- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM _____________ TO
COMMISSION FILE NUMBER: 0-26006
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TARRANT APPAREL GROUP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-4181026
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
3151 EAST WASHINGTON BOULEVARD
LOS ANGELES, CALIFORNIA 90023
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (323) 780-8250
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
Number of shares of Common Stock of the registrant outstanding as of May 12,
2004: 28,814,763.
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TARRANT APPAREL GROUP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at March 31, 2004
(Unaudited) and December 31, 2003 (Audited)....................... 3
Consolidated Statements of Operations and
Comprehensive Income (Loss) for the Three Months
Ended March 31, 2004 and March 31, 2003........................... 4
Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2004 and March 31, 2003.................... 5
Notes to Consolidated Financial Statements........................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ..............................14
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ......................................................28
Item 4. Controls and Procedures..............................................29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................30
Item 2. Changes in Securities................................................30
Item 6. Exhibits and Reports on Form 8-K.....................................31
SIGNATURES...........................................................32
CAUTIONARY LEGEND REGARDING FORWARD-LOOKING STATEMENTS
Some of the information in this Quarterly Report on Form 10-Q may
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
both as amended. These forward-looking statements are subject to various risks
and uncertainties. The forward-looking statements include, without limitation,
statements regarding our future business plans and strategies and our future
financial position or results of operations, as well as other statements that
are not historical. You can find many of these statements by looking for words
like "will", "may", "believes", "expects", "anticipates", "plans" and
"estimates" and for similar expressions. Because forward-looking statements
involve risks and uncertainties, there are many factors that could cause the
actual results to differ materially from those expressed or implied. These
include, but are not limited to, economic conditions. This Quarterly Report on
Form 10-Q contains important cautionary statements and a discussion of many of
the factors that could materially affect the accuracy of Tarrant's
forward-looking statements and such statements and discussions are incorporated
herein by reference. Any subsequent written or oral forward-looking statements
made by us or any person acting on our behalf are qualified in their entirety by
the cautionary statements and factors contained or referred to in this section.
We do not intend or undertake any obligation to update any forward-looking
statements to reflect events or circumstances after the date of this document or
the date on which any subsequent forward-looking statement is made or to reflect
the occurrence of unanticipated events.
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2004 2003
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ................. $ 850,510 $ 3,319,964
Restricted cash ........................... -- 2,759,742
Accounts receivable, net .................. 51,335,809 57,165,926
Due from related parties .................. 17,488,693 18,056,488
Inventory ................................. 19,663,013 23,251,591
Temporary quota rights .................... 2,567,686 --
Prepaid expenses and other receivables .... 2,259,851 1,776,142
Income taxes receivable ................... 270,274 277,695
------------- -------------
Total current assets ........................ 94,435,836 106,607,548
Property and equipment, net ............... 132,786,788 135,645,751
Other assets .............................. 2,846,191 2,269,011
Excess of cost over fair value of net
assets acquired, net ................... 8,582,845 8,582,845
------------- -------------
Total assets ................................ $ 238,651,660 $ 253,105,155
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings ................ $ 27,842,179 $ 29,293,323
Accounts payable .......................... 20,653,038 23,514,894
Accrued expenses .......................... 13,851,102 11,194,421
Income taxes .............................. 16,835,889 16,497,939
Due to related parties .................... 1,440,632 5,418,795
Due to shareholders ....................... -- 496
Current portion of long-term obligations .. 28,878,196 38,705,240
------------- -------------
Total current liabilities ................... 109,501,036 124,625,108
Long-term obligations ........................ 559,364 588,272
Deferred tax liabilities ..................... 297,423 275,129
Minority interest in UAV ..................... 4,798,071 5,141,620
Minority interest in Tarrant Mexico .......... 14,100,530 14,766,215
Commitments and contingencies
Shareholders' equity:
Preferred stock, 2,000,000 shares
authorized; no shares issued
and outstanding ........................ -- --
Common stock, no par value, 100,000,000
shares authorized; 28,814,763 shares
(2004) and 27,614,763 shares (2003)
issued and outstanding ................. 111,515,091 107,891,426
Warrant to purchase common stock .......... 1,842,833 1,798,733
Contributed capital ....................... 1,559,510 1,505,831
Retained earnings ......................... 18,014,903 20,988,434
Notes receivable from officer/shareholder . (4,794,779) (4,796,428)
Accumulated other comprehensive loss ...... (18,742,322) (19,679,185)
------------- -------------
Total shareholders' equity .................. 109,395,236 107,708,811
------------- -------------
Total liabilities and shareholders' equity .. $ 238,651,660 $ 253,105,155
============= =============
The accompanying notes are an integral part of these consolidated financial
statements
3
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)
THREE MONTHS ENDED MARCH 31,
------------------------------
2004 2003
------------ ------------
Net sales .................................. $ 42,154,905 $ 78,736,204
Cost of sales .............................. 34,654,837 69,933,725
------------ ------------
Gross profit ............................... 7,500,068 8,802,479
Selling and distribution expenses .......... 2,642,399 2,729,512
General and administrative expenses ........ 10,779,151 7,383,022
------------ ------------
Loss from operations ....................... (5,921,482) (1,310,055)
Interest expense ........................... (793,783) (1,493,013)
Interest income ............................ 94,271 87,264
Other income ............................... 3,496,732 316,314
Other expense .............................. (359,202) (325,744)
Minority interest .......................... 880,548 (236,397)
------------ ------------
Loss before provision for income taxes ..... (2,602,916) (2,961,631)
Provision for income taxes ................. 370,615 917,298
------------ ------------
Net loss ................................... $ (2,973,531) $ (3,878,929)
============ ============
Net loss per share - Basic and Diluted ..... $ (0.10) $ (0.24)
============ ============
Weighted average common and common
equivalent shares:
Basic and Diluted ....................... 28,485,093 15,837,327
============ ============
Net loss ................................... $ (2,973,531) $ (3,878,929)
Foreign currency translation adjustment .... 936,863 (4,357,551)
------------ ------------
Total comprehensive loss ................... $ (2,036,668) $ (8,236,480)
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
4
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTHS ENDED MARCH 31,
----------------------------
2004 2003
------------ ------------
Operating activities:
Net loss ....................................... $ (2,973,531) $ (3,878,929)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Deferred taxes .............................. 22,294 17,560
Depreciation and amortization ............... 3,823,071 3,954,631
Unrealized (gain) loss on foreign currency .. (542,621) 263,553
Compensation expense related to stock option 53,679 --
Provision for returns and discounts ......... 292,929 205,865
Income from investments ..................... (365,733) --
Minority interest ........................... (880,548) 236,397
Changes in operating assets and liabilities:
Restricted cash ........................... 2,759,742 --
Accounts receivable ....................... 5,607,999 (8,639,412)
Due to/from related parties ............... (3,531,602) (267,016)
Inventory ................................. 3,643,250 (3,368,424)
Temporary quota rights .................... (2,567,686) (1,797,182)
Prepaid expenses and other receivables .... (470,274) (146,176)
Accounts payable .......................... (2,891,778) 2,590,609
Accrued expenses and income tax payable ... 2,953,301 2,373,551
------------ ------------
Net cash provided by (used in) operating
activities ............................. 4,932,492 (8,454,973)
Investing activities:
Purchase of fixed assets .................... (23,271) (270,876)
Increase in other assets .................... (327,497) (414,865)
Collection of advances from shareholders/
officers ................................. 1,650 734,225
------------ ------------
Net cash provided by (used in) investing
activities ............................. (349,118) 48,484
Financing activities:
Short-term bank borrowings, net ............. (1,464,122) 5,782,246
Proceeds from long-term obligations ......... 27,677,749 61,116,424
Payment of long-term obligations and bank
borrowings ............................... (36,991,080) (60,836,592)
Borrowings from shareholders/officers ....... -- 1,809,850
Proceeds from issuance of common stock and
warrant .................................. 3,667,765 --
Repurchase of stock ......................... -- (393,178)
------------ ------------
Net cash provided by (used in) financing
activities ............................. (7,109,688) 7,478,750
Effect of exchange rate on cash ................ 56,860 31,943
------------ ------------
Decrease in cash and cash equivalents .......... (2,469,454) (895,796)
Cash and cash equivalents at beginning of period 3,319,964 1,388,482
------------ ------------
Cash and cash equivalents at end of period ..... $ 850,510 $ 492,686
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
5
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF CONSOLIDATION
The accompanying financial statements consist of the consolidation of
Tarrant Apparel Group, a California corporation (formerly "Fashion Resource,
Inc."), and its majority owned subsidiaries located primarily in the U.S.,
Mexico, and Asia. At March 31, 2004, we owned 75% of our subsidiaries in Mexico
and 50.1% of United Apparel Ventures, LLC ("UAV"). We consolidate these entities
and reflect the minority interests in earnings (losses) of the ventures in the
accompanying financial statements. All inter-company amounts are eliminated in
consolidation. The 25% minority interest in our subsidiaries in Mexico is owned
by affiliates of Mr. Kamel Nacif, one of our shareholders. The 49.9% minority
interest in UAV is owned by Azteca Production International, a corporation owned
by the brothers of our Chairman, Gerard Guez.
We serve specialty retail, mass merchandise and department store chains
and major international brands by designing, merchandising, contracting for the
manufacture of, manufacturing directly and selling casual apparel for women, men
and children under private label. Commencing in 1999, we expanded our operations
from sourcing apparel to sourcing and operating our own vertically integrated
manufacturing facilities. In August 2003, we determined to abandon our strategy
of being both a trading and vertically integrated manufacturing company, and
effective September 1, 2003, we leased and outsourced operation of our
manufacturing facilities in Mexico to affiliates of Mr. Kamel Nacif, one of our
shareholders. (See Note 10).
Historically, our operating results have been subject to seasonal
trends when measured on a quarterly basis. This trend is dependent on numerous
factors, including the markets in which we operate, holiday seasons, consumer
demand, climate, economic conditions and numerous other factors beyond our
control. Generally, the second and third quarters are stronger than the first
and fourth quarters. There can be no assurance that the historic operating
patterns will continue in future periods.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation of the results of operations for the periods
presented have been included.
The consolidated financial data at December 31, 2003 is derived from
audited financial statements which are included in the our Annual Report on Form
10-K for the year ended December 31, 2003, and should be read in conjunction
with the audited financial statements and notes thereto. Interim results are not
necessarily indicative of results for the full year.
The accompanying unaudited consolidated financial statements include
all majority-owned subsidiaries in which we exercise control. Investments in
which we exercise significant influence, but which we do not control, are
accounted for under the equity method of accounting. The equity method of
accounting is used when we have a 20% to 50% interest in other entities, except
for variable interest entities for which we are considered the primary
beneficiary under Financial Accounting Standards Board ("FASB") Interpretation
No. 46, "Consolidation of Variable Interest Entities," an interpretation of ARB
No. 51. Under the equity method, original investments are recorded at cost and
adjusted by our share of undistributed earnings or losses of these entities. All
significant intercompany transactions and balances have been eliminated from the
Consolidated Financial Statements.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Significant estimates used by us in
preparation of the Consolidated Financial Statements include: (i) allowance for
returns, discounts and bad debts, (ii) inventory, (iii) valuation of long lived,
intangible assets, and goodwill, (iv) income taxes, and (v) debt covenants.
Actual results could differ from those estimates.
Assets and liabilities of our Mexico and Hong Kong subsidiaries are
translated at the rate of exchange in effect on the balance sheet date; income
and expenses are translated at the average rates of exchange prevailing during
the respective periods. The functional currency in which we transact business in
Hong Kong is the Hong Kong dollar and in Mexico is the peso.
Foreign currency gains and losses resulting from translation of assets
and liabilities are included in other comprehensive income (loss). Transaction
gains or losses, other than inter-company debt deemed to be of a long-term
nature, are included in net income (loss) in the period in which they occur.
6
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Certain 2003 amounts have been reclassified to conform to the 2004
presentation.
