses increased from $12.4 million in
1994 to $13.5 million in 1995. As a percentage of net sales, these expenses
declined from 7.0% in 1994 to 6.6% in 1995, due to a decrease in bad debt
expense.
Operating income was $9.9 million in 1994, or 5.6% of net sales,
compared to $10.2 million in 1995, or 5.0% of net sales, due to the factors
described above. After adjusting for the $873,000 bad debt expense taken during
the third quarter of 1994, the $293,000 bad debt expense taken during the fourth
quarter of 1995 and the $1.7 million non-recurring charge related to the grant
of the LDA Option during the third quarter of 1995, operating income as a
percentage of net sales decreased from 6.1% in 1994 to 6.0% in 1995. This
decrease in operating income as a percentage of net sales was due to the
decrease in the gross profit margin, which amounted to 0.3% of net sales, offset
by the decrease in selling and distribution expenses, which amounted to 0.2% of
net sales.
Other income increased from $1.4 million, or 0.8% of net sales, in 1994
to $2.0 million, or 1.0% of net sales, in 1995. This increase resulted primarily
from $773,000 of interest income in 1995 compared to $78,000 in 1994 and $1.1
million of management fee income in 1995 compared to $1.0 million in 1994, as
unfavorably offset by a decline in royalty income from $431,000 in 1994 to
$20,000 in 1995. Management fee income was derived from an agreement with FIS
which sourced and sold garments under the B.U.M. Equipment label until it ceased
operations in the second quarter of 1996.
Income before income taxes was $7.6 million in 1994 and $8.3 million in
1995, representing 4.3% and 4.0% of net sales, respectively. After adjusting for
the $873,000 bad debt expense recorded during the third quarter of 1994, the
$293,000 bad debt expense recorded during the fourth quarter of 1995 and the
$1.7 million non-recurring charge related to the grant of the LDA Option during
the third quarter of 1995, income before income taxes as a percentage of net
sales increased from 4.8% in 1994 to 5.0% in 1995. This decrease in income
before taxes as a percentage of net sales was primarily due to the decrease in
the gross profit margin, which amounted to 0.3% of net sales, as offset by the
decrease in selling and distribution expenses, which amounted to 0.2% of net
sales, and the increase in other income, which amounted to 0.2% of net sales.
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18
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in the Company's consolidated statements of income in millions of dollars
and as a percentage of net sales, as adjusted in the pro forma manner described
in the footnotes to the tables:
QUARTER ENDED
-------------------------------------------------------------
Mar. 31, June 30, Sept. 30 Dec. 31, Mar. 31, June 30,
1994 1994 1994 1994 1995 1995
------ ------ ------ ------ ------ ------
(IN MILLIONS)
Net sales ................. $ 28.0 $ 41.9 $ 58.7 $ 48.5 $ 45.3 $ 57.6
Gross profit .............. 5.3 6.6 8.8 7.7 6.9 9.2
Operating income .......... 2.1 2.7 3.4 1.7 2.0 3.7
Net income ................ 1.4 2.1 3.0 0.7 1.4 2.6
Pro forma net
income (1) ............. 0.8 1.7 2.3 0.6 1.1 2.2
QUARTER ENDED
-------------------------------------------------------------
Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1995 1995 1996 1996 1996 1996
------ ------ ------ ------ ------ ------
Net sales ................. $ 58.1 $ 44.2 $ 42.1 $ 68.9 $ 50.0 $ 68.9
Gross profit .............. 8.9 7.2 7.1 11.3 8.2 11.0
Operating income .......... 2.8(2) 1.8 2.4 5.5 3.7 4.9
Net income ................ 2.0(2) 1.4 1.5 3.6 2.2 2.7
Pro forma net
income (1) ............. 1.0(2) 1.4 1.5 3.6 2.2 2.7
QUARTER ENDED
-------------------------------------------------------------
Mar. 31, June 30, Sept. 30 Dec. 31, Mar. 31, June 30,
1994 1994 1994 1994 1995 1995
------ ------ ------ ------ ------ ------
(IN MILLIONS)
Net sales.................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit............... 19.0 15.8 15.0 15.8 15.3 16.0
Operating income........... 7.5 6.4 5.8 3.6 4.5 6.3
Net income................. 4.9 5.1 5.1 1.4 3.1 4.5
Pro forma net
income (1).............. 2.7 4.0 3.9 1.3 2.4 3.8
QUARTER ENDED
-------------------------------------------------------------
Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1995 1995 1996 1996 1996 1996
------ ------ ------ ------ ------ ------
Net sales.................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit............... 15.3 16.3 16.8 16.4 16.5 16.0
Operating income........... 4.7(2) 4.0 5.6 8.0 7.5 7.1
Net income................. 3.4(2) 3.1 3.5 5.2 4.4 4.0
Pro forma net
income (1).............. 1.8(2) 3.1 3.5 5.2 4.4 4.0
- ------------------
(1) 1994 and the first three quarters of 1995 reflect an income tax
provision which is the sum of (i) U.S. income taxes for the Company
computed as if the Company had been taxed as a C. Corporation at an
effective tax rate of 40% for federal and state tax purposes for the
period it was an S Corporation and (ii) the historical tax provision of
the Company and its non-U.S. consolidated subsidiaries for all other
periods.
(2) Includes $1.7 million, or 3.0% of net sales, non-recurring charge in
the third quarter of 1995 related to the grant of the LDA Option by the
Original Shareholders.
As is typical for the Company, quarterly net sales fluctuated
significantly because the Company's customers typically place bulk orders with
the Company, and a change in the number of orders shipped in any one period may
have a material effect on the net sales for that period.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements arise from the funding of its
working capital needs, principally inventory, finished goods
shipments-in-transit, and accounts receivable, including receivables from the
Company's contract manufacturers that relate primarily to fabric purchased by
the Company for use by those manufacturers. (The Company generally purchases
fabric for delivery directly to the manufacturer's factory. The Company then
invoices the manufacturer for the fabric, and reduces payments to the
manufacturer for finished goods by the amount of outstanding invoices.) The
Company's primary sources for working capital are cash flow from operations and
borrowings under the Company's bank credit agreements and factoring agreement.
During 1996, net cash provided by operating activities was $2.3
million, which resulted primarily from net income of $10.0 million, as partially
offset by a net increase in working capital items, including an increase of
$14.8 million in accounts receivable, as partially offset by an increase of
accounts payable of $3.1 million and a decrease in inventory of $3.0 million.
The increase in accounts receivable resulted from an increase in sales as
partially offset by an increase in advances from the factor, which advances are
accounted for as an offset to accounts receivable. At December 31, 1996,
advances from the factor were approximately $2.1 million as compared to no such
advances at December 31, 1995.
18
19
During 1996, cash flow used in investing activities was $381,000, which
was used for capital expenditures and the purchase of permanent quota.
In 1996, cash flow used in financing activities equaled $8.7 million,
primarily as a result of the repayment of bank borrowings.
The Company has credit facilities of $33.0 million and $10.0 million
with The Hongkong and Shanghai Banking Corporation Limited ("HKSB") and Standard
Chartered Bank ("SCB"), respectively, for direct borrowings and the purchase and
exportation of finished goods. Under these facilities, the Company may arrange
for the issuance of letters of credit and bank acceptances, as well as cash
borrowings for working capital. These facilities are subject to review at any
time and the right of HKSB and/or SCB to demand payment at any time. Interest on
cash borrowings under HKSB's facility accrues at the U.S. best lending rate plus
one-half to three-quarters percent per annum. As of December 31, 1996, the U.S.
best lending rate equaled seven percent. Interest on cash borrowings under SCB's
facility accrues at SCB's prime rate for lending Hong Kong Dollars. As of
December 31, 1996 SCB's Hong Kong Dollar prime rate equaled eight and one-half
percent. These facilities are subject to certain restrictive covenants including
a provision that the aggregate net worth, as adjusted, of the Company will
exceed $27.0 million. See Note 7 of Notes to Consolidated Financial Statements.
