<PAGE>
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, 1997
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 November
10, 1997 was 6,601,414.
1
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TARRANT APPAREL GROUP
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C>
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at
September 30, 1997 and December 31, 1996 (Audited)....... 3
Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 1997 and
September 30, 1996....................................... 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1997 and
September 30, 1996 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........................................ 17
Item 2. Changes in Securities.................................... 17
Item 3. Defaults Upon Senior Securities.......................... 17
Item 4. Submission of Matters to a Vote of Security Holders...... 17
Item 5. Other Information........................................ 17
Item 6. Exhibits and Reports on Form 8-K......................... 17
SIGNATURES............................................... 18
INDEX TO EXHIBITS........................................ 19
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
--------------------
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ----------------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents.................................................. $ 4,782,930 $ 1,120,456
Accounts receivable, net................................................... 35,772,696 44,483,884
Due from affiliates........................................................ 1,253,303 96,416
Due from officers.......................................................... 1,069,863 --
Inventory.................................................................. 20,469,279 10,820,169
Temporary quota............................................................ 5,930,975 1,723,085
Prepaid expenses........................................................... 821,524 458,087
Prepaid income taxes....................................................... -- 990,771
Deferred tax asset......................................................... 423,416 803,482
------------- ---------------
Total current assets.................................................. 70,523,986 60,496,350
Property and equipment, net.................................................. 2,682,859 2,618,869
Permanent quota, net......................................................... 195,611 211,085
Other assets................................................................. 107,741 93,394
------------- ---------------
Total assets.......................................................... $ 73,510,197 $ 63,419,698
============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank borrowings............................................................ $ 5,629,001 $ 6,809,676
Accounts payable........................................................... 14,006,772 14,200,229
Accrued expenses........................................................... 6,775,780 4,880,115
Income taxes............................................................... 1,626,052 576,947
------------- ---------------
Total current liabilities............................................. 28,037,605 26,466,967
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized; none
issued and outstanding................................................... -- --
Common stock, no par value, 10,000,000 shares authorized;
6,601,414 shares (1997) and 6,552,276 shares (1996), issued
and outstanding.......................................................... 16,007,627 15,485,734
Contributed capital........................................................ 1,434,259 1,434,259
Retained earnings.......................................................... 28,030,706 20,032,738
------------- ---------------
Total shareholders' equity............................................ 45,472,592 36,952,731
------------- ---------------
Total liabilities and shareholders' equity............................ $ 73,510,197 $ 63,419,698
============== ===============
</TABLE>
See accompanying notes.
3
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TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -----------------------------
1997 1996 1997 1996
--------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales................................. $69,217,716 $50,008,358 $196,701,774 $160,971,577
Cost of sales............................. 59,527,963 41,771,216 167,161,595 134,400,317
----------- ----------- ----------- ------------
Gross profit.............................. 9,689,753 8,237,142 29,540,179 26,571,260
Selling and distribution expenses......... 2,075,759 1,643,002 6,325,934 5,151,670
General and administrative expenses....... 3,551,201 2,855,063 10,667,296 9,816,375
----------- ----------- ----------- ------------
Income from operations.................... 4,062,793 3,739,077 12,546,949 11,603,215
Interest expense.......................... (389,158) (451,515) (1,147,024) (1,436,461)
Interest income........................... 59,429 116,892 109,367 245,690
Other income (expense).................... 253,289 (75,426) 263,676 76,939
----------- ----------- ----------- ------------
Income before provision for income taxes.. 3,986,353 3,329,028 11,772,968 10,489,383
Provision for income taxes................ (1,275,000) (1,120,000) (3,775,000) (3,232,786)
----------- ----------- ----------- ------------
Net income................................ $ 2,711,353 $ 2,209,028 $ 7,997,968 $ 7,256,597
=========== =========== =========== ============
Net income per share...................... $ 0 .40 $ 0.34 $ 1.18 $ 1.11
=========== =========== =========== ============
Weighted average common and common
equivalent shares outstanding........... 6,806,227 6,513,062 6,791,386 6,509,496
=========== =========== =========== ============
</TABLE>
See accompanying notes.
