<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934, for the quarterly period ended September 30, 1996
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934, for the transition period from ________ to _________
Commission File Number: 0-26430
TARRANT APPAREL GROUP
(Exact name of registrant as specified in its charter)
CALIFORNIA 95-4181026
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3151 EAST WASHINGTON BOULEVARD
LOS ANGELES, CALIFORNIA 90023
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (213) 780-8250
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Number of shares of Common Stock of the registrant outstanding as of October
30, 1996 was 6,500,000.
This report includes a total of 17 pages.
<PAGE> 2
TARRANT APPAREL GROUP
FORM 10-Q
INDEX
<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at
September 30, 1996 and December 31, 1995 (Audited) . . . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 1996 and September 30, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1996 and September 30, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 2. Changes in Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
</TABLE>
2
<PAGE> 3
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements.
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
---------------- --------------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,947,718 $ 7,881,210
Accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,447,611 29,232,849
Due from affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57,885 861,105
Due from Original Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . 3,000,000 --
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,646,386 13,808,661
Temporary quota . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 659,366 1,373,368
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 512,930 404,481
Deferred tax asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 902,523 866,577
---------------- --------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 58,174,419 54,428,251
Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,750,424 3,011,192
Permanent quota, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289,501 388,374
Trademarks, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 12,581
Long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135,601 --
---------------- --------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 61,349,945 $ 57,840,398
================ ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,484,412 $ 15,940,098
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,454,819 11,123,799
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,545,576 3,214,497
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,192,948 1,146,411
---------------- --------------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . 27,677,755 31,424,805
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized; none issued
and outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- --
Common stock, no par value, 10,000,000 shares authorized;
6,500,000 shares, issued and outstanding . . . . . . . . . . . . . . . . . . 14,950,222 14,950,222
Contributed capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,434,259 1,434,259
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,287,709 10,031,112
---------------- --------------
Total shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . 33,672,190 26,415,593
---------------- --------------
Total liabilities and shareholders' equity . . . . . . . . . . . . . . . . $ 61,349,945 $ 57,840,398
================ ==============
</TABLE>
See accompanying notes.
3
<PAGE> 4
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -------------------------------
1996 1995 1996 1995
------------ --------------- -------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales . . . . . . . . . . . . . . . . . . . $ 50,008,358 $ 58,134,663 $ 160,971,577 $ 160,980,795
Cost of sales . . . . . . . . . . . . . . . . . 41,771,216 49,268,743 134,400,317 135,986,840
------------ --------------- -------------- --------------
Gross profit . . . . . . . . . . . . . . . . . 8,237,142 8,865,920 26,571,260 24,993,955
Selling and distribution expenses . . . . . . . 1,643,002 1,815,397 5,151,670 5,191,247
General and administrative expenses . . . . . . 2,855,063 2,557,475 9,816,375 9,607,371
Nonrecurring charge related to LDA Option . . . -- 1,734,259 -- 1,734,259
------------ --------------- -------------- --------------
Income from operations . . . . . . . . . . . . 3,739,077 2,758,789 11,603,215 8,461,078
Interest expense . . . . . . . . . . . . . . . (451,515) (1,055,603) (1,436,461) (3,637,423)
Interest income . . . . . . . . . . . . . . . . 116,892 140,056 245,690 702,847
Other income (expense) . . . . . . . . . . . . (75,426) 317,488 76,939 1,036,476
------------ --------------- -------------- --------------
Income before provision for income taxes . . . 3,329,028 2,160,730 10,489,383 6,562,978
Provision for income taxes . . . . . . . . . . (1,120,000) (189,401) (3,232,786) (624,661)
------------ --------------- -------------- --------------
Net income . . . . . . . . . . . . . . . . . . $ 2,209,028 $ 1,971,329 $ 7,256,597 $ 5,938,317
============ =============== ============== ==============
PRO FORMA DATA:
Income before provision for income tax . . . $ 3,329,028 $ 2,160,730 $ 10,489,383 $ 6,562,978
Pro forma adjustment to eliminate
LDA Option . . . . . . . . . . . . . . . . -- 1,734,259 -- 1,734,259
------------ --------------- -------------- --------------
Pro forma income before income taxes . . . . 3,329,028 3,894,989 10,489,383 8,297,237
Pro forma provision for income taxes . . . . (1,120,000) (1,119,705) (3,232,786) (2,260,967)
------------ --------------- -------------- --------------
Pro forma net income after adjustment for
nonrecurring charge and pro forma
provision for income taxes . . . . . . . . $ 2,209,028 $ 2,775,284 $ 7,256,597 $ 6,036,270
============ =============== ============== ==============
Pro forma net income per share after
provision for income taxes . . . . . . . . $ 0.34 $ 0.47 $ 1.11 $ 1.21
============ =============== ============== ==============
Income before provision for income taxes . . 2,160,730 6,562,978
Pro forma provision for income taxes . . . . (1,119,705) (2,260,967)
--------------- --------------
Pro forma net income after adjustment for
pro forma taxes . . . . . . . . . . . . . $ 1,041,025 $ 4,302,011
=============== ==============
Pro forma net income per share after
provision for income taxes . . . . . . . . $ 0.18 $ 0.87
=============== ==============
Weighted average common and common
equivalent shares outstanding. . . . . . . . 6,513,062 5,913,043 6,509,496 4,971,014
============ =============== ============== ==============
</TABLE>
See accompanying notes.
