<PAGE>
As filed with the Securities and Exchange Commission on November 14, 2000
-------------------------------------------------------
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, 2000
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 7,
2000: 15,832,315
<PAGE>
TARRANT APPAREL GROUP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets at September 30, 2000 (Unaudited) and December 31, 1999
(Audited)....................................................................................... 3
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2000 and
September 30, 1999.............................................................................. 4
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2000
and September 30, 1999.......................................................................... 5
Notes to Consolidated Financial Statements...................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 14
Item 2. Changes in Securities........................................................................... 14
Item 3. Defaults Upon Senior Securities................................................................. 14
Item 4. Submission of Matters to a Vote of Security Holders............................................. 14
Item 5. Other Information............................................................................... 14
Item 6. Exhibits and Reports on Form 8-K................................................................ 14
SIGNATURES...................................................................................... 15
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
---------------------
TARRANT APPAREL GROUP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 2000 December 31,1999
------------------- ----------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 636,489 $ 2,239,511
Accounts receivable, net............................................................. 89,010,612 70,922,626
Due from affiliates.................................................................. 4,077,162 1,031,879
Due from shareholders/officers....................................................... 281,541 1,891,739
Inventory............................................................................ 61,966,318 62,362,409
Temporary quota...................................................................... 1,774,784 4,521,200
Prepaid expenses..................................................................... 9,811,348 3,413,416
Prepaid income taxes................................................................. 102,449 296,681
------------ ------------
Total current assets................................................................. 167,660,703 146,679,461
Property and equipment, net.......................................................... 120,294,116 111,520,497
Permanent quota, net................................................................. 512,867 584,402
Other assets......................................................................... 17,036,831 11,658,832
Excess of cost over fair value of net assets acquired................................ 24,940,325 24,599,215
------------ ------------
Total assets......................................................................... $330,444,842 $295,042,407
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank borrowings.................................................................... $ 25,382,422 $ 55,144,818
Accounts payable................................................................... 34,029,988 27,915,169
Accrued expenses................................................................... 20,340,316 7,814,114
Income taxes....................................................................... 6,151,249 4,694,483
Deferred tax liability............................................................. 860,940 ---
Due to shareholders/officers....................................................... --- 16,143,238
Current portion of long term debt.................................................. 33,032,429 9,771,867
------------ ------------
Total current liabilities......................................................... 119,797,344 121,483,689
Long-term obligations............................................................... 64,096,943 34,155,247
Minority interest payable........................................................... 928,424 ---
------------ ------------
Total liabilities.................................................................... 184,822,711 155,638,936
Commitments and contingencies
Shareholders' equity:
Preferred stock, 2,000,000 shares authorized; none issued and outstanding.......... --- ---
Common stock, no par value, 20,000,000 shares authorized; 15,822,315 shares
(2000) and 15,800,315 shares (1999) issued and outstanding......................... 69,691,483 69,595,141
Contributed capital................................................................ 1,434,259 1,434,259
Retained earnings.................................................................. 73,670,227 68,365,373
Accumulated other comprehensive (loss)/income...................................... 826,162 8,698
------------ ------------
Total shareholders' equity......................................................... 145,622,131 139,403,471
------------ ------------
Total liabilities and shareholders' equity......................................... $330,444,842 $295,042,407
============ ============
</TABLE>
See accompanying notes.
3
<PAGE>
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales............................................ $107,018,847 $110,542,148 $313,794,262 $304,367,407
Cost of sales........................................ 85,815,003 91,273,243 256,339,187 250,102,157
------------ ------------ ------------ ------------
Gross profit......................................... 21,203,844 19,268,905 57,455,075 54,265,250
Selling and distribution expenses.................... 4,659,566 3,788,705 13,250,860 9,639,714
General and administrative expenses.................. 11,264,848 5,839,593 27,533,524 16,293,520
Amortization of excess of cost over fair value of net
assets acquired...................................... 684,456 609,796 2,036,703 1,643,731
------------ ------------ ------------ ------------
Income from operations............................... 4,594,974 9,030,811 14,633,988 26,688,285
Interest expense..................................... (2,604,073) (1,363,464) (7,125,029) (3,394,707)
Interest income...................................... 76,102 (16,008) 213,120 262,990
Other (expense)/income............................... 103,818 78,304 473,807 319,581
Minority interest.................................... 502,947 --- 224,517 ---
------------ ------------ ------------ ------------
Income before provision for income taxes............. 2,673,768 7,729,643 8,420,403 23,876,149
Provision for income taxes........................... (989,294) (2,860,000) (3,115,549) (8,755,000)
------------ ------------ ------------ ------------
Net income........................................... $ 1,684,474 $ 4,869,643 $ 5,304,854 $ 15,121,149
============ ============ ============ ============
Net income per share:
Basic.............................................. $0.11 $0.31 $0.34 $1.01
============ ============ ============ ============
Diluted............................................ $0.11 $0.30 $0.33 $0.92
============ ============ ============ ============
Weighted average common and common equivalent shares:
Basic.............................................. 15,822,311 15,783,278 15,812,152 14,999,368
============ ============ ============ ============
Diluted............................................ 15,978,648 16,437,796 15,967,304 16,364,261
============ ============ ============ ============
</TABLE>
See accompanying notes.