4
<PAGE>
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------
1997 1996
--------------- --------------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................... $ 7,997,968 $ 7,256,597
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Deferred tax provision.................................... 380,066 (35,946)
Depreciation and amortization............................. 654,378 657,150
Allowance for returns and discounts....................... 27,126 (714,294)
Changes in operating assets and liabilities:
Accounts receivable..................................... 8,684,062 (1,500,468)
Due from affiliates and officers........................ (2,226,750) 803,220
Inventory............................................... (9,649,110) 3,162,275
Temporary quota......................................... (4,207,890) 714,002
Prepaid expenses........................................ (377,784) (108,449)
Prepaid income taxes.................................... 990,771
Accounts payable........................................ (193,457) 1,331,020
Accrued expenses........................................ 1,895,665 1,331,077
Income taxes payable.................................... 1,049,105 46,539
-------------- --------------
Net cash provided by operating activities............. 5,024,150 12,942,723
-------------- --------------
INVESTING ACTIVITIES
Purchase of fixed assets...................................... (573,690) (151,926)
Purchase of long-term investments............................. -- (135,601)
Purchase of permanent quota................................... (129,205) (133,002)
-------------- --------------
Net cash used in investing activities.................. (702,895) (420,529)
-------------- --------------
FINANCING ACTIVITIES
Bank borrowings, net.......................................... (1,180,675) (6,455,686)
Due from officers............................................. -- (3,000,000)
Exercise of stock options including related tax benefit....... 521,894
-------------- --------------
Net cash used in financing activities.................. (658,781) (9,455,686)
-------------- --------------
Increase in cash and cash equivalents......................... 3,662,474 3,066,508
Cash and cash equivalents at beginning of period.............. 1,120,456 7,881,210
-------------- --------------
Cash and cash equivalents at end of period.................... $ 4,782,930 $ 10,947,718
============== ==============
</TABLE>
See accompanying notes.
5
<PAGE>
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.
The accompanying financial statements include the accounts of the
Company and its consolidated subsidiaries. All significant intercompany
investments, transactions and balances have been eliminated.
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, 1996 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, 1996, 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.
Assets and liabilities of the Hong Kong and United Arab Emirates
subsidiaries are translated at the rate of exchange in effect on the balance
sheet date; income and expenses are translated at the rate of exchange
prevailing during the year. The principal foreign currency in which the Company
transacts business is the Hong Kong dollar.
Foreign currency gains and losses resulting from translation of
assets and liabilities are included in the balance sheets whereas transaction
gains and losses are included in the statements of income. To date, such gains
and losses have been immaterial. As of September 30, 1997, the Hong Kong
subsidiaries had retained earnings of 218.9 million Hong Kong dollars
(equivalent to US$28.2 million) and an intercompany receivable due from Tarrant
Apparel Group of US$25.2 million.
6
<PAGE>
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
3. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
-------------- --------------
<S> <C> <C>
U.S. trade accounts
receivable................ $ 14,925,993 $ 22,024,048
Foreign trade accounts
receivable................. 10,028,829 8,198,978
Due from factor............. 11,519,622 16,034,018
Other receivables........... 1,240,534 141,996
Allowance for returns and
discounts.................. (1,942,282) (1,915,156)
-------------- --------------
$ 35,772,696 $ 44,483,884
============== ==============
</TABLE>
Due from factor consists of $29.7 million and $18.1 million of
unmatured accounts receivable assigned to the factor, less $18.2 million and
$2.1 million of advances received from the factor, at September 30, 1997 and
December 31, 1996, respectively.
The Company has accounts receivable-secured credit facilities with
NationsBanc Commercial Corporation ("NBCC") and The CIT Group/Commercial
Services, Inc. ("CIT"). The NBCC facility was amended in May 1997 and the CIT
facility was amended in October 1997. NBCC acts as the Company's factor for
accounts receivable from the Company's major customers other than Lerner New
York and Target Stores. The Company may receive an advance from NBCC of up to
90% of the purchase price of factored accounts receivable plus 90% of certain
receivables that are not factored. CIT will advance up to 100% of the amount of
accounts receivable from Lerner New York and Target Stores plus an over-advance
of up to $10 million, up to a maximum amount of $25 million.
4. INVENTORY
Inventory consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
-------------- --------------
<S> <C> <C>
Raw materials......................... $ 4,102,642 $ 2,113,849
Work-in-process....................... 5,102,932 1,701,023
Finished goods shipments-in-transit... 2,342,474 2,252,118
Finished goods........................ 8,921,231 4,753,179
-------------- --------------
$ 20,469,279 $ 10,820,169
============== ==============
</TABLE>
Raw materials are composed of fabric and trim accessories.
