<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, 1998
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: (323) 780-8250
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Number of shares of Common Stock of the registrant outstanding as of November 6,
1998 was 13,713,330.
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, 1998 and December 31, 1997 (Audited)............ 3
Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 1998
and September 30, 1997........................................ 4
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and September 30, 1997... 5
Notes to Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................... 9
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............................................. 18
</TABLE>
2
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
--------------------
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- ------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents......................................... $ 1,866,154 $ 5,305,129
Accounts receivable, net.......................................... 63,479,037 34,078,352
Due from officers and affiliates.................................. 3,392,452 1,605,140
Inventory......................................................... 38,730,486 23,266,196
Temporary quota................................................... 4,860,369 2,874,382
Prepaid expenses.................................................. 2,193,163 1,203,931
Prepaid income taxes.............................................. 102,509 478,050
------------ ------------
Total current assets............................................ 114,624,170 68,811,180
Property and equipment, net........................................ 4,562,550 2,707,257
Permanent quota, net............................................... 205,413 145,268
Other assets....................................................... 4,701,661 196,973
Excess of cost over fair value of net assets acquired, net......... 14,981,225 ---
------------ ------------
Total assets................................................... $139,075,019 $ 71,860,678
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank borrowings................................................... $ 25,105,736 $ 4,287,518
Accounts payable.................................................. 21,912,003 12,549,961
Accrued expenses.................................................. 15,787,700 5,117,183
Income taxes...................................................... 2,485,338 969,115
Deferred tax liability............................................ 1,172,573 582,957
------------ ------------
Total current liabilities....................................... 66,463,350 23,506,734
Long-term obligations.............................................. 3,087,193 --
------------ ------------
Total liabilities............................................... 69,550,543 23,506,734
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized; none issued -- --
and outstanding.................................................
Common stock, no par value, 20,000,000 shares authorized; 20,173,702 16,100,483
13,713,330 shares (1998), 13,219,928 shares (1997), issued
and outstanding.................................................
Contributed capital.............................................. 1,434,259 1,434,259
Retained earnings................................................ 47,916,515 30,819,202
------------ ------------
Total shareholders' equity...................................... 69,524,476 48,353,944
------------ ------------
Total liabilities and shareholders' equity...................... $139,075,019 $ 71,860,678
============ ============
</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,
------------------------------- --------------------------------
1998 1997 1998 1997
------------ ----------- ------------ ------------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net sales...................................... $114,948,224 $69,217,716 $279,305,521 $196,701,774
Cost of sales.................................. 95,258,023 59,527,963 228,403,202 167,161,595
------------ ----------- ------------ ------------
Gross profit................................... 19,690,201 9,689,753 50,902,319 29,540,179
Selling and distribution expenses.............. 3,055,548 2,075,759 7,569,704 6,325,934
General and administrative expenses............ 5,260,433 3,551,201 15,726,802 10,667,296
------------ ----------- ------------ ------------
Income from operations......................... 11,374,220 4,062,793 27,605,813 12,546,949
Interest expense............................... (806,288) (389,158) (1,677,854) (1,147,024)
Interest income................................ 88,038 59,429 236,757 109,367
Other income................................... 438,231 253,289 522,597 263,676
------------ ----------- ------------ ------------
Income before provision for income taxes....... 11,094,201 3,986,353 26,687,313 11,772,968
Provision for income taxes..................... (4,000,000) (1,275,000) (9,590,000) (3,775,000)
------------ ----------- ------------ ------------
Net income..................................... $ 7,094,201 $ 2,711,353 $ 17,097,313 $ 7,997,968
============ =========== ============ ============
Net income per share
Basic..................................... $0.52 $0.21 $1.27 $0.61
============ =========== ============ ============
Diluted................................... $0.49 $0.20 $1.21 $0.59
============ =========== ============ ============
Weighted average common and common
equivalent shares outstanding
Basic..................................... 13,591,741 13,202,828 13,435,151 13,163,829
============ =========== ============ ============
Diluted.................................... 14,453,810 13,612,454 14,154,577 13,582,771
============ =========== ============ ============
</TABLE>
See accompanying notes.