4
<PAGE>
TARRANT APPAREL GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
2000 1999
---- ----
<S> <C> <C>
Operating activities
Net income........................................................................ $ 5,304,854 $ 15,121,149
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization................................................... 9,089,425 6,607,744
Deferred taxes.................................................................. 1,055,172 (245,668)
Provision for returns and discounts............................................. 775,010 119,790
Minority interest............................................................... (224,517) ---
Changes in operating assets and liabilities:
Accounts receivable.......................................................... (18,862,996) (10,683,259)
Due from affiliates and officers............................................. (3,866,926) 5,332,853
Inventory.................................................................... 396,091 (14,062,242)
Temporary quota.............................................................. 2,746,416 (744,370)
Prepaid expenses............................................................. (6,397,931) (2,680,532)
Accounts payable............................................................. 6,114,818 13,795,794
Accrued expenses............................................................. 14,201,253 (858,513)
------------ ------------
Net cash provided by operating activities.................................... 10,330,669 11,702,746
------------ ------------
Investing activities
Purchase of fixed assets........................................................ (13,763,648) (44,550,492)
Increase of permanent quota..................................................... (221,935) (691,124)
Acquisitions.................................................................... (2,036,706) (11,088,365)
Increase in other assets........................................................ (5,378,001) (8,355,338)
------------ ------------
Net cash used in investing activities......................................... (21,400,290) (64,685,319)
------------ ------------
Financing activities
Increase/(decrease) in bank borrowings.......................................... (29,316,146) 26,212,642
Increase/(decrease) in debt..................................................... 60,184,672 6,518,682
Increase/(decrease) in long term obligations.................................... (7,428,664) 16,002,714
Increase/(decrease) in advances from shareholders/officers...................... (13,711,397) ---
Exercise of stock options including related tax effect.......................... 225,921 3,716,642
Repurchase of stock............................................................. (122,525) ---
------------ ------------
Net cash provided by financing activities..................................... 9,831,861 52,450,680
------------ ------------
Effect of exchange rate on cash............................................... (365,262) 437,402
------------ ------------
Net decrease in cash and cash equivalents......................................... (1,603,022) (94,491)
Cash and cash equivalents at beginning of period.................................. 2,239,511 4,318,520
------------ ------------
Cash and cash equivalents at end of period........................................ $ 636,489 $ 4,224,029
============ ============
</TABLE>
See accompanying notes.
5
<PAGE>
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 accounting principles generally accepted in the United States 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 accounting principles generally accepted in the United
States 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, 1999 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, 1999, 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 accounting principles
generally accepted in the United States 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 Mexico, 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 currencies in which the
Company transacts business are the Hong Kong dollar and the Mexican peso in
Mexico.