Pursuant to an agreement (the "Factoring Agreement") with NationsBanc
Commercial Corporation ("NBCC"), NBCC acts as the Company's sole factor for its
accounts receivable. The Factoring Agreement provides that NBCC will pay the
Company an amount equal to the gross amount of the Company's accounts receivable
from customers reduced by certain offsets, including among other things,
discounts, returns and a commission payable by the Company to NBCC. The
commission equals four-tenths of one percent, plus an additional one-quarter of
one percent of the gross amount of its accounts receivable depending on the
maturity of the account receivable. Prior to the date upon which NBCC must pay
for the Company's accounts receivable, the Company may receive an advance of up
to 85% of the purchase price of its accounts receivable, less certain offsets,
although NBCC may in its discretion advance a greater amount to the Company.
Interest on such advances accrues at the rate of one-quarter of one percent per
annum below the prime rate charged from time to time by NBCC, except that the
interest rate is in no event less than five percent per annum. As of December
31, 1996, the prime rate equaled eight and one-quarter percent. Under the
Factoring Agreement, NBCC is obligated to pay the Company for accounts
receivable on the third business day following payment of the account receivable
or, with respect to all accounts receivable for which NBCC has assumed the
credit risk, the earlier of such date or the 120th day after the due date of the
account receivable. Subject to its credit review procedures, NBCC may decline to
accept the credit risk on certain accounts receivable. The Factoring Agreement
continues in force from year to year and may be terminated by NBCC on any
anniversary of its effective date (September 28) or by the Company at any time,
provided that in each case, the terminating party gives sixty days prior written
notice.
The Company believes that its cash flow from operations and borrowings
under its current financing facilities should be sufficient to fund its
operations for the foreseeable future.
The Company does not believe that the moderate levels of inflation in
the United States in the last three years have had a significant effect on net
sales or profitability.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K" for the Company's financial statements, and the notes thereto, and the
financial statement schedules filed as part of this report.
19
20
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On December 29, 1995, the Company replaced its former independent
accounting firm, Coopers & Lybrand L.L.P. ("C&L"), with Ernst & Young LLP
("E&Y"). The decision to change independent accountants was made following a
review of competitive proposals submitted by C&L, E&Y and another major public
accounting firm, and was recommended by the Company's Audit Committee and
approved by the Company's Board of Directors.
C&L's reports on the Company's financial statements for 1994 did not
contain an adverse opinion or a disclaimer of opinion, and were not qualified or
modified as to uncertainty, audit scope or accounting principles. Since the
Company originally engaged C&L in January 1994 through December 29, 1995,
there were no disagreements between the Company and C&L on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure, which disagreements, if not resolved to the satisfaction of
C&L, would have caused C&L to make a reference to the subject matter of the
disagreement in connection with its reports.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information concerning the directors and executive officers of the
Company is incorporated herein by reference from the section entitled "Proposal
1 - Election of Directors" contained in the definitive Proxy Statement of the
Company to be filed pursuant to Regulation 14A within 120 days after the end of
the Company's last fiscal year (the "Proxy Statement").
Effective as of February 28, 1997, Walter L. Krieger resigned as a
Director of the Company for personal reasons.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning executive compensation is incorporated
herein by reference from the section entitled "Proposal 1 - Election of
Directors" contained in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information concerning the security ownership of certain beneficial
owners and management is incorporated herein by reference from the sections
entitled "General Information - Security Ownership of Principal Shareholders and
Management" and "Proposal 1 - Election of Directors" contained in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning certain relationships and related
transactions is incorporated herein by reference from the section entitled
"Proposal 1 - Election of Directors - Certain Relationships and Related
Transactions" contained in the Proxy Statement.
20
21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(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) Reports on Form 8-K. None.
