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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
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: 0-26430
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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,
2003: 15,765,425.
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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, 2003 (Unaudited)
and December 31, 2002 (Audited)............................... 3
Consolidated Statements of Operations for the Three Months
Ended March 31, 2003 and March 31, 2002....................... 4
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2003 and March 31, 2002....................... 5
Notes to Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk ... 26
Item 4. Controls and Procedures....................................... 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 28
Item 2. Changes in Securities and Use of Proceeds..................... 29
Item 3. Defaults Upon Senior Securities .............................. 29
Item 4. Submission of Matters to a Vote of Security Holders........... 29
Item 5. Other Information............................................. 29
Item 6. Exhibits and Reports on Form 8-K.............................. 29
SIGNATURES.................................................... 30
CERTIFICATIONS................................................ 31
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
DECEMBER 31,
MARCH 31, 2003 2002
------------- -------------
ASSETS (UNAUDITED)
Current assets:
Cash and cash equivalents ................. $ 492,686 $ 1,388,482
Accounts receivable, net .................. 72,630,450 65,287,902
Due from affiliates ....................... 11,083,928 8,510,993
Due from officers ......................... 456,490 456,500
Inventory ................................. 48,150,577 44,782,154
Temporary quota ........................... 1,797,182 --
Prepaid expenses and other receivables .... 5,364,960 5,135,672
Income taxes receivable ................... 197,088 280,200
------------- -------------
Total current assets ........................ 140,173,361 125,841,903
Property and equipment, net ............... 152,902,540 159,998,629
Other assets .............................. 2,144,050 2,539,040
Excess of cost over fair value of net
assets acquired, net ...................... 27,896,710 28,064,019
------------- -------------
Total assets ................................ $ 323,116,661 $ 316,443,591
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank borrowings ................ $ 35,109,171 $ 29,326,924
Accounts payable .......................... 34,710,464 32,119,854
Accrued expenses .......................... 14,121,412 12,566,475
Income taxes .............................. 13,459,002 12,640,388
Due to affiliates ......................... 8,688,425 5,264,238
Due to shareholders ....................... 486,588 486,875
Current portion of long-term obligations .. 23,716,821 21,706,502
------------- -------------
Total current liabilities ................... 130,291,883 114,111,256
Long-term obligations ........................ 54,437,042 55,903,976
Deferred tax liabilities ..................... 425,311 407,751
Minority interest in UAV ..................... 3,980,891 3,205,167
Minority interest in Tarrant Mexico .......... 20,634,034 21,654,538
Commitments and contingencies
Shareholders' equity:
Preferred stock, 2,000,000 shares
authorized; 100,000 Shares issued
and outstanding ......................... 8,820,573 8,820,573
Common stock, no par value, 35,000,000
shares authorized; 15,765,425 shares
(2003) and 15,846,315 shares (2002)
issued and outstanding ................. 69,056,813 69,368,239
Contributed capital ....................... 1,434,259 1,434,259
Retained earnings ......................... 52,994,165 56,873,094
Notes receivable from shareholders ........ (4,867,301) (5,601,804)
Accumulated other comprehensive income .... (14,091,009) (9,733,458)
------------- -------------
Total shareholders' equity .................. 113,347,500 121,160,903
------------- -------------
Total liabilities and shareholders'
equity .................................... $ 323,116,661 $ 316,443,591
============= =============
See accompanying notes
3
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED MARCH 31,
-----------------------------
2003 2002
------------ ------------
Net sales .................................... $ 78,736,204 $ 65,164,184
Cost of sales ................................ 69,933,725 56,745,212
------------ ------------
Gross profit ................................. 8,802,479 8,418,972
Selling and distribution expenses ............ 2,729,512 2,637,012
General and administrative expenses .......... 7,383,022 6,612,886
------------ ------------
Income (loss) from operations ................ (1,310,055) (830,926)
Interest expense ............................. (1,493,013) (899,967)
Interest income .............................. 87,264 57,678
Other income ................................. 316,314 224,461
Other expense ................................ (325,744) (203,730)
Minority interest ............................ (236,397) (437,787)
------------ ------------
Income (loss) before provision for income
taxes and cumulative effect of
accounting change ......................... (2,961,631) (2,090,271)
Provision (credit) for income taxes .......... 917,298 (364,020)
------------ ------------
Income (loss) before cumulative effect of
accounting change ......................... (3,878,929) (1,726,251)
Cumulative effect of accounting change ....... -- (4,871,244)
------------ ------------
Net income (loss) ............................ $ (3,878,929) $ (6,597,495)
============ ============
Net income (loss) per share - Basic and
Diluted:
Before cumulative effect of accounting
change ................................. $ (0.24) $ (0.11)
Cumulative effect of accounting change .... -- (0.31)
------------ ------------
After cumulative effect of accounting
change ................................. $ (0.24) $ (0.42)
============ ============
Weighted average common and common
equivalent shares:
Basic and Diluted ......................... 15,837,327 15,831,648
============ ============
See accompanying notes
4
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
THREE MONTHS ENDED MARCH 31,
2003 2002
------------ ------------
Operating activities:
Net loss ....................................... $ (3,878,929) $ (6,597,496)
Adjustments to reconcile net loss to net
cash used in operating activities:
Deferred taxes .............................. 17,560 (24,460)
Depreciation and amortization ............... 3,954,631 2,822,297
Cumulative effect of accounting change ...... -- 4,871,244
Unrealized loss on foreign currency ......... 263,553 112,391
Provision for returns and discounts ......... 205,865 (2,128,847)
Minority interest ........................... 236,397 283,100
Changes in operating assets and
liabilities:
Accounts receivable ....................... (8,639,412) (1,721,252)
Due from affiliates ....................... (267,016) 1,850,357
Inventory ................................. (3,368,424) (3,847,354)
Temporary quota ........................... (1,797,182) (1,801,508)
Prepaid expenses and other receivables .... (146,176) (486,033)
Accounts payable .......................... 2,590,609 7,086,586
Accrued expenses and income tax payable ... 2,373,551 (502,652)
------------ ------------
Net cash used in operating activities ..... (8,454,973) (83,627)
Investing activities:
Purchase of fixed assets .................... (270,876) (595,240)
(Increase) decrease in other assets ......... (414,865) 110,649
Advances to shareholders/officers ........... -- (1,593,046)
Repayments of advances from shareholders/
officers .................................. 734,225 22,140
------------ ------------
Net cash provided by (used in) investing
activities ............................. 48,484 (2,055,497)
Financing activities:
Short-term bank borrowings, net ............. 5,782,246 7,265,892
Proceeds from long-term obligations ......... 61,116,424 1,931,703
Payment of long-term obligations and
bank borrowings ........................... (60,836,592) (6,531,521)
Repayments to shareholders/officers ......... -- (908,772)
Borrowings from shareholders/officers ....... 1,809,850 38,403
Exercise of stock options ................... -- 4,821
Repurchase of stock ......................... (393,178) --
------------ ------------
Net cash provided by financing
activities .............................. 7,478,750 1,800,526
Effect of changes in foreign currency .......... 31,943 583,449
------------ ------------
Decrease (increase) in cash and cash
equivalents ................................. (895,796) 244,851
Cash and cash equivalents at beginning of
period ...................................... 1,388,482 1,524,447
------------ ------------
Cash and cash equivalents at end of period ..... $ 492,686 $ 1,769,298
============ ============
See accompanying notes.