5. BANK BORROWINGS
Bank borrowings consist of import trade bills payable.
7
<PAGE>
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
6. INVESTMENT IN AND ADVANCES TO JOINT VENTURE
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 50% investment in Litex was accounted for under the equity
method. In March 1995, the Company entered an agreement with the third party
whereby the third party acquired the Company's interest in Litex for
consideration of $2,000,000, of which $545,000 was paid in cash with the balance
to be received through deductions taken against future production purchased by
the Company from the third party ($391,000 and $225,000 was received through
deductions taken against 1995 and 1996 production, respectively). The deferred
gain on the sale of approximately $839,000 was settled by the payment of
approximately $419,000 from the third party to the Company in February 1997.
7. PRO FORMA EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board (FASB)
issued "Earnings Per Share" (Statement No. 128) establishing standards for
computing and presenting earnings per share for publicly-held common stock or
potential common stock. Statement No. 128 supersedes the standards for
computing earnings per share previously found in APB Opinion No. 15, Earning Per
Share and simplifies the standards for computing earnings per share. In
addition, Statement No. 128 replaces the presentation of primary earnings per
share with a presentation of basic earnings per share, requires dual
presentation of basic and diluted earnings per share on the face of the income
statement for all entities with complex capital structures and requires a
reconciliation of the numerator and denominator of the basic earnings per share
computation to the numerator and denominator of the diluted earnings per share
computation. The statement is effective for financial statements for both
interim and annual periods ending after December 15, 1997, with earlier
application not permitted. However, an entity is permitted to disclose pro
forma earnings per share prior to adoption in the notes to the financial
statements.
8
<PAGE>
Pro forma disclosure pursuant to Statement No. 128 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -------------------------
1997 1996 1997 1996
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
PRO FORMA BASIC EPS COMPUTATION
Numerator............................ $2,711,353 $2,209,028 $7,997,968 $7,256,597
---------- ---------- ---------- ----------
Denominator
Weighted average common shares
outstanding...................... 6,601,414 6,500,000 6,581,915 6,500,000
---------- ---------- ---------- ----------
Total shares....................... 6,601,414 6,500,000 6,581,915 6,500,000
---------- ---------- ---------- ----------
Pro forma Basic EPS................... $ 0.41 $ 0.34 $ 1.22 $ 1.12
========== ========== ========== ==========
PRO FORMA DILUTED EPS COMPUTATION
Numerator............................ $2,711,353 $2,209,028 $7,997,968 7,256,597
---------- ---------- ---------- ----------
Denominator
Weighted average common shares
outstanding...................... 6,601,414 6,500,000 6,581,915 6,500,000
Incremental shares from assumed
conversion of options............ 204,813 13,062 209,471 9,496
---------- ---------- ---------- ----------
Total shares....................... 6,806,227 6,513,062 6,791,386 6,509,496
---------- ---------- ---------- ----------
Pro forma Diluted EPS................. $ 0.40 $ 0.34 $ 1.18 $ 1.11
========== ========== ========== ==========
</TABLE>
9
<PAGE>
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, Limited Stores, Lane Bryant and Express, all
of which are divisions of The Limited, and mass merchandisers, such as Target
Stores. The Company's products are manufactured in a variety of woven and knit
fabrications and include jeanswear, casual pants, t-shirts, shorts, blouses,
shirts and other tops, dresses, leggings and jackets.
On July 28, 1995, the Company 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.
The Company continues to geographically diversify its worldwide
sourcing operations. During the third quarter of 1997, the Company
substantially expanded its use of independent cutting, sewing and finishing
contractors in Mexico, primarily for its increasing sales of commodity products.
The Company intends to continue to attempt to geographically balance
its sourcing operations. The Company believes that the start up costs related
to this diversification will, over time, be offset by the benefits of a more
diversified sourcing base, including increasing the Company's access to emerging
providers of low cost production, enhancing the proximity of the Company's
sourcing base to the Company's customers and principal executive offices and
lessening certain risks associated with doing business abroad (including
transportation delays, economic or political instability, currency fluctuations,
restrictions on the transfer of funds and the imposition of tariffs, export
duties, quotas and other trade restrictions).
