STAGE II APPAREL CORP, 10-K405, 1998-03-31

STAGE II APPAREL CORP
10-K405, 1998-03-31
MEN'S & BOYS' FURNISHGS, WORK CLOTHG, & ALLIED GARMENTS

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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 1997 Commission File No. 1-9502

STAGE II APPAREL CORP.
(Exact name of registrant as specified in its charter)

New York 13-3016967
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

350 Fifth Avenue
New York, New York 10118
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (212) 564-5865

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Name of each exchange on which registered
Common Stock, $.01 par value American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K under the Securities Exchange Act of 1934 is not contained
herein, and will not be contained, to the best of the Registrant's knowledge, in
definitive proxy or information statements incorporated in Part III of this Form
10-K or any amendments to this Form 10-K. |X|

As of March 16, 1998, 3,903,267 shares of Common Stock were outstanding, and the
aggregate market value of shares held by unaffiliated shareholders was
approximately $1,879,000.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the Proxy Statement for the 1998 Annual Meeting of
Shareholders are incorporated by reference into Part III of this Report.

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<PAGE>

PART I

Item 1. Business

Introduction

General. Stage II Apparel Corp. (the "Company" or "Stage II") designs and
distributes an extensive range of men's and boy's casual apparel and activewear.
The Company markets its apparel to mass merchandisers under nationally
recognized brand names as well as proprietary and private labels. During the
last three years, the Company has streamlined its operations to focus on its
most popular labels and has increased reliance on its proprietary labels. The
Company's products are produced to its specifications by various independent
manufacturers in Asia, Africa and Europe. Stage II also acts as purchasing agent
for various major retailing customers.

Market Position. Management of the Company has been engaged in importing
and marketing apparel for over 40 years and believes that Stage II is a
recognized supplier of men's and boy's casual apparel and activewear. This
assessment is based on factors including merchandiser recognition of the
Company's licensed brand names as reflected in independent studies, its apparel
sales penetration in major chain stores and the fragmented nature of its
industry segment. Stage II sells its products primarily to sporting goods and
specialty stores, mass merchandisers and various wholesale membership clubs.
During 1997, the Company had over 500 customers.

Market Sector. Stage II has specialized in casual apparel and activewear
primarily for men and boys since its inception in 1980. The Company's products
offer customers a wide selection of apparel styles, fabrics and colors for
leisure and sports activities and are sold at "popular" and "moderate to better"
prices.

Redirection of Business

Recurring Losses. In systematically reducing the scope of its business to
focus on its most popular apparel lines, the Company has experienced
difficulties in maintaining strong gross profit margins and cutting fixed costs,
resulting in substantial losses over the last four years. See "Management's
Discussion and Analysis of Financial Position and Results of Operations." In
addition, the Company has been dependent on the expertise of its Chairman, Jack
Clark, who has reached retirement age and elected to reduce his management role
with the Company. In response to these developments, the Company has been
seeking to implement strategic changes to reverse the decline in its business.
These efforts have been undertaken with a view to increasing shareholder values
by bringing in a new management team, cutting expenses and adding new apparel
licenses or business lines to the Company's reduced asset base.

Change of Control. In February 1998, Stage II and Jack Clark, Robert
Plotkin and Steven R. Clark, founders of the Company (the "Founders"), entered
into a Stock Purchase Agreement (the "Purchase Agreement") with Richard Siskind,
the principal shareholder and CEO of several companies engaged in various
segments of the apparel industry. The transactions contemplated by the Purchase
Agreement (the "Change of Control Transactions") include the sale to Mr. Siskind
of 1.9 million shares (the "Control Shares") of the Company's common stock ("SA
Common Stock") held by the Founders in consideration for their release from
guarantees of the Company's indebtedness to its factor and their receipt of
options to reacquire a total of 1.5 million shares of SA Common Stock from Mr.
Siskind at exercise prices ranging from $.50 to $1.50 per share (the "Founders
Options"). The Control Shares represent 48.7% of the SA Common Stock outstanding
as of the date of this Report. The consummation of the Change of Control
Transactions is scheduled for April 1998 and is subject to various closing
conditions.

Other Change of Control Transactions. In addition to the sale of the
Control Shares, the Change of Control Transactions contemplated by the Purchase
Agreement include (i) the Company's issuance to Mr. Siskind of options to
purchase up to 1.5 million shares of SA Common Stock on the same terms as the
Founders Options, exercisable only to the extent the Founders Options are
exercised, (ii) the reconstitution of the Company's board of directors with

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designees of Mr. Siskind, (iii) the addition of a new management team headed by
Mr. Siskind and (iv) the arrangement by Mr. Siskind of a new credit facility for
the Company. Mr. Siskind is also expected to receive options to purchase up to
900,000 shares of SA Common Stock at an exercise price of $.75 per share. All of
the options issuable to Mr. Siskind will be subject to shareholder approval at
the next annual meeting of the Company's shareholders. The Company believes Mr.
Siskind's experience, industry contacts and successful track record will enable
Stage II to complete the turnaround started by its current management. To assist
in that effort, Jack Clark is expected to enter into a new employment agreement
with the Company contemplating a transitional role for one year and the
termination of his existing buy-sell agreement with Stage II.

Products

General. The Company's product mix was historically based on the
perception that retail customers preferred quality brand name apparel over
comparable proprietary or private label products. Stage II implemented this
strategy by acquiring U.S. license rights to nationally recognized brand names,
expanding its product lines to accommodate as many as sixteen brand name
licenses by 1993. Over the past few years, in response to increased demand for
more moderately priced activewear for men and boys, the Company has consolidated
its branded apparel lines to concentrate on its most popular licenses. Stage II
has also placed greater emphasis on its own proprietary labels, including Main
Event, Pro Tour, Timber Run, Rancho Santa Fe, Top Seed and Metro Clothing
Company.

Brand Name Licenses. During the course of its license acquisition program,
the Company has added and thereafter discontinued various brand name licenses in
favor of more advantageous arrangements for its current brand name lines. During
1996, Stage II added an exclusive license with Dunlop for men's activewear and
relinquished license rights for its McGregor, Walt Disney, Taz/Major League
Baseball and Coleman lines. During 1997, the Company further consolidated its
product lines by extending the term of its Dunlop license, terminating its
license for the Spalding brand and liquidating its interest in Woody Sports
Apparel, Inc. ("Woody Sports"), which held Canadian activewear licenses from the
National Hockey League, Major League Baseball, the National Collegiate Athletic
Association and the Canadian Football League. Stage II has also elected to
terminate its manufacturing arrangements with Unique Sports Generation ("Unique
Sports"), a non-exclusive licensee of the National Basketball Association and
the National Football League for various categories of men's and boy's
activewear. See "Management's Discussion and Analysis of Financial Position and
Results of Operations--Discontinued Operations."

Licensed Brand Name Apparel Sales. The Company's licensed brand name
apparel generally sells at a higher price and with greater gross profit margins
than its comparable private and proprietary label apparel. During 1997, 1996 and
1995, sales of brand name apparel accounted for approximately 60%, 71% and 78%,
respectively, of the Company's net sales. The gradual reduction in brand name
apparel as a percentage of the Company's overall product mix reflects its
strategy for increasing reliance on its own proprietary labels and its
customers' private labels in response to greater demand for more moderately
priced men's and boy's activewear.

License Agreements. The Company's license agreements require it to make
minimum annual royalty payments ranging from approximately $75,000 to $600,000.
These thresholds generally increase for each successive license year. The
license agreements also provide the licensor with a right of termination if the
Company defaults on these obligations or fails to maintain quality control.
Stage II is in compliance with the terms of each of its license agreements. The
agreements run for various periods and are generally renewable. Prior to
expiration of a profitable license, Stage II is usually able to obtain renewals
or replacements on comparable terms.

The Company's Spalding line accounted for over 10% of its net sales in
1997, and its Spalding and Coleman lines each accounted for over 10% of net
sales in 1996 and 1995. The license agreements with Spalding and Coleman were
terminated by mutual consent in 1997 and 1996, respectively, and replaced with
the Dunlop license. The Company also increased emphasis on its own Timber Run
label, which accounted for approximately 15% of its net sales in 1997.

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Marketing and Distribution

Marketing Strategy. The Company's marketing strategy focuses on multiple
product lines of quality casual apparel and activewear distinguished by design,
label and price. This permits Stage II to sell products to both discount and
full price operating divisions of major retailers. The Company's mix of brand
name and proprietary label apparel also enables it to deliver similar apparel
items under different labels to competing merchandising customers.

Marketing Vehicles. Stage II sells its products through a sales force
consisting of five sales employees and nine sales agents located in New York
City and other domestic locations. The Company advertises its brand name
products through its catalogs distributed each season and magazines including
Discount Stores News, a trade periodical, and the Daily News Record. The Company
also displays its merchandise in showrooms at its New York City headquarters. In
addition, Stage II exhibits its apparel at the semi-annual trade shows produced
by the Men's Apparel Guild in Las Vegas (MAGIC), a major men's and boy's apparel
show, and other trade shows, including the Atlanta Super Show and the BATMAN's
show for big and tall men's apparel.

Customers. In 1997, the Company's products were sold to over 500 customers
operating national and regional chains of sporting goods, specialty and mass
merchandising stores throughout the United States and Canada. Some of the
Company's largest customers during 1997 (measured by sales) included Ames
Department Stores, Inc., Army-Airforce Exchange Service, Hills Dept. Stores,
K-Mart Stores, Inc., Henry Modell & Co., Value City, Venture Stores, Inc. and
Wal-Mart Stores, Inc. Approximately 52% of the Company's 1997 net sales were
made to its ten largest customers, of which Wal-Mart Stores, Inc. and Ames
Department Stores, Inc. accounted for approximately 13% and 14%, respectively,
compared to 1996 levels of 17% and 14%, respectively.

Distribution. The Company's brand name and proprietary label products are
generally prepacked at the manufacturing site into cartons, shipped to an East
Coast warehouse and then shipped directly to the customer without repacking.
Products sold under retailers' own private labels are shipped directly to the
retailer.

Manufacturing

General. Stage II does not currently own or operate any manufacturing
facilities. Although the Company previously operated a domestic screen printing
facility, those operations were discontinued in 1993.

Manufacturing Sources. The Company's products are manufactured in
accordance with its designs, specifications and production schedules by
approximately 50 independent manufacturers located in over 16 countries in Asia,
Africa and Europe. Stage II determines its manufacturing requirements based on
customer orders placed or indicated approximately six months prior to shipment.
Manufacturing is then arranged on an order-by-order basis.

While there are no long term contractual commitments between Stage II and
its manufacturers, management believes the Company can continue to meet its
manufacturing requirements from its current manufacturers and, if necessary,
from other foreign and domestic sources. The Company's management has extensive
experience in the apparel industry and has established long term relationships
with independent manufacturers over the years. Management believes that these
relationships facilitate its sourcing of manufacturing requirements. The Company
also believes that the number and geographical diversity of its manufacturing
sources minimize the potential risks of quota limitations on imports from
certain foreign countries and adverse consequences that would result from
termination of its relationship with any of its manufacturers. See "Imports and
Import Restrictions" below.

Production Allocations. Stage II allocates production among its suppliers
based on a number of criteria, including quota considerations for foreign
suppliers, availability of production capability, quality, pricing and
flexibility in meeting changing production requirements on relatively short
notice.