4
<PAGE> 5
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------
1996 1995
------------ ------------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,256,597 $ 5,938,317
Adjustments to reconcile net income to net cash provided by
operating activities:
Nonrecurring charge related to LDA Option . . . . . . . . . . . . . . . . -- 1,734,259
Deferred tax provision . . . . . . . . . . . . . . . . . . . . . . . . . (35,946) (531,846)
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . 657,150 654,629
Loss on sale of fixed assets . . . . . . . . . . . . . . . . . . . . . . -- 61,063
Allowance for returns and discounts . . . . . . . . . . . . . . . . . . . (714,294) 497,474
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . (1,500,468) (9,907,191)
Due from affiliates . . . . . . . . . . . . . . . . . . . . . . . . 803,220 (395,407)
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,162,275 2,736,577
Temporary quota . . . . . . . . . . . . . . . . . . . . . . . . . . 714,002 (1,011,448)
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . (108,449) 1,189,728
Prepaid income taxes . . . . . . . . . . . . . . . . . . . . . . . . -- (14,053)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . 1,331,020 (2,705,804)
Accrued expenses and income taxes payable . . . . . . . . . . . . . 1,377,616 2,605,547
------------ ------------
Net cash provided by operating activities . . . . . . . . . . . 12,942,723 851,845
------------ ------------
INVESTING ACTIVITIES
Purchase of fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . . (151,926) (592,534)
Purchase of long-term investments . . . . . . . . . . . . . . . . . . . . . . (135,601) --
Purchase of permanent quota . . . . . . . . . . . . . . . . . . . . . . . . . (133,002) (341,928)
Investment in and advances to joint venture . . . . . . . . . . . . . . . . . -- 1,346,854
------------ ------------
Net cash (used in) provided by investing activities . . . . . . (420,529) 412,392
------------ ------------
FINANCING ACTIVITIES
Bank borrowings, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,455,686) (10,673,394)
Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 4,760,900
Due from Original Shareholders . . . . . . . . . . . . . . . . . . . . . . . (3,000,000) --
Long-term obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- (98,585)
Distribution to Original Shareholders . . . . . . . . . . . . . . . . . . . . -- (5,000,000)
Net proceeds from issuance of common stock . . . . . . . . . . . . . . . . . -- 14,823,299
------------ ------------
Net cash (used in) provided by financing activities . . . . . . (9,455,686) 3,812,220
------------ ------------
Increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . 3,066,508 5,076,457
Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . 7,881,210 502,565
------------ ------------
Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . $ 10,947,718 $ 5,579,022
============ ============
</TABLE>
See accompanying notes.
5
<PAGE> 6
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF CONSOLIDATION
On July 28, 1995, Tarrant Apparel Group, a California corporation
(formerly Fashion Resource, Inc.) (the Company) completed an initial public
offering (the Offering) of 2,000,000 shares of the Company's common stock at a
price of $9.00 per share. The proceeds to the Company, net of underwriting
discounts and commissions and offering expenses, were $14.8 million.