4
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TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------
1998 1997
------------- ------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.......................................................... $ 17,097,313 $ 7,997,968
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Deferred tax provision............................................ 589,616 380,066
Depreciation and amortization..................................... 1,487,367 654,378
Provision for returns and discounts............................... 1,269,277 27,126
Changes in operating assets and liabilities:
Accounts receivable........................................... (26,994,040) 8,684,062
Due from affiliates and officers.............................. (1,787,312) (2,226,750)
Inventory..................................................... (7,715,618) (9,649,110)
Temporary quota............................................... (1,985,987) (4,207,890)
Prepaid expenses.............................................. (924,048) (377,784)
Prepaid income taxes.......................................... 375,541 990,771
Accounts payable.............................................. 4,020,985 (193,457)
Accrued expenses.............................................. 9,643,947 1,895,665
Income taxes payable.......................................... 1,516,223 1,049,105
----------- -----------
Net cash (used in) provided by operating activities......... (3,406,736) 5,024,150
----------- -----------
INVESTING ACTIVITIES
Purchase of fixed assets............................................ (335,009) (573,690)
Acquisition of MGI.................................................. (6,058,685) ---
Acquisition of Rocky, net of cash................................... (7,969,453) ---
Purchase of permanent quota......................................... (151,581) (129,205)
Increase in other assets............................................ (4,479,127) ---
----------- -----------
Net cash used in investing activities....................... (18,993,855) (702,895)
----------- -----------
FINANCING ACTIVITIES
Bank borrowings, net................................................ 17,364,577 (1,180,675)
Payment of long-term debt........................................... (1,126,180) ---
Exercise of stock options including related tax benefit............. 2,723,219 521,894
----------- -----------
Net cash provided by (used in) financing activities......... 18,961,616 (658,781)
----------- -----------
(Decrease) increase in cash and cash equivalents.................... (3,438,975) 3,662,474
Cash and cash equivalents at beginning of period.................... 5,305,129 1,120,456
----------- -----------
Cash and cash equivalents at end of period.......................... $ 1,866,154 $ 4,782,930
=========== ===========
</TABLE>
See accompanying notes.
5
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TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF CONSOLIDATION
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, 1997 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, 1997, 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 average rates 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 statements of income. Historically, such gains
and losses have been immaterial. At September 30, 1998, the Hong Kong
subsidiaries had shareholders' equity of $35.3 million and an intercompany
receivable due from Tarrant Apparel Group of $35.1 million.
6
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TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
3. RECENT ACQUISITIONS
On July 2, 1998, the Company purchased the partnership interests in Rocky
Apparel, L.P., a Delaware limited partnership ("Rocky"). Rocky operates
manufacturing facilities in Mississippi and sources in Mexico. The purchase
price consisted of $7,500,000 in cash and 80,890 shares of common stock of the
Company, paid on closing. The purchase price was subsequently reduced by
$122,000 based on an equal amount of negative net equity of Rocky at closing. In
addition, the Company was required to repay $3.4 million of debt to one of the
sellers on closing and to guarantee the bank indebtedness of Rocky in the amount
of $5.0 million. The Company was granted a security interest in the 80,890
shares to secure the performance of obligations under the purchase agreement,
including, without limitation, the indemnification obligations. This transaction
has been accounted for as a purchase and the purchase price has been allocated
based on the fair value of assets acquired and liabilities assumed. The excess
of cost over fair value of net assets acquired is being amortized over 15 years.
The operations of Rocky have been included with those of the Company commencing
on July 1, 1998.
Rocky designs, develops and contracts for the manufacture of men's, womens
and childrens denim apparel, for Abercrombie & Fitch, Limited Stores, Express
and Structure. The purchase price was financed by the Company from a new credit
facility and cash flow from operations. For a description of such credit
facility, see "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
In connection with this acquisition, Rocky extended the term of an existing
employment agreement with Gabriel Zeitouni, the President and a former principal
owner of Rocky. Under this employment agreement, Mr.Zeitouni will continue to be
employed as the President of Rocky for a term ending on December 31, 2002,
unless extended by the mutual agreement of the Company and Mr.Zeitouni, will be
paid a base salary which increases from $350,000 for 1998 to $450,000 for 2002
and will receive cash bonuses based upon certain performance criteria. Also, Mr.