(c) Exhibits. The following is a list of exhibits filed as a part of
this report.
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
------ ----------- ----
3.1 Restated Articles of Incorporation of the Company (1).................................
3.2 Restated Bylaws of the Company (1)....................................................
4.1 Specimen of Common Stock Certificate (2)..............................................
10.1 Note in the principal amount of $2,600,000 dated March 15, 1995 in favor of
Imperial Bank (1).....................................................................
10.2 General Security Agreement dated March 15, 1995, by and between the Company
and Imperial Bank (1).................................................................
10.3 Factoring Agreement effective as of September 28, 1993, as amended, by and
between the Company and NationsBanc Commercial Corporation (1)........................
10.4 1995 Stock Option Plan dated as of May 1, 1995 (1)....................................
10.5 Letter Agreement dated February 17, 1995 between Tarrant Company Limited and
The Hongkong and Shanghai Banking Corporation Limited (1).............................
10.6 Letter dated April 18, 1995 from The Hongkong and Shanghai Banking
Corporation Limited to Tarrant Company Limited regarding the
release of certain security interests (1).............................................
10.7 Commercial Lease dated January 1, 1994 and GET and the Company (1)....................
10.8 Tenancy Agreement dated July 15, 1994 between Lynx International Limited and
Tarrant Company Limited, as amended by that certain Supplementary
Tenancy Agreement dated December 30, 1994 and that certain Second Supplementary
Tenancy Agreement dated December 31, 1994 (1).........................................
10.9 Lease Agreement dated June 10, 1994, between Yip Sik Kin and Tarrant
Company Limited (translated from Chinese) (1).........................................
10.10 Tenancy Contract effective as of December 24, 1994, between Khalifa al Muhairi
and Tarrant Trading Co. Ltd. (1)......................................................
10.11 Agreement dated as of June 1, 1995, by and among Pret-A-Porter, the Company,
French Designers, Inc., Bernard Aidan, Gerard Guez and Todd Kay (5)...................
21
22
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
------ ----------- ----
10.12 Services Agreement dated as of April 1, 1995, by and between F.I.S., Inc. and the
Company (2)...........................................................................
10.13 Services Agreement dated as of October 1, 1994, by and between the Company
and GET (1)...........................................................................
10.14 Services Agreement dated as of October 1, 1994, by and between the Company and
Lynx International Limited (1)........................................................
10.15 Indemnification Agreement dated as of March 14, 1995, by and among the Company,
Gerard Guez and Todd Kay (2)..........................................................
10.16 Promissory Note in the initial principal amount of $2 million dated February 8, 1995,
by Gerard Guez in favor of the Company (2)............................................
10.17 Promissory Note in the initial principal amount of $1 million dated February 8, 1995,
by Todd Kay in favor of the Company (2)...............................................
10.18 Promissory Note in the principal amount of $1,334,566.71 dated December 31, 1994,
by F.I.S., Inc. in favor of the Company (2)...........................................
10.19 Release dated as of June 1, 1995, by and between the Company and certain other
parties signatory thereto (2).........................................................
10.20 Option Agreement dated as of July 28, 1995, by and among Limited Direct
Associates, L.P., Gerard Guez, Todd Kay and the Company (5)...........................
10.21 Registration Rights Agreement dated as of July 28, 1995, by and among the
Company and Limited Direct Associates, L.P. (5).......................................
10.22 Reorganization and Tax Indemnification Agreement dated as of June 13, 1995,
by and among the Company and its shareholders (5).....................................
10.23 Employment Agreement dated as of January 1, 1995, by and between the Company
and Gerard Guez (2)...................................................................
10.24 Agreement dated as of January 1, 1995, by and between the Company and
Todd Kay (1)..........................................................................
10.25 Employment Agreement dated as of January 1, 1994, by and between the Company
and Jimmy Esebag, as amended, by that certain Amendment No. 1 dated as of
June 1, 1995 (2)......................................................................