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Report on Form 10-Q contains forward-looking statements which are
subject to a variety of risks and uncertainties. The Company's actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below.
Variability of Quarterly Results. The Company has experienced, and
expects to continue to experience, a substantial variation in its net sales and
operating results from quarter to quarter. The Company believes that the
factors which influence this variability of quarterly results include the timing
of the Company's introduction of new product lines, the level of consumer
acceptance of each new product line, general economic and industry conditions
that affect consumer spending and retailer purchasing, the availability of
manufacturing capacity, the seasonality of the markets in which the Company
participates, the timing of trade shows, the product mix of customer orders, the
timing of the placement or cancellation of customer orders, the occurrence of
chargebacks in excess of reserves and the timing of expenditures in anticipation
of increased sales and actions of competitors. Accordingly, a comparison of the
Company's results of operations from period to period is not necessarily
meaningful, and the Company's results of operations for any period are not
necessarily indicative of future performance.
10
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Economic Conditions. The apparel industry historically has been
subject to substantial cyclical variation, and a recession in the general
economy or uncertainties regarding future economic prospects that affect
consumer spending habits have in the past had, and may in the future have, a
materially adverse effect on the Company results of operations. In addition,
certain retailers, including some of the Company customers, have experienced in
the past, and may experience in the future, financial difficulties which
increase the risk of extending credit to such retailers. These retailers have
attempted to improve their own operating efficiencies by concentrating their
purchasing power among a narrowing group of vendors. There can be no assurance
that the Company will remain a preferred vendor for its existing customers. A
decrease in business from or loss of a major customer could have a material
adverse effect on the Company's results of operations. The Company has a non-
recourse accounts receivable factoring agreement. There can be no assurance
that the Company's factor will approve the extension of credit to certain retail
customers in the future. If a customer's credit is not approved by the factor,
the Company could either assume the collection risk on sales to the customer
itself, require that the customer provide a letter of credit or choose not to
make sales to the customer.
Reliance on Key Customers. Affiliated stores owned by The Limited
(including Lerner New York, Limited Stores, Express and Lane Bryant) accounted
for 68.1% of the Company's net sales in the first nine months of 1997 and 67.1%
of the Company's net sales for all of 1996. The loss of such customer could
have a material adverse effect on the Company's results of operations. From
time to time, certain of the Company's major customers have experienced
financial difficulties. The Company does not have long-term contracts with any
of its customers and, accordingly, there can be no assurance that any customer
will continue to place orders with the Company to the same extent it has in the
past, or at all. In addition, the Company's results of operations will depend
to a significant extent upon the commercial success of its major customers.
Dependence on Contract Manufacturers. All of the Company's products,
with the exception of certain test runs and samples, are manufactured by
independent cutting, sewing and finishing contractors. The use of contract
manufacturers and the resulting lack of direct control over the production of
its products could result in the Company's failure to receive timely delivery of
products of acceptable quality. Although the Company believes that alternative
sources of cutting, sewing and finishing services are readily available, the
loss of one or more contract manufacturers could have a materially adverse
effect on the Company's results of operations until an alternative source is
located and has commenced producing the Company's products.
Although the Company monitors the compliance of its independent
contractors with applicable labor laws, the Company does not control its
contractors or their labor practices. The violation of federal or state labor
laws by one of the Company's contractors can result in the Company being subject
to fines and the Company's goods which are manufactured in violation of such
laws being seized or their sale in interstate commerce being prohibited. From
time to time, the Company has been notified by federal or state authorities that
certain of its contractors are the subject of investigations or have been found
to have violated applicable labor laws. To date, the Company has not been
subject to any sanctions that, individually or in the aggregate, could have a
material adverse effect upon the Company, and the Company is not aware of any
facts on which any such sanctions could be based. There can be no assurance,
however, that in the future the Company will not be subject to sanctions as a
result of violations of applicable labor laws by its contractors, or that such
sanctions will not have a material adverse effect on the Company. In addition,
certain of the Company's customers, including The Limited and Target Stores,
require strict compliance by their apparel manufacturers, including the Company,
with applicable labor laws. There can be no
11
<PAGE>
assurance that the violation of applicable labor laws by one of the Company's
contractors will not have a material adverse effect on the Company's
relationship with its customers.