In order to facilitate the Offering, Gerard Guez, the Chairman and
Chief Executive Officer of the Company, and Todd Kay, the President of the
Company (the Original Shareholders), contributed all of the capital stock of
(i) NO! Jeans, Inc., a California corporation, and Tarrant Company Limited and
Marble Limited, both Hong Kong corporations, and (ii) a 49% interest in Tarrant
Trading Limited, a United Arab Emirates corporation, to the Company. As a
result, these affiliates became direct or indirect subsidiaries of the Company
(the Reorganization). In addition, a stock dividend of 14,999 shares for each
outstanding share of the Company was effected.
The accompanying financial statements include the accounts of the
Company and its consolidated subsidiaries for the periods following the
Offering (July 29, 1995 through September 30, 1995 and the three and nine
months ended September 30, 1996) and the combined accounts of the predecessor
companies prior to the Offering. The combination of the predecessor companies
was accounted for in a manner similar to a pooling of interest. All
significant intercompany investments, transactions and balances have been
eliminated.
In 1994, the Company entered into a corporate joint venture, Litex,
Ltd. (Litex), a Hong Kong corporation, with a third party in Hong Kong to
establish and operate a garment manufacturing facility in the People's Republic
of China. The Company sold its interest in the joint venture to the third
party in March 1995. The investment in Litex has been accounted for under the
equity method.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation of the
results of operations for the periods presented have been included.
The consolidated financial data at December 31, 1995 is derived from
audited financial statements which are included in the Company's Annual Report
on Form 10-K for the year ended December 31, 1995, and should be read in
conjunction with the audited financial statements and notes thereto. Interim
results are not necessarily indicative of results for the full year.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
6
<PAGE> 7
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Concurrent with the closing of the Offering, the Company changed its
tax status from an S Corporation, which is essentially a non-taxed, or
pass-through entity, to a taxed C Corporation for income tax purposes. As an S
Corporation the Company paid a 1.5% income tax to the State of California on
its net taxable income.
3. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
U.S. trade accounts receivable . . . . . . . . . . . $ 16,272,729 $ 12,020,557
Foreign trade accounts receivable . . . . . . . . . 10,041,700 7,557,814
Due from factor . . . . . . . . . . . . . . . . . . 6,283,428 11,417,866
Other receivables . . . . . . . . . . . . . . . . . 483,210 584,362
Allowance for returns and discounts . . . . . . . . (1,633,456) (2,347,750)
------------- ------------
$ 31,447,611 $ 29,232,849
============= ============
</TABLE>
4. INVENTORY
Inventory consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Raw materials . . . . . . . . . . . . . . . . . . . $ 1,943,170 $ 1,726,598
Work-in-process . . . . . . . . . . . . . . . . . . 1,270,489 714,286
Finished goods shipments-in-transit . . . . . . . . 2,394,288 6,768,152
Finished goods . . . . . . . . . . . . . . . . . . . 5,038,439 4,599,625
------------- ------------
$ 10,646,386 $ 13,808,661
============= ============
</TABLE>
Raw materials are composed of fabric and trim accessories.
5. BANK BORROWINGS
Bank borrowings consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Hong Kong line of credit . . . . . . . . . . . . . . $ -- $ 1,463,799
Import trade bills payable . . . . . . . . . . . . . 9,484,412 11,587,427
Advances against trade accounts receivable . . . . . -- 2,888,872
------------- ------------
$ 9,484,412 $ 15,940,098
============= ============
</TABLE>
7
<PAGE> 8
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
6. LDA OPTION
The consolidated statements of income reflect a charge related to the
granting by the Original Shareholders of a four-year option (the LDA Option) to
Limited Direct Associates, L.P. (LDA), a limited partnership, the general and
limited partners of which are subsidiaries of The Limited, Inc. and the
granting by the Company of registration rights to LDA pertaining to the option
shares. Historically sales to divisions of The Limited, Inc. have represented
a significant portion of the Company's sales. Subject to certain anti-dilution
provisions, the LDA Option grants LDA the right to purchase from the Original
Shareholders an aggregate of approximately 10% (649,999 shares) of the
Company's common stock at a price per share of $7.20. For accounting purposes,
even though the LDA Option was granted by the Original Shareholders and will
not cover any shares of the Company's unissued common stock, the LDA Option has
been treated as though it was granted by the Company. Accordingly, in the
quarter ended September 30, 1995, the Company recorded a nonrecurring charge
to earnings, in the amount of $1.7 million, which equals the $1.4 million
estimated fair market value of the LDA Option plus the $300,000 estimated value
of the expenses of registration for the offer and sale of the option shares.