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.") (the "Parent Company" or the "Company"), and its wholly owned
subsidiaries located primarily in the U.S. and Asia. The Company owns 75% of its
subsidiaries in Mexico, 51% of Jane Doe International, LLC ("JDI"), and 50.1% of
United Apparel Ventures, LLC ("UAV"). The Company consolidates these entities
and reflects the minority interests in earnings (losses) of the ventures in the
accompanying financial statements. All inter-company amounts are eliminated in
consolidation.
The Company serves 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,
moderately priced apparel for women, men and children under private label.
Commencing in 1999, the Company expanded its operations from sourcing apparel to
sourcing and operating its own vertically integrated manufacturing facilities.
Historically, the Company's 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 the Company operates, holiday
seasons, consumer demand, climate, economic conditions and numerous other
factors beyond the Company's 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, 2002 is derived from
audited financial statements which are included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2002, 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 preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Assets and liabilities of the Mexico and Hong Kong subsidiaries are
translated at the rate of exchange in effect on the balance sheet date; income
and expenses are translated at the average rates of exchange prevailing during
the year. The functional currency in which the Company transacts business in
Hong Kong is the Hong Kong dollar and in Mexico is the peso.
Certain 2002 amounts have been reclassified to conform with the 2003
presentation.
3. STOCK BASED COMPENSATION
The Company applies Accounting Principles Board (APB) Opinion 25 and
related interpretations in accounting for our stock-based compensation plans. No
compensation cost is reflected in our net income (loss) related to our stock
option plans for the periods presented, as all options had an exercise price
greater than or equal to the market value of the underlying common stock on the
date of grant. Had the expense for our stock-based compensation been determined
using the fair value based method defined in Financial Accounting Standard
(SFAS) 123, "Accounting for Stock-Based Compensation," our net loss and net loss
per share would have been reduced to the pro forma amounts indicated below:
6
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
2003 2002
------------ ------------
Pro forma net loss ....................... $ (4,851,471) $ (7,159,725)
Pro forma compensation expense,
net of tax ............................. $ (972,542) $ (562,230)
Net loss as reported ..................... $ (3,878,929) $ (6,597,495)
Pro forma loss per share - Basic and
Diluted ................................ $ (0.31) $ (0.45)
Net loss per share - Basic and Diluted ... $ (0.24) $ (0.42)
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 2002 and 2003, expected volatility of 0.65;
risk-free interest rates of 4%, dividend yield of 0% and expected lives 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,
2003 2002
------------ ------------
United States trade accounts receivable ...... $ 50,183,491 $ 42,979,762
Foreign trade accounts receivable ............ 16,525,949 16,445,868
Due from factor .............................. 5,079,504 4,176,598
Other receivables ............................ 5,352,552 6,002,295
Allowance for returns, discounts and bad
debts ..................................... (4,511,046) (4,316,621)
------------ ------------
$ 72,630,450 $ 65,287,902
============ ============
5. INVENTORY
Inventory consists of the following:
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Raw materials
Fabric and trim accessories ............... $ 14,413,840 $ 12,451,447
Raw cotton ................................ 1,307,104 1,017,963
Work-in-process .............................. 7,056,346 9,948,700
Finished goods shipments-in-transit .......... 6,390,638 4,877,002
Finished goods ............................... 18,982,649 16,487,042
------------ ------------
$ 48,150,577 $ 44,782,154
============ ============
6. DEBT
Short-term bank borrowings consist of the following:
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Import trade bills payable ................. $ 5,795,821 $ 5,686,327
Bank direct acceptances .................... 11,005,057 11,272,375
Other Hong Kong credit facilities .......... 9,860,185 6,206,103
Other Mexican credit facilities ............ 4,281,516 4,968,309
Uncleared checks ........................... 4,166,592 1,193,810
------------ ------------
$ 35,109,171 $ 29,326,924
============ ============
7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
Long-term obligations consist of the following:
MARCH 31, DECEMBER 31,
2003 2002
------------ ------------
Vendor financing ........................... $ 6,469,189 $ 7,257,683
Equipment financing ........................ 8,636,930 9,682,290
Debt facility .............................. 60,570,744 58,193,505
Other debt ................................. 2,477,000 2,477,000
------------ ------------
78,153,863 77,610,478
Less current portion ....................... (23,716,821) (21,706,502)
------------ ------------
$ 54,437,042 $ 55,903,976
============ ============
IMPORT TRADE BILLS PAYABLE AND BANK DIRECT ACCEPTANCES
On June 13, 2002, the Company 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, the Company 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 the Company's subsidiaries in Hong Kong, as well
as the Company's permanent quota holdings in Hong Kong. In addition to the
guarantees provided by Tarrant Apparel Group, Fashion Resource (TCL) Inc., and
Tarrant Luxembourg Sarl (previously known as Machrima Luxembourg Sarl), a new
holding company the Company formed during 2002, Mr. Gerard Guez (the Company's
Chairman) also signed a guarantee of $5 million in favor of UPS to secure this
facility. This facility is also subject to certain restrictive covenants,
including no two consecutive quarterly losses; aggregate net worth, fixed charge
ratio, interest coverage ratio and leverage ratio. All the covenants for 2003
have been re-set in line with those of our Debt Facility (see Debt facility
below). The Company was in violation of the no-consecutive-quarterly-losses
covenant and the fixed charge ratio covenant at March 31, 2003, and a waiver has
been obtained at a fee of $10,000. As of March 31, 2003, $24.4 million was
outstanding under this facility within which $13.4 million was letters of
credit.
Since March 2003, Dao Heng Bank in Hong Kong has made available a
letter of credit facility of up to HKD 20 million (equivalent to US $2.6
million) to the Company's subsidiaries in Hong Kong. This is a demand facility
and is secured by the pledge of the Company's office property owned by Gerard
Guez and Todd Kay and the Company's guarantee. As of March 31, 2003, $2 million
was outstanding under this facility.
OTHER MEXICAN CREDIT FACILITIES
As of March 31, 2003, Grupo Famian had a short-term advance from Banco
Bilbao Vizcaya amounting to $148,000. This subsidiary also had a credit facility
of $10 million with Banco Nacional de Comercio Exterior SNC, based on purchase
orders and restricted by certain covenants. After the merger of Grupo Famian
into Tarrant Mexico, Banco Nacional de Comercio Exterior SNC has agreed that
Tarrant Mexico will repay the outstanding amount by making payments of $523,000
per month commencing on March 26, 2003. As of March 31, 2003, $4.1 million was
outstanding under this facility.
VENDOR FINANCING
During 2000, the Company 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, which commenced in February
2000. Of this amount, $6.5 million was outstanding as of March 31, 2003. Of the
$6.5 million, $4.0 million is denominated in Euros and the remainder is payable
in U.S. dollars. The Company is subject to foreign exchange risk resulting from
the fluctuation of the Euro. An unrealized loss of $264,000 and $112,000 was
recorded at March 31, 2003 and 2002, respectively, related to this fluctuation
and is recorded in other income in the accompanying financial statements.
From time to time, the Company opens letters of credit under an
uncommitted credit arrangement with Aurora Capital Associates who issues these
credits through Israeli Discount Bank. As of March 31, 2003, $3.1 million was
open in letters of credit under this arrangement.