Price and Availability of Raw Materials. Cotton fabric is the
principal raw material used in the Company's apparel. Although the Company
believes that its suppliers will continue to be able to procure a sufficient
supply of cotton fabric for its production needs, the price and availability of
cotton may fluctuate significantly depending on supply, world demand, and
currency fluctuations, each of which may affect the price and availability of
cotton fabric. There can be no assurance that fluctuations in the price and
availability of cotton fabric or other raw materials used by the Company will
not have a material adverse effect on the Company's results of operations.
Management of Growth. Since its inception, the Company has
experienced rapid growth in sales. No assurance can be given that the Company
will be successful in maintaining or increasing its sales in the future. Any
future growth in sales will require additional working capital and may place a
significant strain on the Company's management, management information systems,
inventory management, production capability, distribution facilities and
receivables management. Any disruption in the Company's order processing,
sourcing or distribution systems could cause orders to be shipped late, and
under industry practices, retailers generally can cancel orders or refuse to
accept goods due to late shipment. Such cancellations and returns would result
in a reduction in revenue, increased administrative and shipping costs and a
further burden on the Company distribution facilities. In addition, the failure
to timely enhance the Company's operating systems, or unexpected difficulties in
implementing such enhancements, could have a material adverse effect on the
Company's results of operations.
Foreign Manufacturing. Approximately 85% of the Company products were
imported in 1996. As a result, the Company's operations are subject to the
customary risks of doing business abroad, including, among other things,
transportation delays, economic or political instability, currency fluctuations,
restrictions on the transfer of funds and the imposition of tariffs, export
duties, quotas and other trade restrictions.
12
<PAGE>
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:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------
1997 1996 1997 1996
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net sales............................. 100.0% 100.0% 100.0% 100.0%
Cost of sales......................... 86.0 83.5 85.0 83.5
----- ----- ----- -----
Gross profit.......................... 14.0 16.5 15.0 16.5
Selling and distribution expenses..... 3.0 3.3 3.2 3.2
General and administration expenses... 5.1 5.7 5.4 6.1
----- ----- ----- -----
Income from operations................ 5.9 7.5 6.4 7.2
Interest expense...................... (0.6) (0.9) (0.6) (0.9)
Other income.......................... 0.5 0.0 0.2 0.2
----- ----- ----- -----
Income before income taxes............ 5.8 6.6 6.0 6.5
Income taxes.......................... (1.9) (2.2) (1.9) (2.0)
----- ----- ----- -----
Net income............................ 3.9% 4.4% 4.1% 4.5%
===== ===== ===== =====
</TABLE>
THIRD QUARTER 1997 COMPARED TO THIRD QUARTER 1996
Net Sales increased by $19.2 million, or 38.4%, from $50.0 million in the third
quarter of 1996 to $69.2 million in the third quarter of 1997. The increase in
net sales included increases of $11.7 million to divisions of The Limited and
$2.8 million to mass merchandisers. Overall, sales to divisions of The Limited
in the third quarter of 1997 amounted to 65.4% of total net sales, as compared
to 67.1% in the same period last year, whereas sales to mass merchandisers were
26.0% of total net sales as compared to 30.4% in the same period last year.
Gross Profit (which consists of net sales less product costs, duties and direct
costs attributable to production) for the third quarter of 1997 was $9.7
million, or 14.0% of net sales, compared to $8.2 million, or 16.5% of net sales,
in the same period last year, an increase in gross profit of 17.6%. The 2.5%
decrease in the gross profit margin primarily resulted from startup expenses
related to the expansion of Mexican sourcing and unfavorable variances in the
cost of certain import quota. The gross margin realized on $52.0 million of
imported (as computed excluding Mexico) net sales in the third quarter of 1997
was approximately 16.4%, as compared to 17.5% on $108.1 million of imported (as
computed excluding Mexico) net sales in the first six months of 1997, whereas
the gross margin realized on $17.2 million of other net sales in the third
quarter of 1997 was 9.8%.
Selling and Distribution Expenses increased from $1.6 million in the third
quarter of 1996 to $2.1 million in the third quarter of 1997. As a percentage of
net sales, these expenses decreased from 3.3% in the third quarter of 1996 to
3.0% in the third quarter of 1997. This percentage decrease resulted from a
$350,000 increase in freight expense, from 0.4% of net sales in the third
quarter of 1996 to 0.8% of net sales in the third quarter of 1997, which was
offset by the increase in net sales.