The $1.4 million component of this charge was offset by an equal credit to
contributed capital because the Company's capital structure was not affected by
the grant of the LDA Option. The $300,000 component of this charge was
recorded as an accrued expense. Because of the credit to contributed capital,
the net impact of this charge on shareholders' equity was $300,000.
7. PRO FORMA DATA
For federal and state income tax purposes, Tarrant Apparel Group was
treated as an S Corporation under Subchapter S of the Internal Revenue Code of
1986, as amended, and comparable provisions of state income tax laws through
July 28, 1995, the effective date of the Reorganization.
Pro forma income taxes for the three and nine months ended September
30, 1995 have been determined assuming that the Company was a C Corporation
prior to the Reorganization and, therefore, that its U.S. income was taxed at
an effective pro forma tax rate of 40% for the portion of these periods prior
to July 29, 1995. Based upon the Company's expressed intention to permanently
maintain its Hong Kong earnings outside the U.S., no federal or state income
tax has been provided on unremitted earnings of the Hong Kong operations.
A pro forma presentation has been provided to reflect net income and
net income per share adjusted for pro forma taxes and the elimination of the
nonrecurring charge to earnings related to the LDA Option in 1995 (Note 6).
Such charge is considered an unusual event and not indicative of the operations
of the on-going entity. In addition, for the three and nine months ended
September 30, 1995, pro forma net income and net income per share have been
presented adjusted only for income taxes.
8
<PAGE> 9
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
The pro forma net income of $2.8 million and $6.0 million and pro
forma net income per share of $0.47 and $1.21 for the three and nine months
ended September 30, 1995, respectively, have been adjusted from the $3.6
million and $6.8 million and $0.55 and $1.05 previously reported due to the
reversal of a tax credit of $785,000 from the pro forma tax provision since
this was a one-time benefit of the termination of the S Corporation status and
adjustment of the weighted average shares outstanding for the three and nine
months ended September 30, 1995 to 5,913,043 and 4,971,014 shares,
respectively, from 6,500,000 shares previously reported for both periods, to
reflect the shares issued in the Offering as outstanding from the date of
issuance (July 28, 1995) rather than January 1, 1995.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
The Company primarily serves both specialty retail and mass
merchandise store chains by designing, merchandising, contracting for the
manufacture of and selling casual, moderately priced apparel, primarily for
women, under private label. The Company's major customers include specialty
retailers, such as Lerner New York, Lane Bryant, Express and The Limited
Stores, among other divisions of The Limited, Inc., and mass merchandisers,
such as Target Stores. The Company's products are manufactured in a variety of
woven and knit fabrications and include jeanswear, casual pants, t-shirts,
shorts, blouses and dresses.
On July 28, 1995, the Company closed an initial public offering (the
Offering) of 2,000,000 shares of the Company's Common Stock at a price of $9.00
per share. The proceeds to the Company, net of underwriting discounts and
commissions and offering expenses, were $14.8 million. Concurrent with the
closing of the Offering, the Company changed its tax status from an S
Corporation to a C Corporation for income tax purposes.
Upon the change of tax status to a C Corporation, deferred income
taxes became an asset of the Company and were recorded in the balance sheet
with a corresponding credit to the provision for income taxes in the statement
of income. In the quarter ended September 30, 1995, in accordance with FASB
No. 109, the Company recorded in the provision for income tax a deferred tax
credit of $785,000, which principally related to the temporary difference for
book and tax purposes arising from the treatment of the allowance for returns
and discounts.
Concurrent with the closing of the Offering, Gerard Guez, the Chairman
and Chief Executive Officer of the Company, and Todd Kay, the President of the
Company (the Original Shareholders), granted a four-year option (the "LDA
Option") to Limited Direct Associates, L.P. ("LDA'), a limited partnership, the
general and limited partners of which are subsidiaries of The Limited, and the
Company granted registration rights to LDA pertaining to the option shares.