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Quality Control. All finished products manufactured for the Company are
inspected by employees or agents of the Company prior to acceptance and payment
to ensure that they meet the Company's design, quality and other production
specifications. Employees or agents of the Company inspect initial product
samples provided by manufacturers for compliance with production specifications,
and production runs are not authorized until conforming samples have been
approved. Payment for each foreign manufacturing order is generally backed by an
irrevocable international letter of credit issued under the Company's credit
agreement approximately two to six months prior to shipment of the products. The
letters of credit may not be drawn until an authorized employee or agent of
Stage II issues an inspection certificate certifying that the products are in
compliance with the manufacturing order.

Sales Agency Operations

Historically, the Company's Hong Kong subsidiary, Stage II Apparel Corp.
of Hong Kong, Ltd. ("Stage II HK"), provided sales agency services to Stage II
and acted as purchasing agent to certain major retailing customers of the
Company. These functions included monitoring the production and quality control
of garments manufactured for the Company in various foreign locations, inspects
production facilities and evaluates potential future suppliers. Stage II HK also
assisted the Company's manufacturers in locating and purchasing manufacturing
machinery and raw materials from time to time and when necessary to ensure
timely delivery of finished products to meet the Company's manufacturing orders.
The operations of Stage II HK were wound down during the fourth quarter of 1997,
with its monitoring functions being replaced by outside contractors as part of
the Company's cost cutting measures. Its sales agency business is currently
conducted directly by the Company.

During 1997, Stage II and Stage II HK also acted as purchasing agent for
approximately $5 million (net sales equivalent) of apparel for other apparel
companies and retailers. These amounts are not included as net sales of the
Company. Instead, the fees for these services are reflected as commission
income. Information on the amounts of net sales and commission income, operating
profit and identifiable assets attributable to the Company's operations in the
United States and abroad is set forth in Note 2 of the Notes to the Company's
Consolidated Financial Statements included elsewhere in this Report.

Imports and Import Restrictions

Current Import Considerations. The Company imports substantially all of
its products from various foreign countries located in Asia, Africa and Europe.
Since 1963, imports of apparel products from these countries have been subject
to constraints imposed by multilateral textile agreements with the United States
applicable to specific product categories. As products in a certain product
category are imported from a country into the United States, that country's
quota for the product category is utilized. When an annual quota limit is
reached, no more products in the category may enter into the United States
during the year from that country. Stage II monitors the amount of unutilized
quota available for import of the Company's products on a weekly basis and
arranges its production schedules accordingly. The Company further minimizes its
potential exposure to quota risks through, among other things, geographical
diversification of its manufacturing sources and shifts of production among
countries and manufacturers. Stage II bases its choice of manufacturer, in part,
on quota considerations.

Potential Future Restrictions. The Company's ability to obtain necessary
product requirements may be affected by additional bilateral agreements,
unilateral trade restrictions, substantial decreases in textile import quotas, a
significant drop in the value of the dollar against foreign currency, political
instability resulting in the disruption of trade from exporting countries or the
imposition of additional duties, taxes or other charges on imports. From time to
time, legislation has been introduced in both houses of Congress seeking to
limit the import of foreign goods, including cloth, clothes and shoes, to the
United States. The Company's management has substantial experience in developing
and maintaining sources of supply, foreign and domestic, and therefore believes
that Stage II will be able to adjust to any future import restrictions by
obtaining required quota rights or, when necessary, moving production to
countries in which applicable quotas remain unfilled or to countries in which no
quotas are imposed.

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Backlog

The Company's backlog of orders for garments at March 19, 1998 totaled
approximately $10 million, including 1998 sales through that date, representing
a decrease of $4 million from the comparable backlog of approximately $14
million at March 14, 1997, including sales through that date. Substantially all
of the orders at March 19, 1998 were scheduled for delivery by the end of the
year. Backlog represents orders placed by customers that are not yet due for
shipment. The amount of unfilled orders at a particular time is affected by a
number of factors including the scheduling of the manufacture and shipment of
the product, which in some instances is dependent on the desires of the
customer. Cancellations, rejections and returns can reduce the amount of net
sales resulting from the backlog of orders. Accordingly, a comparison of
unfilled orders from period to period is not necessarily meaningful or
indicative of subsequent actual shipments.

Competition

The apparel business is highly competitive and consists of many importers,
distributors and manufacturers, none of which accounts for a significant
percentage of total industry sales, but some of which are larger and have
substantially greater resources than the Company. Stage II competes with
distributors that import apparel from abroad, with domestic retailers having
established foreign manufacturing relationships and with companies that produce
apparel domestically. The Company's sector of the apparel industry is highly
fragmented, and management believes that Stage II is a leading supplier of
casual apparel and activewear marketed to mass merchandisers under a number of
nationally recognized brand names and proprietary labels.

Employees

As of December 31, 1997, the Company had 26 full-time employees. None of
the Company's employees are represented by a union. Stage II considers its
working relationships with employees to be good and has never experienced an
interruption of its operations due to any kind of labor dispute.

Item 2. Properties

New York Office Headquarters

The Company's New York sales and administrative offices are located in the
Empire State Building at 350 Fifth Avenue, New York, New York 10118 and consist
of approximately 10,800 square feet. The offices are occupied under a lease
running through 2006 and providing for an average annual base rent of
approximately $343,000. The Company also is obligated to pay for electricity,
certain taxes and expense escalations.

Distribution Facilities

During 1997, the Company distributed substantially all of its finished
garments in the United States from a public distribution facility located in the
New York metropolitan area, leased on a month-to-month basis. In 1997 and 1996,
the aggregate storage costs incurred at all distribution facilities were
approximately $164,000 and $188,000, respectively.

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Item 3. Legal Proceedings

In April 1996, the Company and Stage II HK commenced a lawsuit in the
Supreme Court of the State of New York against Stuart Goldman, Townsley, Ltd.
("Townsley") and related parties to recoup damages incurred in connection with
their October 1994 acquisition of substantially all the assets and related
liabilities of Townsley, the purchase of all the capital stock of Townsley's
Hong Kong subsidiary and the related employment and subsequent termination of
Mr. Goldman as President of the Company and Stage II HK. In September 1996, Mr.
Goldman and his co-defendants filed an answer denying Stage II's claims in the
lawsuit and asserting various counterclaims. During September 1997, the parties
agreed to settle the lawsuit for a payment from the Company of approximately
$1.15 million, partially offset by the relinquishment of 292,135 shares of the
Company's common stock issued as part of the purchase price for the Townsley
assets. The settlement payments and stock repurchase were completed by the
Company in November 1997.

The Company is a party to several other legal proceedings incidental to
its business, none of which is considered to be material to its financial
position, results of operations or liquidity.

Item 4. Submission of Matters to a Vote of Security Holders

Not Applicable.

PART II

Item 5. Market for the Company's Common Stock and Related Shareholder Matters

Trading Market

The SA Common Stock is listed for trading on the AMEX under the symbol SA.
The following table sets forth, for the periods indicated, the high and low
sales prices for the SA Common Stock as reported on the AMEX.

Market Prices
----------------------
1996: High Low
------- ---------
First quarter ............................................$ 4 1/8 $ 2 13/16
Second quarter............................................ 3 7/8 2 3/4
Third quarter............................................. 3 1/8 2 3/4
Fourth quarter............................................ 3 1 7/8

1997:

First quarter.............................................$ 2 1/8 $ 1 7/16
Second quarter............................................ 1 5/16 1 3/16
Third quarter............................................. 3 1/2
Fourth Quarter............................................ 2 1/16 13/16

1998:

First quarter.............................................$ 2 1/16 $ 5/8

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Security Holders

As of February 28, 1998, there were 115 holders of record of the SA Common
Stock. Stage II estimates that there are at least 900 beneficial owners of its
SA Common Stock.

Dividends

The Company has not paid any dividends on the SA Common Stock since 1994
and does not expect to consider reinstituting dividend payments in the
foreseeable future.

Item 6. Selected Financial Data

The following table presents selected financial data of Stage II at and
for the year ended December 31 in each of the five years through 1997. The
selected financial data presented below has been derived from the Company's
audited consolidated financial statements, which have been restated for each of
the three years ended December 31, 1995 to account for the operations of Woody
Sports as discontinued operations in view of the Company's decision to dispose
of its interest in the subsidiary. For each of the three years through December
31, 1997, the following financial information should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations as well as the Consolidated Financial Statements of the Company and
related Notes included elsewhere in this Report.

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STAGE II APPAREL CORP. AND SUBSIDIARIES

(In thousands, except per share amounts)

<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Net sales ........................................ $ 16,547 $ 33,428 $ 60,177 $ 59,560 $59,574
Cost of goods sold ............................... 14,234 28,016 48,357 46,778 46,270
-------- -------- -------- -------- -------
Gross profit .................................. 2,313 5,412 11,820 12,782 13,304
Commission and other income ...................... 442 678 1,599 853 1,180
-------- -------- -------- -------- -------
2,755 6,090 13,419 13,635 14,484
Selling, general and administrative expenses ..... 6,083 9,195 13,341 13,059 12,201
Impairment of prepaid salary and non-compete ..... 255 512 -- -- --
Impairment of goodwill ........................... 5,029 -- -- -- --
Loss on sale of securities ....................... 285 -- -- -- --
Loss (gain) on settlement of litigation .......... (249) (13) 577 -- --
-------- -------- -------- -------- -------
Operating profit (loss) ....................... (8,648) (3,604) (499) 576 2,283
Interest expense, net ............................ 690 1,588 2,421 1,818 829
-------- -------- -------- -------- -------
Income (loss) from continuing operations
before income taxes (benefit) ............... (9,338) (5,192) (2,920) (1,242) 1,454
Income taxes (benefit) ........................... 74 (33) (342) (438) 629
-------- -------- -------- -------- -------
Income (loss) from continuing operations before
cumulative effect of accounting change ...... (9,412) (5,159) (2,578) (804) 825
-------- -------- -------- -------- -------
Discontinued operations:
Income (loss) from discontinued operations .... -- (324) (684) (61) 8
Gain (loss) on disposal of discontinued
operations .................................. 163 (1,479) -- -- --
-------- -------- -------- -------- -------
(1,803) (684) (61) 8
Cumulative effect of accounting change ........... -- -- -- -- 401
-------- -------- -------- -------- -------
Net income (loss) ................................ $ (9,249) $ (6,962) $ (3,262) $ (865) $ 1,234
======== ======== ======== ======== =======
Net income (loss) per common share:
Income (loss) from continuing operations ...... $ (2.28) $ (1.23) $ (.60) $ (.19) $ .20
Income (loss) from discontinued operations .... .04 (.43) (.18) (.02) --

Cumulative effect of accounting change ........ -- -- -- -- .10
-------- -------- -------- -------- -------
$ (2.24) $ (1.66) $ (.78) $ (.21) $ .30
======== ======== ======== ======== =======
Dividends paid per common share .................. $ -- $ -- $ -- $ .12 $ .12
======== ======== ======== ======== =======
Weighted average common shares outstanding ....... 4,128 4,196 4,195 4,161 4,155
======== ======== ======== ======== =======

<CAPTION>
As of December 31,
-------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- -------
Summary Balance Sheet Data:
Total assets .................................. $ 11,178 $ 25,809 $ 39,536 $ 41,126 $32,747
Due to factor ................................. 4,650 7,174 11,658 9,630 2,149
Long term debt, excluding current portion ..... -- 699 1,295 1,465 --
Shareholders' equity .......................... 5,327 14,390 21,678 24,414 26,409
</TABLE>

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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations

General

The Company has historically developed its product lines primarily through
the acquisition of exclusive and non-exclusive license rights to nationally
recognized brand names for sales of its apparel in the United States. In the
last two years, the Company streamlined its operations to focus on its most
popular labels, relinquishing its license rights for five brand name lines,
liquidating its Canadian subsidiary and discontinuing its arrangements with
Unique Sports for NBA and NFL brand sportswear. These lines were replaced with a
new exclusive license for the Dunlop brand late in 1996. Stage II has also
increased its emphasis on proprietary and private label sales, including its own
Timber Run, Pro Tour and Main Event labels.