10.26 Employment Agreement dated as of November 18, 1994, by and between the
Company and Mark B. Kristof (1).......................................................
10.27 Employment Agreement dated as of July 5, 1994, by and between the Company
and Bradley R. Kenson (1).............................................................
10.28 License Agreement dated January 1, 1994, by and between the Company and GET (1).......
10.29 Assignment dated as of June 1, 1995 with respect to the GET! trademark, executed
by GET in favor of the Company (2)....................................................
10.30 Amendment No. 1 to Commercial Lease dated as of April 1, 1995, by and between
GET and the Company (2)...............................................................
22
23
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
------ ----------- ----
10.31 Lease and Services Agreement dated as of June 1, 1995, by and between Tarrant
Company Limited and French Designers, Inc. (2)........................................
10.32 Note in the principal amount of $2,600,000 dated May 15, 1995, by the Company
in favor of Imperial Bank (2).........................................................
10.33 Letter Agreement dated May 17, 1995, by and between Tarrant Company Limited
and The Hongkong and Shanghai Banking Corporation Limited (2).........................
10.34 Buying Agency Agreement executed as of December 19, 1992, between F.I.S., Inc.
and Tarrant Company Ltd. (2)..........................................................
10.35 Buying Agency Agreement executed as of April 4, 1995, by Azteca Production
International, Inc. and Tarrant Company Ltd., with the Company acknowledging as
to certain matters (2)................................................................
10.36 Tripartite Agreement Assignment of Factoring Proceeds (Advances)
executed and delivered June 6, 1995, by the Company, and accepted
and agreed to by The Hongkong and Shanghai Banking Corporation Limited
and NationsBanc Commercial Corporation (2)............................................
10.37 Security Agreement (Guaranty of Tarrant Co. Ltd. Debt) entered into as of June 6,
1995, by and between The Hongkong and Shanghai Banking Corporation Limited
and the Company (2)...................................................................
10.38 Security Agreement (Tarrant Co. Ltd. Draft Acceptance) entered into as of June 6,
1995, by and between The Hongkong and Shanghai Banking Corporation Limited
and the Company (2)...................................................................
10.39 Agreement dated March 14, 1995, by and among Tarrant Company Limited,
Cheung Shing Hong Holding Ltd., Yip Sik Kin and Lam Kin Fong (3)......................
10.40 Agreement dated March 17, 1995, by and among Tarrant Company Limited,
Cheung Shing Hong Holding Ltd., Yip Sik Kin and Lam Kin Fong (3)......................
10.41 Underwriting Agreement dated as of July 24, 1995, by and among the Company,
Gerard Guez, Todd Kay and Prudential Securities Incorporated (5)......................
10.42 Letter agreement dated August 10, 1995, by and among the Company and
NationsBanc Commercial Corporation(4).................................................
10.43 Letter agreement dated January 30, 1996, by and between Tarrant Company Limited
and The Hongkong and Shanghai Banking Corporation Limited (5).........................
10.44 Promissory Note in the principal amount of $3 million dated March 25, 1996,
by GET in favor of the Company (6)....................................................
10.45 Deed of Trust dated March 25, 1996 by and between GET and the Company (6).............
10.46 Guaranty, Pledge & Security Agreement entered into as of March 25, 1996, by and
between Gerard Guez and the Company (6)...............................................
10.47 Guaranty, Pledge & Security Agreement entered into as of March 25, 1996, by and
between Todd Kay and the Company (6)..................................................