General and Administrative Expenses increased from $2.9 million in the third
quarter of 1996 to $3.6 million in the third quarter of 1997. As a percentage of
net sales, these expenses decreased from
13
<PAGE>
5.7% in the third quarter of 1996 to 5.1% in the third quarter of 1997. This
percentage decrease was primarily due to an increase in net sales which was
offset by the increase in the allowance for bad debt, which includes an
allowance for returns and discounts as well as bad debt expense. The allowance
for returns and discounts is primarily based on a percentage of receivables
which increases with the age of the receivables, but is not a reflection on the
credit worthiness of the customer. The decrease in the allowance for returns and
discounts during the third quarter of 1996 was $364,000, or 0.7% of net sales,
compared to an increase in such allowance of $237,000, or 0.3% of net sales,
during the third quarter of 1997. The most significant portions of the increase
in the allowance for returns and discounts resulted from changes in the amount
and aging of accounts receivable. After adjusting for the net increase in the
allowance for bad debt of $601,000, general and administrative expenses
increased by $95,000, or 0.1% of net sales, in the third quarter of 1997 as
compared to the third quarter of 1996 and the percentage decrease, from 6.4% in
the third quarter of 1996 to 4.8% in the third quarter of 1997, was primarily
due to the effect of the increase in net sales.
Operating Income in the third quarter of 1997 was $4.1 million, or 5.9% of net
sales, compared to $3.7 million, or 7.5% of net sales, in the comparable prior
period, an increase in operating income of 8.7% due to the factors described
above. The 1.6% decrease in operating income as a percentage of net sales is
attributable to a 2.5% decrease in gross profit margin as offset by a 0.9%
decrease in operating expenses.
Other Income increased from $41,000 in the third quarter of 1996, to $313,000 in
the third quarter of 1997. This increase primarily resulted from the realization
of a $275,000 gain on the sale of securities in the third quarter of 1997.
FIRST NINE MONTHS 1997 COMPARED TO FIRST NINE MONTHS 1996
Net Sales increased by $35.7 million, or 22.2%, from $161.0 million in the first
nine months of 1996 to $196.7 million in the first nine months of 1997. The
increase in net sales included increases of $27.3 million to divisions of The
Limited and $5.3 million to mass merchandisers. Overall, sales to divisions of
The Limited in the first nine months of 1997 amounted to 68.1% of total net
sales, as compared to 66.2% in the same period last year, whereas aggregate
sales to mass merchandisers were 24.2% of total net sales as compared to 26.3%
in the same period last year.
Gross Profit (which consists of net sales less product costs, duties and direct
costs attributable to production) for the first nine months of 1997 was $29.5
million, or 15.0% of net sales, compared to $26.6 million, or 16.5% of net
sales, in the same period last year, an increase in gross profit of 11.2%. The
1.5% decrease in the gross profit margin primarily resulted from unfavorable
variances in the cost of certain import quota in the third quarter of 1997 and a
gross margin realization of 8.2% on $34.7 million of other than imported (as
computed including Mexico) net sales in the first nine months of 1997.
Selling and Distribution Expenses increased from $5.2 million in the first nine
months of 1996 to $6.3 million in the first nine months of 1997. These expenses
amounted to 3.2% of net sales in both periods.
General and Administrative Expenses increased from $9.8 million in the first
nine months of 1996 to $10.7 million in the first nine months of 1997. As a
percentage of net sales, these expenses decreased from 6.1% in the first nine
months of 1996 to 5.4% in the first nine months of 1997. This percentage
decrease was primarily due to an increase in net sales which was offset by the
increase in
14
<PAGE>
the allowance for bad debt, which includes an allowance for returns and
discounts as well as bad debt expense. The allowance for returns and discounts
is primarily based on a percentage of receivables which increases with the age
of the receivables, but is not a reflection on the credit worthiness of the
customer. The decrease in the allowance for returns and discounts during the
first nine months of 1996 was $463,000, or 0.3% of net sales, compared to an
increase in such allowance of $191,000, or 0.1% of net sales, during the first
nine months of 1997. The most significant portions of the increase in the
allowance for returns and discounts resulted from changes in the amount and
aging of accounts receivable. After adjusting for the net increase in the
allowance for bad debt of $654,000, general and administrative expenses
increased by $197,000, or 0.1% of net sales, in the first nine months of 1997 as
compared to the first nine months of 1996 and the percentage decrease, from 6.4%
in the first nine months of 1996 to 5.3% in the first nine months of 1997, was
primarily due to the effect of the increase in net sales.