Zeitouni was awarded a stock option for 75,000 shares of the Company's common
stock which vests periodically through December 31, 2002. In the event the
Company terminates his employment without cause, Mr.Zeitouni shall be entitled
to receive (i)a lump sum payment equal to his base salary for the shorter of the
balance of the term or two years and (ii)accrued bonus, if any, through the date
of termination. In the event the Company terminates Mr.Zeitouni's employment
with cause, the Company is obligated to pay the compensation required by the
agreement only through the date of termination. In addition, Mr.Zeitouni has
agreed not to compete with the Company during the two years following the
termination of his employment for cause.
On February 23, 1998, the Company purchased certain assets of MGI
International Limited, a Turks and Caicos corporation. The assets purchased
consist primarily of pending orders and related inventory. The purchase price
consisted of (i) $5,050,000, together with an amount equal to seller's cost of
the inventory purchased, paid in cash on closing, (ii) $500,000 paid on July
21, 1998, together with interest at 7% per annum, and (iii) 2% of the net sales
of goods booked by the Company's newly formed Men's Division for delivery during
1999, provided the orders accepted for delivery in 1999 on March 1, 1999 meet
specified gross profit and gross profit margin requirements.
On February 23, 1998, the Company also purchased certain assets of Marshall
Gobuty International U.S.A., Inc., a California corporation ("MGI USA"). The
assets purchased consist primarily of pending orders and related inventory. The
purchase price consisted of (i) $1,000,000, together with an amount equal to
seller's cost of the inventory purchased, paid in cash on closing and (ii)
$500,000 paid on July 21, 1998, together with interest at 7% per annum.
MGI International Limited and MGI USA ("MGI") each designs, develops and
contracts for the manufacture of men's apparel, including knit and woven tops,
shirts and outerwear (including jackets), for national chain department stores,
including J.C. Penney and Goody's. The purchase price was financed by the
Company from its cash flow from operations. This transaction has been accounted
for as a purchase and the purchase price has been allocated based on the fair
value of assets acquired and liabilities assumed. The excess of cost over fair
value of net assets acquired is being amortized over five years. The operations
of MGI have been included with those of the Company commencing on February 23,
1998.
4. STOCK SPLIT
On April 27, 1998, the Company announced a two-for-one stock split effective
on May 8, 1998. Accordingly, all share and per share amounts have been adjusted
to reflect this split.
7
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TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
5. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- -------------
<S> <C> <C>
U.S. trade accounts receivable....................... $52,441,475 $13,411,719
Foreign trade accounts receivable.................... 16,958,970 9,466,193
Due (to) from factor................................. (4,182,676) 12,028,633
Other receivables.................................... 1,086,357 727,619
Allowance for returns and discounts.................. (2,825,089) (1,555,812)
----------- -----------
$63,479,037 $34,078,352
=========== ===========
</TABLE>
Due (to) from factor consists of $5.5 million and $23.8 million of
unmatured accounts receivable assigned to the factor, less $9.7 million and
$11.8 million of advances received from the factor, at September 30, 1998 and
December 31, 1997, respectively. Effective January 1, 1998, the Company
substantially reduced the volume of receivables assigned to the factor.
6. INVENTORY
Inventory consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- -------------
<S> <C> <C>
Raw materials
Fabric and trim accessories..................... $ 8,900,084 $4,022,298
Raw cotton...................................... 3,479,051 --
Work-in-process...................................... 12,027,471 4,315,703
Finished goods shipments-in-transit.................. 3,407,530 5,655,461
Finished goods....................................... 10,916,350 9,272,734
----------- -----------
$38,730,486 $23,266,196
=========== ===========
</TABLE>
7. BANK BORROWINGS
Bank borrowings consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- -------------
<S> <C> <C>
Import trade bills payable........................... $ 10,472,815 $ 4,287,518
Other Hong Kong credit facilities.................... 314,719 --
United States credit facilities...................... 14,318,202 --
------------ -----------
$ 25,105,736 $ 4,287,518
============ ===========
</TABLE>
8
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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, for women, men and children under
private label. The Company's major customers include specialty retailers, such
as Lerner New York, Limited Stores, Lane Bryant, Structure and Express, all of
which are divisions of The Limited, mass merchandisers, Abercrombie & Fitch and
J.C. Penney. 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.