3. Accounts Receivable
Accounts receivable consists of the following:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------- ------------------
<S> <C> <C>
U.S. trade accounts receivable.................................................... $68,990,060 $54,546,617
Foreign trade accounts receivable................................................. 14,401,386 10,954,919
Due from factor................................................................... 2,128,490 2,161,897
Other receivables................................................................. 7,474,004 6,467,511
Allowance for returns and discounts............................................... (3,983,328) (3,208,318)
----------- -----------
$89,010,612 $70,922,626
=========== ===========
</TABLE>
4. Inventory
Inventory consists of the following:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
Raw materials
Fabric and trim accessories..................................................... $20,325,520 $16,932,830
Raw cotton...................................................................... 1,424,425 1,555,752
Work-in-process................................................................... 24,523,969 9,949,447
Finished goods shipments-in-transit............................................... 2,402,985 7,112,939
Finished goods.................................................................... 13,289,419 26,811,441
----------- -----------
$61,966,318 $62,362,409
=========== ===========
</TABLE>
6
<PAGE>
TARRANT APPAREL GROUP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Unaudited)
5. Debt
Bank borrowings consist of the following:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
Import trade bills payable........................................................ $ 4,574,037 $ 5,315,382
Direct bank acceptances........................................................... 14,463,517 15,697,171
Other foreign credit facilities................................................... 2,156,301 2,536,033
United States credit facilities................................................... 4,188,567 31,596,232
----------- -----------
$25,382,422 $55,144,818
=========== ===========
</TABLE>
Long-term debt consists of the following:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ -----------------
<S> <C> <C>
Vendor financing.................................................................. $ 18,795,788 $21,427,158
Equipment loans and capital leases................................................ 18,148,912 21,115,075
Debt Facility..................................................................... 60,184,672 ---
Other debt........................................................................ --- 1,384,881
------------ -----------
97,129,372 43,927,114
Less current portion.............................................................. (33,032,429) (9,771,867)
------------ -----------
$ 64,096,943 $34,155,247
============ ===========
</TABLE>
Long-term debt consists of certain secured and unsecured equipment financings
related to the capital investment program in Mexico. A total of $8.7 million at
September 30, 2000 of this debt is denominated in Deutsch marks and the Euro.
The Company bears the risk of any foreign currency fluctuation with regard to
this debt. The majority of the long-term debt at September 30, 2000 pertains to
a revolving credit, factoring and security agreement (the "Debt Facility")
entered into on January 21, 2000 with a syndicate of lending institutions. The
Debt Facility provides for a revolving facility of $105.0 million, including a
letter of credit facility not to exceed $20.0 million, and matures on January
31, 2005. The Debt Facility provides for interest at LIBOR plus LIBOR rate
margin determined by the Total Leverage Ratio, as defined. The Debt Facility is
secured by receivables, intangibles, inventory and various other specified non-
equipment assets of the Company. In addition, the Debt Facility is subject to
various financial covenants including requirements for tangible net worth, fixed
charge coverage ratios and interest coverage ratios, among others, and prohibits
the payment of dividends. The Company was either in compliance or had received
commitments for waivers and loan amendments to the Debt Facility with regard to
the September 30, 2000 covenants.
6. Acquisition of Jane Doe
On April 12, 2000, the Company formed a new company, Jane Doe International,
LLC, ("JDI"). This company was formed for the purpose of purchasing the assets
of Needletex, Inc., the owner of the Jane Doe brand. JDI is owned 51% by Fashion
Resource (TCL), Inc., a subsidiary of Tarrant Apparel Group, and 49% by
Needletex, Inc. The purchase price was $1,200,000 in cash paid at closing, plus
approximately $600,000 representing Needletex's actual out-of-pocket costs
associated with the work-in-process and inventory acquired to fulfill current
season customer's orders and certain employee costs associated with fulfilling
such orders. The collection is manufactured in various locations throughout the
Far East and consists of t-shirts, sweaters, dresses and sportswear that are
sold in specialty stores and department stores throughout the United States.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
--------------------------------------------------------------------------
Results of Operations.
-----------------------
General
The Company serves specialty retail, mass merchandise and national department
store chains by designing, merchandising, contracting for the manufacture of,
manufacturing directly, 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, as well as
Target Stores (a division of Dayton Hudson), Abercrombie & Fitch, J.C. Penney,K-
Mart, Mervyns, Sears and Walmart. 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.
Commencing in the third quarter of 1997, the Company substantially expanded its
use of independent cutting, sewing and finishing contractors in Mexico,
primarily for basic garments. The gross sales of products sourced in Mexico were
approximately $104 million and $200 million in fiscal 1998 and 1999,
respectively. The Company has also commenced the vertical integration of its
business through the development and acquisition of fabric and production
capacity in Mexico. The Company believes that these strategies will create a
more diversified sourcing base, increase the Company's access to emerging
providers of low cost production, enhance the proximity of the Company's
sourcing base to the Company's customers and lessen 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). The Company's vertical integration strategy has encountered
delays and costs customary for the startup of new businesses, including the
development of policies, procedures and systems and locating and retaining
qualified management. In addition, these startup delays and costs have been
exacerbated by the need to understand local customs, the significant political,
economic and cultural changes in Mexico and the delays and costs associated with
developing manufacturing operations and systems. See "Factors That May Affect
Future Results."