3. STOCK BASED COMPENSATION
We have adopted the disclosure provisions of Statement of Financial
Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation
- - Transition and Disclosure," an amendment of FASB Statement No. 123. This
pronouncement requires prominent disclosures in both annual and interim
financial statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We account
for stock compensation awards under the intrinsic value method of Accounting
Principles Board ("APB") Opinion No. 25, rather than the alternative fair-value
accounting method. Under the intrinsic-value method, if the exercise price of
the employee's stock options equals the market price of the underlying stock on
the date of the grant, no compensation expense is recognized. For the three
months ended March 31, 2004 and 2003, $54,000 and $0 was recorded, respectively,
as an expense related to our stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Our pro forma
information follows:
THREE MONTHS ENDED MARCH 31,
---------------------------
2004 2003
----------- -----------
Net loss as reported ........................... $(2,973,531) $(3,878,929)
Add stock-based employee compensation
charges report in net loss ................... 53,679 --
Less total stock-based employee compensation
expense, determined under the fair value
method ....................................... (1,344,072) (972,542)
----------- -----------
Pro forma net loss ............................. $(4,263,924) $(4,851,471)
=========== ===========
Pro forma loss per share - Basic and Diluted ... $ (0.15) $ (0.31)
Net loss per share as reported -- Basic and
Diluted ........................................ $ (0.10) $ (0.24)
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 2004 and 2003: weighted-average volatility
factors of the expected market price of our common stock of 0.51 and 0.65 for
the three months ended March 31, 2004 and 2003, respectively, weighted-average
risk-free interest rates of 3% and 4% for the three months ended March 31, 2004
and 2003, respectively, dividend yield of 0% and weighted-average expected life
of the options of 4 years. These pro forma results may not be indicative of the
future results for the full fiscal year due to potential grants, vesting and
other factors.
4. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
United States trade accounts
receivable ............................ $ 29,021,255 $ 30,729,774
Foreign trade accounts receivable ........ 20,947,760 24,528,500
Due from factor .......................... 635,797 955,534
Other receivables ........................ 5,250,309 5,178,501
Allowance for returns, discounts
and bad debts ......................... (4,519,312) (4,226,383)
------------ ------------
$ 51,335,809 $ 57,165,926
============ ============
7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. INVENTORY
Inventory consists of the following:
MARCH 31, DECEMBER 31,
2004 2003
----------- -----------
Raw materials - fabric and trim accessories ...... $ 3,664,848 $ 5,859,558
Work-in-process .................................. 639,523 1,094,786
Finished goods shipments-in-transit .............. 5,946,871 7,522,464
Finished goods ................................... 9,411,771 8,774,783
----------- -----------
$19,663,013 $23,251,591
=========== ===========
6. DEBT
Short-term bank borrowings consist of the following:
MARCH 31, DECEMBER 31,
2004 2003
----------- -----------
Import trade bills payable ................. $ 3,930,375 $ 3,113,030
Bank direct acceptances .................... 17,973,084 12,660,945
Other Hong Kong credit facilities .......... 4,536,083 11,375,363
Other Mexican credit facilities ............ 1,402,637 2,143,985
----------- -----------
$27,842,179 $29,293,323
=========== ===========
Long-term obligations consist of the following:
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
Vendor financing ................... $ 2,236,978 $ 3,971,490
Equipment financing ................ 2,623,881 3,710,355
Debt facility ...................... 24,576,701 31,611,667
------------ ------------
29,437,560 39,293,512
Less current portion ............... (28,878,196) (38,705,240)
------------ ------------
$ 559,364 $ 588,272
============ ============
IMPORT TRADE BILLS PAYABLE AND BANK DIRECT ACCEPTANCES
On June 13, 2002, we entered into a letter of credit facility of $25
million with UPS Capital Global Trade Finance Corporation ("UPS") to replace the
credit facility of The Hong Kong and Shanghai Banking Corporation Limited in
Hong Kong. Under this facility, we may arrange for the issuance of letters of
credit and acceptances. The facility is a one-year facility subject to renewal
on its anniversary and is collateralized by the shares and debentures of all of
our subsidiaries in Hong Kong, as well as our permanent quota holdings in Hong
Kong. In addition to the guarantees provided by Tarrant Apparel Group and our
subsidiaries, Fashion Resource (TCL) Inc. and Tarrant Luxembourg Sarl, Gerard
Guez, our Chairman, also signed a guarantee of $5 million in favor of UPS to
secure this facility. This facility bears interest at 4.5% per annum at March
31, 2004. Under this facility, we are subject to certain restrictive covenants,
including that we maintain a specified tangible net worth, fixed charge ratio,
and leverage ratio. In May 2004, we established new financial covenants with UPS
for the fiscal year of 2004. Tangible net worth, fixed charge ratio and leverage
ratio for the first quarter of 2004 were fixed at $80 million, 0.25 to 1 and
1.50 to 1, respectively. Capital expenditures are capped at $700,000 per
quarter. As of March 31, 2004, we were in compliance with these covenants. In
December 2003, a temporary additional line of credit consisting of a $2.8
million standby letter of credit was made available to us against a restricted
deposit of $2.8 million. This temporary facility was cancelled in February 2004
and the deposit had since been released. The expiration date of our main credit
facility with UPS has been extended to December 31, 2004, subject to certain
conditions. One of the conditions requires that on or before May 31, 2004, we
must refinance the debt facility currently provided by GMAC Commercial Credit
LLC. If we fail to satisfy this condition, we will incur a penalty of $100,000
payable to UPS. As of March 31, 2004, $24.6 million was outstanding under this
facility, and an additional $50,000 was available for future borrowings. In
addition, $0.4 million of open letters of credit were outstanding as of March
31, 2004.
8
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Since March 2003, DBS Bank (Hong Kong) Limited (formerly known as Dao
Heng Bank) has made available a letter of credit facility of up to HKD 20
million (equivalent to US $2.6 million) to our subsidiaries in Hong Kong. This
is a demand facility and is secured by the pledge of our office property owned
by Gerard Guez, our Chairman, and Todd Kay, our Vice Chairman, and by our
guarantee. The letter of credit facility was increased to HKD 23 million
(equivalent to US $3.0 million) in August 2003. As of March 31, 2004, $1.4
million was outstanding under this facility. In addition, $1.6 million of open
letters of credit were outstanding as of March 31, 2004. In December 2003, a tax
loan for HKD 2 million (equivalent to US $256,000) was also made available to
our Hong Kong subsidiaries. As of March 31, 2004, $194,000 was outstanding under
this loan.
OTHER MEXICAN CREDIT FACILITIES
As of March 31, 2004, Tarrant Mexico S. de R.L. de C.V., Famian
division was indebted to Banco Nacional de Comercio Exterior SNC in the amount
of $1.4 million pursuant to a credit facility assumed by Tarrant Mexico
following its merger with Grupo Famian. We are currently repaying $250,000 plus
interest (LIBOR plus 6%) monthly on this facility.
VENDOR FINANCING
During 2000, we financed equipment purchases for a manufacturing
facility with certain vendors. A total of $16.9 million was financed with
five-year promissory notes, which bear interest ranging from 7.0% to 7.5%, and
are payable in semi-annual payments, which commenced in February 2000. Of this
amount, $2.2 million was outstanding as of March 31, 2004. Of the $2.2 million,
$1.4 million was denominated in Euros and the remainder was payable in U.S.
dollars. We are subject to foreign exchange risk resulting from the fluctuation
of the Euro. An unrealized gain of $543,000 and an unrealized loss of $264,000
were recorded for the three months ended March 31, 2004 and 2003, respectively,
related to this fluctuation and were recorded in other income and other expense
in the accompanying financial statements.
From time to time, we open letters of credit under an uncommitted
credit arrangement with Aurora Capital Associates, which issues these credits
through Israeli Discount Bank. As of March 31, 2004, $889,000 was outstanding
under this facility and $3.1 million of letters of credit were open under this
arrangement.
EQUIPMENT FINANCING
We have an equipment loan with an initial borrowing of $16.25 million
from GE Capital Leasing ("GE Capital"), which matures in November 2005. The loan
is secured by equipment located in Puebla and Tlaxcala, Mexico. As of March 31,
2004, this facility had a balance of $2.5 million. Interest accrues at a rate of
2.5% over LIBOR. Under this facility, we are subject to covenants on tangible
net worth of $30 million, leverage ratio of not more than two times at the end
of each financial year, and no losses for two consecutive quarters. As of March
31, 2004, we were in compliance with these covenants. The waiver for breach of
covenants in 2003 required additional collateral in the form of a second lien on
our headquarters, which is owned by Gerard Guez, and Todd Kay. Due to an
objection by the first-lien holder to the second lien, we have agreed to
accelerate the monthly repayment installment by approximately $75,000 commencing
January 2004 in lieu of the additional collateral. In addition, there was
approximately $100,000 of notes payable to various vendors.
DEBT FACILITY
We are party to a revolving credit, factoring and security agreement
(the "Debt Facility") with GMAC Commercial Credit, LLC. The Debt Facility
provided a revolving facility of $90 million, including a letter of credit
facility not to exceed $20 million, and matures on January 31, 2005. The Debt
Facility also provided a term loan of $25 million, which is being repaid in
monthly installments of $687,500. The amount we can borrow under the Debt
Facility is determined based on a defined borrowing base formula related to
eligible accounts receivable and inventories. The Debt Facility provides for
interest at LIBOR plus the LIBOR rate margin determined by the Total Leverage
Ratio (as defined), and is collateralized by our receivables, intangibles,
inventory and various other specified non-equipment assets. This facility bears
interest at 6% per annum at March 31, 2004. Under the facility, we are subject
to various financial covenants on tangible net worth, interest coverage, fixed
charge ratio and leverage ratio, and are prohibited from paying dividends. In
May 2004, the maximum facility amount was reduced to $45 million in total and we
established new financial covenants with GMAC for the fiscal year of 2004.
Tangible net worth, fixed charge ratio and leverage ratio for the first quarter
of 2004 were fixed at $80 million, 0.25 to 1 and 1.50 to 1, respectively. The
fixed charge ratio
9
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
increases to 1.0 to 1.0 at June 30, 2004; 1.25 to 1.0 at September 30, 2004 and
2.0 to 1.0 at December 31, 2004. Capital expenditures are capped at $700,000 per
quarter. As of March 31, 2004, we were in compliance with all the covenants. A
total of $24.6 million (of which $3.4 million related to the term portion) was
outstanding under the Debt Facility at March 31, 2004. Based on the borrowing
base formula, no additional amounts were available for borrowing under the Debt
Facility at March 31, 2004.
The Debt Facility with GMAC and the credit facilities with UPS and GE
Capital all carry cross-default clauses. A breach of a financial covenant set by
GMAC, UPS or GE Capital constitutes an event of default under all of the credit
facilities, entitling these financial institutions to demand payment in full of
all outstanding amounts under their respective debt and credit facilities.
GUARANTEES
Guarantees have been issued since 2001 in favor of YKK, Universal
Fasteners, and RVL Inc. for $750,000, $500,000 and an unspecified amount,
respectively, to cover trim purchased by Tag-It Pacific Inc. on our behalf. We
have not reported a liability for these guarantees. We issued the guarantees to
cover trim purchased by Tag-it in order to ensure our production in a timely
manner. If Tag-it ever defaults, we would have to pay the outstanding liability
due to these vendors by Tag-it for purchases made on our behalf. We have not had
to perform under these guarantees since inception. It is not predictable to
estimate the fair value of the guarantee; however, we do not anticipate that we
will incur losses as a result of these guarantees. As of March 31, 2004, Tag-It
Pacific Inc. had approximately $18,000 due to RVL Inc.