The Company continues to geographically diversify its worldwide sourcing
operations. Commencing in the third quarter of 1997, the Company has
substantially expanded its use of independent cutting, sewing and finishing
contractors in Mexico, primarily for its increasing sales of commodity products.
The Company believes that additional costs and inefficiencies that may occur as
a result of this strategy will, over time, be offset by the benefits of lower
cost production and greater control over the quality and reliability of its
products.
The Company is currently negotiating the acquisition of an established
denim mill located in Puebla, Mexico with an annual capacity of approximately 18
million meters of denim. The Company anticipates that the purchase price for
such mill will be approximately $100 million, consisting of approximately $50
million of the Company's Common Stock and approximately $50 million in notes or
a combination of cash and notes.
In addition, the Company is negotiating a contract to acquire a turn-
key facility being constructed in Puebla, Mexico by an affiliate of the seller
of the denim mill described above. This facility is expected to have an annual
capacity of approximately 18 million meters of twill and will also house
cutting, washing, finishing, packing and shipping activities as well as a
distribution center. Construction of this facility commenced in the third
quarter of 1998, and it is anticipated that the Company will take possession of
this facility in the year 2000. The Company anticipates that the cost of such
facility will be approximately $35 million, of which approximately $15 million
may be financed on a long-term basis by certain equipment suppliers.
The Company currently anticipates that net sales of products sourced in
Mexico will exceed $100 million in 1998.
On July 2, 1998, the Company acquired Rocky Apparel, L.P. which designs,
contracts for the manufacture of and sells private label apparel for men and
women to national retailers, including Abercombie & Fitch and three divisions of
The Limited. See "Note 3 to Notes to Consolidated Financial Statements--Recent
Acquisitions."
On February 23, 1998, the Company acquired certain assets of Marshall Gobuty
International U.S.A., Inc. and MGI International Limited ("MGI"), which design,
contract for the manufacture of and sell private label apparel for men and boys
to national retailers, including J.C. Penney. See Note 3 to Notes to
Consolidated Financial Statements--Recent Acquisitions."
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.
Vertical Integration. In late 1997, the Company commenced the vertical
integration of a portion of its business. Key elements of this strategy may
include (i) establishing cutting, sewing, washing, finishing, packing, shipping
or distribution activities in company-owned facilities or through the
acquisition of established contractors and (ii) establishing fabric production
capability through the acquisition of established mills or the construction of
new mills. The Company has no history of operating textile mills or cutting,
sewing, washing, finishing, packing or shipping activities upon which an
evaluation of the prospects of the Company's vertical integration strategy can
be based. In addition, such operations are subject to the customary risks
associated with owning a manufacturing business, including, but not limited to,
the maintenance and management of manufacturing facilities, equipment, employees
and inventories. See "--Foreign Manufacturing."
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.
9
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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.
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, Structure and Lane Bryant) accounted
for approximately 65% of the Company's net sales in the first nine months of
1998 and approximately 70% of the Company's net sales in 1997. 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 state, federal or foreign 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 state, federal or foreign 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
10
<PAGE>
such sanctions will not have a material adverse effect on the Company. In
addition, certain of the Company's customers, including The Limited require
strict compliance by their apparel manufacturers, including the Company, with
applicable labor laws. There can be no 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's 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's products were
imported in 1997. 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.
Impact of Year 2000. The Year 2000 Issue is the result of computer programs
being written using two digits rather than four to define the applicable year.
Any of the Company's computer programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
The Company has determined that it will be required to modify or replace
portions of its software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The Company also has
initiated formal communications with its significant suppliers and large
customers to determine the extent to which the Company's interface systems are
vulnerable to those third parties' failure to remediate their own Year 2000
Issues. The Company presently believes that with modifications to existing
software and conversions to new software, the cost of which is not expected to
be material to the Company's results of operation or financial position, the
Year 2000 Issue will not pose significant operational problems for its computer
systems. The Company will use both internal and external resources to reprogram,
or replace, and test the software for Year 2000 modifications. The Company
anticipates completing the Year 2000 project prior to
11
<PAGE>
any anticipated impact on its operating systems. However, if such modifications
and conversions are not made, or are not completed timely, the Year 2000 Issue
could have a material adverse effect on the operations of the Company. Likewise,
there can be no assurance that the systems of other companies on which the
Company's systems rely will be timely converted and would not have a material
adverse effect on the Company's systems.
