<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 March 31, 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: (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 May 6, 1998
was 13,412,418 (as adjusted to reflect a two-for-one stock split to shareholders
of record at the close of business on May 8, 1998).
1
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TARRANT APPAREL GROUP
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
PART I. FINANCIAL INFORMATION ----
<S> <C>
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at
March 31, 1998 and December 31, 1997 (Audited).......... 3
Consolidated Statements of Income for the
Three Months Ended March 31, 1998 and March 31, 1997.... 4
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1998 and March 31, 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....................................... 15
Item 2. Changes in Securities................................... 15
Item 3. Defaults Upon Senior Securities......................... 15
Item 4. Submission of Matters to a Vote of Security Holders..... 15
Item 5. Other Information....................................... 15
Item 6. Exhibits and Reports on Form 8-K........................ 15
SIGNATURES.............................................. 16
INDEX TO EXHIBITS....................................... 17
</TABLE>
2
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
--------------------
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------- -------------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents............... $ 2,498,902 $ 5,305,129
Accounts receivable, net................ 54,042,913 34,078,352
Due from affiliates..................... 1,229,906 3,470
Due from officers....................... 2,180,261 1,601,670
Inventory............................... 22,057,710 23,266,196
Temporary quota......................... 3,959,968 2,874,382
Prepaid expenses........................ 2,091,617 1,203,931
Prepaid income taxes.................... 478,050 478,050
------------- -------------
Total current assets................. 88,539,327 68,811,180
Property and equipment, net.............. 2,628,622 2,707,257
Permanent quota, net..................... 148,138 145,268
Other assets............................. 214,960 196,973
Excess of cost over fair value of net
assets acquired......................... 5,900,000 ---
------------- -------------
Total assets....................... $ 97,431,047 $ 71,860,678
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank borrowings......................... $ 22,204,848 $ 4,287,518
Short-term debt......................... 1,000,000 ---
Accounts payable........................ 13,482,548 12,549,961
Accrued expenses........................ 6,205,704 5,117,183
Income taxes............................ 1,128,826 969,115
Deferred tax liability.................. 1,099,832 582,957
------------- -------------
Total current liabilities............ 45,121,758 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;
13,412,418 shares (1998),
13,219,928 shares (1997), issued
and outstanding....................... 17,275,469 16,100,483
Contributed capital.................... 1,434,259 1,434,259
Retained earnings...................... 33,599,561 30,819,202
------------- -------------
Total shareholders' equity.......... 52,309,289 48,353,944
------------- -------------
Total liabilities and
shareholders' equity............... $ 97,431,047 $ 71,860,678
============= =============
</TABLE>
See accompanying notes.
3
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TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------
1998 1997
----------- -----------
(UNAUDITED)
<S> <C> <C>
Net sales.................................. $64,257,177 $53,604,701
Cost of sales.............................. 53,309,710 44,822,034
----------- -----------
Gross profit............................... 10,947,467 8,782,667
Selling and distribution
expenses.................................. 2,097,921 2,082,763
General and administrative
expenses.................................. 4,291,702 3,307,262
----------- -----------
Income from operations..................... 4,557,844 3,392,642
Interest expense........................... (324,262) (462,224)
Interest income............................ 51,118 35,412
Other income............................... 65,659 5,545
----------- -----------
Income before provision for
income taxes.............................. 4,350,359 2,971,375
Provision for income taxes................. (1,570,000) (950,000)
----------- -----------
Net income................................. $ 2,780,359 $ 2,021,375
=========== ===========
Net income per share
Basic.................................... $ 0.21 $ 0.15
=========== ===========
Diluted.................................. $ 0.20 $ 0.15
=========== ===========
Weighted average common and common
equivalent shares outstanding
Basic.................................... 13,281,262 13,110,462
=========== ===========
Diluted.................................. 13,756,100 13,543,234
=========== ===========
</TABLE>
See accompanying notes.