8
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
EQUIPMENT FINANCING
The Company has two equipment loans with the initial borrowings of
$16.25 million and $5.2 million from GE Capital Leasing ("GE Capital") and Bank
of America Leasing ("BOA"), respectively. The loans are secured by equipment
located in Puebla and Tlaxcala, Mexico. The amounts outstanding as of March 31,
2003 were $6.4 million due to GE Capital and $2.1 million due to BOA. Interest
accrues at a rate of 2.5% over LIBOR. The loan from GE Capital will mature in
2005, and the loan from BOA will mature in 2004. The GE Capital facilities are
subject to covenants on Tangible Net Worth ($30 million), leverage ratio of not
more than two times, and no losses for two consecutive quarters. The Company was
in violation of the covenant on consecutive quarterly losses and obtained a
waiver from GE Capital for a fee of $25,000. The BOA facility is subject to a
financial benchmark on debt service coverage (0.8:1 before March 31, 2003 and
1.25:1 thereafter) and a leverage ratio of not more than 2 times. The Company is
in violation of the debt service coverage benchmark and is negotiating for a
waiver of the breach. Under the agreement, BOA has the option to accelerate
repayment of all outstanding principal amount to become payable in six equal
monthly installments of $350,000 each. For this reason, the debt has been
classified as a current liability.
The Debt Facility with GMAC Commercial Credit, LLC ("GMAC") (described
below) and the credit facilities with GE Capital, UPS and BOA all carry
cross-default clauses. A breach of a financial covenant set by GMAC, UPS or GE
Capital constitutes an event of default, entitling these banks to demand payment
in full of all outstanding amounts under their respective debt and credit
facilities.
DEBT FACILITY
On January 21, 2000, the Company entered into a new revolving credit,
factoring and security agreement (the "Debt Facility") with a syndicate of
lending institutions. The Debt Facility initially provided a revolving facility
of $105.0 million, including a letter of credit facility not to exceed $20.0
million, and matures on January 31, 2005. The Debt Facility provides for
interest at LIBOR plus the LIBOR rate margin determined by the Total Leverage
Ratio (as defined). The Debt Facility is collateralized by receivables,
intangibles, inventory and various other specified non-equipment assets of the
Company. In addition, the facility is subject to various financial covenants on
tangible net worth, interest coverage, fixed charge ratio and leverage ratio and
prohibits the payment of dividends. On March 2, 2001, the Company entered into
an amendment of our Debt Facility with GMAC, who solely assumed the facility in
2000. This amendment reduced the $105.0 million facility to $90.0 million. The
over-advance line of $25 million was converted to a term facility to be repaid
by monthly installments of $500,000 before August 2001 and $687,500 thereafter.
The Company and GMAC have established new financial covenants for the remainder
of fiscal 2003 based on the Company's projections, which include requirements
for tangible net worth of not less than $75 million on each of June 30, 2003 and
September 30, 2003 and $80 million on December 31, 2003; fixed charge ratio of
0.7 to 1 on June 30, 2003, and 1.1 to 1 for the rest of 2003; leverage ratio of
not more than 2.50:1, 2.25:1 and 2.0:1 for June 30, September 30 and December
31, 2003, respectively; and capital expenses are capped at $800,000 per quarter.
A total of $60.6 million was outstanding under the Debt Facility at March 31,
2003.
As of March 31, 2003, the Company was in violation of covenants on
interest coverage, total leverage ratio and fixed charge under the Debt
Facility. The Company received a waiver from GMAC with respect to its violation
of these covenants and with respect to compliance at December 31, 2002 and March
31, 2003 with all financial covenants under the Debt Facility. The Company paid
GMAC $45,000 for this waiver.
GUARANTEES
Guarantees have been issued 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 behalf of the Company.
7. GOODWILL - STATEMENT NO. 142
SFAS No. 142, "Goodwill and Other Intangible Assets," requires that
goodwill and other intangibles be tested for impairment using a two-step
process. The first step is to determine the fair value of the reporting unit,
which may be calculated using a discounted cash flow methodology, and compare
this value to its carrying value. If the fair value exceeds the carrying value,
no further work is required and no impairment loss would be recognized. The
second step is an allocation of the fair value of the reporting unit to all of
the reporting unit's assets and liabilities under a hypothetical purchase price
allocation. Based on the evaluation performed to adopt SFAS No. 142 along with
continuing difficulties being experienced in the industry, the Company recorded
a non-cash charge of $4.9 million in the first quarter of 2002 to reduce the
carrying value of goodwill to the estimated fair value.
9
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
The following table displays the change in the gross carrying amount of
goodwill by business units for the quarter ended March 31, 2003:
Tag Mex
Tarrant Tarrant Inc. - Tag Mex Inc.
Mexico - Mexico - Rocky - Chazzz &
Total Jane Doe Ajalpan Famian Division MGI Division
----------- -------- ---------- ---------- ---------- ------------
Balance as of $28,064,019 $150,338 $2,739,378 $9,069,923 $7,521,536 $8,582,844
December 31, 2002....
Foreign currency ----
translation.......... (167,309) ---- ---- (167,309) ----
Balance as of
March 31, 2003....... $27,896,710 $150,338 $2,739,378 $8,902,614 $7,521,536 $8,582,844
8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board (FASB)
issued FASB Interpretation No. (FIN) 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 requires that guarantees issued after December 31, 2002 are
recorded as liabilities at fair value, with the offsetting entry recorded based
on the circumstances in which the guarantee was issued. Adoption of FIN 45 did
not have a material impact on the Company's financial statements.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of SFAS 123." This
statement provides alternate methods of transition for a voluntary change to the
fair value method of accounting for stock-based compensation. This statement
also amends the disclosure requirements of SFAS 123 and APB Opinion 28, "Interim
Financial Reporting" to require prominent disclosure in both annual and interim
financial statements about the method of accounting for stock-based compensation
and the effect of the method used on reported results. The Company has adopted
the disclosure provisions of SFAS 148.
In January 2003, the FASB issued SFAS 46, "Consolidation of Variable
Interest Entities," which is effective for interim periods beginning after June
15, 2003. The Company does not expect FIN 46 to have a material impact on its
financial statements.
9. INCOME TAXES
The Company's 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 the Company has taxable losses in
Mexico, it is subject to a minimum tax. (3) The earnings of the Company's Hong
Kong subsidiary are taxed at a rate of 16% versus the 35% U.S. federal rate.
10
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
10. EARNINGS 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,
-------------------------------
2003 2002
------------ ------------
Basic and Diluted EPS Computation:
Numerator ...................... $ (3,878,929) $ (6,597,495)
Denominator:
Weighted average common
shares outstanding ............. 15,837,327 15,831,648
------------ ------------
Total shares ................... 15,837,327 15,831,648
------------ ------------
Basic EPS ...................... $ (0.24) $ (0.42)
============ ============
Net loss per share has been computed in accordance with SFAS No. 128,
"Earnings Per Share". All options have been excluded from the computation in the
period presented in the above table as the impact would be anti-dilutive.
The Series A Preferred Stock accrues dividends at an annual rate of 7%
of the initial stated value of $88.20 per share, payable only when and as
declared by our Board of Directors. In the event we liquidate, dissolve or wind
up our business, the holders of Series A Preferred shares will be entitled to
receive, prior to any distribution on our common stock, a distribution equal to
the initial stated value of the Series A Preferred shares plus all accrued and
unpaid dividends. At March 31, 2003, there was $154,350 in accrued and unpaid
dividends on the Series A Preferred Stock.
Pursuant to a put option agreement, in March 2003, the Company
completed the purchase of an aggregate of 80,890 shares of the company's common
stock from Gabe Zeitouni, a former employee of the Company, and Rocky Apparel,
Inc. and Gabriel Manufacturing Company, entities controlled by Mr. Zeitouni.