Historically, sales to divisions of The Limited have represented a significant
portion of the Company's sales. Subject to certain anti-dilution provisions,
the LDA Option grants LDA the right to purchase an aggregate of approximately
10% (649,999 shares) of the Company's outstanding Common Stock at a price per
share of $7.20. For accounting purposes, even though the LDA Option was
granted by the Original Shareholders, and will not cover any shares of the
Company's unissued Common Stock, the LDA Option has been treated as though it
was granted by the Company. Accordingly, in the quarter ended September 30,
1995, the Company recorded a nonrecurring charge to earnings, in the amount of
$1.7 million, which equals the $1.4 million estimated fair market value of the
LDA Option plus the $300,000 estimated value of the expenses of registration of
the offer and sale of the option shares. The $1.4 million component of this
charge was offset by an equal credit to contributed capital because the
Company's capital structure was not affected by the grant of the LDA Option.
The $300,000 component of this charge was recorded as an accrued expense.
Because of the credit to contributed capital, the net impact of this charge on
shareholders' equity was $300,000.
Except for the historical information contained herein, the matters
addressed in this Item 2 constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such forward-looking
statements are subject to a variety of risks and uncertainties, including those
discussed below that could cause actual results to differ materially from those
anticipated by the Company's management. The Private Securities Litigation
Reform Act of 1995 (the "Act") provides certain "safe harbor"
10
<PAGE> 11
provisions for forward-looking statements. All forward-looking statements made
in this Quarterly Report on Form 10-Q are made pursuant to the Act.
The Company typically experiences significant shifts in its net sales
on a customer by customer and quarter by quarter basis. The Company believes
that these shifts are due primarily to the nature of the Company's business.
As is customary in the industry, the Company does not have long-term contracts
with its customers, and most of the Company's sales are derived from large bulk
orders. Thus, a change in the timing of receipt, shipment or number of orders
received by the Company could result in a significant shift in the timing or
amount of the Company's revenues. The Company may also experience significant
shifts in revenues if a customer decides, for fashion or other reasons, not to
re-order specific product lines that had previously accounted for a significant
amount of that customer's business with the Company.
Furthermore, significant fluctuations occur in the Company's product
mix from period to period because of changing fashion trends or customer
tastes, and the price at which a particular garment is sold by the Company will
vary significantly depending on, among other things, the fabric used,
construction and the country of origin (and, accordingly, the amount of time
available to manufacture the garment).
11
<PAGE> 12
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items in the Company's consolidated statements of income as a percentage of net
sales and as adjusted in the pro forma manner set forth in the footnote to the
table:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------- ---------------------
1996 1995 1996 1995
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net sales . . . . . . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0% 100.0%
Cost of sales . . . . . . . . . . . . . . . . . . . . . 83.5 84.7 83.5 84.5
------ ------ ------ ------
Gross profit . . . . . . . . . . . . . . . . . . . . . 16.5 15.3 16.5 15.5
Selling and distribution expenses . . . . . . . . . . . 3.3 3.2 3.2 3.2
General and administration expenses . . . . . . . . . . 5.7 4.4 6.1 5.9
Nonrecurring charge related to LDA Option(1) . . . . . -- 3.0 -- 1.1
------ ------ ------ ------
Operating income . . . . . . . . . . . . . . . . . . . 7.5 4.7 7.2 5.3
Interest expense . . . . . . . . . . . . . . . . . . . (0.9) (1.8) (0.9) (2.3)
Other income . . . . . . . . . . . . . . . . . . . . . 0.0 0.8 0.2 1.1
------ ------ ------ ------
Income before income taxes . . . . . . . . . . . . . . 6.6 3.7 6.5 4.1
Pro forma income taxes . . . . . . . . . . . . . . . . (2.2) (1.9)(2) (2.0) (1.4)(2)
------ ------ ------ ------
Pro forma net income . . . . . . . . . . . . . . . . 4.4% 1.8% 4.5% 2.7%
====== ====== ====== ======
</TABLE>
- --------------------------
(1) On the effective date of the Offering the Company incurred a nonrecurring
charge to earnings related to a grant by the Original Shareholders to
Limited Direct Associates, L.P., an affiliate of The Limited, Inc., of a
four-year option to purchase an aggregate of 649,999 shares, or 10% of the
Company's Common Stock, at an exercise price equal to $7.20 per share.