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 SEPTEMBER 30, ENDED SEPTEMBER 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Net sales....................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales................................... 82.9 86.0 81.8 85.0
------ ------ ------ ------
Gross profit.................................... 17.1 14.0 18.2 15.0
Selling and distribution expenses............... 2.7 3.0 2.7 3.2
General and administration expenses *........... 4.5 5.1 5.6 5.4
------ ------ ------ ------
Income from operations.......................... 9.9 5.9 9.9 6.4
Interest expense................................ (0.7) (0.6) (0.6) (0.6)
Other income.................................... 0.5 0.5 0.3 0.2
------ ------ ------ ------
Income before income taxes...................... 9.7 5.8 9.6 6.0
Income taxes.................................... (3.5) (1.9) (3.5) (1.9)
------ ------ ------ ------
Net income...................................... 6.2% 3.9% 6.1% 4.1%
====== ====== ====== ======
</TABLE>
* Includes amortization of excess of cost over fair value of net assets
acquired.
THIRD QUARTER 1998 COMPARED TO THIRD QUARTER 1997
Net Sales increased by $45.7 million, or 66.1%, from $69.2 million in the third
quarter of 1997 to $114.9 million in the third quarter of 1998. The increase in
net sales included an aggregate increase in sales (excluding Rocky) of $19.4
million to divisions of The Limited, primarily as a result of an increased
volume of unit sales, and $29.5 million as a result of the MGI and Rocky
Acquisitions, as offset by a $4.9 million decrease to mass merchandisers.
Excluding acquisitions, sales increased by $16.2 million, or 23.4% over the same
period last year. Overall, sales to divisions of The Limited in the third
quarter of 1998 amounted to 63.5% of total net sales, as compared to 65.4% in
the comparable prior period, whereas sales to mass merchandisers were 11.4% of
total net sales as compared to 26.0% 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 1998 was $19.7
million, or 17.1% of net sales, compared to $9.7 million, or 14.0% of net sales,
in the comparable prior period, an increase in gross profit of 103.2%. The 3.1%
increase in the gross profit margin included benefits of 2.0% from a reduction
in returns and inventory markdown, 0.4% from domestic production of the Men's
Division and 0.5% from a reduction of direct costs attributable to production as
a percentage of net sales.
12
<PAGE>
Selling and Distribution Expenses were $3.1 million in the third quarter of 1998
and $2.1 million in the third quarter of 1997. As a percentage of net sales,
these expenses decreased from 3.0% in the third quarter of 1997 to 2.7% in the
third quarter of 1998. After adjusting for expenses related to the operations of
MGI and Rocky of $949,000, as compared to no such expenses in the third quarter
of 1997, selling and distribution expenses increased by $31,000 in the third
quarter of 1998 as compared to the third quarter of 1997.