10.48 Letter agreement dated February 22, 1996, by and between Tarrant Company Limited
and Standard Chartered Bank........................................................... 57
23
24
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
------ ----------- ----
10.49 Letter agreement dated March 8, 1996, by and between Tarrant Company Limited
and Standard Chartered Bank........................................................... 61
10.50 Guarantee Agreement entered into as of August 30, 1996, by and between Standard
Chartered Bank and the Company........................................................ 63
10.51 Letter of Undertaking entered into as of August 30, 1996, by and between Standard
Chartered Bank and the Company........................................................ 68
10.52 Intercreditor Agreement entered into as of November 1, 1996, between The Hongkong
and Shanghai Banking Corporation Limited, Standard Chartered Bank and Tarrant
Company Limited...................................................................... 69
10.53 Security Agreement entered into as of November 1, 1996, by and between Standard
Chartered Bank and the Company....................................................... 73
10.54 Amendment to Security Agreement (Guaranty of Tarrant Co. Ltd. Debt) entered into
as of November 1, 1996, between The Hongkong and Shanghai Banking Corporation
Limited and the Company.............................................................. 84
10.55 Agreement dated January 29, 1997 by and among Tarrant Company Limited,
Cheung Shing Hong Holding Ltd., Yip Sik Kin and Lam Kin Fong......................... 86
23 Consent of Ernst & Young LLP......................................................... 91
- -------------------------
(1) Filed as an exhibit to the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on May 4, 1995 (File
No. 33-91874).
(2) Filed as an exhibit to Amendment No. 1 to Registration Statement on
Form S-1 filed with the Securities and Exchange Commission on June 15,
1995.
(3) Filed as an exhibit to Amendment No. 2 to Registration Statement on
Form S-1 filed with the Securities and Exchange Commission on July 11,
1995.
(4) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1995.
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 30, 1995.
(6) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1996.
24
25
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Page
----
Financial Statements
Report of Independent Auditors - Ernst & Young, L.L.P............................................................. F-2
Report of Independent Auditors - Coopers & Lybrand, L.L.P......................................................... F-3
Consolidated Balance Sheets - December 31, 1995 and 1996.......................................................... F-4
Consolidated Statements of Operations - Three year period ended December 31, 1996................................. F-5
Consolidated Statements of Shareholders' Equity - Three year period ended December 31, 1996....................... F-6
Consolidated Statements of Cash Flows - Three year period ended December 31, 1996................................. F-7
Notes to Consolidated Financial Statements........................................................................ F-8
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts................................................................... F-31
F-1
26
Report of Independent Auditors
Board of Directors
Tarrant Apparel Group
We have audited the accompanying consolidated balance sheets of Tarrant Apparel
Group and subsidiaries as of December 31, 1995 and 1996, and the related
consolidated statements of income, shareholders' equity, and cash flows the
years then ended. Our audits also included the financial statement schedule for
the years ended December 31, 1995 and 1996, listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Tarrant Apparel
Group and subsidiaries at December 31, 1995 and 1996 and the consolidated
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule for the years ended December 31, 1995
and 1996, when considered in relation to the basic financial statements, taken
as a whole, presents fairly in all material respects the information set forth
therein.
ERNST & YOUNG LLP
Los Angeles, California
February 18, 1997
F-2
27
Report of Independent Accountants
To the Shareholders of
Tarrant Apparel Group and Affiliates
We have audited the accompanying Tarrant Apparel Group and Affiliates (the
Company), as identified in Note 1 of the Notes To Combined Financial Statements
combined statement of operations, shareholders' equity and cash flows for the
year ended December 31, 1994. Our audit also included the financial statement
schedule for the year ended December 31, 1994 listed in the Index at Item 14(a).
These combined financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
combined financial statements and schedule based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
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 out 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 Tarrant Apparel Group and Affiliates
combined results of its operations and its combined cash flows for the year
ended December 31, 1994, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule for
the year ended December 31, 1994, when considered in relation to the basic
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
As discussed in Note 1 to the combined financial statements, in 1994 the Company
changed its method of accounting for its investments in debt and equity
securities.
COOPERS & LYBRAND L.L.P.