(2) Reflects an income tax provision which is the sum of (i) U.S. income taxes
computed as if the Company had been taxed as a C Corporation at an
effective tax rate of 40% for federal and state tax purposes for the period
it was an S Corporation and (ii) the historical tax provision of the
Company and its non-U.S. consolidated subsidiaries for all other periods.
The pro forma income tax as a percentage of net sales has been adjusted
from the 0.6% and 0.9% previously reported for the three and nine months
ended September 30, 1995, respectively, due to the reversal of a tax credit
of $785,000 since this was a one-time benefit of the termination of the S
Corporation status.
THIRD QUARTER 1996 COMPARED TO THIRD QUARTER 1995
Net Sales decreased by $8.1 million, or 14.0%, from $58.1 million in the third
quarter of 1995 to $50.0 million in the third quarter of 1996. The decrease in
net sales resulted from a decrease in sales of $13.3 million to Kmart as offset
in part by an increase of sales to Target of $7.7 million. In addition, the
timing of certain orders has shifted approximately $4 million of sales from the
third quarter to the fourth quarter of 1996. Overall, sales to divisions of
The Limited, Inc. in the third quarter of 1996 amounted to 67.1% of total net
sales, as compared to 49.9% in the comparable prior period, whereas sales to
Target were 30.2% of total net sales as compared to 12.7% in the same period
last year. In the third quarter of 1996, there were no sales to Kmart as
compared to $13.3 million (or 22.8% of total net sales) for the same period
last year. The Company anticipates no sales to Kmart for the remainder of 1996
as compared to $5.3 million in the quarter ending December 31, 1995. However,
the Company is seeking to replace these sales for the remainder of 1996 with
new business and growth of existing relationships with, among others, Target,
Lane Bryant and Express. Overall, sales for the remainder of the year are
expected to exceed those achieved in the fourth quarter of 1995.
12
<PAGE> 13
Gross Profit (which consists of net sales less product costs, duties and direct
costs attributable to production) for the third quarter of 1996 was $8.2
million, or 16.5% of net sales, compared to $8.9 million, or 15.3% of net
sales, in the comparable prior period, a decrease in gross profit of 7.1%,
which resulted from the decrease in net sales as offset in part by an increase
in gross profit margin. The 1.2% increase in the gross profit margin can be
attributed to a reduction of sourcing for manufacturers and certain business
with Kmart.
Selling and Distribution Expenses decreased from $1.8 million in the third
quarter of 1995 to $1.6 million in the third quarter of 1996. As a percentage
of net sales, these expenses were 3.2% in the third quarter of 1995 and 3.3% in
the third quarter of 1996.
General and Administrative Expenses increased from $2.6 million in the third
quarter of 1995 to $2.9 million in the third quarter of 1996. As a percentage
of net sales, these expenses increased from 4.4% in the third quarter of 1995
to 5.7% in the third quarter of 1996. This percentage increase is primarily
due to the decrease in net sales. Excluding an increase in professional fees
necessitated by the transition from a private to a public company, the absolute
amount of these expenses remained constant in the third quarter of 1996 as
compared to the third quarter of 1995.
Operating Income in the third quarter of 1996 was $3.7 million, or 7.5% of net
sales, compared to $2.8 million, or 4.7% of net sales, in the comparable prior
period. After adjusting for the $1.7 million nonrecurring charge recorded in
the third quarter of 1995, operating income as a percentage of sales decreased
from 7.7% in the third quarter of 1995 to 7.5% in the third quarter of 1996.
The 0.2% difference in operating income as a percentage of net sales is
attributable to a 1.2% increase in gross profit margin and a 1.4% increase in
operating expenses.
Other Income (which consists primarily of management fees and interest income)
decreased from $458,000, or 0.8% of net sales, in the third quarter of 1995, to
$41,000, in the third quarter of 1996. The decrease primarily resulted from
$117,000 of interest and $4,000 of management fee income in the third quarter
of 1996 as compared to $140,000 and $245,000, respectively, in the third
quarter of 1995. Management fee income is derived from an agreement with
F.I.S., Inc. (FIS) which sourced and sold garments under the B.U.M. Equipment
label and is two-thirds owned by the Original Shareholders. Since FIS has now
elected to discontinue the sale of products bearing the B.U.M. Equipment label,
the resulting substantial reduction of the management fee component of other
income will continue in future periods.