General and Administrative Expenses (which include amortization of excess of
cost over fair value of net assets acquired) increased from $3.6 million in the
third quarter of 1997 to $5.3 million in the third quarter of 1998. As a
percentage of net sales, these expenses decreased from 5.1% in the third quarter
of 1997 to 4.5% in the third quarter of 1998. This percentage decrease included
a decrease in the allowance for bad debt, as offset by increases in amortization
of the excess of cost over fair value of net assets acquired, bonus accruals and
expenses related to the operations of MGI and Rocky. The allowance for bad
debt 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 increase in
the allowance for returns and discounts during the third quarter of 1997 was
$189,000, or 0.3% of net sales, compared to a decrease in such allowance of
$230,000, or 0.2% of net sales, during the third quarter of 1998. The most
significant portions of the decrease in the allowance for returns and discounts
resulted from changes in the amount and aging of accounts receivable. Bad debt
expense was $48,000 in the third quarter of 1997 as compared to a recovery of
$52,000 in the third quarter of 1998. Bonus accruals were $0 in the third
quarter of 1997 as compared to $706,000 in the third quarter of 1998. After
adjusting for the net decrease in the allowance for bad debt of $519,000, the
$470,000 amortization of the excess of cost over fair value of net assets
acquired in the third quarter of 1998, as compared to no such amortization in
the third quarter of 1997, the $706,000 increase in bonus accruals and expenses
related to the operations of MGI and Rocky of $870,000 in the third quarter of
1998 as compared to no such expenses in the third quarter of 1997, general and
administrative expenses increased by $182,000 in the third quarter of 1998 as
compared to the third quarter of 1997, as summarized below:
<TABLE>
<CAPTION>
Quarter Ended September 30,
----------------------------- Increase/
1998 1997 (Decrease)
------------ ------------ ------------
<S> <C> <C> <C>
$5,260,000 $3,551,000 $1,709,000
Less: Bad Debt Expense (52,000) 48,000 (100,000)
Allowance for Returns & Discounts (230,000) 189,000 (419,000)
---------- ---------- ----------
Allowance for Bad Debt (282,000) 237,000 (519,000)
Amortization of Goodwill 470,000 -0- 470,000
Bonus Accruals 706,000 -0- 706,000
MGI and Rocky Operations 870,000 -0- 870,000
---------- ---------- ----------
$3,496,000 $3,314,000 $ 182,000
========== ========== ==========
</TABLE>
Operating Income in the third quarter of 1998 was $11.4 million, or 9.9% of net
sales, compared to $4.1 million, or 5.9% of net sales, in the comparable prior
period, an increase in operating income of 180.0% due to the factors described
above. The 4.0% improvement in operating income as a percentage of net sales is
attributable to a 3.1% increase in gross profit margin and a 1.3% decrease in
operating expenses as offset by a 0.4% increase in the amortization of the
excess of cost over fair value of net assets acquired.
13
<PAGE>
Other Income increased from $313,000, or 0.5% of net sales, in the third quarter
of 1997, to $526,000, or 0.5% of net sales, in the third quarter of 1998. The
increase primarily resulted from an increase in management fee income from $0 in
the third quarter of 1997 to $377,000 in the third quarter of 1998 as offset by
the realization of a $275,000 gain on the sale of securities in the third
quarter of 1997 as compared to no such gain in the third quarter of 1998.
FIRST NINE MONTHS 1998 COMPARED TO FIRST NINE MONTHS 1997
Net Sales increased by $82.6 million, or 42.0%, from $196.7 million in the first
nine months of 1997 to $279.3 million in the first nine months of 1998. The
increase in net sales included an aggregate increase in sales (excluding Rocky)
of $34.7 million to divisions of The Limited, $0.8 million to mass
merchandisers, primarily as a result of an increased volume of unit sales, and
$50.5 million as a result of the MGI and Rocky Acquisitions. Excluding
acquisitions, sales increased by $32.1 million, or 16.3% over the same period
last year. Overall, sales to divisions of The Limited in the first nine months
of 1998 amounted to 63.3% of total net sales, as compared to 68.1% in the
comparable prior period, whereas aggregate sales to mass merchandisers were
17.3% of total net sales as compared to 24.2% 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 1998 was $50.9
million, or 18.2% of net sales, compared to $29.5 million, or 15.0% of net
sales, in the comparable prior period, an increase in gross profit of 72.3%.
The 3.2% increase in the gross profit margin included benefits of 1.8% from a
reduction in returns and inventory markdown, 0.4% from domestic production of
the Men's Division and 0.4% from a reduction of direct costs attributable to
production as a percentage of net sales.
Selling and Distribution Expenses increased from $6.3 million in the first nine
months of 1997 to $7.6 million in the first nine months of 1998. As a percentage
of net sales, these expenses decreased from 3.2% in the first nine months of
1997 to 2.7% in the first nine months of 1998. After adjusting for expenses
related to the operations of MGI and Rocky of $1.6 million, as compared to no
such expenses in the first nine months of 1997, selling and distribution
expenses decreased by $343,000 in the first nine months of 1998 as compared to
the first nine months of 1997.