7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 addresses when a company
should consolidate in its financial statements the assets, liabilities and
activities of a variable interest entity ("VIE"). It defines VIEs as entities
that either do not have any equity investors with a controlling financial
interest, or have equity investors that do not provide sufficient financial
resources for the entity to support its activities without additional
subordinated financial support. FIN 46 also requires disclosures about VIE's
that a company is not required to consolidate, but in which it has a significant
variable interest. The consolidation requirements of FIN 46 applied immediately
to variable interest entities created after January 31, 2003. We have not
obtained an interest in a VIE subsequent to that date. A modification to FIN 46
(FIN 46(R)) was released in December 2003. FIN 46(R) delayed the effective date
for VIEs created before February 1, 2003, with the exception of special-purpose
entities ("SPE"), until the first fiscal year or interim period ending after
March 15, 2004. FIN 46(R) delayed the effective date for SPEs until the first
fiscal year or interim period after December 15, 2003. We are not the primary
beneficiary of any SPEs at December 31, 2003. We adopted FIN 46(R) for non-SPE
entities as of March 31, 2004. The adoption of FIN 46 did not result in the
consolidation of any VIEs, nor is the adoption of FIN 46(R) expected to result
in the consolidation of any VIEs. We are continuing to evaluate the impact of
FIN 46(R) will have on our financial statements.
8. INCOME TAXES
Our effective tax rate differs from the statutory rate principally due
to the following reasons: (1) A full valuation allowance has been provided for
deferred tax assets as a result of the operating losses in the United States and
Mexico, since recoverability of those assets has not been assessed as more
likely than not; (2) Although we have taxable losses in Mexico, we are subject
to a minimum tax; and (3) The earnings of our Hong Kong subsidiary are taxed at
a rate of 17.5% versus the 35% U.S. federal rate.
In January 2004, the Internal Revenue Service completed its examination
of our Federal income tax returns for the years ended December 31, 1996 through
2001. The IRS has proposed adjustments to increase our income tax payable for
the six years under examination by an aggregate of approximately $14.5 million.
This adjustment would also result in additional state taxes and interest of
approximately $12.6 million. We believe that we have meritorious defenses to and
intend to vigorously contest the proposed adjustments. If the proposed
adjustments are upheld through the administrative and legal process, they could
have a material impact on our earnings and cash flow. We believe we have
provided adequate reserves for any reasonably foreseeable outcome related to
these matters on the balance sheet included in the Consolidated Financial
Statements under the caption "Income Taxes". We do not believe that the
adjustments, if any, arising from the IRS examination, will result in an
additional income tax liability beyond what is recorded in the accompanying
balance sheet.
10
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. LOSS PER SHARE AND EQUITY
A reconciliation of the numerator and denominator of basic earnings per
share and diluted earnings per share is as follows:
THREE MONTHS ENDED MARCH 31,
--------------------------------
Basic and Diluted EPS Computation: 2004 2003
-------------- --------------
Numerator.............................. $ (2,973,531) $ (3,878,929)
Denominator:
Weighted average common shares
outstanding - Basic and Diluted..... 28,485,093 15,837,327
Basic and Diluted EPS.................. $ (0.10) $ (0.24)
============== =============
Basic and diluted loss per share has been computed in accordance with
SFAS No. 128, "Earnings Per Share." Options and warrants to purchase a total of
9,849,019 shares and 6,354,987 shares have been excluded from the computation in
the three months ended March 31, 2004 and 2003, respectively, as the impact
would be anti-dilutive.
In January 2004, we sold an aggregate of 1,200,000 shares of our common
stock at a price of $3.35 per share, for aggregate proceeds to us of
approximately $3.7 million after payment of placement agent fees and other
offering expenses. We used the proceeds of this offering for working capital
purposes. The securities sold in the offering were registered under the
Securities Act of 1933, as amended, pursuant to our effective shelf registration
statement. In conjunction with this public offering, we issued a warrant to
purchase 30,000 shares of our common stock to the placement agent. This warrant
has an exercise price of $3.35 per share, is fully vested and exercisable and
has a term of five years. The warrant was valued using the Black-Scholes option
valuation model with the following assumptions: risk-free interest rate of 3%;
dividend yields of 0%; volatility factors of the expected market price of
warrants of 0.51; and an expected life of four years.
10. RELATED PARTY TRANSACTIONS
As of March 31, 2004, related party affiliates were indebted to us in
the amount of $17.5 million. This amount included various employee receivables
totaling $450,000 at March 31, 2004. Amount due from our shareholder and officer
was $4.8 million at March 31, 2004 which has been shown as reductions to
shareholders' equity in the accompanying financial statements. Total interest
paid by related party affiliates, the Chairman and the Vice Chairman were
$93,000 and $84,000 for the three months ended March 31, 2004 and 2003,
respectively.
From time to time, we have borrowed funds from, and advanced funds to,
certain officers and principal shareholders, including Messrs. Guez and Kay. The
maximum amount of such advances to Mr. Guez in the first quarter of 2004 was
approximately $4,796,000. Mr. Guez had an outstanding advance from us in the
amount of $4,795,000 as of March 31, 2004. All advances to, and borrowings from,
Mr. Guez and Mr. Kay in 2004 bore interest at the rate of 7.75%. All existing
loans to officers and directors before July 30, 2002 are grandfathered under the
Sarbanes-Oxley Act of 2002. No further personal loans will be made to officers
and directors in compliance with the Sarbanes-Oxley Act.
Since June 2003, United Apparel Ventures, LLC has been selling to Seven
Licensing Company, LLC ("Seven Licensing"), jeans wear bearing the brand
"Seven7", which is ultimately purchased by Express. Seven Licensing is
beneficially owned by Gerard Guez. Total sales to Seven Licensing in the three
months ended March 31, 2004 was $2.2 million. In 1998, a California limited
liability company owned by our Chairman and Vice Chairman purchased 2,300,000
shares of the common stock of Tag-It Pacific, Inc. ("Tag-It") (or approximately
37% of such common stock then outstanding). Tag-It is a provider of brand
identity programs to manufacturers and retailers of apparel and accessories.
Starting from 1998, Tag-It assumed the responsibility for managing and sourcing
all trim and packaging used in connection with products manufactured by or on
behalf of us in Mexico. This arrangement is terminable by Tag-It or us at any
time. We believe that the terms of this arrangement, which is subject to the
acceptance of our customers, are no less favorable to us than could be obtained
from unaffiliated third parties. We purchased
11
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
$200,000 and $4.2 million of trim inventory from Tag-It in the three months
ended March 31, 2004 and 2003, respectively. We purchased $4.1 million and $9.7
million of finished goods and services from Azteca and its affiliates in the
three months ended March 31, 2004 and 2003, respectively. Our total sales of
fabric and services to Azteca in the three months ended March 31, 2004 and 2003
were $586,000 and $3.1 million, respectively. Two and one half percent of gross
sales as management fees were paid in the three months ended March 31, 2004 to
each of the members of UAV, per the operating agreement. The amount paid to
Azteca, the minority member of UAV, totaled $121,000 and $481,000 in the three
months ended March 31, 2004 and 2003, respectively. Net amounts due from these
related parties as of March 31, 2004 was $17.0 million.
On October 16, 2003, we entered into a lease with affiliates of Mr.
Kamel Nacif, one of our shareholders, a substantial portion of our manufacturing
facilities and operations in Mexico including real estate and equipment. The
lease was effective as of September 1, 2003. We leased our twill mill in
Tlaxcala, Mexico, and our sewing plant in Ajalpan, Mexico, for a period of 6
years and for an annual rental fee of $11 million. The assets subject to these
leases have a net book value of approximately $91 million as of March 31, 2004.
In connection with this transaction, we also entered into a management services
agreement pursuant to which Mr. Nacif's affiliates will manage the operation of
our remaining facilities in Mexico. The term of the management services
agreement is also for a period of 6 years. In the three months ended March 31,
2004, $2.8 million of lease income was recorded in other income. Additionally,
we entered into a purchase commitment agreement with Mr. Nacif's affiliates to
purchase annually, six million yards of fabric manufactured at the facilities
leased and/or operated by Mr. Nacif's affiliates at market prices to be
negotiated. Using current market prices, the purchase commitment would be
approximately $19 million per year. We purchased $1.5 million of fabric from
Acabados y Terminados, an affiliate of Mr. Nacif, in the three months ended
March 31, 2004. We were indebted to Mr. Kamel Nacif and his affiliates in the
amount of $1.4 million as of March 31, 2004.
Under lease agreements entered into between two entities owned by Mr.
Guez, our Chairman, Mr. Kay, our Vice Chairman and us, we paid $332,000 in each
of the three months ended March 31, 2004 and 2003 for rent for office and
warehouse facilities. One of these lease agreements expires in June 2004. The
second lease currently is on a month-to-month basis pending our planned
relocation.
We reimbursed our principal shareholder for fuel and related expenses
whenever our executives used the aircraft for business purposes from 477
Aviation LLC, which is wholly owned by our principal shareholder.
In the second quarter of 2003, we acquired a 45% equity interest in the
owner of the trademark "American Rag CIE" and the operator of American Rag
retail stores for $1.4 million, and our subsidiary, Private Brands, Inc.,
acquired a license to certain exclusive rights to this trademark. The investment
in American Rag, LLC totaling $1.8 million at March 31, 2004 was accounted for
under the equity method and included in other assets.
11. COMMITMENTS AND CONTINGENCIES
In connection with the restructuring of our Mexican operations, and the
resulting reduction in our Mexican work force, we became the target of workers'
rights activists who have picketed our customers, stuffed electronic mailboxes
with inaccurate, protest e-mails, and threatened customers with retaliation for
continuing business with us. While we have defended our position to our
customers, some of our larger customers for Mexico-produced jeans wear have been
reluctant to place orders with us in response to actions taken and contemplated
by these activist groups. As a consequence, we project a loss of approximately
$75 million in revenue from sales of Mexico-produced merchandise in 2004.
12
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
12. OPERATIONS BY GEOGRAPHIC AREAS
Our predominant business is the design, distribution and importation of
private label and private brand casual apparel. Substantially all of our
revenues are from the sales of apparel. We are organized into three geographic
regions: the United States, Asia and Mexico. We evaluate performance of each
region based on profit or loss from operations before income taxes not including
the cumulative effect of change in accounting principles. Information about our
operations in the United States, Asia, and Mexico is presented below.
Inter-company revenues and assets have been eliminated to arrive at the
consolidated amounts.
ADJUSTMENTS
AND
UNITED STATES ASIA MEXICO ELIMINATIONS TOTAL
------------ ------------ ------------ ------------ ------------
THREE MONTHS ENDED
MARCH 31, 2004
Sales ....................... $ 39,162,000 $ 797,000 $ 2,196,000 $ -- $ 42,155,000
Inter-company sales ......... -- 18,168,000 4,418,000 (22,586,000) --
------------ ------------ ------------ ------------ ------------
Total revenue ............... $ 39,162,000 $ 18,965,000 $ 6,614,000 $(22,586,000) $ 42,155,000
============ ============ ============ ============ ============
Income (loss) from operations $ (1,726,000) $ 1,040,000 $ (5,235,000) $ -- $ (5,921,000)
============ ============ ============ ============ ============
THREE MONTHS ENDED
MARCH 31, 2003
Sales ....................... $ 71,631,000 $ 1,167,000 $ 5,938,000 $ -- $ 78,736,000
Inter-company sales ......... 2,096,000 29,906,000 8,761,000 (40,763,000) --
------------ ------------ ------------ ------------ ------------
Total revenue ............... $ 73,727,000 $ 31,073,000 $ 14,699,000 $(40,763,000) $ 78,736,000
============ ============ ============ ============ ============
Income (loss) from operations $ (1,095,000) $ 3,645,000 $ (3,860,000) $ -- $ (1,310,000)
============ ============ ============ ============ ============
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
BUSINESS OVERVIEW AND RECENT DEVELOPMENTS
We are a leading provider of casual apparel, serving specialty retail,
mass merchandise and department stores, branded wholesalers and specialty chains
located primarily in the United States by designing, merchandising, contracting
for the manufacture of, manufacturing directly and selling casual apparel for
women, men and children. Our major customers include specialty retailers, such
as Express, a division of The Limited, as well as Lerner New York, J.C. Penney,
K-Mart, Kohl's, Mervyns, and Wal-Mart. Our products are manufactured in a
variety of woven and knit fabrications and include jeans wear, casual pants,
t-shirts, shorts, blouses, shirts and other tops, dresses and jackets.