FIRST NINE MONTHS 1996 COMPARED TO FIRST NINE MONTHS 1995
Net Sales were $161.0 million in the first nine months of 1995 and the first
nine months of 1996. The flat net sales resulted from an increase of sales to
Target of $20.9 million as offset by a decrease of sales to Kmart of $30.0
million. Overall, sales to divisions of The Limited, Inc. in the first nine
months of 1996 amounted to 66.2% of total net sales, as compared to 54.3% in
the comparable prior period, whereas sales to Target were 25.7% of total net
sales as compared to 12.7% in the same period last year. In the first nine
months of 1996, sales to Kmart were $4.4 million (or 2.7% of total net sales)
as compared to $34.4 million (or 21.3% of total net sales) for the same period
last year. See net sales discussion in quarterly comparison.
Gross Profit (which consists of net sales less product costs, duties and direct
costs attributable to production) for the first nine months of 1996 was $26.6
million, or 16.5% of net sales, compared to $25.0 million, or 15.5% of net
sales, in the comparable prior period, an increase in gross profit of 6.3%.
The 1.0% increase in the gross profit margin can be attributed to a reduction
of sourcing for manufacturers and certain low margin business with Kmart.
13
<PAGE> 14
Selling and Distribution Expenses were $5.2 million in the first nine months of
1995 and the first nine months of 1996. As a percentage of net sales, these
expenses were 3.2% in both periods.
General and Administrative Expenses were $9.6 million in the first nine months
of 1995 and $9.8 million in the first nine months of 1996. As a percentage of
net sales, these expenses increased from 5.9% in the first nine months of 1995
to 6.1% in the first nine months of 1996. This percentage increase is
primarily due to an increase in professional fees necessitated by the
transition from a private to a public company.
Operating Income in the first nine months of 1996 was $11.6 million, or 7.2% of
net sales, compared to $8.5 million, or 5.3% of net sales, in the comparable
prior period. After adjusting for the $1.7 million nonrecurring charge
recorded in the third quarter of 1995, operating income as a percentage of net
sales increased from 6.4% in 1995 to 7.2% in 1996. The 0.8% improvement in
operating income as a percentage of net sales is attributable to a 1.0%
increase in gross profit margin and a 0.2% increase in operating expenses.
Other Income (which consists primarily of management fees and interest income)
decreased from $1.7 million, or 1.1% of net sales, in the first nine months of
1995, to $323,000, or 0.2% of net sales, in the first nine months of 1996. The
decrease primarily resulted from $246,000 of interest and $56,000 of management
fee income in the first nine months of 1996 as compared to $703,000 and
$951,000, respectively, in the first nine months of 1995. See other income
discussion in quarterly comparison.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary need for funds has been to finance inventory,
finished goods shipments-in-transit and accounts receivable, including
receivables from the Company's contract manufacturers that relate primarily to
fabric purchased by the Company for use by those manufacturers. (The Company
generally purchases fabric for delivery directly to the manufacturer's factory.
The Company then invoices the manufacturer for the fabric, and reduces payments
to the manufacturer for finished goods by the amount of outstanding invoices.)
The Company's primary sources for working capital are cash flow from
operations, borrowings under the Company's bank credit agreement and factoring
agreement and proceeds from its initial public offering.
During the first nine months of 1996, net cash provided by operating
activities was $12.9 million, which resulted from net income of $7.3 million
and a net decrease in working capital items of $5.6 million. The working
capital change included a $1.3 million increase in accounts payable and a
decrease of $3.2 million in inventory primarily related to the timing of
finished goods shipments-in-transit as partially offset by a $1.5 million
increase in accounts receivable.
During the first nine months of 1996, cash flow used in investing
activities was $421,000, which consisted of capital expenditures and the
purchase of long-term investments and permanent quota.
In the nine months ended September 30, 1996, cash flow used in financing
activities equaled $9.5 million, as a result of the repayment of $6.5 million
of bank borrowings and a $3.0 million loan to the Original Shareholders.