In general, the Company's established brand name apparel sells at a higher
price and with greater gross profit margins than its comparable non-branded
apparel. These advantages are partially offset by royalty and advertising
expenses incurred in accordance with the Company's license agreements for its
brand name apparel. These costs are included in selling, general and
administrative ("SG&A") expenses. Difficulties in reducing fixed overhead costs
and maintaining strong gross profit margins in the face of intensified
competition, consolidation and overall weakness in the retail apparel market
contributed to the Company's net losses in 1997, 1996 and 1995 aggregating $9.2
million, $7.0 million and $3.3 million, respectively. These losses include
noncash charges aggregating $5.3 million in 1997 and $1.7 million in 1996. See
"Asset Writedowns" below.

Recent Developments

Stage II has financed its losses over the last three years with borrowings
under its credit facility that have been reduced from time to time with
repatriated earnings of its Hong Kong subsidiary aggregating $9.4 million in
1997, of which $6.0 million was used to repay short term debt, and $3.4 million
in 1996, all of which was used for debt reduction. As part of its strategy for
returning to profitability, in addition to consolidating its licensing
arrangements, reducing the scope of its operations to concentrate on its most
successful products and trimming overhead expenses, the Company has added new
commission sales personnel and realigned management to focus on its core product
lines.

In addition to these efforts, the Company has been seeking to implement
strategic changes to reverse the decline in its business. These efforts have
been undertaken with a view in increasing shareholder values by bringing in a
new management team, cutting expenses and adding new apparel licenses or
business lines to the Company's reduced asset base. The Change of Control
Transactions scheduled for completion in April 1998 were structured to address
these goals. See "Business--Redirection of Business."

Discontinued Operations

During the third quarter of 1996, the Company finalized its plan to
liquidate the operations of Woody Sports and provided for a loss on disposal of
$1.5 million, comprised of a provision of $326,000 for operating losses during
the phase-out period, a noncash impairment charge of $1.1 million against
goodwill of the subsidiary and a $100,000 charge against prepaid salaries. The
Company's consolidated statements of operations for the years ended December 31,
1996 and 1995 have been restated to account for the operations of Woody Sports
as discontinued operations in view of the Company's decision to dispose of its
interest in the subsidiary. The liquidation of Woody Sports was completed in the
third quarter of 1997.

Asset Writedowns

In 1996, the Company implemented the Financial Accounting Standards
Board's Statement No. 121, Accounting for the Impairment Long Lived Assets to be
Disposed of ("FAS 121"). Under FAS 121, certain assets are

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<PAGE>

required to be reviewed periodically for impairment whenever circumstances
indicate their carrying amount exceed their fair value and may not be
recoverable. At December 31, 1997, the Company recognized noncash impairment
charges totaling $5.3 million, reflecting a $5.0 million writedown of goodwill
attributable to a planned reduction in emphasis on proprietary labels received
in prior acquisitions and a related $255,000 writedown of a former officer's
prepaid salary and non-compete covenant. See "Legal Proceedings." In addition,
in July 1996, as part of the plan of liquidation for Woody Sports, the Company
took noncash charges aggregating $1.2 million against the assets of its Canadian
subsidiary. See "Discontinued Operations" above. The Company also took charges
of $512,000 in 1996 for writedowns of a former officer's prepaid salary and a
non-compete covenant.

Results of Operations

Seasonality. Stage II experiences some seasonal business fluctuations due
primarily to seasonal buying patterns for its product mix of casual apparel and
activewear. While sales of the Company's products are made throughout the year,
the largest sales volume has historically occurred in the third quarter. The
following table reflects these quarterly fluctuations, which have been restated
to account for the operations of Woody Sports as discontinued operations and
should not be construed as indicative of future net sales.

Quarterly Net Sales
(In thousands)

First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
1997 .......... $ 4,067 $ 2,348 $ 5,718 $ 4,414 $16,547
1996 .......... 8,437 5,693 10,397 8,901 33,428
1995 .......... 14,015 12,233 20,387 13,542 60,177

The following tables present the Company's gross profit from continuing
operations, income (loss) from continuing operations and income (loss) per share
from continuing operations on a quarterly basis during the last three years. The
reduction in gross profit from continuing operations in the fourth quarter of
1997 reflects the sell off of discontinued lines and an increase in inventory
markdowns. Amounts may not add across due to rounding.

Quarterly Gross Profit from Continuing Operations
(In thousands)

First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
1997 .......... $ 677 $ 300 $ 1,295 $ 41 $ 2,313
1996 .......... 1,647 811 2,126 828 5,412
1995 .......... 3,126 2,271 4,393 2,030 11,820

Quarterly Income (Loss) from Continuing Operations
(In thousands)

First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
1997 .......... $(1,068) $(1,678) $ 133 $(6,799) $(9,412)
1996 .......... (1,377) (2,489) 12 (1,305) (5,159)
1995 .......... (453) (769) 464 (1,820) (2,578)

10
<PAGE>

Quarterly Income (Loss) Per Share from Continuing Operations

First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
1997 .......... $ (.26) $ (.40) $ .03 $ (1.66) $ (2.28)
1996 .......... (.33) (.59) .00 (.31) (1.23)
1995 .......... (.10) (.18) .11 (.43) (.62)

1997 and 1996. Net sales of $16.5 million from continuing operations in
1997 decreased by 50.5% from $33.4 million in 1996. The decrease primarily
reflects the termination of certain brand name apparel licenses as part of the
planned reduction in the scope of the Company's operations. Sales of replacement
brand name and proprietary lines did not begin to offset the decline until the
third quarter of 1997.

Cost of goods sold as a percentage of sales increased to 86.0% in 1997
from 83.8% in 1996. The increase reflects lower gross profit margins primarily
resulting from higher levels of promotional sales in response to the continuing
weak retail trade and the sell off of discontinued lines.

Commission and other income decreased by approximately $.2 million during
1997 compared to the prior year, reflecting a decline in the Company's sales
agency business.

SG&A expenses for 1997 decreased by 33.8% to $6.1 million compared to $9.2
million for 1996, primarily from a reduction in variable costs associated with
lower sales volumes. SG&A expenses as a percentage of sales increased to 36.8%
for 1997 compared to 27.5 % in 1996, reflecting a faster decline in sales than
the Company's ability to reduce fixed SG&A expenses.

Interest and factoring expenses decreased by $1.4 million or 60.1% for
1997 compared to 1996. The decrease resulted from a reduction of current debt
with repatriated earnings of Stage II HK and from a decline in volume of
factored receivables. During 1997, the Company realized interest income of
$242,000 and recognized a loss of $285,000 on the sale of marketable securities.

The Company recognized noncash impairment charges aggregating $5.3 million
at December 31, 1997, reflecting a $5.0 million writedown of goodwill
attributable to prior acquisitions in 1994 and a $255,000 writedown of a former
officer's prepaid salary and non-compete covenant. In 1997, the Company also
recognized a $249,000 gain relating to the Townsley settlement in the third
quarter of 1997. In 1996, the Company recognized noncash charges of $1.2 million
against the carrying value of its Canadian subsidiary's assets and prepaid
salaries plus $512,000 for writedowns of a former officer's prepaid salary and
non-compete covenant. See "Asset Writedowns" and "Discontinued Operations" above
and "Legal Proceedings."

The Company recognized losses from continuing operations before income tax
benefits of $9.3 million in 1997 and $5.2 million in 1996, reflecting the
foregoing developments. After accounting for the disposal of the Company's
discontinued subsidiary, the losses were $2.24 per share in 1997 based on
4,128,000 average common shares outstanding and $1.66 per share in 1996 based on
4,196,000 average common shares outstanding. See "Discontinued Operations"
above.

1996 Compared to 1995. Net sales of $33.4 million from continuing
operations in 1996 decreased by 44.5% from $60.2 million in 1995. The decrease
reflects intensified competition, consolidation and overall weakness in the
retail apparel trade, the termination of certain brand name apparel licenses and
a planned reduction in the scope of the Company's operations. Approximately
$10.2 million or 38.1% of the sales decline was attributable to the
relinquishment of four brand name apparel licenses in 1996.

11
<PAGE>

Cost of goods sold as a percentage of sales increased to 83.8% in 1996
compared to 80.4% in 1995. The increase reflects lower gross profit margins
primarily resulting from higher levels of promotional sales in response to the
continuing weak retail trade and the sell off of discontinued lines.

Commission and other income decreased by approximately $.9 million during
1996 compared to the prior year, reflecting a decline in the Company's sales
agency business.

SG&A expenses for 1996 decreased by 31.1% to $9.2 million compared to
$13.3 million for 1995, primarily from a reduction in variable costs associated
with lower sales volumes and a cost reduction plan adopted in the second quarter
of the year as part of the Company's redirection of its business. SG&A expenses
as a percentage of sales increased to 27.5% for 1996 compared to 22.2% in the
prior year, reflecting a faster decline in sales than the Company's ability to
reduce fixed SG&A expenses.

During 1996, Stage II recognized noncash charges aggregating $1.2 million
against the carrying value of its Canadian subsidiary's assets and prepaid
salaries plus $512,000 for writedowns of a former officer's prepaid salary and
non-compete covenant. See "Asset Writedowns" above. In addition, during 1995,
the Company recognized a provision of $577,000 for litigation costs relating
primarily to performance adjustments for an acquisition completed by Stage II in
1987.

Interest and factoring expenses, net of interest income, aggregated $1.6
million or 4.8% of sales in 1996 compared to $2.4 million or 4.0% of sales in
1995, representing a decrease of $.8 million or 34.4%. The decrease reflects
lower interest rates, reduced levels of borrowing and slightly higher levels of
interest income.

The Company recognized losses from continuing operations before income tax
benefits in 1996 and 1995 aggregating $5.2 million and $2.9 million,
respectively, reflecting the foregoing developments. After accounting for losses
of $324,000 and $765,000 from discontinued operations of Woody Sports in 1996
and 1995, respectively, and a charge of $1.5 million in 1996 for an estimated
loss on disposal of the discontinued operations, the Company's net loss was $7.0
million or $1.66 per share in 1996 based on 4,196,000 average common shares
outstanding compared to a net loss of $3.3 million or $.78 per share for 1995
based on 4,195,000 average common shares outstanding. See "Discontinued
Operations" above.

Liquidity and Capital Resources

Liquidity. Net cash used by Stage II's operating activities during 1997
aggregated $297,000. The Company's cash position during the period was increased
by the sale of marketable securities held by Stage II HK netting $5.3 million.
The Company's cash position increased from $429,000 at December 31, 1996 to
$641,000 at December 31, 1997.