4
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TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------
1998 1997
------------ -----------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................. $ 2,780,359 $ 2,021,375
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and
amortization............................ 265,067 194,072
Loss on sale of fixed
assets................................... 43,375 105
Provision for returns and
discounts................................ 225,670 186,461
Changes in operating assets and
liabilities:
Accounts receivable................... (20,190,231) 2,961,460
Due from affiliates
and officers......................... (1,805,027) (280,325)
Inventory.............................. 1,208,486 (2,292,730)
Temporary quota........................ (1,085,586) (2,109,977)
Prepaid expenses....................... (887,686) (21,188)
Prepaid income taxes................... --- 511,672
Accounts payable....................... 932,587 (1,528,054)
Accrued expenses....................... 1,747,120 1,581,586
------------ -----------
Net cash provided by
(used in) operating
activities.......................... (16,765,866) 1,224,457
------------ -----------
INVESTING ACTIVITIES
Purchase of fixed assets.................... (53,232) (95,540)
Acquisition of MGI.......................... (6,050,000) ---
Purchase of permanent quota................. (29,445) (115,786)
------------ -----------
Net cash used in
investing activities................... (6,132,677) (211,326)
------------ -----------
FINANCING ACTIVITIES
Bank borrowings, net........................ 17,917,330 983,336
Issuance of short-term debt................. 1,000,000 ---
Exercise of stock options
including related tax
benefit.................................... 1,174,986 226,584
------------ -----------
Net cash provided by
financing activities................... 20,092,316 1,209,920
------------ -----------
Increase (decrease) in cash
and cash equivalents....................... (2,806,227) 2,223,051
Cash and cash equivalents at
beginning of period........................ 5,305,129 1,120,456
------------ -----------
Cash and cash equivalents at
end of period.............................. $ 2,498,902 $ 3,343,507
============ ===========
</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 March 31, 1998, the Hong Kong subsidiaries
had shareholders' equity of $31.1 million and an intercompany receivable due
from Tarrant Apparel Group of $28.1 million.
3. 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.
6
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TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
4. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
<S> <C> <C>
U.S. trade accounts receivable................. $45,646,912 $13,411,719
Foreign trade accounts receivable.............. 11,223,765 9,466,193
Due (to) from factor........................... (1,570,682) 12,028,633
Other receivables.............................. 524,400 727,619
Allowance for returns and discounts............ (1,781,482) (1,555,812)
----------- -----------
$54,042,913 $34,078,352
=========== ===========
</TABLE>
Due (to) from factor consists of $4.3 million and $17.5 million of unmatured
accounts receivable assigned to the factor, less $6.0 million and $11.8
million of advances received from the factor, at March 31, 1998 and December
31, 1997, respectively. Effective January 1, 1998, the Company substantially
eliminated its use of the factor.
5. INVENTORY
Inventory consists of the following:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
Raw materials
Fabric and trim accessories.......... $ 5,618,290 $ 4,022,298
Raw cotton........................... 2,530,058 --
Work-in-process........................ 4,613,890 4,315,703
Finished goods shipments-in-transit.... 1,907,386 5,655,461
Finished goods......................... 7,388,086 9,272,734
----------- -----------
$22,057,710 $23,266,196
=========== ===========
</TABLE>
6. BANK BORROWINGS
Bank borrowings consist of the following:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- -----------
<S> <C> <C>
Import trade bills payable.............................. $ 5,847,930 $ 4,287,518
Other Hong Kong credit facilities....................... 7,281,178 --
United States credit facilities......................... 9,075,740 --
=========== ===========
$22,204,848 $ 4,287,518
=========== ===========
</TABLE>
7
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TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
7. 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.
8. RECENT ACQUISITION
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
consists of (i) $5,050,000, together with an amount equal to seller's cost of
the inventory purchased, payable in cash on closing, (ii) $500,000 payable on
July 31, 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 consists of (i) $1,000,000, together with an amount equal to
seller's cost of the inventory purchased, payable in cash on closing and (ii)
$500,000 payable on July 31, 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.
In connection with this acquisition, the Company entered into employment
agreements with Marshall Gobuty, the President and principal shareholder of the
sellers, and four senior employees of MGI. Under his employment agreement, Mr.