The Company has a $33.0 million credit facility with The Hongkong and
Shanghai Banking Corporation Limited ("HKSB") for direct borrowings and the
purchase and exportation of finished goods. Under this facility, which is
secured by a lien on certain inventory, the Company may arrange for the
issuance of letters of credit and bank acceptances, as well as cash borrowings
for working capital. This facility is subject to review at any time and the
right of HKSB to demand payment at any time. Interest on cash borrowings and
bank acceptances accrues at HKSB's U.S. best lending rate plus one-half to
three-quarters percent per annum. As of September 30, 1996, the U.S. best
lending rate equaled seven percent.
14
<PAGE> 15
The line of credit is subject to certain restrictive covenants imposed by HKSB
including a provision that the aggregate net worth, as adjusted, of the Company
will exceed $22.0 million plus 50% of net income earned after December 31, 1995
(i.e., $25.6 million as of September 30, 1996).
Pursuant to an agreement (the "Factoring Agreement") with NationsBanc
Commercial Corporation ("NBCC"), NBCC acts as the Company's sole factor for its
accounts receivable. The Factoring Agreement, under which NBCC is secured by a
lien on certain accounts receivable, provides that NBCC will pay the Company an
amount equal to the gross amount of the Company's accounts receivable reduced
by certain offsets, including among other things, discounts, returns and a
commission payable by the Company to NBCC. The commission equals four-tenths
of one percent, plus an additional one-quarter of one percent of the gross
amount of its accounts receivable depending on the maturity of the account
receivable. Prior to the date upon which NBCC must pay for the Company's
accounts receivable, the Company may receive an advance of up to 85% of the
purchase price of its accounts receivable, less certain offsets, although NBCC
may in its discretion advance a greater amount to the Company. Interest on
such advances accrues at the rate of one-quarter of one percent per annum below
the prime rate charged from time to time by NBCC, except that the interest rate
is in no event less than five percent per annum. As of September 30, 1996, the
prime rate equaled eight and one- quarter percent. Under the Factoring
Agreement, NBCC is obligated to pay the Company for accounts receivable on the
third business day following payment of the account receivable or, with respect
to all accounts receivable for which NBCC has assumed the credit risk, the
earlier of such date or the 120th day after the due date of the account
receivable. Subject to its credit review procedures, NBCC may decline to accept
the credit risk on certain accounts receivable. The Factoring Agreement
continues in force from year to year and may be terminated by NBCC on any
anniversary of its effective date (September 28) or by the Company at any time,
provided that in each case, the terminating party gives sixty days prior
written notice.
The Company believes that its cash flow from operations and borrowings
under its current financing facilities should be sufficient to fund its
operations and capital expenditures for the foreseeable future.
15
<PAGE> 16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits: None.
(b) Reports on Form 8-K: None.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TARRANT APPAREL GROUP
Date: October 30, 1996 By: /s/ Mark B. Kristof
----------------------------------
Mark B. Kristof
Vice President - Finance and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
17
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED STATEMENTS OF INCOME AND BALANCE SHEETS AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH SEPTEMBER 30, 1996 FORM 10-Q FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 10,947,718
<SECURITIES> 135,601
<RECEIVABLES> 33,081,067
<ALLOWANCES> 1,633,456
<INVENTORY> 10,646,386
<CURRENT-ASSETS> 58,174,419
<PP&E> 4,771,397
<DEPRECIATION> 2,020,973
<TOTAL-ASSETS> 61,349,945
<CURRENT-LIABILITIES> 27,677,755
<BONDS> 0
0
0
<COMMON> 14,950,222
<OTHER-SE> 18,721,968
<TOTAL-LIABILITY-AND-EQUITY> 61,349,945
<SALES> 160,971,577
<TOTAL-REVENUES> 161,294,206
<CGS> 134,400,317
<TOTAL-COSTS> 134,400,317
<OTHER-EXPENSES> 15,002,652
<LOSS-PROVISION> (34,607)
<INTEREST-EXPENSE> 1,436,461
<INCOME-PRETAX> 10,489,383
<INCOME-TAX> 3,232,786
<INCOME-CONTINUING> 7,256,597
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,256,597
<EPS-PRIMARY> 1.11
<EPS-DILUTED> 1.11
</TABLE>