General and Administrative Expenses (which include amortization of excess of
cost over fair value of net assets acquired) increased from $10.7 million in the
first nine months of 1997 to $15.7 million in the first nine months of 1998. As
a percentage of net sales, these expenses increased from 5.4% in the first nine
months of 1997 to 5.6% in the first nine months of 1998. This percentage
increase included increases in the allowance for bad debt, amortization of the
excess of cost over fair value of net assets acquired, bonus accruals and
expenses related to the operations of MGI and Rocky. The allowance for bad debt
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 increase in the
allowance for returns and discounts during the first nine months of 1997 was
$191,000, or 0.1% of net sales, compared to an increase in such allowance of
$841,000 or 0.3% of net sales, during the first nine months of 1998. 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. Bad debt
expense was $205,000 in the first nine months of 1997 as compared to $79,000 in
the first nine months of 1998. Bonus accruals were $783,000 in the first nine
months of 1997 as compared to $2.1 million in the first nine months of 1998.
After adjusting for the net increase in the allowance for bad debt of $524,000,
the $870,000 amortization of the excess of cost over fair value of net assets
acquired in the first nine months of 1998, as compared to no such amortization
in the first six months of 1997, the $1.3 million increase in bonus accruals and
expenses related to the operations of MGI and Rocky of $1.9 million, as compared
to no such expenses in
14
<PAGE>
the first nine months of 1997, general and administrative expenses increased by
$457,000 in the first nine months of 1998 as compared to the first nine months
of 1997, as summarized below:
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------- Increase/
1998 1997 (Decrease)
-------------- -------------- -----------
<S> <C> <C> <C>
$15,727,000 $10,667,000 $5,060,000
Less: Bad Debt Expense 79,000 205,000 (126,000)
Allowance for Returns & Discounts 841,000 191,000 650,000
----------- ----------- ----------
Allowance for Bad Debt 920,000 396,000 524,000
Amortization of Goodwill 870,000 -0- 870,000
Bonus Accruals 2,132,000 783,000 1,349,000
MGI and Rocky Operations 1,860,000 -0- 1,860,000
----------- ----------- ----------
$ 9,945,000 $ 9,488,000 $ 457,000
=========== =========== ==========
</TABLE>
Operating Income in the first nine months of 1998 was $27.6 million, or 9.9% of
net sales, compared to $12.5 million, or 6.4% of net sales, in the comparable
prior period, an increase in operating income of 120.0% due to the factors
described above. The 3.5% increase in operating income as a percentage of net
sales is attributable to a 3.2% increase in gross profit margin and a 0.6%
decrease in operating expenses as offset by a 0.3% increase in the amortization
of the excess of cost over fair value of net assets acquired.
Other Income increased from $373,000, or 0.2% of net sales, in the first nine
months of 1997 to $759,000, or 0.3% of net sales, in the first nine months of
1998. This increase primarily resulted from $109,000 and $0 of interest and
management fee income, respectively, in the first nine months of 1997, which
also included a $275,000 gain on the sale of stock, as compared to $237,000 and
$431,000 of such income, respectively, in the first nine months of 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary need for funds has been to finance acquisitions,
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 facilities, issuance of long-term debt, proceeds from exercise of stock
options and proceeds from its initial public offering.
During the first nine months of 1998, net cash used in operating activities
was $3.4 million, which resulted primarily from net income of $17.1 million and
a net increase in working capital items of $23.9 million. In this period, cash
flow used in investing activities was $19.0 million which primarily consisted of
$13.8 million for the MGI and Rocky Acquisitions and $3.1 million of capital
expenditure commitments related to vertical integration programs while cash flow
provided by financing activities equaled $19.0 million, a result of $17.4
million of additional bank borrowings, the payment of $1.1 million of
long-term debt
15
<PAGE>
and $2.7 million of proceeds from the exercise of stock options.
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 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, 1998, 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, 1998, SCB's Hong Kong dollar prime rate equaled ten 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"). Prior to January 1, 1998, NBCC acted as the Company's
factor for accounts receivable. Effective January 1, 1998, the Company
substantially reduced the volume of receivables assigned to the factor. The
Company may receive an advance from NBCC of up to 90% of accounts receivable,
except receivables from Lerner New York and Target Stores. 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, 1998, the prime rates equaled
eight and one-half percent and the LIBOR rates equaled five and six-tenths
percent.