Pursuant to the terms of the put option, the per share purchase price for these
shares was $18.54 for an aggregate purchase price of $1,499,701. Of this amount,
$1,106,523 was previously advanced by the Company to Mr. Zeitouni in accordance
with the terms of a separation agreement between the Company and Mr. Zeitouni,
and $393,178 was paid to Mr. Zeitouni upon receipt of the purchased shares. The
purchased shares have been returned to the status of authorized but un-issued
shares.
11. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) were as follows:
THREE MONTHS ENDED MARCH 31,
---------------------------
2003 2002
----------- -----------
Net income (loss) .................... $(3,878,929) $(6,597,495)
Foreign currency translation
adjustment ........................... (4,357,550) 2,109,212
----------- -----------
Total comprehensive income (loss) .... $(8,236,479) $(4,488,283)
=========== ===========
12. SUBSEQUENT EVENTS
In April 2003, the Company acquired an equity interest in the owner of
the trademark "American Rag CIE," and the Company's subsidiary, Private Brands,
Inc., acquired a license to certain exclusive rights to this trademark. Private
Brands also entered into multi-year exclusive distribution agreement with
Federated Merchandising Group ("FMG"), the sourcing arm of Federated Department
Stores, to supply FMG with American Rag CIE, a new casual sportswear collection
for juniors and young men. Private Brands will design and manufacture a full
collection of American Rag apparel, which will be distributed by FMG exclusively
to Federated stores across the country. Beginning in August 2003, the American
Rag collection will be available in approximately 100 select Macy's, the Bon
Marche, Burdines, Goldsmith's, Lazarus and Rich's-Macy's locations.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
We are a leading provider of private label casual apparel, serving
specialty retail, mass merchandise and department store chains and major
international brands located primarily in the United States by designing,
merchandising, contracting for the manufacture of, manufacturing directly and
selling casual, moderately-priced apparel for women, men and children. Our major
customers include specialty retailers, such as Lerner New York, Limited Stores
and Express, all of which are divisions of The Limited, as well as Lane Bryant,
Abercrombie & Fitch, J.C. Penney, K-Mart, Kohl's, Mervyns, Sears 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.
From inception, we relied primarily on independent contract
manufacturers located primarily in the Far East. Commencing in the third quarter
of 1997, and taking advantage of the North American Free Trade Agreement, or
NAFTA, we substantially expanded our use of independent cutting, sewing and
finishing contractors in Mexico, primarily for basic garments. Commencing in
1999, and concluding in December 2002 with the purchase of a denim and twill
manufacturing plant in Tlaxacala, Mexico, we engaged in an ambitious program to
develop a vertically integrated manufacturing operation in Mexico while
maintaining our sourcing operation in the Far East. We believe that the dual
strategy of maintaining independent contract manufacturers in the Far East and
operating manufacturing facilities in Mexico controlled by us can best serve the
different needs of our customers and enable us to capitalize on advantages
offered by both markets. We believe this diversified approach also helps to
mitigate the risks of doing business outside of North America, such as
transportation delays, economic and political instability, currency
fluctuations, restrictions on the transfer of funds and the imposition of
tariffs, export duties, quota, and other trade restrictions.
In April 2003, we acquired an equity interest in the owner of the
trademark "American Rag CIE," and our subsidiary, Private Brands, Inc., acquired
a license to certain exclusive rights to this trademark. Private Brands also
entered into multi-year exclusive distribution agreement with Federated
Merchandising Group ("FMG"), the sourcing arm of Federated Department Stores, to
supply FMG with American Rag CIE, a new casual sportswear collection for juniors
and young men. Private Brands will design and manufacture a full collection of
American Rag apparel, which will be distributed by FMG exclusively to Federated
stores across the country. Beginning in August 2003, the American Rag collection
will be available in approximately 100 select Macy's, the Bon Marche, Burdines,
Goldsmith's, Lazarus and Rich's-Macy's locations.
On June 28, 2000, we signed a production agreement with Manufactures
Cheja, the original term of which extended through February 2002. We extended
the contract for an additional quantity of 6.4 million units commencing on April
1, 2002, which was amended on November 8, 2002, for the manufacture of 5.7
million units through September 30, 2004. We have unrecouped advances to Cheja
of approximately $2.7 million related to the production agreement to be recouped
out of future production.
On April 12, 2000, we formed a new company, Jane Doe International,
LLC, or JDI. This company was formed for the purpose of purchasing the assets of
Needletex, Inc., owner of the Jane Doe brand. JDI is owned 51% by Fashion
Resource (TCL), Inc., a subsidiary of ours, and 49% by Needletex, Inc. In March
2001, we converted JDI from an operating company to a licensing company, and
entered into two licenses with regards to the use of the Jane Doe trademark.
Pending the outcome of our litigation with Patrick Bensimon, owner of Needletex
Inc., this licensing company has been largely dormant in its activities in 2002
and 2003. For a description of the terms of this acquisition and details of the
litigation, see "Part II, Item 1. Legal Proceedings."
On December 2, 1998, we contracted to acquire a fully operational
facility being constructed near Puebla, Mexico by an affiliate of Kamel Nacif, a
significant shareholder. On October 16, 2000, we extended our option to purchase
the facility until September 30, 2002. In September 2002, we exercised the
option to purchase the facility and completed the transaction at the end of
December 2002.
We have entered into a program of sharing Mexico production capacity
with Azteca Productions International ("Azteca"), a corporation owned by the
brothers of Gerard Guez, the Chairman of the Company. We
12
believe improved utilization of our production facilities should lower unit
costs and favorably impact margins. In order to manage the shared utilization,
new procedures have been adopted, which we believe will maintain control and
appropriately allocate costs between Azteca and us.
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 for interim financial statements. 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.
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, 2002.
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, 2003, the balance in the allowance for returns,
discounts and bad debts reserves was $4.5 million, compared to $4.3 million at
March 31, 2002.
INVENTORY
Our inventories are valued at the lower of cost or market. Under
certain market conditions, estimates and judgments regarding the valuation of
inventory are employed by us to properly value inventory. Reserve 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.
13
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 adopted SFAS No. 142 in fiscal 2002 and
performed our first annual assessment of impairment, which resulted in an
impairment loss of $4.9 million.
We utilized the discounted cash flow methodology to estimate fair
value. At March 31, 2003, we have a goodwill balance of $27.9 million, and a net
property and equipment balance of $152.9 million.
INCOME TAXES
As part of the process of preparing our consolidated financial
statements, management is required to estimate income taxes in each of the
jurisdictions in which we operate. The process involves estimating actual
current tax expense along with assessing temporary differences resulting from
differing treatment of items for book and tax purposes. These timing differences
result in deferred tax assets and liabilities, which are included in our
consolidated balance sheet. Management records a valuation allowance to reduce
its deferred tax assets to the amount that is more likely than not to be
realized. Management has considered future taxable income and ongoing tax
planning strategies in assessing the need for the valuation allowance. Increases
in the valuation allowance result in additional expense to be reflected within
the tax provision in the consolidated statement of operations. Accruals are also
estimated for ongoing audits regarding Federal tax issues that are currently
unresolved. We routinely monitor the potential impact of these situations and
believe that amounts are properly accrued for.
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 88% of our long-term debt would become due in
full if any of the debt is in default. In anticipation of us not being able to
meet the required covenants due to various reasons, we either negotiate for
changes in the relative covenants or an advance waiver or reclassify the
relevant debt as current. We believe that results of operations will improve for
the year ending December 31, 2003 and thereafter and the likelihood of our
defaulting on debt covenants is decreasing absent any material negative event
affecting the U.S. economy as a whole. We also believe that our lenders would
provide waivers if necessary. However, our expectations of future operating
results and continued compliance with other debt covenants cannot be assured and
our lenders' actions are not controllable by us. If projections of future
operating results are not achieved and the debt is placed in default, we would
be required to reduce our expenses, including by curtailing operations, and to
raise capital through the sale of assets, issuance of equity or otherwise, any
of which could have a material adverse effect on our financial condition and
results of operations.