Gobuty will be employed as the Vice President - Men's of the Company for a term
commencing on March 1, 1998 and ending on February 23, 1999, unless extended by
the mutual agreement of the Company and Mr. Gobuty, and will be paid an annual
base salary of $375,000 and will receive such benefits and perquisites as are
provided by the Company to its executive officers generally. In the event the
Company terminates his employment without cause, Mr. Gobuty shall be entitled to
receive (i) a lump sum payment equal to his base salary for the balance of the
term and (ii) continuation of group medical and disability insurance of the
balance of the term. In the event the Company terminates Mr. Gobuty's
employment with cause, the Company is obligated to pay the compensation required
by the agreement only through the date of termination. In addition, the sellers
and Mr. Gobuty have agreed not to compete with the Company during the two years
following the termination of his employment for any reason.
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, 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, mass merchandisers 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. 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 costs and inefficiencies 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).
On February 23, 1998, the Company acquired certain assets of Marshall Gobuty
International U.S.A., Inc. and MGI International Limited which design, contract
for the manufacture of and sell private label apparel for men and boys to
national retailers, including J.C. Penney (the "Gobuty Acquisition").
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
9
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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 and Lane Bryant) accounted for
approximately 63% of the Company's net sales in the first quarter 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 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
10
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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 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 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 any anticipated
impact on its operating systems. However, if such modifications and conversions
are
11
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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
ENDED MARCH 31,
-----------------
1998 1997
-------- --------
<S> <C> <C>
Net sales........................................ 100.0% 100.0%
Cost of sales.................................... 82.9 83.6
-------- --------
Gross profit..................................... 17.1 16.4
Selling and distribution expenses................ 3.3 3.9
General and administration expenses*............. 6.7 6.2
-------- --------
Operating income................................. 7.1 6.3
Interest expense................................. (0.5) (0.9)
Other income..................................... 0.2 0.1
-------- --------
Income before income taxes....................... 6.8 5.5
Income taxes..................................... (2.5) (1.7)
-------- --------
Net income....................................... 4.3% 3.8%
======== ========
</TABLE>
* Includes amortization of excess of cost over fair value of net assets
acquired.
FIRST QUARTER 1998 COMPARED TO FIRST QUARTER 1997
Net Sales increased by $10.7 million, or 19.9%, from $53.6 million in the first
quarter of 1997 to $64.3 million in the first quarter of 1998. The increase in
net sales included an aggregate increase in sales of $7.5 million to divisions
of The Limited, primarily as a result of an increased volume of unit sales,
$1.1 million to mass merchandisers and $1.3 million as a result of the Gobuty
Acquisition. Overall, sales to divisions of The Limited in the first quarter of
1998 amounted to 62.5% of total net sales, as compared to 60.9% in the
comparable prior period, whereas sales to mass merchandisers were 28.3% of total
net sales as compared to 31.7% 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 quarter of 1998 was $10.9
million, or 17.1% of net sales, compared to $8.8 million, or 16.4% of net sales,
in the comparable prior period, an increase in gross profit of 24.6%. The
increase in the gross profit margin resulted from a reduction in discounts and
allowances from 1.2% of net sales in the first quarter of 1997 to 0.5% of net
sales in the first quarter of 1998.
Selling and Distribution Expenses were $2.1 million in the first quarter of 1997
and the first quarter of 1998. As a percentage of net sales, these expenses
decreased from 3.9% in the first quarter of 1997 to 3.3% in the first quarter of
1998 as a result of the increase in net sales.
General and Administrative Expenses (which includes amortization of excess of
cost over fair value of net assets acquired) increased from $3.3 million in the
first quarter of 1997 to $4.3 million in the
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<PAGE>
first quarter of 1998. As a percentage of net sales, these expenses increased
from 6.2% in the first quarter of 1997 to 6.7% in the first quarter of 1998.
This percentage increase was primarily due to an increase in the allowance for
bad debt and amortization of the excess of cost over fair value of net assets
acquired as offset by the increase in net sales. 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 decrease in the
allowance for returns and discounts during the first quarter of 1997 was
$58,000, or 0.1% of net sales, compared to an increase in such allowance of
$92,000, or 0.1% of net sales, during the first quarter 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. After
adjusting for the net increase in the allowance for bad debt of $150,000, and
the $100,000 amortization of the excess of cost over fair value of net assets
acquired in the first quarter of 1998, as compared to no such amortization in
the first quarter of 1997, general and administrative expenses increased by
$735,000 in the first quarter of 1998 as compared to the first quarter of 1997,
and such expenses were 6.3% of net sales in the first quarter of 1997 as
compared to 6.4% of net sales in the first quarter of 1998.