On June 28, 2000, the Company signed an exclusive production agreement with
Manufacturers Cheja through March 2002. The agreement provides the Company with
100% of Cheja's production capacity of nine million garments per year.
On April 12, 2000, the Company formed a new company Jane Doe International, LLC,
("JDI"). This company was formed for the purpose of purchasing the assets of
Needletex, Inc., owner of the Jane Doe brand. JDI is owned 51% by Fashion
Resource (TCL), Inc., a subsidiary of Tarrant Apparel Group, and 49% by
Needletex, Inc. The collection is manufactured in various locations throughout
the Far East and consists of t-shirts, sweaters, dresses and sportswear that are
sold in specialty stores and department stores throughout the United States. For
a description of the Jane Doe acquisition, see Note 6 in Notes to Consolidated
Financial Statement.
On August 1, 1999, the Company acquired all of the outstanding stock of
Industrial Exportadora Famian, S.A. de C.V. and Coordinados Elite, S.A. de C.V.,
both Mexican corporations ("Grupo Famian"). Grupo Famian operates seven apparel
production facilities in and near Tehuacan, Mexico. The Company has since
expanded the capacity of Grupo Famian to provide "full package production"
(i.e., cut, sew, launder, finish and pack) of 180,000 units per week. For a
description of the Grupo Famian acquisition, see the Company's Quarterly Report
on Form 10-Q for the quarterly period ended June 30, 1999.
On April 18, 1999, the Company finalized an agreement to acquire certain assets
of a denim mill located in Puebla, Mexico with an annual capacity of 18 million
meters ("Jamil"). For a description of Jamil acquisition see the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1998.
On December 2, 1998, the Company contracted to acquire a turn-key facility being
constructed near Puebla, Mexico by an affiliate of the seller of the denim mill
described above. This facility is ultimately expected to have an annual capacity
of approximately 18 million meters of twill and will also house ancillary
facilities. Construction of this facility commenced in the third quarter of
1998. During the fourth quarter of 1999, the Company began using this facility
for cutting, washing, finishing and packing. On October 16, 2000, the Company
revised its agreement regarding the turn-key facility to extend its option to
purchase the facility until September 30, 2002. With this amendment, the Company
has also sold or leased certain assets associated with the facility. The
purchase price for such assets, together with approximately $12.5 million
previously advanced by the Company to the developer of the facility, is
represented by a promissory note of approximately $48 million payable over 5
years at eight and one-half percent on a 10 year amortization. The equipment
sold and 1,724,000 shares of stock in the Company have been pledged as
collateral for this note. The Company anticipates that the cost of this facility
will be approximately $97 million. The production agreement gives the Company
the right to purchase up to 100% of the production capacity of the facility
during the option period. For a description of the amended terms of this
facility development agreement, see the Company's Current Report on Form 8-K
filed with the Securities and Exchange Commission on October 31, 2000.
The assets sold in connection with the extension of the option were sold at cost
resulting in no income or loss being recorded on the transaction. The assets
were primarily included in property and equipment ($33.0 million at September
30, 2000) and other assets ($12.5 million at September 30, 2000) in the
accompanying financial statements and represented non-operating assets awaiting
installation. These assets had been acquired by the Company pursuant to the
original Facility Development Agreement. After September 30, 2000 these costs
will be reclassified into a long-term note receivable.
During 1999, the Company began a consolidation strategy to gain efficiencies as
a result of its acquisitions. As a result, the Company has discontinued use of
its Mississippi Rocky Apparel plants and shifted this production to its Mexico
facilities.
Management continues to focus much of its attention on transforming the Company
from a sourcing company to a fully vertical integrated manufacturer, providing
full package production from raw materials (mostly cotton) to finished garments.
Its manufacturing operations were developed in Mexico through acquisition and
development of manufacturing plants, while its traditional sourcing business
continues at the same time predominantly out of the Far East.
8
<PAGE>
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 1997, the Company commenced the vertical integration of
its business. Key elements of this strategy include (i) establishing cutting,
sewing, washing, finishing, packing, shipping and 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 operations prior to beginning this strategy 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.