14
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in our consolidated statements of income as a percentage of net sales:
THREE MONTHS ENDED
MARCH 31,
--------------------
2003 2002
------- -------
Net sales .......................................... 100.0% 100.0%
Cost of sales ...................................... 88.8 87.1
------- -------
Gross profit ....................................... 11.2 12.9
Selling and distribution expenses .................. 3.4 4.0
General and administration expenses ................ 9.4 10.0
------- -------
Income (loss) from operations ...................... (1.6) (1.1)
Interest expense ................................... (1.9) (1.4)
Interest income .................................... 0.1 0.0
Other income ....................................... 0.4 0.3
Other expense ...................................... (0.4) (0.3)
Minority interest .................................. (0.3) (0.7)
------- -------
Income (loss) before taxes and
cumulative effect of accounting
change ............................................ (3.7) (3.2)
Income taxes (credit) .............................. 1.2 (0.6)
------- -------
Net income (loss) before cumulative
effect of accounting change ....................... (4.9)% (2.6)%
======= =======
Cumulative effect of accounting change
net of tax benefit ................................ -- (7.5)
Net income (loss) .................................. (4.9)% (10.1)%
======= =======
FIRST QUARTER 2003 COMPARED TO FIRST QUARTER 2002
Net sales increased by $13.6 million, or 20.8%, to $78.7 million in
first quarter of 2003 from $65.2 million in the first quarter of 2002. The
increase in net sales included an increase in sales of $1.4 million to mass
merchandisers, an increase of $4.1 million to divisions of The Limited, Inc., an
increase of $2.9 million to Tommy Hilfiger through UAV and an increase in sales
of $4.2 million to Federated Stores Inc. The increase in net sales in the first
quarter of 2003 was primarily attributable to the recovery from the effect of
the September 11, 2001 terrorist attacks on the United States, which
substantially affected the first quarter of 2002.
Gross profit consists of net sales less product costs, direct labor,
manufacturing overhead, duty, quota, freight in, brokerage, and warehousing.
Gross profit increased by $384,000, or 4.6%, to $8.8 million, or 11.2% of net
sales in the first quarter of 2003 from $8.4 million, or 12.9% of net sales in
the first quarter of 2002. The decrease in gross profit as a percentage of net
sales occurred primarily because of the increase in fixed manufacturing overhead
included in gross profit, which commenced upon our acquisition in December 2002
of additional manufacturing facilities in Mexico. During the first quarter of
2003, we only achieved 50% utilization of the capacity of our Mexican
facilities.
Selling and distribution expenses increased by $93,000, or 3.5%, to
$2.7 million in the first quarter of 2003 from $2.6 million in the first quarter
of 2002. As a percentage of net sales, these expenses decreased to 3.4% in the
first quarter of 2003 from 4.0% in the first quarter of 2002. General and
administrative expenses increased by $770,000, or 11.6%, to $7.4 million in the
first quarter of 2003 from $6.6 million in the first quarter of 2002. As a
percentage of net sales, these expenses decreased to 9.4% in the first quarter
of 2003 from 10.0% in the first quarter of 2002. The increase in such expenses
as a percentage of net sales is primarily due to an increase of provision for
the allowance for returns and discounts of $194,000 in the first quarter of 2003
compared to $111,000 in the first quarter of 2002.
Operating loss in the first quarter of 2003 was $1.3 million, or 1.6%
of net sales, compared to $831,000, or 1.1% of net sales, in the comparable
period of 2002, because of the factors discussed above.
Interest expense increased by $593,000, or 65.9%, to $1.5 million in
the first quarter of 2003 from $900,000 in the first quarter of 2002. As a
percentage of net sales, these expenses increased to 1.9% in the first quarter
of 2003 from 1.4% in the first quarter of 2002. This increase was a result of
increased interest margin paid to GMAC and UPS. Interest income
15
was $87,000 in the first quarter of 2003, compared to $58,000 in the first
quarter of 2002. Other income was $317,000 in the first quarter of 2003,
compared to $224,000 in the first quarter of 2002. Other expense increased to
$326,000 in the first quarter of 2003 from $204,000 in the first quarter of
2002, due to the unrealized exchange loss relating to Euro denominated debts of
$264,000 in the first quarter of 2003 and $112,000 in the first quarter of 2002.
Net expense on minority interest in the first quarter of 2003 was
$236,000 representing $1.3 million profit shared by the 49.9% minority partner
in the UAV joint venture, which was offset by $1.0 million attributed to the
minority shareholder in Tarrant Mexico for his 25% share in the loss. In the
first quarter of 2002 minority interest expense was $438,000, consisting of
profit shared by the minority partner in the UAV joint venture.
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,
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.
Following is a summary of our contractual obligations and commercial
commitments available to us as of March 31, 2003 (in millions):
CONTRACTUAL OBLIGATIONS PAYMENTS DUE BY PERIOD
- ----------------------- ------------------------------------------------------
LESS THAN BETWEEN BETWEEN AFTER
TOTAL 1 YEAR 2-3 YEARS 4- 5 YEARS 5 YEARS
------- -------- --------- ---------- -------
Long-term debt.......... $ 78.1 $ 23.7 $ 54.4 $ 0 $ 0
Operating leases........ $ 12.0 $ 3.0 $ 2.8 $ 2.6 $ 3.6
Total contractual cash
obligations.......... $ 90.1 $ 26.7 $ 57.2 $ 2.6 $ 3.6
Guarantees have been issued in favor of YKK, Universal Fasteners and
RVL Inc. for $750,000, $500,000 and unspecified amount, respectively, to cover
trim purchased by Tag-it Pacific Inc. on behalf of the Company.
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
--------------------------------------------
TOTAL
COMMERCIAL COMMITMENTS AMOUNTS
AVAILABLE TO US AS OF COMMITTED LESS THAN BETWEEN BETWEEN AFTER
MARCH 31, 2003 TO US 1 YEAR 2-3 YEARS 4- 5 YEARS 5 YEARS
- ----------------------- ------- -------- --------- ---------- -------
Lines of credit....... $ 130.6 $ 50.3 $ 79.9 $ 0.4 $ --
Letters of credit
(within lines
of credit)......... $ 27.6 $ 27.6 -- -- $ --
Total commercial
commitments........ $ 130.6 $ 50.3 $ 79.9 $ 0.4 $ --
During the first three months of 2003, net cash used by operating
activities was $8.4 million, as compared to $84,000 for the same period in 2002.
Net cash outflow from operating activities in 2003 was caused by the operating
loss of $3.9 million offset by depreciation and amortization of $4.0 million. In
addition, increases of $8.6 million in accounts receivable, $3.4 million in
inventory and $1.8 million in temporary quota were offset by increases of $2.6
million in accounts payable and $2.4 million in accrued expenses and income tax
payable.
16
During the first three months of 2003, net cash provided by investing
activities was $48,000, as compared to cash of $2.1 million used in investing
activities for the same period in 2002. Cash used in investing activities in
2003 included approximately $415,000 of increase in other assets and $734,000 of
repayments of advances from shareholders/officers.