Operating Income in the first quarter of 1998 was $4.6 million, or 7.1% of net
sales, compared to $3.4 million, or 6.3% of net sales, in the comparable prior
period, an increase in operating income of 34.3% due to the factors described
above. The 0.8% improvement in operating income as a percentage of net sales is
attributable to a 0.1% decrease in operating expenses and a 0.7% increase in
gross profit margin.
Other Income increased from $41,000, or 0.1% of net sales, in the first quarter
of 1997, to $117,000, or 0.2% of net sales, in the first quarter of 1998. The
increase primarily resulted from an increase in management fees and interest
income from $35,000 and $0, respectively, in the first quarter of 1997 to
$51,000 and $54,000, respectively, in the first quarter of 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary need for funds has been to finance inventory, finished
goods shipments-in-transit and accounts receivable, including receivables from
the Company's contract manufacturers that relate primarily to fabric purchased
by the Company for use by those manufacturers. (The Company generally purchases
fabric for delivery directly to the manufacturer's factory. The Company then
invoices the manufacturer for the fabric, and reduces payments to the
manufacturer for finished goods by the amount of outstanding invoices.) The
Company's primary sources for working capital are cash flow from operations,
borrowings under the Company's bank credit agreement and factoring agreement and
proceeds from its initial public offering.
During the first three months of 1998, net cash used in operating activities
was $16.8 million, which resulted primarily from net income of $2.8 million and
a net increase in working capital items of $19.0 million.
During the first three months of 1998, cash flow used in investing activities
was $6.1 million which primarily consisted of the Gobuty Acquisition.
In the three months ended March 31, 1998, cash flow provided by financing
activities equaled $20.1 million, a result of $17.9 million of additional bank
borrowings, the issuance of $1.0 million of short-term debt to fund a portion of
the Gobuty Acquisition and $1.2 million of proceeds from the exercise of stock
options.
13
<PAGE>
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 March 31, 1998, HKSB's U.S. Dollar
prime rate equaled seven and one-quarter percent. Interest on cash advances
under SCB's facility accrues at SCB's prime rate for lending Hong Kong dollars.
As of March 31, 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 eliminated its use of 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 March 31, 1998, the prime rates equaled eight and one-half percent
and the LIBOR rates equaled five and seven-tenths percent.
The Company has financed its operations to date from its cash flow from
operations, borrowings under its financing facilities and the proceeds from its
initial public offering in July 1995. The Company believes that its cash flow
from operations and borrowings under its current financing facilities should be
sufficient to fund its current operations for the foreseeable future.
In late 1997, the Company commenced the vertical integration of its business.
Key elements of this strategy include (i) establishing cutting, sewing,
finishing and packaging operations through the acquisition of established
contractors or the construction of new facilities and (ii) establishing fabric
production capability through the acquisition of established mills or the
construction of new mills. To date, capital expenditure and working capital
commitments aggregating $6.9 million and $2.5 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 therefor. There can be no assurance that additional
capital, if and when required, will be available on terms acceptable to the
Company, or at all.
14
<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.
-----------------
On April 27, 1998, the Company announced a two-for-one stock split
effective on May 8, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) Exhibits: Reference is made to the Index to Exhibits on page 17
for a description of the exhibit filed as part of this Report on
Form 10-Q.
(b) Reports on Form 8-K: None.
15
<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: May 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)
16
<PAGE>
INDEX TO EXHIBITS
-----------------
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
10.43.2 Letter agreement dated April 16, 1998, by and between Tarrant
Company Limited and The Hongkong Shanghai Banking Corporation
Limited
27 Financial Data Schedule
</TABLE>
17
<PAGE>
EXHIBIT 10.43.2
---------------
THE HONGKONG AND SHANGHAI BANKING CORPORATION LIMITED
Hong Kong Main Office: 1 Queen's Road Central, Hong Kong
Ref: Corporate & Institutional Banking
- Textiles & Garments Division
CONFIDENTIAL
Tarrant Co. Ltd.