During 2003, we launched our private brands initiative, where we
acquire ownership of or exclusively license rights to a brand name and sell
apparel products under this brand to a single retail company within a geographic
region. In the second quarter of 2003, we acquired an equity interest in the
owner of the trademark "American Rag CIE," and the operator of American Rag
retail stores, and our subsidiary, Private Brands, Inc., acquired a license to
certain exclusive rights to this trademark. Private Brands then entered into a
multi-year exclusive distribution agreement with Federated Merchandising Group
("FMG"), the sourcing arm of Federated Department Stores, to supply FMG with
American Rag CIE, a new casual sportswear collection for juniors and young men.
Private Brands designs and manufactures a full collection of American Rag
apparel exclusively for sale in Federated stores across the country. Currently,
the American Rag collection is available in approximately 160 select Macy's, the
Bon Marche, Burdines, Goldsmith's, Lazarus and Rich's-Macy's locations. During
2003, we also began selling products under our own brand "No Jeans" exclusively
to Wet Seal, and on April 1, 2004, we entered into a license agreement with
Cynthia Rowley to manufacture, market and distribute Cynthia Rowley branded
jeanswear for women.
In connection with the restructuring of our Mexican operations, and the
resulting reduction in our Mexican work force, we became the target of workers'
rights activists who have picketed our customers, stuffed electronic mailboxes
with inaccurate, protest e-mails, and threatened customers with retaliation for
continuing business with us. While we have defended our position to our
customers, some of our larger customers for Mexico-produced jeans wear have been
reluctant to place orders with us in response to actions taken and contemplated
by these activist groups. As a consequence, we experienced a significant decline
in revenue from sales of Mexico-produced merchandise during the first quarter of
2004. We anticipate that this decline in revenue will continue during the
remainder of fiscal 2004, resulting in a projected loss of approximately $75
million in revenue from sales of Mexico-produced merchandise in 2004.
In January 2004, we sold an aggregate of 1,200,000 shares of our common
stock at a price of $3.35 per share, for aggregate proceeds to us of
approximately $3.7 million after payment of placement agent fees and other
offering expenses. We used the proceeds of this offering for working capital
purposes. The securities sold in the offering were registered under the
Securities Act of 1933, as amended, pursuant to our effective shelf registration
statement. In conjunction with this public offering, we issued a warrant to
purchase 30,000 shares of our common stock to the placement agent; the warrant
has an exercise price of $3.35 per share, is fully vested and exercisable and
has a term of five years.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of our financial condition and
results of operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosures
of contingent assets and liabilities. On an ongoing basis, we evaluate
estimates, including those related to returns, discounts, bad debts,
inventories, intangible assets, income taxes, and contingencies and litigation.
We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
14
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. For a further discussion on the application of these and
other accounting policies, see Note 1 to our audited consolidated financial
statements included in our Annual Report on Form 10-K for the year ended
December 31, 2003.
ACCOUNTS RECEIVABLE--ALLOWANCE FOR RETURNS, DISCOUNTS AND BAD DEBTS
We evaluate the collectibility of accounts receivable and charge backs
(disputes from the customer) based upon a combination of factors. In
circumstances where we are aware of a specific customer's inability to meet its
financial obligations (such as in the case of bankruptcy filings or substantial
downgrading of credit sources), a specific reserve for bad debts is taken
against amounts due to reduce the net recognized receivable to the amount
reasonably expected to be collected. For all other customers, we recognize
reserves for bad debts and charge backs based on our historical collection
experience. If collection experience deteriorates (for example, due to an
unexpected material adverse change in a major customer's ability to meet its
financial obligations to us), the estimates of the recoverability of amounts due
us could be reduced by a material amount.
As of March 31, 2004, the balance in the allowance for returns,
discounts and bad debts reserves was $4.5 million.
INVENTORY
Our inventories are valued at the lower of cost or market. Under
certain market conditions, we use estimates and judgments regarding the
valuation of inventory to properly value inventory. Inventory adjustments are
made for the difference between the cost of the inventory and the estimated
market value and charged to operations in the period in which the facts that
give rise to the adjustments become known.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We assess the impairment of identifiable intangibles, long-lived assets
and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors considered important that could
trigger an impairment review include, but are not limited to, the following:
o a significant underperformance relative to expected historical
or projected future operating results;
o a significant change in the manner of the use of the acquired
asset or the strategy for the overall business; or
o a significant negative industry or economic trend.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets." According to this
statement, goodwill and other intangible assets with indefinite lives are no
longer subject to amortization, but rather an annual assessment of impairment
applied on a fair-value-based test.
We utilized the discounted cash flow methodology to estimate fair
value. As of March 31, 2004, we have a goodwill balance of $8.6 million, and a
net property and equipment balance of $132.8 million. Our goodwill balance
reflects the write off of $19.5 million of goodwill in 2003.
INCOME TAXES
As part of the process of preparing our consolidated financial
statements, management is required to estimate income taxes in each of the
jurisdictions in which we operate. The process involves estimating actual
current tax expense along with assessing temporary differences resulting from
differing treatment of items for book and tax purposes. These timing differences
result in deferred tax assets and liabilities, which are included in our
consolidated balance sheet. Management records a valuation allowance to reduce
our net deferred tax assets to the amount that is more likely than not to be
realized. Management has considered future taxable income and ongoing
15
tax planning strategies in assessing the need for the valuation allowance.
Increases in the valuation allowance result in additional expense to be
reflected within the tax provision in the consolidated statement of operations.
In addition, accruals are also estimated for ongoing audits regarding
U.S. Federal tax issues that are currently unresolved, based on our estimate of
whether, and the extent to which, additional taxes will be due. We routinely
monitor the potential impact of these situations and believe that amounts are
properly accrued for. If we ultimately determine that payment of these amounts
is unnecessary, we will reverse the liability and recognize a tax benefit during
the period in which we determine that the liability is no longer necessary. We
will record an additional charge in our provision for taxes in any period we
determine that the original estimate of a tax liability is less than we expect
the ultimate assessment to be. See Note 8 of the "Notes to Consolidated
Financial Statements" for a discussion of current tax matters.
DEBT COVENANTS
Our debt agreements require the maintenance of certain financial ratios
and a minimum level of net worth as discussed in Note 6 to our Consolidated
Financial Statements. If our results of operations erode and we are not able to
obtain waivers from the lenders, the debt would be in default and callable by
our lenders. In addition, due to cross-default provisions in a majority of the
debt agreements, approximately 83% of our long-term debt would become due in
full if any of the debt is in default. In anticipation of us not being able to
meet the required covenants due to various reasons, we either negotiate for
changes in the relative covenants or obtain an advance waiver or reclassify the
relevant debt as current. We also believe that our lenders would provide waivers
if necessary. However, our expectations of future operating results and
continued compliance with other debt covenants cannot be assured and our
lenders' actions are not controllable by us. If projections of future operating
results are not achieved and the debt is placed in default, we would be required
to reduce our expenses, by curtailing operations, and to raise capital through
the sale of assets, issuance of equity or otherwise, any of which could have a
material adverse effect on our financial condition and results of operations.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in our consolidated statements of operations as a percentage of net sales:
THREE MONTHS
ENDED MARCH 31,
---------------------
2004 2003
------- -------
Net sales ........................................ 100.0% 100.0%
Cost of sales .................................... 82.2 88.8
------- -------
Gross profit ..................................... 17.8 11.2
Selling and distribution expenses ................ 6.3 3.4
General and administration expenses .............. 25.5 9.4
------- -------
Loss from operations ............................. (14.0) (1.6)
Interest expense ................................. (1.9) (1.9)
Interest income .................................. 0.2 0.1
Other income ..................................... 8.3 0.4
Other expense .................................... (0.9) (0.4)
Minority interest ................................ 2.1 (0.3)
------- -------
Loss before taxes and ............................ (6.2) (3.7)
cumulative effect of accounting change
Income taxes ..................................... 0.9 1.2
------- -------
Net loss ......................................... (7.1)% (4.9)%
======= =======
FIRST QUARTER 2004 COMPARED TO FIRST QUARTER 2003
Net sales decreased by $36.6 million, or 46.5%, to $42.2 million in
first quarter of 2004 from $78.7 million in the first quarter of 2003. The
decrease in net sales was caused primarily by a decline in Mexico based sales
resulting from the cessation of our manufacturing operations in Mexico in
September 2003 and the resulting labor difficulties we experienced following the
reduction in our Mexico work force. Some of our larger customers for
Mexico-produced jeans wear did not place orders with us during the first quarter
of 2004 in response to actions taken and contemplated by workers' rights
activists.
16
Gross profit consists of net sales less product costs, direct labor,
manufacturing overhead, duty, quota, freight in, brokerage, and warehousing.
Gross profit decreased by $1.3 million to $7.5 million in the first quarter of
2004 from $8.8 million in the first quarter of 2003. The decrease in gross
profit occurred primarily because of the decrease in sales volume, partially
offset by a reclassification of depreciation and amortization of our Mexico
assets of $3.4 million in the first quarter of 2004 from cost of goods sold to
general and administrative expenses. The reclassification was due to our
cessation of direct manufacturing in Mexico and the lease of our Mexico assets.
As a percentage of net sales, gross profit increased from 11.2% in the first
quarter of 2003 to 17.8% in the first quarter of 2004 primarily due to this
reclassification of depreciation and amortization of our Mexico assets.
Selling and distribution expenses decreased by $87,000, or 3.2%, to
$2.6 million in the first quarter of 2004 from $2.7 million in the first quarter
of 2003. As a percentage of net sales, these expenses increased to 6.3% in the
first quarter of 2004 from 3.5% in the first quarter of 2003 primarily due to
fixed expenses incurred.
General and administrative expenses increased by $3.4 million, or
46.0%, to $10.8 million in the first quarter of 2004 from $7.4 million in the
first quarter of 2003. The increase was caused by the reclassification of
depreciation and amortization of our Mexico assets of $3.4 million from cost of
goods sold. As a percentage of net sales, these expenses increased to 25.6% in
the first quarter of 2004 from 9.4% in the first quarter of 2003 due to the
increase in general and administrative expenses and the significant decline in
sales during the first quarter of 2004.
Operating loss in the first quarter of 2004 was $5.9 million, or 14.0%
of net sales, compared to $1.3 million, or 1.7% of net sales, in the comparable
period of 2003, because of the factors discussed above.
Interest expense decreased by $699,000, or 46.8%, to $794,000 in the
first quarter of 2004 from $1.5 million in the first quarter of 2003 due to a
reduction in the average debt balance outstanding resulting from debt repayment
following our equity financing transactions in late 2003 and January 2004. As a
percentage of net sales, these expenses remained as 1.9%. Interest income was
$94,000 in the first quarter of 2004, compared to $87,000 in the first quarter
of 2003. Other income was $3.5 million in the first quarter of 2004, compared to
$316,000 in the first quarter of 2003, due primarily to $2.8 million of lease
income received for the lease of our facilities and equipment in Mexico and an
unrealized gain on foreign currency of $543,000 in the first quarter of 2004.
Other expense was $359,000 in the first quarter of 2004, compared to $326,000 in
the first quarter of 2003.