Capital Resources. The Company had retained earnings of $9.3 million at
December 31, 1996, including unremitted earnings of Stage II HK in the amount of
$11.7 million, of which $8.6 million was invested in marketable fixed-income
securities. Stage II HK has paid only local (i.e., foreign) taxes associated
with its unremitted earnings, which are subject to the current U.S. tax rate
(less the amount previously paid in local taxes) when repatriated and made
available for domestic use.

During 1997, the Company repatriated all of Stage II HK's cash and
marketable securities aggregating $9.4 million of which $6.0 million was used to
reduce short term debt. The repatriation did not trigger domestic taxes due to
the availability of net operating losses to offset the taxable income created. A
loss of $285,000 was incurred from the related sale of marketable securities.

In April 1997, the Company obtained a new credit facility (the "Credit
Facility") under a factoring agreement with Milberg Factors Corp. (the
"Factor"). In connection with the refinancing, the Company repaid $6 million of
its

12
<PAGE>

borrowings under its prior credit facility with repatriated earnings of Stage II
HK and refinanced the balance of net direct borrowings aggregating $1.8 million
under the Credit Facility. As of December 31, 1997, the Company's net direct
borrowings under the Credit Facility aggregated $4.6 million.

The Credit Facility provides for short term borrowings by Stage II at a
floating interest rate equal to 1/2% above the prime rate. Borrowings under the
Credit Agreement are payable upon demand and secured by the Company's inventory,
accounts receivable, cash surrender value of officers' life insurance,
restricted cash and marketable securities. The Factor purchases the Company's
accounts receivable that it has preapproved, without recourse except in cases of
merchandise returns or billing or merchandise disputes in the normal course of
business. In addition, the Factor is responsible for the accounting and
collection of all accounts receivable sold to it by the Company. The Factor
receives a commission under the Credit Agreement in an amount less than 1% of
the net receivables it purchases.

The Credit Agreement also provides for the issuance of letters of credit
to fund the Company's foreign manufacturing orders. The aggregate amount of
letters of credit and borrowings available under the Credit Agreement are
determined from time to time based upon the requirements of the Company, with a
borrowing and letter of credit limit up to approximately $13 million.

The Credit Facility is scheduled to expire in April 1999, subject to
automatic one-year renewal terms unless terminated at the option of either
party. As a condition to the Change of Control Transactions, Richard Siskind has
undertaken to arrange a new credit facility for the Company. Under the modified
arrangements, guarantees of a portion of the Company's indebtedness under the
Credit Facility provided by two of the Founders are expected to be replaced by a
guaranty from Mr. Siskind. See "Business--Redirection of Business."

The Company believes that its internally generated funds and borrowings
available under its Credit Agreement will be sufficient to meet its foreseeable
working capital requirements. Stage II may reborrow amounts repaid under its
Credit Agreement or seek other external means to finance its operations in the
future. As of December 31, 1997, Stage II had no material capital expenditure
requirements.

Inflation. The general level of inflation in domestic and foreign
economies has not had a material effect on the Company's operating results
during the last three years.

New Accounting Pronouncement. In June 1996, the Financial Accounting
Standards Board issued Statement No. 130, Reporting Comprehensive Income ("FAS
130"). FAS 130 is effective for fiscal years beginning after December 15, 1997.
FAS 130 establishes standards for reporting and display of comprehensive income
and its components in financial statements. These standards will be reflected in
the Company's financial statements for the year ending December 31, 1998.

Year 2000 Compliance. The Company believes that it is year 2000 compliant
and does not currently anticipate any disruption in its operations as a result
of any failure in its year 2000 compliance. Stage II does not currently have any
information about the status of year 2000 compliance by its suppliers or
customers.

Forward Looking Statements

This Report includes forward looking statements within the meaning of
Section 21E of the Securities Exchange Act relating to matters such as
anticipated operating and financial performance, business prospects,
developments and results of the Company. Actual performance, prospects,
developments and results may differ materially from anticipated results due to
economic conditions and other risks, uncertainties and circumstances partly or
totally outside the control of the Company, including risks of inflation,
fluctuations in market demand for the Company's products and changes in the
level of future expenses for the manufacturing and distribution of those
products. Words such as "anticipated," "expect," "intend" and similar
expressions are intended to identify forward looking statements, all of which
are subject to these risks and uncertainties.

13
<PAGE>

Item 8. Financial Statements and Supplementary Data

Index to Financial Statements

Page
----
Stage II Apparel Corp. and Subsidiaries:

Independent Auditors' Reports ............................................ F-1
Consolidated Balance Sheets - December 31, 1997 and 1996 ................. F-3
Consolidated Statements of Operations - For the years ended
December 31, 1997, 1996 and 1995 ....................................... F-4
Consolidated Statements of Cash Flows - For the years ended
December 31, 1997, 1996 and 1995 ....................................... F-5
Consolidated Statements of Shareholders' Equity - For the years ended
December 31, 1997, 1996 and 1995 ....................................... F-6
Notes to Consolidated Financial Statements ............................... F-7

Item 9. Changes in and Disagreements with Accountants in Accounting and
Financial Disclosure

On July 25, 1997, the Company dismissed KPMG Peat Marwick LLP ("KPMG") as
its independent accountants. On the same date, the Company engaged Mahoney Cohen
& Company, CPA, P.C. ("MC&C") as its independent accountants. The change in
accountants was approved by the Audit Committee of the Board. Neither of KPMG's
reports on the Company's financial statements for the years ended December 31,
1996 and 1995 contained an adverse opinion or disclaimer of opinion, or was
qualified or modified as to uncertainty, audit scope or accounting principles.
During the last two years and the interim period prior to the change in
accountants, (i) the Company had no disagreements with KPMG on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure, (ii) KPMG did not advise the Company of any "reportable
event" as defined in Regulation S-K under the Securities Exchange Act of 1934
and (iii) the Company did not consult with MC&C on any accounting, auditing,
financial reporting or any other matters.

PART III

Item 10. Executive Officers of the Company

The executive officers of the Company are as follows:

<TABLE>
<CAPTION>
Officer of
Stage II
Name Age Position Since
- ---- --- ------------------------------------------------------------- ----------
<S> <C> <C> <C>
Jack Clark............ 70 Chairman of the Board 1982
Steven R. Clark....... 41 Executive Vice President - Sales 1980
Ronald Cohen.......... 55 Executive Vice President - Operations 1996
Carl Jenkins.......... 54 Executive Vice President - Production and Foreign Operations 1996
Michael Hanrahan...... 38 Chief Financial Officer and Treasurer 1997
</TABLE>

A summary of the business experience and background of the Company's
officers is set forth below.

Jack Clark has served as the Chairman of the Board of the Company and a
director since 1982. From 1982 through January 1987, he served as a consultant
to the Company and other apparel companies in his capacity as president of
J.C.C. Consulting Corp., with his services since that date provided directly and
exclusively to the Company. Mr. Clark is primarily responsible for the Company's
strategic planning, including product designs and development, manufacturing and
acquisitions. Mr. Clark has been engaged in the apparel business for over 40
years.

14
<PAGE>

Steven R. Clark has been a member of the Company's sales force and served
as a director of the Company since its formation in 1980, and has served as its
President since 1996 and Executive Vice President - Big and Tall Apparel since
1992, prior to which he was Division Head - Big and Tall Apparel. He is the son
of Jack Clark, Chairman of the Board of the Company, and has been engaged in the
apparel business for over 15 years.

Ronald Cohen joined Stage II in 1988 as Director of Operations and was
appointed as Executive Vice President-Operations of Stage II in 1996. He also
served as a director of the Company from 1996 until March 1998. Mr. Cohen is
principally responsible for the Company's computer operations, import
arrangements and sales monitoring. Prior to joining Stage II, Mr. Cohen served
for four years as President of Scottodd, Inc., a consulting company.

Carl Jenkins joined the Company in 1994 as Director of Production and
Foreign Operations and was appointed as Executive Vice President - Production
and Foreign Operations in 1996. Prior to joining Stage II, he served in a
similar position with Townsley for more than five years.

Michael Hanrahan joined the Company in 1997 as Chief Financial Officer and
Treasurer. From 1994 to 1997, Mr. Hanrahan was Director of Finance at Listeff
Fashions, Inc., prior to which he served as Manager of Financial Reporting at
Bernard Chaus Inc. since 1989. Mr. Hanrahan is a certified public accountant and
a graduate of Seton Hall University.

The balance of Part III to this Report is incorporated by reference to the
Company's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders
to be filed with the Securities and Exchange Commission on or before April 30,
1998.

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) Financial Statements and Schedules:

(1) Financial Statements: The financial statements listed in the
Index under Item 8 are included at the end of this Report.

(2) Schedules: All schedules for which provision is made in
applicable accounting regulations of the SEC have been omitted
as the schedules are either not required under the related
instructions, are not applicable or the information required
thereby is set forth in the Company's Consolidated Financial
Statements or the Notes thereto.

15
<PAGE>

(3) Exhibits:

Exhibit
Number: Exhibit
------- -------

2.1* Amended and Restated Certificate of Incorporation of the
Company.
3.2* By-Laws of the Company.
4.1* Form of Stock Certificate.
10.1* 1987 Incentive Stock Option Plan.
10.2 License agreement dated March 14, 1996 between Dunlop
Slazenger Corporation and the Company (incorporated by
reference to Exhibit 10.6 to the Company's Annual Report
on Form 10-K (File No. 1-9502) for the year ended
December 31, 1995).
10.3 Stock Purchase Agreement dated as of February 26, 1998
among the Company, Jack Clark, Robert Plotkin, Steven R.
Clark and Richard Siskind (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K
(File No. 1-9502) filed on March 2, 1998).
10.4 Management Agreement dated as of February 26, 1998
between the Company and Richard Siskind (incorporated by
reference to Exhibit 10.2 to the Company's Current
Report on Form 8- K (File No. 1-9502) filed on March 2,
1998).
10.5 1998 Nonqualified Stock Option Plan--A (incorporated by
reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K (File No. 1-9502) filed on March __,
1998)
10.6 1998 Nonqualified Stock Option Plan--B (incorporated by
reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K (File No. 1-9502) filed on March __,
1998)
10.7 Buy-Sell Agreement dated as of January 31, 1992 among
the Company, Jack Clark and Robert Plotkin (incorporated
by reference to Exhibit 10.15 to the Company's Annual
Report on Form 10-K (File No. 1-9502) for the year ended
December 31, 1994).
21.1 Subsidiaries of the Company (incorporated by reference
to Exhibit 21.1 to the Company's Annual Report on Form
10-K (File No. 1-9502) for the year ended December 31,
1994).
24.1 Power of Attorney of Jack Clark, Robert Plotkin and
Steven R. Clark.

- ----------
* Incorporated by reference to the corresponding Exhibit filed with the
Company's Registration Statement on Form S-1, as amended (Reg. No.
33-12959).

(b) Reports on Form 8-K:

A Current Report on Form 8-K was filed by the Company on December 9, 1997.

16
<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, this 27th day of
March, 1998.

STAGE II APPAREL CORP.