Los Angeles, California
March 31, 1995
F-3
28
Tarrant Apparel Group
Consolidated Balance Sheets
DECEMBER 31
1995 1996
--------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 7,881,210 $ 1,120,456
Accounts receivable, net (Note 3) 29,232,849 44,483,884
Due from affiliates (Note 12) 861,105 96,416
Inventory (Note 4) 13,808,661 10,820,169
Temporary quota 1,373,368 1,723,085
Prepaid expenses 404,481 458,087
Prepaid income taxes - 990,771
Deferred tax asset 866,577 803,482
--------------------------------------
Total current assets 54,428,251 60,496,350
Property and equipment, net (Note 5) 3,011,192 2,618,869
Permanent quota, net 388,374 211,085
Other assets 12,581 93,394
--------------------------------------
Total assets $ 57,840,398 $ 63,419,698
======================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank borrowings (Note 7) $ 15,940,098 $ 6,809,676
Accounts payable 11,123,799 14,200,229
Accrued expenses 3,214,497 4,880,115
Income taxes 1,146,411 576,947
--------------------------------------
Total current liabilities 31,424,805 26,466,967
Long-term obligations - -
Commitments and contingencies (Note 9)
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized; none
issued and outstanding - -
Common stock, no par value, 10,000,000 shares authorized;
6,500,000 shares (1995), 6,552,276 shares (1996) issued and
outstanding 14,950,222 15,485,734
Contributed capital 1,434,259 1,434,259
Retained earnings 10,031,112 20,032,738
--------------------------------------
Total shareholders' equity 26,415,593 36,952,731
--------------------------------------
Total liabilities and shareholders' equity $ 57,840,398 $ 63,419,698
======================================
See accompanying notes.
F-4
29
Tarrant Apparel Group
Consolidated Statements of Income
YEAR ENDED DECEMBER 31
1994 1995 1996
-----------------------------------------------------
Net sales $ 177,107,555 $ 205,173,716 $ 229,861,024
Cost of sales 148,739,611 172,959,246 192,287,596
-----------------------------------------------------
Gross profit 28,367,944 32,214,470 37,573,428
Selling and distribution expenses 6,117,939 6,761,320 7,124,732
General and administrative expenses 12,359,215 13,492,382 13,989,826
Nonrecurring charge related to LDA option - 1,734,259 -
-----------------------------------------------------
Income from operations 9,890,790 10,226,509 16,458,870
Interest expense (3,695,567) (4,002,518) (1,864,734)
Interest income 78,562 772,766 336,785
Other income (expense) (Note 9) 1,366,915 1,273,777 (301,509)
-----------------------------------------------------
Income before provision for income taxes and cumulative
effect of accounting change 7,640,700 8,270,534 14,629,412
Provision for income taxes (Note 8) 597,382 960,256 4,627,786
-----------------------------------------------------
Income before cumulative effect of accounting change 7,043,318 7,310,278 10,001,626
Cumulative effect of change in accounting for investments
in debt and equity securities (net of tax of $20,000) 94,043 - -
-----------------------------------------------------
Net income $ 7,137,361 $ 7,310,278 $ 10,001,626
=====================================================
Proforma data - 1994 and 1995 (Note 16, unaudited)
Income before provision for
income taxes and cumulative
effect of accounting change $ 7,640,700 $ 8,270,534 $ 14,629,412
Pro forma adjustment to eliminate LDA option - 1,734,259 -
-----------------------------------------------------
Pro forma income before income taxes and cumulative
effect of change in accounting 7,640,700 10,004,793 14,629,412
Pro forma provision for income taxes (2,376,681) (2,596,562) (4,627,786)
Cumulative effect of change in accounting 94,043 - -
-----------------------------------------------------
Pro forma net income after adjustment for nonrecurring
charge and pro forma provision for income taxes $ 5,358,062 $ 7,408,231 $ 10,001,626
=====================================================
Pro forma net income per share $1.19 $1.38 $1.53
=====================================================
Income before provision for income taxes and cumulative
effect of accounting change $ 8,270,534
Pro forma provision for taxes (2,596,562)
-------------------
Pro forma net income after adjustment for pro forma taxes $ 5,673,972
===================
Pro forma net i