Losses allocated to minority interests in the first quarter of 2004 was
$881,000, representing the minority partner's share of losses in UAV totaling
$223,000, and the minority shareholder in Tarrant Mexico for his 25% share in
the loss totaling $658,000. In the first quarter of 2003, we allocated $236,000
of profit to minority interest representing the minority partner's share of
profit in UAV for $1.3 million, offset by $1.0 million attributed to the
minority shareholder in Tarrant Mexico for his 25% share in the loss.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity requirements arise from the funding of our working
capital needs, principally inventory, finished goods shipments-in-transit,
work-in-process and accounts receivable, including receivables from our contract
manufacturers that relate primarily to fabric we purchase for use by those
manufacturers. Our primary sources for working capital and capital expenditures
are cash flow from operations, borrowings under our bank and other credit
facilities, borrowings from principal shareholders, issuance of long-term debt,
sales of equity securities, borrowing from affiliates and the proceeds from the
exercise of stock options.
Our liquidity is dependent, in part, on customers paying on time. Any
abnormal charge backs or returns may affect our source of short-term funding. We
are also subject to market price changes. Any changes in credit terms given to
major customers may have an impact on our cash flow. Suppliers' credit is
another major source of short-term financing and any adverse changes in their
terms will have negative impact on our cash flow.
During the first three months of 2004, net cash provided by operating
activities was $4.9 million, as compared to net cash used by operating
activities of $8.5 million for the same period in 2003. Net cash provided by
operating activities in the first quarter of 2004 was the result of the
operating loss of $3.0 million and increases of $2.6 million in temporary quota
rights and $3.0 million in accrued expenses and income tax payable, offset by
17
depreciation and amortization of $3.8 million and decreases of $5.6 million in
accounts receivable, $3.6 million in inventory and $2.9 million in accounts
payable.
During the first three months of 2004, net cash used in investing
activities was $349,000, as compared to cash of $48,000 provided by investing
activities for the same period in 2003. Cash used in investing activities in the
first quarter 2004 included approximately $327,000 of increase in other assets.
During the first three months of 2004, net cash used in financing
activities was $7.1 million, as compared to $7.5 million of net cash provided by
financing activities for the same period in 2003. Cash used in financing
activities in 2004 included $3.7 million of proceeds from issuance of common
stock and $27.7 million of proceeds from long-term obligations, offset by $37.0
million of payments of long-term obligations and bank borrowings.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Following is a summary of our contractual obligations and commercial
commitments available to us as of March 31, 2004 (in millions):
PAYMENTS DUE BY PERIOD
----------------------------------------------------
CONTRACTUAL OBLIGATIONS Total Less than Between Between After
1 year 2-3 years 4-5 years 5 years
- ----------------------------------- ------ --------- --------- --------- -------
Long-term debt..................... $ 29.4 $28.9 $ 0.5 $ 0 $ 0
Operating leases................... 0.9 0.5 0.3 0.1 0
Minimum royalties.................. 10.0 0.5 1.3 1.7 6.5
Purchase commitment................ 105.6 19.2 38.4 38.4 9.6
Employment contracts............... 3.8 1.8 2.0 0 0
------ --------- --------- --------- -------
Total Contractual Cash Obligations. $149.7 $50.9 $42.5 $40.2 $16.1
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
- ------------------------------------ -------------- --------------------------------------------
TOTAL AMOUNTS LESS
COMMERCIAL COMMITMENTS COMMITTED TO THAN BETWEEN BETWEEN AFTER
AVAILABLE TO US US 1 YEAR 2-3 YEARS 4-5 YEARS 5 YEARS
- ------------------------------------ -------------- --------- --------- --------- -------
Lines of credit................... $ 122.1 $ 121.5 $ 0.6 $ -- $ --
Letters of credit (within
lines of credit)............... $ 27.9 $ 27.9 $ -- $ -- $ --
Total commercial commitments...... $ 122.1 $ 121.5 $ 0.6 $ -- $ --
On June 13, 2002, we entered into a letter of credit facility of $25
million with UPS Capital Global Trade Finance Corporation ("UPS"). Under this
facility, we may arrange for the issuance of letters of credit and acceptances.
The facility is a one-year facility subject to renewal on its anniversary and is
collateralized by the shares and debentures of all of our subsidiaries in Hong
Kong, as well as our permanent quota holdings in Hong Kong. In addition to the
guarantees provided by Tarrant Apparel Group and our subsidiaries, Fashion
Resource (TCL) Inc. and Tarrant Luxembourg Sarl, Gerard Guez, our Chairman, also
signed a guarantee of $5 million in favor of UPS to secure this facility. This
facility bears interest at 4.5% per annum at March 31, 2004. Under this
facility, we are subject to certain restrictive covenants, including that we
maintain a specified tangible net worth, fixed charge ratio, and leverage ratio.
In May 2004, we established new financial covenants with UPS for the fiscal year
of 2004. Tangible net worth, fixed charge ratio and leverage ratio for the first
quarter of 2004 were fixed at $80 million, 0.25 to 1 and 1.50 to 1,
respectively. Capital expenditures are capped at $700,000 per quarter. As of
March 31, 2004, we were in compliance with these covenants. In December 2003, a
temporary additional line of credit consisting of a $2.8 million standby letter
of credit was made available to us against a restricted deposit of $2.8 million.
This temporary facility was cancelled in February 2004 and the deposit had since
been released. The expiration date of our main credit facility with UPS has been
extended to December 31, 2004, subject to satisfaction of certain conditions.
One of the conditions requires that on or before May 31, 2004, we refinance the
Debt Facility currently provided by GMAC Commercial Credit LLC. If we fail to
satisfy this condition, we will incur a penalty of $100,000 payable to UPS. As
of March 31, 2004, $24.6 million was outstanding under this facility with UPS,
and
18
an additional $50,000 was available for future borrowings. In addition, $0.4
million of open letters of credit were outstanding as of March 31, 2004.
Since March 2003, DBS Bank (Hong Kong) Limited (formerly known as Dao
Heng Bank) has made available a letter of credit facility of up to HKD 20
million (equivalent to US $2.6 million) to our subsidiaries in Hong Kong. This
is a demand facility and is secured by the pledge of our office property, which
is owned by Gerard Guez, our Chairman and Todd Kay, our Vice Chairman, and by
our guarantee. In August 2003, the letter of credit facility increased to HKD 23
million (equivalent to US $3.0 million). As of March 31, 2004, $1.4 million was
outstanding under this facility. In addition, $1.6 million of open letters of
credit were outstanding as of March 31, 2004. In December 2003, a tax loan for
HKD 2 million (equivalent to US $256,000) was also made available to our Hong
Kong subsidiaries. As of March 31, 2004, $194,000 was outstanding under this
loan.
We are party to a revolving credit, factoring and security agreement
(the "Debt Facility") with GMAC Commercial Credit, LLC. The Debt Facility
provided a revolving facility of $90 million, including a letter of credit
facility not to exceed $20 million, and matures on January 31, 2005. The Debt
Facility also provided a term loan of $25 million, which is being repaid in
monthly installments of $687,500. The amount we can borrow under the Debt
Facility is determined based on a defined borrowing base formula related to
eligible accounts receivable and inventories. The Debt Facility provides for
interest at LIBOR plus the LIBOR rate margin determined by the Total Leverage
Ratio (as defined in the Debt Facility agreements), and is collateralized by our
receivables, intangibles, inventory and various other specified non-equipment
assets. This facility bears interest at 6% per annum at March 31, 2004. Under
the facility, we are subject to various financial covenants on tangible net
worth, interest coverage, fixed charge ratio and leverage ratio, and are
prohibited from paying dividends. In May 2004, the facility amount was reduced
to $45 million in total and we established new financial covenants with GMAC for
the fiscal year of 2004. Tangible net worth, fixed charge ratio and leverage
ratio for the first quarter of 2004 were fixed at $80 million, 0.25 to 1 and
1.50 to 1, respectively. The fixed charge ratio increases to 1.0 to 1.0 at June
30, 2004; 1.25 to 1.0 at September 30, 2004 and 2.0 to 1.0 at December 31, 2004.
Capital expenditures are capped at $700,000 per quarter. As of March 31, 2004,
we were in compliance with all the covenants. A total of $24.6 million (of which
$3.4 million related to the term portion) was outstanding under the Debt
Facility at March 31, 2004. Based on the borrowing base formula, no additional
amounts were available for borrowing under the Debt Facility at March 31, 2004.
The amount we can borrow under the Debt Facility is determined based on
a defined borrowing base formula related to eligible accounts receivable and
inventories. Our borrowing base availability ranged from approximately $20
million to $30 million from January 1, 2004 to March 31, 2004. A significant
decrease in eligible accounts receivable and inventories due to the aging of
receivables and inventories, among other factors, can have an adverse effect on
our borrowing capabilities under our credit facility, which may adversely affect
the adequacy of our working capital. In addition, we have typically experienced
seasonal fluctuations in sales volume. These seasonal fluctuations result in
sales volume decreases in the first and fourth quarters of each year due to the
seasonal fluctuations experienced by the majority of our customers. During these
quarters, borrowing availability under our credit facility may decrease as a
result of decreases in eligible accounts receivables generated from our sales.
At March 31, 2004, Tarrant Mexico S. de R.L. de C.V., Famian division
is indebted to Banco Nacional de Comercio Exterior SNC in the amount of $1.4
million pursuant to a credit facility assumed by Tarrant Mexico following its
merger with Grupo Famian. We are now repaying $250,000 plus interest (LIBOR plus
6%) monthly on this facility.
We have an equipment loan with an initial borrowing of $16.25 million
from GE Capital Leasing ("GE Capital"), which matures in November 2005. The loan
is secured by equipment located in Puebla and Tlaxcala, Mexico. As of March 31,
2004, this facility had a balance of $2.5 million. Interest accrues at a rate of
2.5% over LIBOR. Under this facility, we are subject to covenants on tangible
net worth of $30 million, leverage ratio of not more than two times at the end
of each financial year, and no losses for two consecutive quarters. As of March
31, 2004, we were in compliance with these covenants. The waiver for breach of
covenants in 2003 required additional collateral in the form of a second lien on
our headquarters, which is owned by Gerard Guez and Todd Kay. Due to an
objection by the first-lien holder to the second lien, we have agreed to
accelerate the monthly repayment installment by approximately $75,000 commencing
January 2004 in lieu of the additional collateral.
19
The Debt Facility with GMAC and the credit facilities with UPS and GE
Capital all carry cross-default clauses. A breach of a financial covenant set by
GMAC, UPS or GE Capital constitutes an event of default under all of the credit
facilities, entitling these financial institutions to demand payment in full of
all outstanding amounts under their respective debt and credit facilities.
During 2000, we financed equipment purchases for a new manufacturing
facility with certain vendors. A total of $16.9 million was financed with
five-year promissory notes, which bear interest ranging from 7.0% to 7.5%, and
are payable in semiannual payments commencing in February 2000. Of this amount,
$2.2 million was outstanding as of March 31, 2004. Of the $2.2 million, $1.4
million was denominated in the Euro, and the remainder was payable in U.S.
dollars.
From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates who issues these letters of credit out
of Israeli Discount Bank. As of March 31, 2004, $889,000 was outstanding under
this facility and $3.1 million of letters of credit were open under this
arrangement.
We have financed our operations from our cash flow from operations,
borrowings under our bank and other credit facilities, issuance of long-term
debt (including debt to or arranged by vendors of equipment purchased for our
Mexican twill and production facility), the proceeds from the exercise of stock
options and from time to time shareholder advances. Our short-term funding
relies very heavily on our major customers, banks, suppliers and major
shareholders. From time to time, we have had temporary over-advances from our
banks. Any withdrawal of support from these parties will have serious
consequences on our liquidity.
From time to time in the past, we borrowed funds from, and advanced
funds to, certain officers and principal shareholders, including Gerard Guez and
Todd Kay. The greatest outstanding balance of such advances to Mr. Guez in the
first quarter of 2004 was approximately $4,796,000. Mr. Guez had an outstanding
advance from us in the amount of $4,795,000 as of March 31, 2004. All advances
to, and borrowings from, Messrs. Guez and Kay bore interest at the rate of 7.75%
during the period. Since the enactment of the Sarbanes-Oxley Act in 2002, no
further personal loans (or amendments to existing loans) have been or will be
made to officers or directors of Tarrant.