By: /s/ Michael Hanrahan By: /s/ Jack Clark
-------------------------------------- ---------------------------
Michael Hanrahan Jack Clark
Chief Financial Officer Chairman of the Board
(Principal Financial and Accounting Officer) (Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacity and on the
date indicated.

Title Date
----- ----

Jack Clark, Robert Plotkin* and Directors
Steven R. Clark*

By: /s/ Jack Clark March 27, 1998
-------------------------------------
*Jack Clark as attorney-in-fact

17
<PAGE>

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors and Shareholders of Stage II Apparel Corp.:

We have audited the accompanying consolidated balance sheet of Stage II Apparel
Corp. and subsidiaries as of December 31, 1997, and the related consolidated
statements of operations, cash flows and shareholders' equity for the year then
ended. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Stage II Apparel
Corp. and subsidiaries at December 31, 1997, and the results of their operations
and their cash flows for the year then ended, in conformity with generally
accepted accounting principles.

MAHONEY COHEN & COMPANY, CPA, P.C.

New York, New York
March 31, 1997

F-1
<PAGE>

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors and Shareholders of Stage II Apparel Corp.:

We have audited the accompanying consolidated balance sheets of Stage II Apparel
Corp. and subsidiaries as of December 31, 1996, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
years in the two-year period ended December 31, 1996. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Stage II Apparel
Corp. and subsidiaries at December 31, 1996, and the results of their operations
and their cash flows for each of the years in the two-year period ended December
31, 1996, in conformity with generally accepted accounting principles.

KPMG PEAT MARWICK LLP

New York, New York
March 26, 1998

F-2
<PAGE>

STAGE II APPAREL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1996
--------- ---------
<S> <C> <C>
ASSETS:
Cash and cash equivalents.......................................................... $ 641 $ 429
Restricted cash (note 3).......................................................... 679 --
Accounts receivable (notes 3 and 5)................................................ 496 1,334
Finished goods inventory (notes 3 and 6)........................................... 2,496 5,130
Prepaid expenses................................................................... 214 374
Prepaid income taxes and refunds receivable........................................ 30 130
--------- ---------
Total current assets............................................................. 4,556 7,397
Property and equipment, at cost, less accumulated depreciation (note 7)............ 500 585
Marketable securities (notes 3 and 8).............................................. 3,325 8,655
Goodwill, less accumulated amortization and impairment of $7,654
and $2,056 at December 31, 1997 and 1996, respectively........................... 1,960 7,558
Covenant not to compete, less accumulated amortization of $213
at December 31, 1996............................................................. -- 300
Other assets...................................................................... 837 1,314
--------- ---------
TOTAL ASSETS..................................................................... $ 11,178 $ 25,809
========= =========
LIABILITIES:
Due to factor (note 3)............................................................. $ 4,650 $ 7,174
Due to bank (note 4)............................................................... -- 434
Accounts payable................................................................... 850 1,838
Notes payable - current (note 9)................................................... -- 185
Notes payable to shareholder - current (note 10)................................... -- 411
Income taxes payable............................................................... -- 8
Accrued royalties.................................................................. 78 182
Other current liabilities.......................................................... 273 488
--------- ---------
Total current liabilities........................................................ 5,851 10,720
Notes payable - long term (note 9)................................................. -- 199
Notes payable to shareholder - long term (note 10)................................. -- 500
--------- ---------
TOTAL LIABILITIES................................................................ 5,851 11,419
--------- ---------
SHAREHOLDERS' EQUITY (notes 16 and 17):
Preferred stock, $.01 par value, 1,000 shares authorized;
none issued and outstanding...................................................... -- --
Common stock, $.01 par value, 9,000 shares authorized; 4,993 shares
issued and 3,904 shares outstanding at December 31, 1997; 4,993
shares issued and 4,196 shares outstanding at December 31, 1996.................. 50 50
Additional paid-in capital......................................................... 7,502 7,502
Retained earnings.................................................................. 97 9,346
--------- ---------
7,649 16,898
Less treasury stock, at cost; 1,089 shares at December 31, 1997; and
797 shares at December 31, 1996.................................................. (2,302) (2,092)
Allowance for decline in market value of securities available for sale (note 8) (20) (329)
Cumulative translation adjustment.................................................. -- (87)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY....................................................... 5,327 14,390
--------- ---------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......................................... $ 11,178 $ 25,809
========= =========
</TABLE>

See Notes to Consolidated Financial Statements.

F-3
<PAGE>

STAGE II APPAREL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net sales ...................................................... $ 16,547 $ 33,428 $ 60,177
Cost of goods sold (note 6) .................................... 14,234 28,016 48,357
-------- -------- --------
Gross profit ................................................... 2,313 5,412 11,820
Commission and other income .................................... 442 678 1,599
-------- -------- --------
2,755 6,090 13,419

Selling, general and administrative expenses (notes 12, 15 & 18) 6,083 9,195 13,341
Impairment of prepaid salary and non-compete ................... 255 512 --
Impairment of goodwill ......................................... 5,029 -- --
Loss on sale of marketable securities .......................... 285 -- --
Loss (gain) on settlement of litigation (notes 10 and 15) ...... (249) (13) 577
-------- -------- --------
Operating loss ................................................. (8,648) (3,604) (499)
Other income (expenses):
Interest income ............................................. 242 748 734
Interest and factoring expenses ............................. (932) (2,336) (3,155)
-------- -------- --------
Loss from continuing operations before income taxes (benefit) .. (9,338) (5,192) (2,920)

Income taxes (benefit) (note 14) ............................... 74 (33) (342)
-------- -------- --------
Loss from continuing operations ................................ (9,412) (5,159) (2,578)
-------- -------- --------
Discontinued operations:
Loss from discontinued operations ........................... -- (324) (684)
Gain (loss) on disposal of discontinued operations .......... 163 (1,479) --
-------- -------- --------
163 (1,803) (684)
-------- -------- --------
Net loss ....................................................... $ (9,249) $ (6,962) $ (3,262)
======== ======== ========
Net loss per common share:
Loss from continuing operations ............................. $ (2.28) $ (1.23) $ (.62)
Loss from discontinued operations ........................... .04 (.43) (.16)
-------- -------- --------
$ (2.24) $ (1.66) $ (.78)
======== ======== ========
Weighted average common shares outstanding ..................... 4,128 4,196 4,195
======== ======== ========
</TABLE>

See Notes to Consolidated Financial Statements.

F-4
<PAGE>

STAGE II APPAREL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Operating Activities:
Net loss ............................................................. $ (9,249) $ (6,962) $ (3,262)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Provision for discontinued operations .............................. -- 1,187 --
Depreciation and amortization of property and equipment ............ 124 171 202
Amortization and impairment of goodwill and non-compete covenant ... 5,908 1,032 666
Gain on settlement of litigation ................................... (249) -- --
Loss on sale of marketable securities .............................. 285 -- --
Loss on sale or abandonment of property and equipment .............. -- 26 --
Minority interest in loss of subsidiary ............................ -- -- (81)
Deferred tax expense ............................................... -- -- 417
Changes in assets and liabilities, net of effects of acquisition:
Decrease in accounts receivable, net ............................. 838 670 97
Decrease in finished goods inventory ............................. 2,634 7,354 311
Decrease in prepaid expenses ..................................... 160 554 272
Decrease (increase) in prepaid income taxes and refunds receivable 100 613 (187)
Decrease (increase) in other assets .............................. 467 (27) 268
Decrease in accounts payable ..................................... (988) (807) (327)
Decrease in income taxes payable ................................. (8) (42) (109)
Decrease in accrued royalties .................................... (104) (466) (203)
Increase (decrease) in other current liabilities ................. (215) 75 (606)
-------- -------- --------
Net cash provided by (used in) operating activities .................. (297) 3,378 (2,542)
-------- -------- --------
Investing Activities:
Purchase of property and equipment, net ............................ (39) (9) (124)
Sale or redemption of available for sale marketable securities ..... 6,259 2,139 412
Purchase of available for sale marketable securities ............... (905) -- (198)
Investment in Woody Sports Apparel Inc. ............................ -- -- (226)
-------- -------- --------
Net cash provided by (used in) investing activities ................ 5,315 2,130 (136)
-------- -------- --------
Financing Activities:
Payments of notes payable .......................................... (1,046) (171) (158)
Borrowings from factor ............................................. 19,731 29,847 63,277
Repayments to factor ............................................... (22,255) (34,332) (61,248)
Increase in restricted cash ........................................ (678) -- --
Borrowings from bank ............................................... -- 2,862 6,133
Repayments to bank ................................................. (434) (3,439) (5,531)
Treasury stock transactions, net ................................... (210) -- 23
-------- -------- --------
Net cash provided by (used in) financing activities .................. (4,893) (5,233) 2,496
-------- -------- --------
Effects of exchange rate changes on cash ............................. 87 3 (32)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ................. 212 278 (214)
Cash and cash equivalents at beginning of year ....................... 429 151 365
-------- -------- --------
Cash and cash equivalents at end of year ............................ $ 641 $ 429 $ 151
======== ======== ========
Supplemental disclosure of cash flows information:
Cash paid for income taxes ......................................... $ 2 $ 16 $ 164
======== ======== ========
Cash paid for interest, excluding factoring fees ................... $ 642 $ 1,680 $ 3,121
======== ======== ========
Supplemental schedule of noncash investing and financing activities:
Increase (decrease) in allowance for decline in market value of
available for sale securities .................................. $ (309) $ 329 $ --
======== ======== ========
</TABLE>

See Notes to Consolidated Financial Statements.

F-5
<PAGE>

STAGE II APPAREL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In thousands, except per share data)

<TABLE>
<CAPTION>
Allowance for
Decline in
Common Market Value
Stock Additional Treasury Cumulative of Securities Total
Par Paid In Retained Stock Translation Available Shareholders'
Value Capital Earnings Cost Adjustment For Sale Equity
------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 ..................... $ 50 $ 7,721 $ 19,570 $ (2,106) $ (58) $ (762) $ 24,415

Issuance of treasury stock in settlement (note 16) -- 8 -- 14 -- -- 22
Payment on contractual value of stock (note 16) .. -- (227) -- -- -- -- (227)
Translation adjustment ........................... -- -- -- -- (32) -- (32)
Decline in market value of securities ............ -- -- -- -- -- 762 762
Net loss ......................................... -- -- (3,262) -- -- -- (3,262)
------- -------- -------- -------- -------- -------- --------

Balance at December 31, 1995 ..................... 50 7,502 16,308 (2,092) (90) -- 21,678

Translation adjustment ........................... -- -- -- -- 3 -- 3
Decline in market value of securities ............ -- -- -- -- -- (329) (329)
Net loss ......................................... -- -- (6,962) -- -- -- (6,962)
------- -------- -------- -------- -------- -------- --------

Balance at December 31, 1996 ..................... 50 7,502 9,346 (2,092) (87) (329) 14,390

Purchase of treasury stock in settlement (note 16) -- -- -- (210) -- -- (210)
Translation adjustment ........................... -- -- -- -- 87 -- 87
Increase in market value of securities ........... -- -- -- -- -- 309 309
Net loss ......................................... -- -- (9,249) -- -- -- (9,249)
------- -------- -------- -------- -------- -------- --------

Balance at December 31, 1997 ..................... $ 50 $ 7,502 $ 97 $ (2,302) $--- $ (20) $ 5,327
======= ======== ======== ======== ======== ======== ========
</TABLE>

See Notes to Consolidated Financial Statements.