The Company has an unsecured $10 million credit facility with SCB which is
available for general corporate purposes. This facility is cross-defaulted to
the Company's other bank credit facilities and interest on advances accrues at
the rate of one and one-quarter percent over LIBOR.
The Company guarantees a $5 million credit facility for Rocky Apparel, LLC, a
wholly-owned subsidiary of the Company which acquired the partnership interests
in Rocky Apparel, L.P., a Delaware limited partnership. See "Note 3 to Notes
to Consolidated Financial Statements -- Recent Acquisitions."
The Company has financed its operations to date from its cash flow from
operations, borrowings under its bank credit facilities and the proceeds from
its initial public offering. The Company believes that its cash flow from
operations and borrowings under its current financing facilities should be
sufficient to fund its existing operations for the foreseeable future.
The Company has commenced a capital investment program under which it
currently anticipates investing approximately $135 million in the acquisition of
a denim mill and the construction of a facility which will produce twill and
house cutting, washing, finishing, packing and shipping activities and a
distribution center in Puebla, Mexico. See "--General." The Company may seek to
finance this and future capital investment programs through various methods,
including, but not limited to, borrowings under the Company's bank credit
facilities and long-term financing provided by the sellers of such facilities or
the suppliers of certain equipment used in such facilities. To date, capital
expenditure and working capital commitments aggregating $9.1 million and $3.5
million, respectively, have been made with respect to vertical integration
programs by the Company. The success of the Company's vertical integration
strategy may depend, in part, on its ability to obtain financing therefore.
There can be no assurance that such financing, if and when required, will be
available on terms acceptable to the Company, or at all.
16
<PAGE>
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.
-----------------
The proxy materials for the 1998 annual meeting of stockholders held on
May 1, 1998 were mailed to stockholders of the Company on March 20,
1998. Stockholder proposals to be presented at the 1999 annual meeting
of stockholders must be received at the Company's executive offices at
3151 East Washington Boulevard, Los Angeles, California, 90023,
addressed to the attention of the Corporate Secretary by November 20,
1998, in order to be considered for inclusion in the proxy materials
relating to such meeting. Recently, the Securities and Exchange
Commission amended its rule governing a company's ability to use
discretionary proxy authority with respect to stockholder proposals
which were not submitted by the stockholders in time to be included in
the proxy statement. As a result of that rule change, in the event a
stockholder proposal is not submitted to the Company prior to February
3, 1999, the proxies solicited by the Board of Directors for the 1999
annual meeting of stockholders will confer authority on the holders of
the proxy to vote the shares in accordance with their best judgment and
discretion if the proposal is presented at the 1999 annual meeting of
stockholders without any discussion of the proposal in the proxy
statement for such meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) Exhibits: None.
(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 6, 1998 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>
27 Financial Data Schedule
</TABLE>
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,866,154
<SECURITIES> 0
<RECEIVABLES> 66,304,126
<ALLOWANCES> 2,825,089
<INVENTORY> 38,730,486
<CURRENT-ASSETS> 114,624,170
<PP&E> 8,011,647
<DEPRECIATION> 3,449,097
<TOTAL-ASSETS> 139,075,019
<CURRENT-LIABILITIES> 66,463,350
<BONDS> 0
0
0
<COMMON> 20,173,702
<OTHER-SE> 49,350,774
<TOTAL-LIABILITY-AND-EQUITY> 139,075,019
<SALES> 279,305,521
<TOTAL-REVENUES> 280,064,875
<CGS> 228,403,202
<TOTAL-COSTS> 228,403,202
<OTHER-EXPENSES> 23,296,506
<LOSS-PROVISION> (51,688)
<INTEREST-EXPENSE> 1,677,854
<INCOME-PRETAX> 26,687,313
<INCOME-TAX> 9,590,000
<INCOME-CONTINUING> 17,097,313
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,097,313
<EPS-PRIMARY> 1.27
<EPS-DILUTED> 1.21
</TABLE>