During the first three months of 2003, net cash provided by financing
activities was $7.5 million, as compared to $1.8 million for the same period in
2002. Cash provided by financing activities in 2003 included $5.8 million of
short-term bank borrowings and $61.1 million of proceeds from long-term
obligations, offset by $60.8 million of payments of long-term obligations and
bank borrowings.
As of March 31, 2003, Grupo Famian had a short-term advance from Banco
Bilbao Vizcaya amounting to $148,000. This subsidiary also had a credit facility
of $10 million with Banco Nacional de Comercio Exterior SNC, based on purchase
orders. After the merger of Grupo Famian into Tarrant Mexico, Banco Nacional de
Comercio Exterior SNC has agreed that Tarrant Mexico will repay the outstanding
amount by making payments of $523,000 per month starting March 26, 2003. As of
March 31, 2003, $4.1 million was outstanding.
We have two equipment loans with the initial borrowings of $16.25
million and $5.2 million from GE Capital Leasing ("GE Capital") and Bank of
America Leasing ("BOA"), respectively. The leases are secured by equipment
located in Puebla and Tlaxcala, Mexico. The amounts outstanding as of March 31,
2003 were $6.4 million due to GE Capital and $2.1 million due to BOA. Interest
accrues at a rate of 2.5% over LIBOR. The loan from GE Capital will mature in
2005 and the loan from BOA in 2004. The GE Capital facilities are subject to
covenants on Tangible Net Worth ($30 million), leverage ratio of not more than
two times and no losses for two consecutive quarters. We were in violation of
the covenant on consecutive quarterly losses and obtained a waiver from GE
Capital for a fee of $25,000. The BOA facility is subject to a financial
benchmark on debt service coverage (0.8:1 before March 31, 2003 and 1.25:1
thereafter) and a leverage ratio of not more than 2 times. We were in violation
of the debt service coverage benchmark and are negotiating for a waiver of the
breach. Under the agreement, BOA has the option to accelerate repayment of all
outstanding principal amount to become payable in six equal monthly installments
of $350,000 each. For this reason, the debt has been classified as a current
liability.
On January 21, 2000, we entered into a new revolving credit, factoring
and security agreement (the "Debt Facility") with a syndicate of lending
institutions. The Debt Facility initially provided a revolving facility of
$105.0 million, including a letter of credit facility not to exceed $20.0
million, and matures on January 31, 2005. The Debt Facility provides for
interest at LIBOR plus the LIBOR rate margin determined by the Total Leverage
Ratio (as defined). The Debt Facility is collateralized by receivables,
intangibles, inventory and various other specified non-equipment assets of the
Company. In addition, the facility is subject to various financial covenants on
tangible net worth, interest coverage, fixed charge ratio and leverage ratio and
prohibits the payment of dividends. On March 2, 2001, we entered into an
amendment of our Debt Facility with GMAC Commercial Credit, LLC ("GMAC"), who
solely assumed the facility in 2000. This amendment reduced the $105.0 million
facility to $90.0 million. The over-advance line of $25 million was converted to
a term facility to be repaid by monthly installments of $500,000 before August
2001 and $687,500 thereafter. The Company and GMAC have established new
financial covenants for the remainder of fiscal 2003 based on our projections,
which include requirements for tangible net worth of not less than $75 million
on each of June 30, 2003 and September 30, 2003 and $80 million on December 31,
2003; fixed charge ratio of 0.7 to 1 on June 30, 2003, and 1.1 to 1 for the rest
of the current year; leverage ratio of not more than 2.50:1, 2.25:1 and 2.0:1
for June 30, September 30 and December 31, 2003, respectively; and capital
expenses are capped at $800,000 per quarter. A total of $60.6 million was
outstanding under the Debt Facility at March 31, 2003. As of March 31, 2003, we
were in violation of covenants on interest coverage, total leverage ratio and
fixed charge under the Debt Facility. We received a waiver from GMAC with
respect to its violation of these covenants, and paid GMAC $45,000 for this
waiver.
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, Fashion
Resource (TCL), Inc., and Tarrant Luxembourg SARL (previously known as Machrima
Luxembourg SARL), a new holding company we formed during 2002, Mr. Gerard Guez
(our Chairman) also signed a guarantee of $5 million in favor of UPS to secure
this facility. This facility is
17
also subject to certain restrictive covenants, including no two consecutive
quarterly losses; aggregate net worth, fixed charge ratio, interest coverage
ratio, and leverage ratio. All the covenants for 2003 have now been re-set in
line with those of the Debt Facility mentioned above. As of March 31, 2003,
$24.4 million, of which $13.4 million was for letters of credit, was outstanding
under this facility. As of March 31, 2003, we were in violation of the
no-consecutive-quarterly-losses covenant and the fixed charge ratio covenant and
a waiver has been obtained at a fee of $10,000.
Since March, 2003, Dao Heng Bank in Hong Kong 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 and Todd Kay)
and by our guarantee. As of March 31, 2003, $2 million was outstanding under
this facility
The Debt Facility with GMAC and the credit facilities with UPS, GE
Capital and BOA all carry cross-default clauses. A breach of a financial
covenant set by GMAC, UPS or GE Capital constitutes an event of default,
entitling these banks to demand payment in full of all outstanding amounts under
their respective debt and credit facilities.
During 2000, we financed equipment purchases for the 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,
$6.5 million was outstanding as of March 31, 2003. Of the $6.5 million, $4.0
million is denominated in the Euro. The remainder is payable in U.S. dollars. We
are subject to foreign exchange risk on this Euro exposure.
From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates who issues these letters of credits out
of Israeli Discount Bank. As of March 31, 2003, $3.1 million in 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,
Todd Kay and Kamel Nacif. The greatest outstanding balance of such borrowings
from Mr. Kay in the first quarter of 2003 was $487,000. The greatest outstanding
balance of such advances to Messrs. Guez and Nacif during the first quarter of
2003 was approximately $4,879,000 and $723,000, respectively. As of March 31,
2003, we were indebted to Mr. Kay and Mr. Nacif in the amount of $487,000 and
$1.8 million, respectively. Mr. Guez had an outstanding advance from us in the
amount of $4,867,000 as of March 31, 2003. 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 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, 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.
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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 President and a
member of our 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 month period ended March 31, 2003,
for rent for office and warehouse facilities.
From time to time in the past, we borrowed funds from, and advanced
funds to, certain officers and principal shareholders, including Gerard Guez,
Todd Kay and Kamel Nacif. The greatest outstanding balance of such borrowings
from Mr. Kay in the first quarter of 2003 was $487,000. The greatest outstanding
balance of such advances to Messrs. Guez and Nacif during the first quarter of
2003 was approximately $4,879,000 and $723,000, respectively. As of March 31,
2003, we were indebted to Mr. Kay and Mr. Nacif in the amount of $487,000 and
$1.8 million, respectively. Mr. Guez had an outstanding advance from us in the
amount of $4,867,000 as of March 31, 2003. 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.