Operating Income in the first nine months of 1997 was $12.5 million, or 6.4% of
net sales, compared to $11.6 million, or 7.2% of net sales, in the comparable
prior period, an increase in operating income of 8.1% due to the factors
described above. The 0.8% decrease in operating income as a percentage of net
sales is attributable to a 1.5% decrease in gross profit margin as offset by a
0.7% decrease in operating expenses.
Other Income was $323,000, or 0.2% of net sales, in the first nine months of
1996 and $373,000, or 0.2% of net sales, in the first nine months of 1997. The
1996 period included $246,000 and $56,000 of interest and management fee income,
respectively, as compared to $109,000 and $0 of such income, respectively, in
the 1997 period which also included a $275,000 gain on the sale of stock.
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 of working capital are cash flow from operations,
borrowings under the Company's credit facilities and proceeds from its initial
public offering.
During the first nine months of 1997, net cash provided by operating
activities was $5.0 million, which primarily resulted from net income of $8.0
million and a net increase in working capital items of $4.0 million.
During the first nine months of 1997, cash flow used in investing
activities was $703,000, which primarily consisted of capital expenditures and
the purchase of permanent quota.
In the nine months ended September 30, 1997, cash flow used in
financing activities equaled $659,000 million, primarily as a result of the
repayment of $1.2 million increase in bank borrowings.
The Company has credit facilities of $33 million and $10 million
with the Hongkong and Shanghai Banking Corporation Limited ("HKSB") and Standard
Chartered Bank ("SCB"), respectively, for borrowings and the purchase and
exportation of finished goods. Under these facilities, the Company may arrange
for the issuance of letters of credit and acceptances, as well as
15
<PAGE>
cash advances. These facilities are subject to review at any time and the right
of either lender to demand payment at any time. Interest on cash advances under
HKSB's facility accrues at HKSB's prime rate for lending U.S. dollars plus one-
half to three-quarters percent per annum. As of September 30, 1997, HKSB's U.S.
dollar prime rate equaled eight and one-half percent. Interest on cash advances
under SCB's facility accrues at SCB's prime rate for lending Hong Kong dollars.
As of September 30, 1997, SCB's Hong Kong dollar prime rate equaled eight and
three-quarters percent. These facilities are subject to certain restrictive
covenants including a provision that the aggregate net worth, as adjusted, of
the Company will exceed $30 million, that the Company will not incur two
consecutive quarterly losses and that the Company will maintain a certain debt
to equity ratio.
The Company has accounts receivable-secured credit facilities with
NationsBanc Commercial Corporation ("NBCC") and The CIT Group/Commercial
Services, Inc. ("CIT"). NBCC acts as the Company's factor for accounts
receivable from the Company's major customers other than Lerner New York and
Target Stores. Subject to a shared risk arrangement, NBCC will pay the Company
an amount equal to the gross amount of the Company's accounts receivable reduced
by certain offsets, including discounts, returns and commission. The commission
is two-tenths of one percent on accounts as to which NBCC and the Company share
the credit risk, which principally include affiliates of The Limited, and six-
tenths of one percent on all other accounts. On shared risk accounts, the
Company must incur an aggregate loss in excess of $1 million in any twelve-month
period before NBCC must pay for uncollectible accounts receivable whereas NBCC
pays 100% of uncollectible accounts receivable on all other obligors, if
approved. The Company may receive an advance from NBCC of up to 90% of the
purchase price of factored accounts receivable plus 90% of certain receivables
that are not factored. CIT will advance up to 100% of the amount of accounts
receivable from Lerner New York and Target Stores plus an over-advance of up to
$10 million, up to a maximum amount of $25 million. The CIT facility is subject
to the same restrictive covenants as apply to the HKSB and SCB facilities.
Interest on advances from both NBCC and CIT accrues at the rate of one and one-
quarter percent below the bank's respective prime rates or, at the option of the
Company, one and one-quarter percent over the respective LIBOR rates. As of
September 30, 1997, the prime rates equaled eight and one-half percent and the
LIBOR rates equaled five and seven-tenths percent.