F-6
<PAGE>

STAGE II APPAREL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Principles of Consolidation. The consolidated financial statements include
the accounts of Stage II Apparel Corp. and its subsidiaries (the "Company" or
"Stage II"). Each subsidiary is wholly owned other than a majority owned
Canadian subsidiary that was liquidated during 1997. All significant
intercompany balances and transactions have been eliminated in consolidation.

Business Activity. The Company designs, arranges for the manufacture and
markets an extensive range of sports and casual apparel. Products are marketed
under exclusive and non-exclusive brand name licenses as well as proprietary and
private labels. None of the Company's license agreements requires more than
$10,000 in up-front payments. See Note 15--Commitments and Contingencies. Stage
II also acts as purchasing agent for various major retailing customers.

Revenue Recognition. Stage II recognizes revenue from all categories of
apparel sales at the time merchandise is shipped. Commissions from sales agency
operations are recognized when invoiced to customers.

Goodwill. The Company's goodwill, representing the excess of purchase
price over fair value of net assets acquired, is amortized on a straight-line
basis over 15 years, the expected periods to be benefitted. Stage II assesses
the recoverability of goodwill by determining whether the amortization of the
goodwill balance over its remaining life can be recovered through undiscounted
future operating cash flows of the acquired products, customers and operations.

Restatement for Discontinued Operations. The consolidated statement of
operations for the year ended December 31, 1995 has been restated to account for
the operations of Woody Sports Apparel, Inc. ("Woody Sports"), a former 80%
owned Canadian subsidiary, as discontinued operations in view of the Company's
decision to dispose of its interest in Woody Sports. See Note 4--Discontinued
Operations.

Asset Impairment under FAS 121. On January 1, 1996, the Company adopted
the Financial Accounting Standards Board's Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of ("FAS
121"). FAS 121 requires long-lived assets and certain identifiable intangibles
to be reviewed for impairment whenever changes in circumstances such as
significant declines in sales, earnings or cash flows or material changes in the
business climate indicate that their carrying amount may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of the asset to future net cash flows expected to be generated
by the asset. If the asset is considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the asset
exceeds the fair value of the asset. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less cost to sell. See Note
4--Discontinued Operations and Note 10--Townsley Acquisition and Litigation.

Cash Equivalents. The Company considers all highly liquid debt instruments
with original maturities of three months or less to be cash equivalents.

Marketable Securities. Marketable securities at December 31, 1997 and 1996
consist of U.S. Treasury Notes, Government National Mortgage Association
("GNMA") bonds and corporate equity securities. The Company classifies its debt
and equity securities as available-for-sale and records the securities at fair
value. Unrealized holding

F-7
<PAGE>

gains and losses, net of the related tax effect, on available-for-sale
securities are excluded from earnings and are reported as a separate component
of shareholders' equity until realized. Realized gains and losses from the sale
of available-for-sale securities are determined on a specific identification
basis. A decline in the market value of any available-for-sale security below
cost that is deemed other than temporary results in a reduction in carrying
amount to fair value. The impairment is charged to earnings, and a new cost
basis for the security is established. Dividend and interest income are
recognized when earned.

Finished Goods Inventory. Finished goods inventory is stated at the lower
of cost (first-in, first-out method) or market.

Property and Equipment. Property and equipment are recorded at cost.
Depreciation and amortization are computed on both the straight-line and
accelerated methods, at rates based upon estimated useful lives of 3 to 5 years
for automobiles, 5 to 7 years for furniture, fixtures and equipment and the
shorter of the lease term or life of the leasehold improvements. When assets are
retired or otherwise disposed of, the cost and related accumulated depreciation
are removed from the accounts, and any resulting gain or loss is reflected in
operations. The cost of maintenance and repairs is charged to income as
incurred, and significant renewals and betterments are capitalized.

Income Taxes. Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are projected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.

Earnings (Loss) per Share. In December 1997, the Company adopted Statement
of Financial Accounting Standards No. 128, Earnings Per Share ("FAS 128"). Under
FAS 128, companies that are publicly held or have complex capital structures are
required to present basic and diluted earnings per share ("EPS") on the face of
the income statement. FAS 128 replaces the presentation of primary EPS with a
presentation of basic EPS and, if applicable, diluted EPS. Basic EPS excludes
dilution and is computed by dividing income available to common shareholders by
the weighted average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted and the resulting
additional shares are dilutive because their inclusion decreases the amount of
EPS. The effect on earnings (loss) per share of the Company's outstanding stock
options is antidilutive and therefore not included in the calculation of the
weighted average number of common shares outstanding.

Stock Based Compensation. The Company adopted Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation ("FAS
123"), in 1996. Under the provisions of FAS 123, companies can elect to account
for stock based compensation plans using a fair value based method or continue
measuring compensation expense for those plans using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. The Company has elected to
continue using the intrinsic value method to account for its stock based
compensation plans. See Note 17--Stock Option Plans.

Use of Estimates. Management of the Company has made a number of estimates
and assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities to prepare these financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.

Foreign Currency Translation. The assets and liabilities of Woody Sports
are translated at prevailing year- end rates of exchange, and its income and
expense accounts are translated at the weighted average rates for each

F-8
<PAGE>

period presented. Prior to the liquidation of Woody Sports in 1997, foreign
exchange translation gains or losses were recorded in the equity section of the
accompanying consolidated balance sheets. Upon the inquistion of Woody Sports,
translation gains or losses were included in the determination of net loss.

Reclassifications. Certain 1996 and 1995 items have been reclassified to
conform to the 1997 consolidated financial statement presentation.

Note 2. Major Customers and Geographic Area Data

Stage II operates in one industry segment. The Company's apparel sales are
made primarily in the United States. Its customers are generally comprised of
sporting goods and specialty store chains, mass merchandisers and various
wholesale membership clubs. During 1997, 1996 and 1995, approximately 13%,17%
and __%, respectively, of net sales were made to Wal-Mart Stores, Inc. During
both 1997 and 1996, approximately 14% of net sales were made to Ames Department
Stores, Inc.

Information regarding the Company's geographic operations, including
corporate assets consisting primarily of cash and marketable securities, is set
forth below. Identifiable assets of the Company's discontinued Canadian
subsidiary aggregating $769,000 and $2.3 million at December 31, 1996 and 1995,
respectively, are included in identifiable assets in the United States. See Note
4--Discontinued Operations.

(In thousands)

<TABLE>
<CAPTION>
Geographic Areas
-------------------------------------------------------------------
United States International
-------------------------------- -------------------------------
1997 1996 1995 1997 1996 1995
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Revenues .................... $ 16,565 $ 33,430 $ 60,346 $ 424 $ 676 $ 1,430
Operating profit (loss) ..... (7,448) (4,684) (2,820) (1,200) 1,080 2,321
Identifiable assets ......... 11,138 6,249 N/A 40 19,560 N/A
Depreciation and amortization 616 694 710 130 139 139
Capital spending ............ 39 9 124 -- -- --
</TABLE>

Note 3. Due to Factor

Stage II maintains a factoring agreement (the "Credit Agreement") with a
financial institution (the "Factor") providing a revolving credit facility for
short-term borrowings by the Company at a floating interest rate equal to 1/2%
above prime prior to June 30, 1995, 1 1/4% above prime for the quarter ended
September 30, 1995, 1% above prime for the quarter ended December 31, 1995 and
1/2% above prime thereafter, with an effective rate of 9% at December 31, 1997.
Borrowings under the Credit Agreement are payable upon demand and secured by the
Company's inventory, accounts receivable, marketable securities, restricted cash
and collateral provided by the two principal shareholders of the Company. The
Factor purchases the Company's accounts receivable that it has preapproved,
without recourse, except in cases of merchandise returns or billing or
merchandise disputes in the normal course of business. The Factor is responsible
for the accounting and collection of all accounts receivable sold to it by Stage
II. The Credit Agreement also provides for the issuance of letters of credit to
fund the Company's foreign manufacturing orders.

F-9
<PAGE>

The aggregate amount of borrowings and letters of credit available under
the Credit Agreement are determined from time to time based upon the
requirements of the Company, with a borrowing and letter of credit limit up to
approximately $13 million. The Company may terminate the Credit Agreement for
any reason at the renewal date, without penalty, upon 30 days' prior written
notice, while the Factor has the right of termination upon 30 days' prior
written notice at any time. The Credit Agreement is scheduled to expire in April
1999, subject to automatic one-year renewal terms unless terminated at the
option of either party.

In 1997 and 1996, borrowings under the Credit Agreement were reduced by
$6.0 million and 3.4 million, respectively, with repatriated earnings of Stage
II HK. The Company was indebted to the Factor under the Credit Agreement at
December 31, 1997 and 1996 as follows:

(In thousands)

December 31,
-----------------------
1997 1996
------ ------
Factor advances .................................... $8,042 $11,500
Accounts receivable ................................ (3,392) (4,326)
------ ------
Net due to factor .................................. $4,650 $7,174
====== ======

Note 4. Discontinued Operations

In July 1996, the Company finalized its plan to liquidate the operations
of Woody Sports, its 80% owned Canadian subsidiary. The operations of Woody
Sports have been accounted for as discontinued operations because the subsidiary
dealt with a separate and distinct class of customers from those of the
Company's continuing operations. As of a result, Stage II provided for an
estimated loss on disposal of $1.5 million at December 31, 1996, consisting of a
provision of $326,000 for operating losses during the phase-out period and
noncash charges aggregating $1.2 million against goodwill and prepaid salaries
of the subsidiary. The Company's consolidated statement of operations for the
year ended December 31, 1995 has been restated to account for the operations of
the discontinued subsidiary separately from continuing operations. The Company's
consolidated balance sheets have not been reclassified. Assets and liabilities
of Woody Sports included in the consolidated balance sheet at December 31, 1996
were as follows:

(In thousands)

December 31,
1996
----

Current assets ........................................... $ 769
Current liabilities ...................................... (996)

During 1996, Woody Sports maintained a line of credit secured by an
assignment of its accounts receivable and inventories, a general security
agreement and an assignment and postponement of intercompany notes and
receivables. The credit facility provided for borrowings at a floating interest
rate equal to 1/2% above the lender's prime rate. On March 31, 1997, all of the
subsidiary's obligations under the facility were repaid, and the facility was
terminated in connection with the liquidation of Woody Sports.

F-10
<PAGE>

Note 5. Accounts Receivable

Accounts receivable, less allowances for returns, discounts and bad debts
aggregating $432,000 and $486,000 at December 31, 1997 and 1996, respectively,
consist primarily of non-factored receivables and other amounts due from
customers for domestic shipments and overseas commissions. Substantially all of
the Company's receivables have been pledged in accordance with the terms of its
Credit Agreement. See Note 3--Due to Factor.

Note 6. Finished Goods Inventory

Inventory, consisting primarily of finished goods, is classified as
follows:

(In thousands)
December 31,
--------------------------
1997 1996
------ ------
Landed ............................................. $1,848 $3,274
In transit ......................................... 648 1,856
------ ------
Total .............................................. $2,496 $5,130
====== ======

The finished goods inventory has been pledged in accordance with the terms
of the Company's Credit Agreement. See Note 3--Due to Factor. For the years
ended December 31, 1997, 1996 and 1995, general and administrative costs charged
to cost of goods sold amounted to $139,000, $711,000 and $870,000, respectively.
General and administrative overhead costs capitalized in inventory at December
31, 1997 and 1996 were $47,000 and $148,000, respectively.