On December 31, 2002, our wholly owned subsidiaries, Tarrant Mexico and
Machrima Luxembourg, acquired a denim and twill manufacturing plant in Tlaxcala,
Mexico, including all machinery and equipment used in the plant, the buildings,
and the real estate on which the plant is located. Pursuant to an Agreement for
the Purchase of Assets and Stock, dated as of December 31, 2002, Tarrant Mexico
purchased from Trans Textil International, S.A. de C.V. ("Trans Textil") all of
the machinery and equipment used in and located at the plant, and the Purchasers
acquired from Jorge Miguel Echevarria Vazquez and Rosa Lisette Nacif Benavides
(the "Inmobiliaria Shareholders") all the issued and outstanding capital stock
of Inmobiliaria Cuadros, S.A. de C.V. ("Inmobiliaria"), which owns the buildings
and real estate. The purchase price for the machinery and equipment was paid by
cancellation of $42 million in indebtedness owed by Trans Textil to Tarrant
Mexico. The purchase price for the Inmobiliaria shares consisted of a nominal
cash payment to the Inmobiliaria Shareholders of $500, and subsequent repayment
by us and our affiliates of approximately $34.7 million in indebtedness of
Inmobiliaria to Kamel Nacif Borge, his daughter Rosa Lisette Nacif Benavides,
and certain of their affiliates, which payment was made by: (i) delivery to Rosa
Lisette Nacif Benavides of one hundred thousand shares of our newly created,
non-voting Series A Preferred Stock, which shares will become convertible into
three million shares of common stock if our common stockholders approve the
conversion at the Annual Meeting; (ii) delivery to Rosa Lisette Nacif Benavides
of an ownership interest representing twenty-five percent of the voting power of
and profit participation in Tarrant Mexico; and (iii) cancellation of
approximately $14.9 million of indebtedness of Mr. Nacif and his affiliates.
The Series A Preferred Stock accrues dividends at an annual rate of 7%
of the initial stated value of $88.20 per share, payable only when and as
declared by our Board of Directors. In the event we liquidate, dissolve or wind
up our business, the holders of Series A Preferred shares will be entitled to
receive, prior to any distribution on our common stock, a distribution equal to
the initial stated value of the Series A Preferred shares plus all accrued and
unpaid dividends. At March 31, 2003, there was $154,350 in accrued and unpaid
dividends on the Series A Preferred Stock.
Kamel Nacif Borge is an employee of Tarrant Mexico and the beneficial
owner of more than 5% of our outstanding common stock. Jamil Textil, S.A. de
C.V., an entity we believe is controlled by Mr. Nacif, owns 1,724,000 shares of
our common stock, representing approximately 10.9% of our outstanding common
stock as of March 31, 2003. Trans Textil, an entity controlled by Mr. Nacif and
his family members, was initially commissioned by us to construct and develop
the plant in December 1998. Subsequent to completion, Trans Textil purchased
and/or leased the plant's manufacturing equipment from us and entered into a
production agreement that gave us the first right to all production capacity of
the plant. This production agreement included the option for us to purchase the
facility and discontinue the production agreement with Trans Textil through
September 30, 2002. We exercised the option and acquired the plant as described
above.
From time to time, we have advanced funds to Mr. Nacif and his
affiliates, and Mr. Nacif and such affiliates have advanced funds to us.
Immediately prior to the mill acquisition, Mr. Nacif and his affiliates owed us
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approximately $7.5 million, which indebtedness was cancelled as part of the
repayment by Inmobiliaria of indebtedness due Mr. Nacif and his affiliates.
On July 1, 2001, we formed an entity to jointly market, share certain
risks and achieve economies of scale with Azteca Production International, Inc.,
called United Apparel Ventures, LLC. 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 31, 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.
In 1998, a California limited liability company owned by Messrs. Guez
and Kay purchased 2,390,000 shares of the Common Stock of Tag-It Pacific, Inc.
(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. 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 customers, are no less favorable to us than could be obtained
from unaffiliated third parties. We purchased $4.2 million of trim inventory
from Tag-It during the three months ended March 31, 2003. From time to time we
have guaranteed the indebtedness of Tag-It for the purchase of trim on our
behalf.
We have adopted a policy that any transactions between us and any of
our affiliates or related parties, including our executive officers, directors,
the family members of those individuals and any of their affiliates, must (i) be
approved by a majority of the members of the Board of Directors and by a
majority of the disinterested members of the Board of Directors and (ii) be on
terms no less favorable to us than could be obtained from unaffiliated third
parties.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report on Form 10-Q contains forward-looking statements,
which are subject to a variety of risks and uncertainties. Our actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below.
RISKS RELATED TO OUR BUSINESS
WE DEPEND ON A GROUP OF KEY CUSTOMERS FOR A SIGNIFICANT PORTION OF OUR SALES. A
SIGNIFICANT ADVERSE CHANGE IN A CUSTOMER RELATIONSHIP OR IN A CUSTOMER'S
FINANCIAL POSITION COULD HARM OUR BUSINESS AND FINANCIAL CONDITION.
Affiliated stores owned by The Limited (including Limited Stores and
Express) accounted for approximately 9.6% and 5.2% of our net sales for the
first quarter of 2003 and 2002, respectively. Lane Bryant accounted for 12.0%
and 25.5% of our net sales for the first quarter of 2003 and 2002, respectively.
Lerner New York accounted for 3.0% and 7.2% of our net sales for the first
quarter of 2003 and 2002, 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 do not have
long-term contracts with any of them, including The Limited. As a result,
purchases generally occur on an order-by-order basis, and the relationship, as
well as particular orders, can generally be terminated by either party at any
time. 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.
20
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.
WE HAVE ONLY LIMITED EXPERIENCE OPERATING A VERTICALLY INTEGRATED BUSINESS.
During 2002, we completed the vertical integration of our business,
which included: (1) establishing cutting, sewing, washing, finishing, packing,
shipping and distribution activities in company-owned facilities or through the
acquisition of established contractors and (2) establishing fabric production
capability through the acquisition of established textile mills or the
construction of new mills. Prior to 1999, we had no previous history of
operating textile mills or cutting, sewing, washing, finishing, packing or
shipping operations upon which an evaluation of the prospects of our vertical
integration strategy can be based. Since the beginning of our vertical
integration strategy, we have experienced increased complexities. In addition,
the implementation of the integration strategy could place significant strain on
our administrative, operational and financial resources and increased demands on
our financial systems and controls. Our ability to manage our vertical
integration successfully will require us to continue to improve and expand these
resources, systems and controls. If our management is unable to manage our
vertical integration effectively, our operating results could be adversely
affected.
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, retailers generally can cancel orders or refuse to
accept goods due to late shipment. Such cancellations and returns would result
in a reduction in revenue, increased administrative and shipping costs and a
further burden on our distribution facilities.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
We have experienced, and expect to continue to experience, substantial
variations in our net sales and operating results from quarter to quarter. We
believe that the factors which influence this variability of quarterly results
include the timing of our introduction of new product lines, the level of
consumer acceptance of each new product line, general economic and industry
conditions that affect consumer spending and retailer purchasing, the
availability of manufacturing capacity, the seasonality of the markets in which
we participate, the timing of trade shows, the product mix of customer orders,
the timing of the placement or cancellation of customer orders, the weather,
transportation delays, 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 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,
21
any decrease in the availability of cotton could impair our ability to meet our
production requirements in a timely manner.
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 growth.
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. Recently, hackers and computer viruses have disrupted the operations
of several 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 available through our bank credit facilities, issuance of long-term
22
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, it may not be available on economically reasonable
terms. In addition, any additional funding may result in significant dilution to
existing stockholders. 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.
We import raw materials and finished garments. 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.
Due to our vertical integration in Mexico, this increased competition could have
an adverse effect on our business and financial condition.
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 PARTIAL DEPENDENCE ON INDEPENDENT MANUFACTURERS REDUCES OUR ABILITY TO
CONTROL THE MANUFACTURING PROCESS, WHICH COULD HARM OUR SALES, REPUTATION AND
OVERALL PROFITABILITY.
Although we have reduced our reliance on outside third party
contractors through our vertical integration in Mexico, a substantial portion of
our sourcing are manufactured by independent cutting, sewing and finishing
contractors. As a result, 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.