The Company believes that its cash flow from operations and borrowings under
its current credit facilities should be sufficient to fund its operations for
the foreseeable future.
16
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
-----------------
On November 13, 1997, the previously disclosed lawsuit against, among
others, the Company, Gerard Guez, its Chairman and Chief Executive
Officer, and Todd Kay, its President, brought by the American Textile
Manufacturers Institute was dismissed with prejudice and final judgment
was entered to that effect which is subject to appeal.
On August 12, 1997, the previously disclosed lawsuit against the
Company, Gerard Guez, its Chairman and Chief Executive Officer, and
Todd Kay, its President, brought by Mark Kasky on behalf of himself and
the general public in San Francisco Superior Court (Case No. 986780)
was dismissed without prejudice.
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: Reference is made to the Index to Exhibits, at
page 19 for a list of exhibits filed as part of this Report
on Form 10-Q.
(b) Reports on Form 8-K: None.
17
<PAGE>
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: November 14, 1997 By: /s/ Mark B. Kristof
--------------------
Mark B. Kristof
Vice President-Finance and
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
18
<PAGE>
INDEX TO EXHIBITS
-----------------
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ---------- -----------
<S> <C>
10.58.1 Letter Agreement dated October 1, 1997 regarding Accounts
Receivable Financing Agreement by and between the Company and The
CIT Group/Commercial Services, Inc.
27 Financial Data Schedule
</TABLE>
19
<PAGE>
EXHIBIT 10.58.1
---------------
The CIT Group/Commercial Services, Inc.
300 South Grand Avenue
Los Angeles, CA 90071
213-513-2400
Date: October 1, 1997
TARRANT APPAREL GROUP
3151 East Washington Blvd.
Los Angeles, CA 90023
Ladies and Gentlemen:
Reference is made to the Accounts Receivable Financing Agreement (herein
the "Agreement") between us dated June 13, 1997.
Pursuant to mutual understanding and agreement, section 3.1(b) of the
Agreement is hereby deleted in its entirety, and the following is inserted in
lieu thereof:
"(b) over-advances, in our sole discretion, with respect to goods invoiced
to either Lerner New York, a division of the Limited Corporation or Target
Stores, a division of the Dayton Hudson Corporation, which goods have not yet
cleared through customs, in an amount up to the aggregate invoice amounts but
not to exceed $10,000,000.00 at any time, and, with the amount of any revolving
credit advances, not to exceed the Maximum Credit Facility."
Except as herein specifically provided, the Agreement remains in full force
and effect in accordance with its terms, and no other change in the terms or
provisions of the Agreement is intended or implied. If you are in agreement
with the foregoing, please sign and return to us the enclosed copy of this
letter to so indicate.
Very truly yours,
THE CIT GROUP/COMMERCIAL SERVICES, INC.
/s/ Robert Lewin
---------------------------
Robert Lewin
Vice President
Read and Agreed to:
TARRANT APPAREL GROUP
By: /s/ Mark B. Kristof
--------------------------------
Name: Mark B. Kristof
------------------------------
Title: Vice President - Finance & CFO
------------------------------
A company of
Dai-Ichi Kangyo Bank and
Chemical Banking Corporation
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 4,782,930
<SECURITIES> 0
<RECEIVABLES> 37,714,979
<ALLOWANCES> 1,942,283
<INVENTORY> 20,469,279
<CURRENT-ASSETS> 70,523,986
<PP&E> 5,341,114
<DEPRECIATION> 2,658,255
<TOTAL-ASSETS> 73,510,197
<CURRENT-LIABILITIES> 28,037,605
<BONDS> 0
0
0
<COMMON> 16,007,627
<OTHER-SE> 29,464,965
<TOTAL-LIABILITY-AND-EQUITY> 73,510,197
<SALES> 196,701,774
<TOTAL-REVENUES> 197,074,817
<CGS> 167,161,595
<TOTAL-COSTS> 167,161,595
<OTHER-EXPENSES> 16,993,230
<LOSS-PROVISION> 205,167
<INTEREST-EXPENSE> 1,147,024
<INCOME-PRETAX> 11,772,968
<INCOME-TAX> 3,775,000
<INCOME-CONTINUING> 7,997,968
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,997,968
<EPS-PRIMARY> 1.18
<EPS-DILUTED> 1.18
</TABLE>