We intend to accumulate a cash reserve to meet any payment obligations
we have to taxing authorities relating to the Internal Revenue Services'
examination of our Federal income tax returns for the years ended December 31,
1996 through 2001. We intend to fund this cash reserve from operations, which
will require us to set aside on a periodic basis a significant amount of our
cash, which cannot be used for other purposes. In January 2004, the Internal
Revenue Service completed its examination of our Federal income tax returns for
the years ended December 31, 1996 through 2001. The IRS has proposed adjustments
to increase our income tax payable for the six years under examination by an
aggregate of approximately $14.5 million. This adjustment would also result in
additional state taxes and interest of approximately $12.6 million. We believe
that we have meritorious defenses to and intend to vigorously contest the
proposed adjustments. If the proposed adjustments are upheld through the
administrative and legal process, they could have a material impact on our
earnings and cash flow. We believe we have provided adequate reserves for any
reasonably foreseeable outcome related to these matters on the balance sheet
included in the Consolidated Financial Statements under the caption "Income
Taxes". We do not believe that the adjustments, if any, arising from the IRS
examination, will result in an additional income tax liability beyond what is
recorded in the accompanying balance sheet.
We may seek to finance future capital investment programs through
various methods, including, but not limited to, borrowings under our bank credit
facilities, issuance of long-term debt, sales of equity securities, leases and
long-term financing provided by the sellers of facilities or the suppliers of
certain equipment used in such facilities. To date, there is no plan for any
major capital expenditure.
We do not believe that the moderate levels of inflation in the United
States in the last three years have had a significant effect on net sales or
profitability.
20
RELATED PARTY TRANSACTIONS
We lease our principal offices and warehouse located in Los Angeles,
California and office space in Hong Kong from corporations owned by Gerard Guez,
our Chairman and Chief Executive Officer, and Todd Kay, our Vice Chairman of the
Board of Directors. We believe, at the time the leases were entered into, the
rents on these properties were comparable to then prevailing market rents. We
paid $332,000 in the three months ended March 31, 2004, for rent for office and
warehouse facilities.
On October 16, 2003, we leased to affiliates of Mr. Kamel Nacif, one of
our shareholders, a substantial portion of our manufacturing facilities and
operations in Mexico including real estate and equipment. We leased our twill
mill in Tlaxcala, Mexico, and our sewing plant in Ajalpan, Mexico, for a period
of 6 years and for an annual rental fee of $11 million. The assets subject to
these leases have a net book value of approximately $91 million as of March 31,
2004. In connection with this transaction, we also entered into a management
services agreement pursuant to which Mr. Nacif's affiliates will manage the
operation of our remaining facilities in Mexico in exchange for the use of such
facilities. The term of the management services agreement is also for a period
of 6 years. In the three months ended March 31, 2004, $2.8 million of lease
income was recorded in other income. We have agreed to purchase annually, six
million yards of fabric manufactured at the facilities leased and/or operated by
Mr. Nacif's affiliates at market prices to be negotiated. Based on current
market price, the purchase commitment would be approximately $19 million
annually. We purchased $1.5 million of fabric from Acabados y Terminados, an
affiliate of Mr. Nacif, in the three months ended March 31, 2004. We were
indebted to Mr. Kamel Nacif and his affiliates in the amount of $1.4 million as
of March 31, 2004.
From time to time in the past, we borrowed funds from, and advanced
funds to, certain officers and principal shareholders, including Gerard Guez and
Todd Kay. The greatest outstanding balance of such advances to Mr. Guez in the
first quarter of 2004 was approximately $4,796,000. Mr. Guez had an outstanding
advance from us in the amount of $4,795,000 as of March 31, 2004. All advances
to, and borrowings from, Messrs. Guez and Kay bore interest at the rate of 7.75%
during the period. Since the enactment of the Sarbanes-Oxley Act in 2002, no
further personal loans (or amendments to existing loans) have been or will be
made to officers or directors of Tarrant.
Since June 2003, United Apparel Venture LLC, a majority owned,
controlled and consolidated subsidiary of Tarrant, has been selling to Seven
Licensing Company, LLC, jeans wear bearing the brand "Seven7", which is
ultimately purchased by Express. Seven Licensing is beneficially owned by Gerard
Guez. Total sales in the three months ended March 31, 2004 were $2.2 million.
On July 1, 2001, we formed an entity to jointly market, share certain
risks and achieve economies of scale with Azteca Production International, Inc.
("Azteca"), called United Apparel Ventures, LLC ("UAV"). Azteca Production
International, Inc. is owned by Hubert Guez, the brother of Gerard Guez, our
Chairman and Chief Executive Officer. This entity was created to coordinate the
production of apparel for a single customer of our branded business. UAV is
owned 50.1% by Tag Mex, Inc., a wholly owned subsidiary of ours, and 49.9% by
Azteca. Results of the operation of UAV have been consolidated into our results
since July 2001 with the minority partner's share of all gains and loses
eliminated through the minority interest line in our financial statements. Since
October 2002 and March 2003, UAV has begun to service both parties' business
with Express and Levi Strauss & Co., respectively. UAV makes purchases from two
related parties in Mexico, Azteca and Tag-It Pacific, Inc.
We purchased $4.1 million of finished goods and services from Azteca
and its affiliates in the three months ended March 31, 2004. Our total sales of
fabric and services to Azteca in the three months ended March 31, 2004 were
$586,000. Two and one half percent of gross sales as management fees were paid
in the three months ended March 31, 2004 to each of the members of UAV, per the
operating agreement.
At March 31, 2004, Messrs. Guez and Kay beneficially owned 1,018,000
and 1,005,000 shares, respectively, of common stock of Tag-It Pacific, Inc.
("Tag-It"), collectively representing 17.5% of Tag-It Pacific's common stock at
March 31, 2004. Tag-It is a provider of brand identity programs to manufacturers
and retailers of apparel and accessories. Tag-It assumed the responsibility for
managing and sourcing all trim and packaging used in connection with products
manufactured by or on our behalf in Mexico. This arrangement is terminable by
either Tag-It or us at any time. We believe that the terms of this arrangement,
which is subject to the acceptance of our
21
customers, are no less favorable to us than could be obtained from unaffiliated
third parties. We purchased $200,000 of trim from Tag-It in the three months
ended March 31, 2004. From time to time we have guaranteed the indebtedness of
Tag-It for the purchase of trim on our behalf. See Note 6 of the "Notes to
Consolidated Financial Statements."
We have adopted a policy that any future transactions between us and
any of our affiliates or related parties, including our executive officers,
directors, the family members of those individuals and any of their affiliates,
must (i) be approved by a majority of the members of the Board of Directors and
by a majority of the disinterested members of the Board of Directors and (ii) be
on terms no less favorable to us than could be obtained from unaffiliated third
parties.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report on Form 10-Q contains forward-looking statements,
which are subject to a variety of risks and uncertainties. Our actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below.
RISKS RELATED TO OUR BUSINESS
WE DEPEND ON A GROUP OF KEY CUSTOMERS FOR A SIGNIFICANT PORTION OF OUR SALES. A
SIGNIFICANT ADVERSE CHANGE IN A CUSTOMER RELATIONSHIP OR IN A CUSTOMER'S
FINANCIAL POSITION COULD HARM OUR BUSINESS AND FINANCIAL CONDITION.
Affiliated stores owned by The Limited (including Limited Stores and
Express) accounted for approximately 10.5% and 9.6% of our net sales for the
first three months of 2004 and 2003, respectively. Lerner New York accounted for
8.0% and 3.0% of our net sales for the first three months of 2004 and 2003,
respectively. Kohl's accounted for 16.3% and 5.1% of our net sales for the first
three months of 2004 and 2003, respectively. Mervyn's accounted for 16.2% and
7.3% of our net sales for the first three months of 2004 and 2003, respectively.
We believe that consolidation in the retail industry has centralized purchasing
decisions and given customers greater leverage over suppliers like us, and we
expect this trend to continue. If this consolidation continues, our net sales
and results of operations may be increasingly sensitive to deterioration in the
financial condition of, or other adverse developments with, one or more of our
customers.
While we have long-standing customer relationships, we generally do not
have long-term contracts with any of them, including Express. Purchases
generally occur on an order-by-order basis, and relationships exist as long as
there is a perceived benefit to both parties. A decision by a major customer,
whether motivated by competitive considerations, financial difficulties, and
economic conditions or otherwise, to decrease its purchases from us or to change
its manner of doing business with us, could adversely affect our business and
financial condition. In addition, during recent years, various retailers,
including some of our customers, have experienced significant changes and
difficulties, including consolidation of ownership, increased centralization of
purchasing decisions, restructurings, bankruptcies and liquidations.
These and other financial problems of some of our retailers, as well as
general weakness in the retail environment, increase the risk of extending
credit to these retailers. A significant adverse change in a customer
relationship or in a customer's financial position could cause us to limit or
discontinue business with that customer, require us to assume more credit risk
relating to that customer's receivables, limit our ability to collect amounts
related to previous purchases by that customer, or result in required prepayment
of our receivables securitization arrangements, all of which could harm our
business and financial condition.
FAILURE TO MANAGE OUR GROWTH AND EXPANSION COULD IMPAIR OUR BUSINESS.
Since our inception, we have experienced periods of rapid growth. No
assurance can be given that we will be successful in maintaining or increasing
our sales in the future. Any future growth in sales will require additional
working capital and may place a significant strain on our management, management
information systems, inventory management, production capability, distribution
facilities and receivables management. Any disruption in our order processing,
sourcing or distribution systems could cause orders to be shipped late, and
under industry practices,
22
retailers generally can cancel orders or refuse to accept goods due to late
shipment. Such cancellations and returns would result in a reduction in revenue,
increased administrative and shipping costs and a further burden on our
distribution facilities.
FAILURE TO MANAGE OUR RESTRUCTURING IN MEXICO COULD IMPAIR OUR BUSINESS.
We have determined to cease directly operating a substantial majority
of our equipment and fixed assets in Mexico, and to lease a large portion of our
facilities and operations in Mexico to a related third party, which we
consummated effective September 1, 2003. As a consequence, we have become
primarily a trading company, relying on third party manufacturers to produce the
merchandise we sell to our customers. We face many challenges related to our
decision to cease directly operating a substantial majority of our equipment and
fixed assets in Mexico. Any failure on our part to successfully manage these
challenges, or other unanticipated consequences may result in loss of customers
and sales, which would have an adverse impact on operations. The challenges we
face include:
o We may lose customers who desire to purchase merchandise
directly from the manufacturer;
o We may experience unanticipated expenses in winding down
manufacturing operations in Mexico, including labor costs and
additional write down of inventory, which may adversely affect
our results of operations in the short term;
o The party to whom we lease our manufacturing operations in
Mexico may default in its obligations to us, in which case we
may not be able to lease the facilities to another party, or
recommence use of the facilities to manufacture goods without
significant cost; and
o We may not be able to transfer Mexico sales to our trading
model in time to replace direct to manufacturer orders we have
experienced in the past due, for instance, to difficulty in
finding third party manufacturers, and capital constraints.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
We have experienced, and expect to continue to experience, substantial
variations in our net sales and operating results from quarter to quarter. We
believe that the factors which influence this variability of quarterly results
include the timing of our introduction of new product lines, the level of
consumer acceptance of each new product line, general economic and industry
conditions that affect consumer spending and retailer purchasing, the
availability of manufacturing capacity, the seasonality of the markets in which
we participate, the timing of trade shows, the product mix of customer orders,
the timing of the placement or cancellation of customer orders, the weather,
transportation delays, quotas, the occurrence of charge backs in excess of
reserves and the timing of expenditures in anticipation of increased sales and
actions of competitors. Due to fluctuations in our revenue and operating
expenses, we believe that period-to-period comparisons of our results of
operations are not a good indication of our future performance. It is possible
that in some future quarter or quarters, our operating results will be below the
expectations of securities analysts or investors. In that case, our stock price
could fluctuate significantly or decline.