13/F & 14/F, Lladro Centre
72-80 Hoi Yuen Road, Kwun Tong
Kowloon 16 April 1998
Attention: Mr. Mark Kristof
Dear Sirs:
BANKING FACILITIES
We refer to our recent discussions and are pleased to advise that we have
reviewed your banking facilities and offer a renewal within the following limits
which will be made available on the specific terms and conditions outlined below
and subject to the satisfactory completion of the security below. These
facilities are subject to review at any time and, in any event by 31 March 1999
and also subject to our overriding right of withdrawal and repayment on demand,
including the right to call for cash cover on demand for prospective and
contingent liabilities.
Import/Export Facilities
- ------------------------
Documentary Credits to your suppliers USD33,000,000
on an 'export-will-buy' basis. or HKD
equivalent
Bills received under these Documentary
Credits will be paid from purchase or
collection proceeds of export D/P or
DC bills or inward remittance.
within which
- ------------
Goods under your control and/or Trust (USD25,000,000)
Receipts and/or D/A bills purchased for or HKD
finished goods and fabric on approved equivalent
drawees. Such D/A bills to have a fixed
maturity date of 45 days from date of
bill of exchange for finished goods only.
A sub-limit of USD10,000,000 will also be available for Marble Ltd within which
Trust Receipts and/or D/A bills purchased for finished goods for USD8,000,000.
GPO Box 64, Hong Kong
Telephone: 2822 1111 Telex: 73205 HSBC HX Telegrams: Hongbank Hongkong
Facsimile:
<PAGE>
Tarrant Co Ltd 16 April 1998
Page 2
- --------------------------------------------------------------------------------
Within the above Import/Export (TR/DA) limits, you may issue documentary credits
to your suppliers covering fabric purchases up to USD15,000,000 or equivalent
with import loan facilities in either HKD or foreign currency for up to 45 days.
Interest on import loans in (a) HKD will be charged on a daily basis at 1/2% per
annum over our best lending rate and (b) in foreign currencies at 1/2% per annum
over the respective foreign currency best lending rate, payable monthly in
arrears to the debit of your current account.
Interest on D/A will be charged on a daily basis at our best lending rate, and
payable monthly in arrears to the debit of your current account.
Within the above Import/Export (TR/DA) limits, you may utilize overdraft
facilities up to HKD12,000,000 (previously HKD7,800,000) of which HKD2,000,000
will be available for Marble Ltd. Interest will be charged on daily balances at
3/4% per annum over our HKD best lending rate and payable monthly in arrears to
the debit of your current account.
Our HKD and USD best lending rates are currently 10% per annum and 7.25% per
annum respectively, but subject to fluctuation at our discretion.
Guarantee issued on your behalf in favour of:
- --------------------------------------------
China Light & Power Co Ltd HKD 115,000
Security
- --------
As security, we continue to hold:
1) An original key man life insurance policy covering Mr. Gerard Guez for
USD6,000,000 assigned in our favour.
2) A UCC-1 filing on the inventory of Tarrant Apparel Group in the USA
(excluding domestic inventory).
3) Intercreditor Agreement dated 1 November 1996 regarding Inventory charged
by UCC-1 filing between ourselves and Standard Chartered Bank.
4) A Tripartite Agreement between Hongkong Bank, NationsBanc Commercial
Corporation and Tarrant Apparel Group whereby 30% of factored proceeds are
assigned to us and used to retire DA bills drawn on Tarrant Apparel Group
(dba Fashion Resource Inc) by Tarrant Co Ltd.
5) Special Deposit Account Agreement among Union Bank of California N A,
Tarrant Apparel Group and ourselves with temporary suspension letter dated
21 May 1997 prepared by Walker, Wright, Tyler & Ward LLP acknowledged and
agreed by the relative parties.
<PAGE>
Tarrant Co Ltd 16 April 1998
Page 3
- --------------------------------------------------------------------------------
Security (Cont'd)
- --------
6) Intercreditor Agreement dated 18 July 1997 with the CIT Group regarding
Tarrant Apparel Group accounts receivable due from Lerner New York and
Target Stores.