23
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 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 95% of our products were imported from outside the U.S.
in the first quarter of 2003, 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.
OUR OPERATIONS IN MEXICO ARE SUBJECT TO RISKS ASSOCIATED WITH MANUFACTURING
FACILITIES. INCREASED COMPETITION FROM OTHER FOREIGN COUNTRIES COULD ADVERSELY
AFFECT THE RESULTS OF OUR OPERATIONS.
As a manufacturer in Mexico, we are subject to the risks associated
with owning a manufacturing business, including but not limited to, the
maintenance and management of manufacturing facilities, equipment, employees,
trade unions and inventories. The risk of being a fully integrated manufacturer
is increased in an industrial wide slowdown because of the fixed costs
associated with manufacturing facilities.
As of 2005, quota on Chinese origin apparel will be phased out. This
may pose serious challenges to Mexican apparel products sold to the United
States market. Products from China now receive the same preferential tariff
treatment accorded goods from countries granted NTR status. With China becoming
a member of the WTO, this status is now permanent. Our products manufactured in
Mexico may be adversely affected by the increased competition from Chinese
products.
OUR COST REDUCTION MEASURES MAY ADVERSELY AFFECT OUR BUSINESS AND OPERATIONS.
Since the beginning of 2000, we have been making efforts to reduce
overhead costs by the elimination of functions duplicated in Los Angeles, New
York and Mexico. In addition, in 2001 we continued reducing headcount by 50% in
the U.S. and approximately 20% in both Mexico and Hong Kong due to decreased
sales. As a result, some personnel may be required to perform additional
functions or responsibilities, which may have an adverse effect on our business
and results of operations.
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.
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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.
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.
RISKS RELATED TO OUR COMMON STOCK
OUR MANAGEMENT OWNS A SIGNIFICANT PERCENTAGE OF OUR COMMON STOCK AND WILL BE
ABLE TO EXERCISE SIGNIFICANT INFLUENCE OVER OUR AFFAIRS.
Our executive officers and directors will continue to beneficially own
56.9% of our outstanding common stock, based upon the beneficial ownership of
our common stock as of March 15, 2003. Accordingly, these stockholders
effectively have the ability to control the outcome on all matters requiring
stockholder 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
25
the market price of our common stock. It could also prevent our stockholders
from realizing a premium over the market prices for their shares of common
stock.
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. 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 are at variable
rates.
ITEM 4. CONTROLS AND PROCEDURES.
Within the 90 days prior to the filing date of this report, 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
26
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.
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.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
PATRICK BENSIMON
Patrick Bensimon caused his company, Needletex, Inc., to transfer its
assets to a newly formed limited liability company now known as Jane Doe
International, LLC pursuant to the terms of an Asset Purchase Agreement dated
April 12, 2000. The new company is beneficially owned 51% by us and 49% by
Bensimon. At the same time, Bensimon entered into an employment agreement with
the new company, which provided for the payment of a salary to Bensimon and a
bonus tied to the new company's sales performance. The existing lenders to
Needletex, Inc. agreed to the asset transfer in return for, among other things,
the confirmation of Bensimon's continuing guaranty of the loan obligations, the
assumption of the loan obligations by the new company and a guaranty of those
obligations by us. We received an express indemnity by Needletex, Inc. and
Bensimon to reimburse us for all amounts we paid to those lenders for the
account of Needletex and Bensimon.
Thereafter a dispute arose as to whether Bensimon had performed in
accordance with his terms of employment set forth in the Employment Agreement.
When an amicable resolution of this dispute could not be achieved, Bensimon
commenced an arbitration proceeding against his employer (Jane Doe
International, LLC), Fashion Resource (TCL), Inc., the managing member of Jane
Doe International, and us. We and other respondents contested and vigorously
opposed the matter.
On January 21, 2003, after the hearing, the arbitration panel issued an
interim award in favor of Bensimon awarding him $1,425,655.00 for salary and
bonus plus interest accrued thereon and legal fees and costs to be determined.
All other claims by Bensimon were denied. The affirmative defenses and
counterclaims asserted by the respondents also were denied. On April 7, 2003 the
panel issued a final award in favor of Bensimon confirming the prior interim
award and awarding Bensimon costs and attorneys fees in the amount of
$489,639.83. On April 28, 2003 Bensimon sought a court order confirming the
final arbitration award, which in all likelihood will be granted. We have
determined not to seek to vacate the award.
On March 10, 2003, we commenced an action against Bensimon in the Los
Angeles County Superior Court seeking damages arising out of the express
indemnity. The amount of the claim held by us is $2,159,387.17, which is
approximately the same amount of the total award made by the arbitration panel
in favor of Bensimon. We sought the appointment of a referee by the Court in
accordance with the terms of the Asset Purchase Agreement. The Court denied this
motion but reserved judgment as to whether the prior arbitration proceedings
previously adjudicated the issue of Bensimon's liability under his express
indemnity. We intend to vigorously oppose any attempt by Bensimon to have this
suit dismissed.
At the outset of the dispute we tendered the claim by Bensimon to our
insurance carrier, which accepted the tender with a reservation of rights as to
whether coverage existed for the claim. The carrier observed the arbitration
process and hearing. After the interim 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 arising out of its denial of coverage for the costs
and fees awarded to Bensimon in the arbitration. We intend to vigorously pursue
this claim.
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.
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ITEM 2. CHANGES IN SECURITIES. None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None.
ITEM 5. OTHER INFORMATION. None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit 10.90.14: Letter Amendment dated May 9, 2003, between
Tarrant Apparel Group, Tag Mex, Inc., Fashion
Resource (TCL), Inc., United Apparel
Ventures, LLC and GMAC Commercial Credit,
LLC. Reference is made to Revolving Credit,
Factoring and Security Agreement dated
January 21, 2000.
Exhibit 10.101.4: Amended and Restated Limited Liability
Company Operating Agreement of United Apparel
Ventures, dated as of October 1, 2002,
between Azteca Production International, Inc.
and Tag Mex, Inc.
Exhibit 10.113: Exclusive Distribution Agreement dated April
1, 2003, between Federated Merchandising
Group, an unincorporated division of
Federated Department Stores, and Private
Brands, Inc.
Exhibit 10.114: Unconditional Guaranty of Performance dated
April 1, 2003, by Tarrant Apparel Group.
Exhibit 10.115: Charge Over Shares dated February 26, 2003 by
Machrima Luxembourg International Sarl in
favor of UPS Capital Global Trade Finance
Corporation.
Exhibit 99.1: Certification Pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 by Gerard Guez
dated May 15, 2003.
Exhibit 99.2: Certification Pursuant to 18 U.S.C. Section
1350 as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 by Patrick
Chow dated May 15, 2003.
(b) Reports on Form 8-K.
Current Report on Form 8-K dated December 31, 2002, reporting
Items 2 and 7, as filed on January 15, 2003.
29
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 15, 2003 By: /s/ Patrick Chow
---------------------------
Patrick Chow,
Chief Financial Officer
Date: May 15, 2003 By: /s/ Gerard Guez
---------------------------
Gerard Guez,
Chief Executive Officer
30
CERTIFICATIONS
I, Gerard Guez, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tarrant Apparel
Group;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 15, 2003 By: /s/ Gerard Guez
------------------------------
Gerard Guez,
Chief Executive Officer
31
CERTIFICATIONS
I, Patrick Chow, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tarrant Apparel
Group;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 15, 2003 By: /s/ Patrick Chow
----------------------------
Patrick Chow,
Chief Financial Officer
32