Note 7. Property and Equipment

The major classes of property and equipment are as follows:

(In thousands)
December 31,
-----------------------
1997 1996
------ ------
Automobiles ........................................ $ -- $ 66
Furniture, fixtures and equipment .................. 583 548
Leasehold improvements ............................. 807 796
------ ------
1,390 1,410
Less accumulated depreciation and amortization ..... 890 825
------ ------
Total .............................................. $ 500 $ 585
====== ======

Note 8. Marketable Securities

The following table sets forth the amortized cost, gross unrealized
holding gains, gross unrealized holding losses and fair value for
available-for-sale securities by major security type at December 31, 1997 and
1996. During 1997 and 1996, the Company sold marketable securities held by Stage
II HK netting $6.3 million and $2.1 million, respectively. The balance of these
securities remained pledged in accordance with the terms of the Company's Credit
Agreement. See Note 3--Due to Factor.

F-11
<PAGE>

(In thousands)

<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized
Amortized Holding Holding Fair
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
U.S. Treasury securities maturing:
2000 - 2007 ............................ $ 2,732 $ 19 $ -- $ 2,751
2012 - 2027 ............................ 434 21 -- 455
GNMAs..................................... 147 -- (40) 107
Equity securities......................... 32 -- (20) 12
--------- ------- ------- ---------
Total........................................ $ 3,345 $ 40 $ (60) $ 3,325
========= ======= ======= =========

Year ended December 31, 1996:
U.S. Treasury securities.................. $ 2,294 $ -- $ 63 $ 2,231
GNMAs..................................... 6,658 -- 245 6,413
Equity securities......................... 32 -- 21 11
--------- ------- ------- ---------
Total........................................ $ 8,984 $ -- $ 329 $ 8,655
========= ======= ======= =========
</TABLE>

Note 9. Notes Payable

Notes payable at December 31, 1996 consist of the following:

(In thousands)

December 31,
1996
----
Unsecured notes assumed in 1994 acquisition, discounted to
reflect an 8% interest rate, payable semiannually, maturing
November 30, 1998................................................ $ 384
Less current maturities............................................. 185
-----
Long term notes payable............................................. $ 199
=====

In 1997, the Company paid $340,000 in full settlement of those notes,
resulting in a $44,000 gain on settlement.

Note 10. Townsley Acquisition and Litigation

In 1994, Stage II acquired substantially all the assets, subject to
related liabilities, of Townsley, Ltd. ("Townsley"). The Company obtained two
covenants not to compete with a former director and executive officer hired in
connection with the acquisition, for which the former officer was paid $850,000.
In addition, the former officer was advanced $400,000 against his first four
years remuneration for overseeing the Company's Hong Kong office and foreign
operations. Notes were issued in to the former offices in this capacity as a
shareholder of Townsley in connection with the Townsley acquisition. At December
31, 1996, these notes consisted of the following:

(In thousands)

December 31,
1996
----
Unsecured note issued for deferred compensation to former
officer, bearing interest at prime, maturing
September 30, 2000, subordinated to Factor..................... $ 500
Unsecured note issued to former officer, bearing interest
at prime, payable annually, maturing September 30, 1996,
subordinated to Factor.......................................... 411
-----
Notes payable...................................................... $ 911
=====

F-12
<PAGE>

In April 1996, the Company and Stage II HK commenced a lawsuit in the
the Supreme Court of the State of New York against Stuart Goldman, Townsley and
related parties to recoup damages incurred in connection with their October 1994
acquisition of substantially all the assets and related liabilities of Townsley,
the purchase of all the capital stock of Townsley's Hong Kong subsidiary and the
related employment and subsequent termination of Mr. Goldman as President of the
Company and Stage II HK. In September 1996, Mr. Goldman and his co-defendants
filed an answer denying Stage II's claims in the lawsuit and asserting various
counterclaims. During September 1997, the parties agreed to settle the lawsuit
for a payment from the Company of approximately $1.15 million. In addition, Mr.
Goldman relinquished of 292,135 shares of the Company's Common Stock issued to
him as part of the purchase price for the Townsley assets.

The settlement payments and stock repurchase were completed by the
Company in November 1997 and had the effects of extinguishing all obligations
from the Company to Mr. Goldman and generating a settlement gain of $205,000. In
addition, at December 31, 1997, the Company recognized noncash impairment
charges totaling $5.3 million, reflecting a $5.0 million writedown of goodwill
attributable to a planned reduction in emphasis on proprietary labels received
in prior acquisitions acquired from Townsley and a related $255,000 writedown of
a former officer's prepaid salary and non-compete covenant.

Note 11. Fair Value of Financial Instruments

The carrying amounts of financial instruments approximate their fair
values as of December 31, 1997 and 1996. The methods and assumptions used to
estimate the fair values of the financial instruments vary among the types of
instruments. For cash, accounts receivable, due to factor, due to bank, accounts
payable, accrued royalties and other current liabilities, the short maturity of
the instruments and obligations supports their fair values at their respective
carrying amounts. For marketable securities, fair values are based on quoted
market prices at the reporting date for these or similar investments. For
long-term debt, the fair value is estimated by discounting the future cash flows
of each instrument at rates currently offered to the Company for similar debt
instruments of comparable maturities.

Note 12. Leases

The Company leases showroom, office and warehouse space, including a
foreign office, under operating leases expiring at various times through 2006.
Certain leases include escalation clauses based upon the cost of living, as
defined. For the years ended December 31, 1997, 1996 and 1995, rent expense
charged to operations, including variable storage charges at a public warehouse
utilized on a month-to-month basis, aggregated approximately $567,000, $874,000
and $1,028,000, respectively. At December 31, 1997, future minimum annual
rentals under noncancellable operating leases (excluding variable storage
charges at a public warehouse that may be utilized on a month-to-month basis)
are as follows:

(In thousands)

Year ending
December 31,
------------

1998.................................................... $ 343
1999.................................................... 343
2000.................................................... 343
2001.................................................... 343
2002.................................................... 343
Thereafter.............................................. 1,372
--------
Total................................................... $ 3,087
========

F-13
<PAGE>

Note 13. Related Party Transactions

Shareholders Agreement. In January 1992, Stage II entered into an
agreement with two principal stockholders, directors and executive officers of
the Company, providing for the Company's repurchase of the shares of its Common
Stock held by the estate of the first of these principals to die. The purchase
price for any shares repurchased under the agreement will be the average of the
closing prices of the Common Stock on its principal trading market during the
five trading days preceding the date of an individual's death or the book value
per share of the Common Stock as reflected in the Company's most recent periodic
report filed with the Securities and Exchange Commission prior to the date of
death, whichever is greater.

Stage II initially purchased insurance policies on the lives of these
individuals covering $6 million of its total repurchase commitment under the
agreement at premiums aggregating approximately $2.5 million over a period of
seven years, with corresponding cash surrender values estimated to reach
approximately $2.1 million by the end of that period. Upon the retirement of one
of the executive officers in December 1994, the agreement was modified to cover
only the remaining officer, and the insurance benefit was reduced to $5.4
million, resulting in reductions of approximately $228,000 and $137,000 in the
premium obligations and cash surrender value, respectively. To the extent not
covered by these policies, the Company had the option to fund the balance of any
repurchase commitment with a promissory note payable over three years with
interest at market rate. The remaining officer has the option, upon the sale of
his entire interest in Stage II, to purchase the Company's insurance policy on
his life at its prevailing cash surrender value.

Consulting Agreement. On March 5, 1996, the Company entered into an
agreement (the "Consulting Agreement") with AMP Consulting Services, Inc.
("AMP"), Fector Detwiler & Co., Inc. ("FDC") and Fortuna Capital Management
Company ("FCM"), a significant shareholder of the Company. The Consulting
Agreement provided for various consulting and financial advisory services and
the issuance of performance-based options (the "Options"). The advisory services
provided under the Consulting Agreement included (i) a review of the Company's
operations to consider ways of increasing the efficiency and financial
performance of the Company's existing apparel business, (ii) the evaluation of
strategic opportunities to either expand or divest the current business and
acquire new businesses within or outside the apparel industry and to develop
profitable strategies for the resulting enterprise and (iii) the identification
of potential transactions to implement the recommended strategic plan. The
Consulting Agreement had a term ending September 1, 1996, subject to earlier
termination or extension by the Company.

In connection with the Consulting Agreement, the Company granted
Options to AMP, FDC and FCM to purchase 200,000 shares, 100,000 shares and
200,000 shares, respectively, of its Common Stock at $3 1/8 per share,
exercisable only if specified performance goals were met (a "Qualifying Event").
In addition, Jack Clark, the Company's Chairman of the Board, issued Options to
FDC and FCM to purchase 434,000 shares and 866,000 shares, respectively, of
Common Stock owned by him upon the occurrence of a Qualifying Event at an
exercise price of $4 3/4 per share. No charge was recognized upon the issuance
of the Options, since there was no assurance that a Qualifying Event would
occur. The FDC and FCM Options expired unexercised on March 1, 1997, and the AMP
Options expired on May 1, 1997.

F-14
<PAGE>

Note 14. Income Taxes

The provision (benefit) for income taxes consists of the following:

(In thousands)

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Income (loss) before provision (benefit) for income taxes, including
discontinued operations:
Domestic ........................................................ $(7,836) $(6,995) $(2,920)
Foreign ......................................................... (1,312) -- (684)
------- ------- -------
(9,175) (6,995) (3,604)
Provision (benefit) for income taxes:
Domestic:
Current:
Federal ..................................................... 74 (36) (740)
State ....................................................... -- 3 14
------- ------- -------
74 (33) (726)
Deferred:
Federal ..................................................... -- -- 379
State ....................................................... -- -- --
------- ------- -------
-- -- 379
------- ------- -------
Foreign ......................................................... -- -- 5
------- ------- -------
$ 74 $ (33) $ (342)
======= ======= =======
</TABLE>

The total provision for income taxes for the years ended December 31,
1997, 1996 and 1995 varied from the United States federal amounts computed by
applying the US statutory rate of 34% to pre-tax income (loss) as a result of
the following:

(In thousands, except percentages)

<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------
1997 Rate 1996 Rate 1995 Rate
------- ---- ------- ---- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Computed expected tax expense (benefit) ...... $(3,120) 34.0% $(2,378) 34.0% $(1,225) 34.0%
Repatriated earnings ......................... 2,040 (22.2) -- N/A -- N/A
Foreign income not subject to tax benefit .... -- N/A -- N/A 634 (6.5)
State and local income taxes (benefit) ....... (90) 1.0 2 -- 9 (.2)
Change in valuation allowance ................ 597 (6.5) 2,220 (31.8) 286 (7.9)
Alternative minimum tax ...................... -- N/A -- N/A 97 (2.7)
Amortization and impairment of
nondeductible goodwill .................... 572 (6.3) 37 (.5) 37 (1.0)
Adjustment of previously recorded tax benefit.. 74 (.8) -- N/A -- N/A
Nondeductible expenses for income tax purposes -- N/A (57) (.8) 118 (3.3)
Other ........................................ 1 N/A 29 (.4) 104 (2.9)
------- ---- ------- ---- ------- ----
$ 74 .8% $ (33) .5% $ (342) 9.5%
======= ==== ======= ==== ======= ====
</TABLE>