7) A security agreement between ourselves and Tarrant Apparel Group dated 6
June 1995 relating to bills of exchange drawn by Tarrant Company Limited on
Tarrant Apparel Group (dba Fashion Resource Inc).
8) An Unlimited Continuing Guarantee dated 11 March 1996 from Tarrant Apparel
Group dba Fashion Resource Inc together with resolution and Certificate of
Incumbency both dated 11 March 1996 and Counsel Opinion dated 13 March
1996.
9) A security agreement between ourselves and Tarrant Apparel Group dated 6
June 1995 relating to the guarantee dated 30 October 1992 from Tarrant
Apparel Group dba Fashion Resource Inc securing these facilities.
10) A Letter of Undertaking from Tarrant Apparel Group with board resolution
stating that:
a) Tarrant Apparel Group will maintain its tangible net worth at a level
in excess of USD30,000,000 at all times.
Tangible net worth is defined as the aggregate of the paid up capital,
reserves and retained profits, or losses, after deducting all amounts
attributable to goodwill, licenses and all other assets which would be
treated as intangibles under generally accepted accounting principals
in Hong Kong or the USA.
b) Tarrant Apparel Group's debt to equity ratio must not exceed 2.0:1 at
each audited financial year end.
The debt to equity ratio is defined as total liabilities (current &
long term) divided by tangible net worth.
c) Tarrant Apparel Group's operations may not have net losses in any two
consecutive quarters.
d) Any mergers or acquisitions which are approved by Tarrant Apparel
Group's board of directors will be notified to us in writing within 24
hours.
11) A Negative Pledge dated 14 February 1996 from Tarrant Co Ltd together with
Minutes of Meeting dated 14 February 1996.
12) A Negative Pledge from Tarrant Apparel Group.
<PAGE>
Tarrant Co Ltd 16 April 1998
Page 4
- --------------------------------------------------------------------------------
Additional Security
- -------------------
1) An unlimited guarantee from Tarrant Co Ltd together with a certified copy
of a Board Resolution covering banking facilities to Marble Ltd in
substantially the form of that enclosed with this facility letter. We
enclose our standard form of guarantee for your completion and return.
Please arrange for the authorized signatories of your company and Marble Ltd, in
accordance with the terms of the mandates given to the Bank, to sign and return
to us the duplicate copy of this letter to signify your confirmation as to the
correctness of the security held, and your continued understanding and
acceptance of the terms and conditions under which these facilities are granted.
A review fee of USD1,000 will be charged to the debit of your current account
upon receipt of your acceptance to these facilities.
The above offer will remain open for your acceptance until 30 April 1998 and if
not accepted by that date will be deemed to have lapsed.
We are pleased to be of continued assistance.
Yours faithfully,
/s/Terence Chiu
- -------------------------------------
Terence Chiu
Senior Corporate Relationship Manager
Enc
/al
Accepted and agreed
/s/ Gerard Guez
- ------------------------------------
Gerard Guez
Chairman and Chief Executive Officer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 2,498,902
<SECURITIES> 0
<RECEIVABLES> 55,824,395
<ALLOWANCES> 1,781,482
<INVENTORY> 22,057,710
<CURRENT-ASSETS> 88,539,327
<PP&E> 5,603,078
<DEPRECIATION> 2,974,456
<TOTAL-ASSETS> 97,431,047
<CURRENT-LIABILITIES> 45,121,758
<BONDS> 0
0
0
<COMMON> 17,275,469
<OTHER-SE> 35,033,820
<TOTAL-LIABILITY-AND-EQUITY> 97,431,047
<SALES> 64,257,177
<TOTAL-REVENUES> 64,373,954
<CGS> 53,309,710
<TOTAL-COSTS> 53,309,710
<OTHER-EXPENSES> 6,389,623
<LOSS-PROVISION> 91,953
<INTEREST-EXPENSE> 324,262
<INCOME-PRETAX> 4,350,359
<INCOME-TAX> 1,570,000
<INCOME-CONTINUING> 2,780,359
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,780,359
<EPS-PRIMARY> 0.21
<EPS-DILUTED> 0.20
</TABLE>