INCREASES IN THE PRICE OF RAW MATERIALS OR THEIR REDUCED AVAILABILITY COULD
INCREASE OUR COST OF SALES AND DECREASE OUR PROFITABILITY.
The principal raw material used in our apparel is cotton. The price and
availability of cotton may fluctuate significantly, depending on a variety of
factors, including crop yields, weather, supply conditions, government
regulation, economic climate and other unpredictable factors. Any raw material
price increases could increase our cost of sales and decrease our profitability
unless we are able to pass higher prices on to our customers. Moreover, any
decrease in the availability of cotton could impair our ability to meet our
production requirements in a timely manner.
23
THE SUCCESS OF OUR BUSINESS DEPENDS UPON OUR ABILITY TO OFFER INNOVATIVE AND
UPGRADED PRODUCTS.
The apparel industry is characterized by constant product innovation
due to changing consumer preferences and by the rapid replication of new
products by competitors. As a result, our success depends in large part on our
ability to continuously develop, market and deliver innovative products at a
pace and intensity competitive with other manufacturers in our segments. In
addition, we must create products that appeal to multiple consumer segments at a
range of price points. Any failure on our part to regularly develop innovative
products and update core products could:
o limit our ability to differentiate, segment and price our
products;
o adversely affect retail and consumer acceptance of our
products; and
o limit sales potential.
The increasing importance of product innovation in apparel requires us
to strengthen our internal research and commercialization capabilities, to rely
on successful commercial relationships with third parties such as fiber, fabric
and finishing providers and to compete and negotiate effectively for new
technologies and product components.
THE FINANCIAL CONDITION OF OUR CUSTOMERS COULD AFFECT OUR RESULTS OF OPERATIONS.
Certain retailers, including some of our customers, have experienced in
the past, and may experience in the future, financial difficulties, which
increase the risk of extending credit to such retailers and the risk that
financial failure will eliminate a customer entirely. These retailers have
attempted to improve their own operating efficiencies by concentrating their
purchasing power among a narrowing group of vendors. There can be no assurance
that we will remain a preferred vendor for our existing customers. A decrease in
business from or loss of a major customer could have a material adverse effect
on our results of operations. There can be no assurance that our factor will
approve the extension of credit to certain retail customers in the future. If a
customer's credit is not approved by the factor, we could assume the collection
risk on sales to the customer itself, require that the customer provide a letter
of credit, or choose not to make sales to the customer.
THE SUCCESS OF OUR BUSINESS DEPENDS ON OUR ABILITY TO ATTRACT AND RETAIN
QUALIFIED EMPLOYEES.
We need talented and experienced personnel in a number of areas
including our core business activities. Our success is dependent upon
strengthening our management depth across our business at a rapid pace. An
inability to retain and attract qualified personnel or the loss of any of our
current key executives could harm our business. Our ability to attract and
retain qualified employees is adversely affected by the Los Angeles location of
our corporate headquarters due to the high cost of living in the Los Angeles
area.
WE DEPEND ON OUR COMPUTER AND COMMUNICATIONS SYSTEMS.
As a multi-national corporation, we rely on our computer and
communication network to operate efficiently. Any interruption of this service
from power loss, telecommunications failure, weather, natural disasters or any
similar event could have a material adverse affect on our business and
operations. Additionally, hackers and computer viruses have disrupted operations
at many major companies. We may be vulnerable to similar acts of sabotage, which
could have a material adverse effect on our business and operations.
WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE.
We may not be able to fund our future growth or react to competitive
pressures if we lack sufficient funds. Currently, we believe we have sufficient
cash on hand and cash available through our bank credit facilities, issuance of
long-term debt, proceeds from loans from affiliates, and proceeds from the
exercise of stock options to fund existing operations for the foreseeable
future. However, in the future we may need to raise additional funds through
equity or debt financings or collaborative relationships. This additional
funding may not be available or, if available,
24
it may not be available on economically reasonable terms. In addition, any
additional funding may result in significant dilution to existing shareholders.
If adequate funds are not available, we may be required to curtail our
operations or obtain funds through collaborative partners that may require us to
release material rights to our products.
OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS.
Substantially all of our import operations are subject to tariffs
imposed on imported products and quotas imposed by trade agreements. In
addition, the countries in which our products are manufactured or imported may
from time to time impose additional new quotas, duties, tariffs or other
restrictions on our imports or adversely modify existing restrictions. Adverse
changes in these import costs and restrictions, or our suppliers' failure to
comply with customs or similar laws, could harm our business. We cannot assure
that future trade agreements will not provide our competitors with an advantage
over us, or increase our costs, either of which could have an adverse effect on
our business and financial condition.
Our operations are also subject to the effects of international trade
agreements and regulations such as the North American Free Trade Agreement, and
the activities and regulations of the World Trade Organization. Generally, these
trade agreements benefit our business by reducing or eliminating the duties
and/or quotas assessed on products manufactured in a particular country.
However, trade agreements can also impose requirements that adversely affect our
business, such as limiting the countries from which we can purchase raw
materials and setting quotas on products that may be imported into the United
States from a particular country. In addition, the World Trade Organization may
commence a new round of trade negotiations that liberalize textile trade by
further eliminating quotas or reducing tariffs. The elimination of quotas on
World Trade Organization member countries by 2005 and other effects of these
trade agreements could result in increased competition from developing
countries, which historically have lower labor costs, including China and
Taiwan, both of which recently became members of the World Trade Organization.
This potential increase in competition from developing countries is one of the
several reasons why we have determined to lease our manufacturing operations in
Mexico.
Our ability to import products in a timely and cost-effective manner
may also be affected by problems at ports or issues that otherwise affect
transportation and warehousing providers, such as labor disputes. These problems
could require us to locate alternative ports or warehousing providers to avoid
disruption to our customers. These alternatives may not be available on short
notice or could result in higher transit costs, which could have an adverse
impact on our business and financial condition.
OUR DEPENDENCE ON INDEPENDENT MANUFACTURERS REDUCES OUR ABILITY TO CONTROL THE
MANUFACTURING PROCESS, WHICH COULD HARM OUR SALES, REPUTATION AND OVERALL
PROFITABILITY.
We depend on independent contract manufacturers to secure a sufficient
supply of raw materials and maintain sufficient manufacturing and shipping
capacity in an environment characterized by declining prices, continuing cost
pressure and increased demands for product innovation and speed-to-market. This
dependence could subject us to difficulty in obtaining timely delivery of
products of acceptable quality. In addition, a contractor's failure to ship
products to us in a timely manner or to meet the required quality standards
could cause us to miss the delivery date requirements of our customers. The
failure to make timely deliveries may cause our customers to cancel orders,
refuse to accept deliveries, impose non-compliance charges through invoice
deductions or other charge-backs, demand reduced prices or reduce future orders,
any of which could harm our sales, reputation and overall profitability. We do
not have material long-term contracts with any of our independent contractors
and any of these contractors may unilaterally terminate their relationship with
us at any time. To the extent we are not able to secure or maintain
relationships with independent contractors that are able to fulfill our
requirements, our business would be harmed.
Although we monitor the compliance of our independent contractors with
applicable labor laws, we do not control our contractors or their labor
practices. The violation of federal, state or foreign labor laws by one of the
our contractors could result in our being subject to fines and our goods that
are manufactured in violation of such laws being seized or their sale in
interstate commerce being prohibited. From time to time, we have been notified
by federal, state or foreign authorities that certain of our contractors are the
subject of investigations or have been found
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to have violated applicable labor laws. To date, we have not been subject to any
sanctions that, individually or in the aggregate, have had a material adverse
effect on our business, and we are not aware of any facts on which any such
sanctions could be based. There can be no assurance, however, that in the future
we will not be subject to sanctions as a result of violations of applicable
labor laws by our contractors, or that such sanctions will not have a material
adverse effect on our business and results of operations. In addition, certain
of our customers, including The Limited, require strict compliance by their
apparel manufacturers, including us, with applicable labor laws and visit our
facilities often. There can be no assurance that the violation of applicable
labor laws by one of our contractors will not have a material adverse effect on
our relationship with our customers.
OUR BUSINESS IS SUBJECT TO RISKS OF OPERATING IN A FOREIGN COUNTRY AND TRADE
RESTRICTIONS.
Approximately 91% of our products were imported from outside the U.S.
in the first quarter of 2004, and most of our fixed assets are located in
Mexico. We are subject to the risks associated with doing business and owning
fixed assets in foreign countries, including, but not limited to, transportation
delays and interruptions, political instability, expropriation, currency
fluctuations and the imposition of tariffs, import and export controls, other
non-tariff barriers (including changes in the allocation of quotas) and cultural
issues. Any changes in those countries' labor laws and government regulations
may have a negative effect on our profitability.
WE CANNOT GUARANTEE THAT OUR FUTURE ACQUISITIONS WILL BE SUCCESSFUL.
In the future, we may seek to continue our growth through acquisition.
We compete for acquisition and expansion opportunities with companies which have
significantly greater financial and management resources than us. There can be
no assurance that suitable acquisition or investment opportunities will be
identified, that any of these transactions can be consummated, or that, if
acquired, these new businesses can be integrated successfully and profitably
into our operations. These acquisitions and investments may also require a
significant allocation of resources, which will reduce our ability to focus on
the other portions of our business, including many of the factors listed in the
prior risk factor.
RISK ASSOCIATED WITH OUR INDUSTRY
OUR SALES ARE HEAVILY INFLUENCED BY GENERAL ECONOMIC CYCLES.
Apparel is a cyclical industry that is heavily dependent upon the
overall level of consumer spending. Purchases of apparel and related goods tend
to be highly correlated with cycles in the disposable income of our consumers.
Our customers anticipate and respond to adverse changes in economic conditions
and uncertainty by reducing inventories and canceling orders. As a result, any
substantial deterioration in general economic conditions, increases in interest
rates, acts of war, terrorist or political events that diminish consumer
spending and confidence in any of the regions in which we compete, could reduce
our sales and adversely affect our business and financial condition. This has
been underscored by the events of September 11, 2001 and the war in the Middle
East.
OUR BUSINESS IS HIGHLY COMPETITIVE AND DEPENDS ON CONSUMER SPENDING PATTERNS.
The apparel industry is highly competitive. We face a variety of
competitive challenges including:
o anticipating and quickly responding to changing consumer
demands;
o developing innovative, high-quality products in sizes, colors
and styles that appeal to consumers of varying age groups and
tastes;
o competitively pricing our products and achieving customer
perception of value; and
o providing strong and effective marketing support.
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WE MUST SUCCESSFULLY GAUGE FASHION TRENDS AND CHANGING CONSUMER PREFERENCES TO
SUCCEED.
Our success is largely dependent upon our ability to gauge the fashion
tastes of our customers and to provide merchandise that satisfies retail and
customer demand in a timely manner. The apparel business fluctuates according to
changes in consumer preferences dictated in part by fashion and season. To the
extent, we misjudge the market for our merchandise, our sales may be adversely
affected. Our ability to anticipate and effectively respond to changing fashion
trends depends in part on our ability to attract and retain key personnel in our
design, merchandising and marketing staff. Competition for these personnel is
intense, and we cannot be sure that we will be able to attract and retain a
sufficient number of qualified personnel in future periods.
OUR BUSINESS IS SUBJECT TO SEASONAL TRENDS.
Historically, our operating results have been subject to seasonal
trends when measured on a quarterly basis. This trend is dependent on numerous
factors, including the markets in which we operate, holiday seasons, consumer
demand, climate, economic conditions and numerous other factors beyond our
control. There can be no assurance that our historic operating patterns will
continue in future periods as we cannot influence or forecast many of these
factors.