The tax effects of temporary differences that gave rise to a
significant portion of the deferred tax assets and liabilities at December 31,
1997 and 1996 are as follows:

F-15
<PAGE>

(In thousands)

<TABLE>
<CAPTION>
December 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Current deferred tax assets:
Inventory tax basis greater than financial statement basis .......... $ 76 $ 135
Allowance for decline in market value of securities ................. 8 132
Salary financial statement basis greater than tax basis ............. -- 70
Non-compete covenant financial statement basis greater than tax basis -- 135
Book loss in excess of tax loss on dissolution of subsidiary ........ -- 200
------- -------
Total gross current deferred tax assets ........................... 84 672
Less valuation allowance ............................................ (84) (672)
------- -------
Net current deferred tax assets ................................... $ -- $ --
======= =======
Long term deferred tax assets:
Net operating loss carryforward ..................................... $ 1,576 $ 1,764
Cumulative foreign currency adjustment .............................. -- 35
Amortization of goodwill and covenant not to compete ................ 1,454 47
------- -------
Total long term deferred tax assets ............................... 3,030 1,846
Less valuation allowance ............................................... (3,020) (1,835)
------- -------
Net long term deferred tax assets ................................... 10 11
------- -------
Long term deferred tax liability:
Property and equipment depreciation ................................. 10 11
------- -------
Total gross long term deferred tax liability ...................... 10 11
------- -------
Net long term deferred assets .......................................... $ -- $ --
======= =======
</TABLE>

For the years ended December 31, 1997, 1996 and 1995, the Company
recorded net increases in the total valuation allowance of $597,000, $2.2
million and $287,000, respectively. In assessing the realizability of deferred
tax assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income and tax planning strategies in
making this assessment. As of December 31, 1997, the Company had net operating
loss carryforwards for income tax purposes of approximately $4.0 million
expiring in 2012.

Prior to 1997, United States income taxes have not been provided on the
unremitted earnings of foreign subsidiaries, since the undistributed earnings
were expected to be indefinitely reinvested or sheltered by available net
operating loss carryforwards. Retained foreign earnings totaling $6.0 million
were repatriated during 1997, and there were no unremitted foreign earnings at
December 31, 1997.

Note 15. Commitments and Contingencies

Outstanding Letters of Credit. At December 31, 1997, the Company was
contingently liable on outstanding letters of credit issued under its Credit
Agreement in the aggregate amount of $2.3 million. See Note 3---Due to Factor.

License Agreements. The Company's license agreements generally require
minimum royalty payments and advertising expenditures, as well as providing for
maintenance of quality control. Royalty expense for the years ended December 31,
1997, 1996 and 1995 aggregated approximately $.8 million, $1.8 million and $3.6
million, respectively. The agreements for the Company's Spalding and Coleman
licenses provided for minimum annual royalty payments of $600,000 and $175,000,
respectively, and were terminated by mutual consent during 1997 and 1996,
respectively

F-16
<PAGE>

The license agreement for the Company's Dunlop line requires a minimum annual
royalty payment of $75,000 and expires in 2002. Under certain circumstances, the
licensor has the right to terminate the license agreement.

During 1997, net sales under the Company's license agreement for the
Spalding brand accounted for more than 10% of consolidated net sales or
approximately $5.3 million. During 1996, net sales under the Company's license
agreements for the Spalding and Coleman brands each accounted for more than 10%
of consolidated net sales or approximately $11.5 million and $7.5 million,
respectively.

Sportsotron Settlement. In June 1995, a jury verdict was rendered
against the Company in a lawsuit brought by Coral Diving Products, Inc. to
collect a performance bonus payment in connection with Stage II's acquisition of
the apparel business of Sportsotron, Inc. in 1987. In consideration for
withdrawing its appeal and post-trial motions to vacate the verdict, the Company
settled the matter in 1995 for $400,000 plus interest from July 1, 1995.

Miscellaneous Claims. Various miscellaneous claims and suits arising in
the ordinary course of business have been filed against the Company. In the
opinion of management, none of these matters will have a material adverse effect
on the results of operations or the financial position of the Company.

Note 16. Shareholders' Equity

In 1995, Stage II was required to make a payment in the amount of
$227,000 to support the contractual value of 63,845 treasury shares of Common
Stock issued in 1993 to the seller as part of the purchase price for the
Company's 80% interest in Woody Sports. The shares had a market value of
$405,000 and a cost basis of $127,000 at the time of issuance.

In 1995, the Company issued 5,500 treasury shares of Common Stock as
part of a negotiated settlement on future commissions to be paid. The shares had
a cost of $14,000 and a contractual value of $23,000 at that time.

In 1997, in connection with the settlement of the Townsley litigation,
Stage II repurchased 292,135 shares of its Common Stock issued as part of the
purchase price for the Townsley assets. See Note 10--Townsley Acquisition and
Litigation.

Note 17. Stock Option Plans

The Company maintains Incentive Stock Option Plans (the "Plans")
adopted in 1987 and 1994 providing for the grant of options to purchase up to
200,000 shares and 300,000 shares, respectively, of Common Stock to key
employees of Stage II. The purchase price per share of Common Stock issuable
upon the exercise of options granted under the Plans is fixed by a Compensation
Committee of the Board of Directors in an amount equal to at least 100% of the
market price of the Common Stock on the date of the grant or 110% of the market
price for optionees who directly or indirectly possess more than 10% of the
total combined voting power of all classes of the stock of the Company or any
parent or subsidiary thereof. Each option granted under the Plans is exercisable
for periods of up to ten years from the date of grant.

Stock option activity under the Plans for each of the three years ended
December 31, 1997 is summarized below:

F-17
<PAGE>

Weighted Average
Shares Subject Exercise Price
to Options Per Share

Balance at December 31, 1994 ........... 173,000 $4 3/8
Options granted ........................ -- --
Options exercised ...................... -- --
Options canceled ....................... 25,000 4 7/8
------- -------

Balance at December 31, 1995 ........... 148,000 4 1/4
Options granted ........................ 60,000 2 7/8
Options exercised ...................... -- --
Options canceled ....................... 68,000 4 3/8
------- -------

Balance at December 31, 1996 ........... 140,000 3 3/8
------- -------

Options granted ........................ -- --
Options exercised ...................... -- --
Options canceled ....................... 85,000 3 5/8
------- -------

Balance at December 31, 1997 ........... 55,000 3 3/4
======= =======

Exercisable at December 31,
1995.................................... 148,000
1996.................................... 140,000
1997.................................... 55,000

Available for grant at December 31,
1995.................................... 352,000
1996.................................... 360,000
1997.................................... 445,000

Stage II adopted the disclosure-only alternative under FAS 123 as of
January 1, 1996. See Note 1--Summary of Significant Accounting Policies. The pro
forma effect of this accounting treatment on net losses for the years ended
December 31, 1997 and 1996 after accounting for options issued in 1996 would
have been immaterial.

In February 1998, the Company entered into a Stock Purchase Agreement
and Management Agreement with Richard Siskind ("Siskind"), providing for (i) the
sale to Siskind of 1,900,000 shares of the Company's Common Stock held by Jack
Clark, Robert Plotkin and Steven R. Clark, officers and directors of the
Company, in consideration for their release from guarantees of the Company's
indebtedness to the Factor and their receipt of options to reacquire a total of
1,500,000 shares of Common Stock from Siskind at exercise prices ranging from
$.50 to $1.50 per share (the "Principal Shareholder Options"), (ii) the
Company's issuance to Siskind of options to purchase up to 1,500,000 shares of
Common Stock on the same terms as the Principal Shareholder Options, exercisable
only to the extent the Principal Shareholder Options are exercised, (iii) the
arrangement by Siskind of a new credit facility for the Company, (iv) the
reconstitution of the Company's board of directors with designees of Siskind,
(v) the addition of a new management team headed by Siskind and (vi) the
Company's issuance to Siskind of options to purchase up to 900,000 shares of
Common Stock at an exercise price of $.75 per share. All of the options issuable
to Siskind will be subject to shareholder approval at the 1998 annual meeting of
the Company's shareholders. The consummation of the transactions contemplated by
these agreements is subject to various closing conditions and is scheduled for
April 1998.

F-18

<PAGE>

Note 18. Employee Stock Ownership and Salary Deferral Plan

In 1994, Stage II converted its Profit Sharing Plan into an Employee
Stock Ownership and Salary Deferral Plan (the "Savings Plan"). Under the Savings
Plan, for each dollar contributed by electing employees to a retirement savings
account up to 12% of their annual compensation, the Company may contribute up to
$.40, subject to certain limitations under Section 401(k) of the Internal
Revenue Code (the "Code"). The Company's expense for these contributions in
1997, 1996 and 1995 aggregated $16,000, $38,000 and $69,000, respectively.

The Saving Plan also enables the Company to make discretionary
contributions for open market purchases of its Common Stock to be allocated to
the accounts of all employees generally in proportion to their annual
compensation. This feature was added in 1994 and is intended to qualify for
treatment under Section 401(a) of the Code. The Company did not make any
discretionary contributions to the Savings Plan for this purpose in 1997, 1996
or 1995.

F-19

EXHIBIT 24.1

POWER OF ATTORNEY

KNOWN ALL MEN BY THESE PRESENTS that each individual whose signature
appears below constitutes and appoints Jack Clark and Michael Hanrahan, and each
of them, his true and lawful attorneys-in-fact and agents with full power of
substitution, for him and in his name, place and stead in any and all
capacities, to sign the Annual Report on Form 10-K of Stage II Apparel Corp. for
the year ended December 31, 1997 (the "Report") and any amendments thereto, and
to file same, with all exhibits thereto, and all documents in connection
therewith, with the Securities and Exchange Commission, pursuant to the
Securities Exchange Act of 1934, as amended, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done to
comply with the provisions of the Securities Exchange Act of 1934, and all
requirements of the Securities and Exchange Commission, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them, or their
or his substitutes, may lawfully do or cause to be done by virtue thereof.

Dated: March 27, 1998

/s/ Jack Clark
----------------------------
Jack Clark

/s/ Robert Plotkin
----------------------------
Robert Plotkin

/s/ Steven R. Clark
----------------------------
Steven R. Clark

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS OF STAGE II APPAREL CORPORATION FOR THE YEAR ENDED DECEMBER 31, 1997
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 641
<SECURITIES> 3,325
<RECEIVABLES> 496
<ALLOWANCES> 0
<INVENTORY> 2,496
<CURRENT-ASSETS> 4,556
<PP&E> 500
<DEPRECIATION> 0
<TOTAL-ASSETS> 11,178
<CURRENT-LIABILITIES> 5,851
<BONDS> 4,650
0
0
<COMMON> 7,552
<OTHER-SE> 97
<TOTAL-LIABILITY-AND-EQUITY> 11,178
<SALES> 16,587
<TOTAL-REVENUES> 16,989
<CGS> 14,234
<TOTAL-COSTS> 20,317
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 932
<INCOME-PRETAX> (9,339)
<INCOME-TAX> 74
<INCOME-CONTINUING> (9,412)
<DISCONTINUED> 163
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,249)
<EPS-PRIMARY> (2.24)
<EPS-DILUTED> (2.24)

</TABLE>