OTHER RISKS RELATED TO AN INVESTMENT IN OUR COMMON STOCK
THE ULTIMATE RESOLUTION OF THE INTERNAL REVENUE SERVICE'S EXAMINATION OF OUR TAX
RETURNS MAY REQUIRE US TO INCUR AN EXPENSE BEYOND WHAT HAS BEEN RESERVED FOR ON
OUR BALANCE SHEET OR MAKE CASH PAYMENTS BEYOND WHAT WE ARE THEN ABLE TO PAY.
In January 2004, the Internal Revenue Service proposed adjustments to
increase our federal income tax payable for the years ended December 31, 1996
through 2001 by an aggregate of approximately $14.5 million. This adjustment
would also result in additional state taxes, penalties and interest of
approximately $12.6 million. If the proposed adjustments are upheld through the
administrative and legal process, they could have a material impact on our
earnings and cash flow. We believe we have provided adequate reserves for any
reasonably foreseeable outcome related to these matters on the balance sheet
included in the Consolidated Financial Statements. If the amount of any actual
liability, however, exceeds our reserves, we would experience an immediate
adverse earnings impact in the amount of such additional liability, which could
be material. Additionally, we anticipate that the ultimate resolution of these
matters will require that we make significant cash payments to the taxing
authorities. Presently we do not have sufficient cash or borrowing ability to
make any future payments that may be required. While we intend to accumulate a
cash reserve to meet this cash outflow contingency from operations, no assurance
can be given that we will have sufficient surplus cash from operations to build
and maintain this reserve by the time such payments are required. Additionally,
cash used to build this reserve will not be available for other corporate
purposes, which could have a material adverse effect on our financial condition
and results of operations.
INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR
SHAREHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS.
As of May 11, 2004, our executive officers and directors and their
affiliates owned approximately 34.5% of the outstanding shares of our common
stock. Gerard Guez, our Chief Executive Officer and Chairman, and Todd Kay, our
Vice Chairman, alone own approximately 23.0% and 11.8%, respectively, of the
outstanding shares of our common stock at May 11, 2004. Accordingly, our
executive officers and directors have the ability to affect the outcome of, or
exert considerable influence over, all matters requiring shareholder approval,
including the election and removal of directors and any change in control. This
concentration of ownership of our common stock could have the effect of delaying
or preventing a change of control of us or otherwise discouraging or preventing
a potential acquirer from attempting to obtain control of us. This, in turn,
could have a negative effect on the market price of our common stock. It could
also prevent our shareholders from realizing a premium over the market prices
for their shares of common stock.
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WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF
OUR COMMON STOCK.
Our shareholders rights plan, our ability to issue additional shares of
preferred stock and some provisions of our articles of incorporation and bylaws
could make it more difficult for a third party to make an unsolicited takeover
attempt of us. These anti-takeover measures may depress the price of our common
stock by making it more difficult for third parties to acquire us by offering to
purchase shares of our stock at a premium to its market price.
OUR STOCK PRICE HAS BEEN VOLATILE.
Our common stock is quoted on the NASDAQ National Market System, and
there can be substantial volatility in the market price of our common stock. The
market price of our common stock has been, and is likely to continue to be,
subject to significant fluctuations due to a variety of factors, including
quarterly variations in operating results, operating results which vary from the
expectations of securities analysts and investors, changes in financial
estimates, changes in market valuations of competitors, announcements by us or
our competitors of a material nature, loss of one or more customers, additions
or departures of key personnel, future sales of common stock and stock market
price and volume fluctuations. In addition, general political and economic
conditions such as a recession, or interest rate or currency rate fluctuations
may adversely affect the market price of our common stock.
In addition, the stock market in general has experienced extreme price
and volume fluctuations that have affected the market price of our common stock.
Often, price fluctuations are unrelated to operating performance of the specific
companies whose stock is affected. In the past, following periods of volatility
in the market price of a company's stock, securities class action litigation has
occurred against the issuing company. If we were subject to this type of
litigation in the future, we could incur substantial costs and a diversion of
our management's attention and resources, each of which could have a material
adverse effect on our revenue and earnings. Any adverse determination in this
type of litigation could also subject us to significant liabilities.
ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO YOU.
Some investors favor companies that pay dividends, particularly in
general downturns in the stock market. We have not declared or paid any cash
dividends on our common stock. We currently intend to retain any future earnings
for funding growth, and we do not currently anticipate paying cash dividends on
our common stock in the foreseeable future. Additionally, we cannot pay
dividends on our common stock unless the terms of our bank credit facilities and
outstanding preferred stock, if any, permit the payment of dividends on our
common stock. Because we may not pay dividends, your return on this investment
likely depends on your selling our stock at a profit.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
FOREIGN CURRENCY RISK. Our earnings are affected by fluctuations in the
value of the U.S. dollar as compared to foreign currencies as a result of doing
business in Mexico as well as certain debt denominated in the Euro. As a result,
we bear the risk of exchange rate gains and losses that may result in the future
as a result of this financing. At times we use forward exchange contracts to
reduce the effect of fluctuations of foreign currencies on purchases and
commitments. These short-term assets and commitments are principally related to
trade payables positions and fixed asset purchase obligations. We do not utilize
derivative financial instruments for trading or other speculative purposes. We
actively evaluate the creditworthiness of the financial institutions that are
counter parties to derivative financial instruments, and we do not expect any
counter parties to fail to meet their obligations.
INTEREST RATE RISK. Because our obligations under our various credit
agreements bear interest at floating rates (primarily LIBOR rates), we are
sensitive to changes in prevailing interest rates. Any major increase or
decrease in market interest rates that affect our financial instruments would
have a material impact on earning or cash flows during the next fiscal year.
Our interest expense is sensitive to changes in the general level of
U.S. interest rates. In this regard, changes in U.S. interest rates affect
interest paid on our debt. A majority of our credit facilities is at variable
rates.
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ITEM 4. CONTROLS AND PROCEDURES.
EVALUATION OF CONTROLS AND PROCEDURES
As of March 31, 2004, our Chief Executive Officer and our Chief
Financial Officer, with the participation of our management, carried out an
evaluation of the effectiveness of our disclosure controls and procedures
pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief
Executive Officer and the Chief Financial Officer believe that, as of the date
of the evaluation, our disclosure controls and procedures are effective in
making known to them material information relating to us (including our
consolidated subsidiaries) required to be included in this report.
Disclosure controls and procedures, no matter how well designed and
implemented, can provide only reasonable assurance of achieving an entity's
disclosure objectives. The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
CHANGES IN CONTROLS AND PROCEDURES
There were no significant changes in our internal controls or in other
factors that could significantly affect internal controls, known to the Chief
Executive Officer or the Chief Financial Officer, subsequent to the date of the
evaluation.
RECOMMENDATIONS OF OUR AUDITORS
During 2003, our prior independent public accountants, Ernst & Young,
LLP, advised us and discussed with the Audit Committee of our Board of Directors
that, due in part to certain acquisitions by our subsidiaries in Mexico and
modifications to our inventory costing methodology, certain improvements in the
internal controls of those subsidiaries were necessary to ensure reporting from
the subsidiaries would be sufficient for us to develop reliable financial
statements. We have and will continue to address the deficiencies identified by
Ernst & Young, LLP in consultation with Grant Thornton LLP, our new independent
certified public accountants.
In connection with its audit of our consolidated financial statements
for the year ended December 31, 2003, Grant Thornton LLP, our independent
accountants, advised the Audit Committee and management of our need for
additional staff with expertise in preparing required disclosures in the notes
to the financial statements, and our need to develop greater internal resources
for researching and evaluating the appropriateness of complex accounting
principles and evaluating the effect of new accounting pronouncements on the
Company. Grant Thornton LLP considers these matters to be significant
deficiencies as that term is defined under standards established by the American
Institute of Certified Public Accountants. In response to the observations made
by Grant Thornton LLP, in 2004 we have implemented certain enhancements to our
financial reporting processes, including increased training of staff on SEC
financial reporting requirements and the acquisition of accounting research
tools. We believe these steps will address the matters raised by Grant Thornton
LLP.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
PATRICK BENSIMON
In January 2004, we reached a settlement with Patrick Bensimon relating
to claims Mr. Bensimon made against Jane Doe International, LLC relating to his
employment agreement with this company. Jane Doe International, LLC, which was
beneficially owned 51% by us and 49% by Needletex Inc., was formed for the
purpose of acquiring assets from Needletex, Inc., a company owned by Mr.
Bensimon, pursuant to the terms of an Asset Purchase Agreement. On January 21,
2003, Mr. Bensimon obtained an arbitration award of $1,425,655 for salary and
bonus plus interest accrued thereon and legal fees and costs to be determined.
On April 7, 2003, the panel issued a final award in favor of Mr. Bensimon
confirming the prior interim award and awarding Mr. Bensimon costs and attorneys
fees in the amount of $489,640. On April 28, 2003, Mr. Bensimon sought a court
order confirming the final award. We asked the court to vacate or modify the
final award.
In January 2004, we settled the employment issue with Mr. Bensimon for
$1.2 million in cash and forgiveness of approximately $859,000 in debts owed by
Needletex Inc. As part of the settlement, we received the remaining 49% interest
in Jane Doe International, LLC. An additional expense of approximately $379,000
was made in the fourth quarter of 2003 to cover the forgiveness of debts.
At the outset of the dispute, we tendered the claim by Mr. Bensimon to
our insurance carrier, which accepted the tender with a reservation of rights as
to whether coverage existed for the claim. After the interim arbitration award
was made, the insurance carrier denied coverage. After the final award by the
arbitration panel, we made demand on the insurance carrier, which was denied. We
then commenced suit against the insurance carrier in the Los Angeles County
Superior Court for breach of contract and related claims. In January 2004, the
carrier settled the case with a cash payment of $330,000.
OTHER MATTERS
From time to time, we are involved in various routine legal proceedings
incidental to the conduct of our business. Our management does not believe that
any of these legal proceedings will have a material adverse impact on our
business, financial condition or results of operations, either due to the nature
of the claims, or because our management believes that such claims should not
exceed the limits of the our insurance coverage.
ITEM 2. CHANGES IN SECURITIES.
In January 2004, we sold an aggregate of 1,200,000 shares of our common
stock at a price of $3.35 per share, for aggregate proceeds to us of
approximately $3.7 million after payment of placement agent fees and other
offering expenses. We used the proceeds of this offering for working capital
purposes. The securities sold in the offering were registered under the
Securities Act of 1933, as amended, pursuant to our effective shelf registration
statement. In conjunction with this public offering, we issued a warrant to
purchase 30,000 shares of our common stock to the placement agent, the warrant
has an exercise price of $3.35 per share, is fully vested and exercisable and
has a term of five years.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
-------- --------------------------------------------
10.31.6 Sixth Deed of Variation to Syndicated Letter
of Credit Facility dated March 17, 2004
among Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited and
UPS Capital Global Trade Finance
Corporation.
31.1 Certificate of Chief Executive Officer
pursuant to Rule 13a-14(a) under the
Securities and Exchange Act of 1934, as
amended.
31.2 Certificate of Chief Financial Officer
pursuant to Rule 13a-14(a) under the
Securities and Exchange Act of 1934, as
amended.
32.1 Certificate of Chief Executive Officer
pursuant to Rule 13a-14(b) under the
Securities and Exchange Act of 1934, as
amended.
32.2 Certificate of Chief Financial Officer
pursuant to Rule 13a-14(b) under the
Securities and Exchange Act of 1934, as
amended.
(b) Current Reports on Form 8-K:
Current Report on Form 8-K, reporting Items 5 and 7, filed on
January 27, 2004.
Current Report on Form 8-K, reporting Items 7 and 12, filed on
March 22, 2004.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TARRANT APPAREL GROUP
Date: May 14, 2004 By: /s/ Patrick Chow
-------------------------------
Patrick Chow,
Chief Financial Officer
Date: May 14, 2004 By: /s/ Gerard Guez
-------------------------------
Gerard Guez,
Chief Executive Officer
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