Start-Up Costs. The Company's vertical integration strategy has encountered
delays and costs customary for the startup of new businesses, including the
development of policies, procedures and systems and locating and retaining
qualified management. In addition, these startup delays and costs have been
exacerbated by the need to understand local customs, the significant political,
economic and cultural changes in Mexico and the delays and costs associated with
developing manufacturing operations.
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 weather, transportation
delays, quotas, the occurrence of chargebacks in excess of reserves and the
timing of expenditures in anticipation of increased sales and actions of
competitors. Accordingly, a comparison of the Company's results of operations
from period to period is not necessarily meaningful, and the Company's results
of operations for any period are not necessarily indicative of future
performance.
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. 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, Structure, Express and Lane Bryant) accounted
for approximately 43% and 45% of the Company's net sales in fiscal 1999 and the
nine months ended September 30, 2000, respectively. 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. The Company has reduced its reliance on
outside third party contractors through its Mexico vertical integration
strategy. However, all international and a portion of its domestic sourcing is
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.
9
<PAGE>
Although the Company monitors the compliance of its independent contractors with
applicable labor laws, the Company has no control over its contractors or their
labor practices. The violation of federal, state or foreign labor laws by one of
the Company's contractors could 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, state 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 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 periods
of 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,
production and 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.
Management of Complexities. Since the beginning of its vertical integration
strategy, the Company has experienced increased complexities. No assurance can
be given that the Company will meet the demands on management, management
information systems, inventory management, production controls, distribution
systems and financial controls given these complexities. Any disruption in the
Company's order process, production and sourcing or distribution may have a
material effect on the Company's results of operations.
Foreign Manufacturing. Approximately 99% of the Company products were imported
(including Mexico) during the first nine months of 2000. 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.
10
<PAGE>
Results of Operations
The following table sets forth, for the periods indicated, certain items in the
Company's consolidated statements of income as a percentage of net sales:
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------- ---------------------------------
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net sales.......................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales...................................... 80.2 82.6 81.7 82.2
----- ----- ----- -----
Gross profit....................................... 19.8 17.4 18.3 17.8
Selling and distribution expenses.................. 4.3 3.4 4.2 3.1
General and administration expenses*............... 11.2 5.8 9.4 5.9
----- ----- ----- -----
Operating income................................... 4.3 8.2 4.7 8.8
Interest expense................................... (2.4) (1.2) (2.3) (1.1)
Other income....................................... 0.2 0.0 0.2 0.2
Minority interest.................................. 0.4 --- 0.1 ---
----- ----- ----- -----
Income before taxes................................ 2.5 7.0 2.7 7.9
Income taxes....................................... 0.9 2.6 1.0 2.9
----- ----- ----- -----
Net income......................................... 1.6% 4.4% 1.7% 5.0%
===== ===== ===== =====
</TABLE>
* Includes amortization of excess of cost over fair value of net assets
acquired.
Third Quarter 2000 Compared to Third Quarter 1999
Net Sales decreased by $3.5 million, or 3.2%, from $110.5 million in the third
quarter of 1999 to $107.0 million in the third quarter of 2000. The decrease in
net sales included an aggregate decrease in sales of $17.1 million to mass
merchandisers, an increase of $9.0 million to divisions of The Limited, and an
increase of $4.3 million as a result of the acquisition of Jane Doe. The
decrease in net sales to mass merchandisers is primarily the result of a dispute
with a contractor leading to late deliveries and quality control problems. The
Company has taken corrective action by replacing this contract vendor. In
addition, the Company believes that its long term vertical integration strategy
will reduce its exposure to outside contractors in the future. Overall, sales to
divisions of The Limited in the third quarter of 2000 amounted to 46% of net
sales, as compared to 36% in the comparable quarter in the prior year.
Gross Profit (which consists of net sales less product costs, duties and direct
costs attributable to production) for the third quarter of 2000 was $21.2
million, or 19.8% of net sales, compared to $19.3 million, or 17.4% of net
sales, in the comparable prior period. The increase in the gross profit was
generated as the Company continues to improve efficiencies at the Company's
Mexico denim plant. The Company's gross profit has increased over the last three
quarters to 19.8% up from 18.5% in the second quarter and 16.5% in the first
quarter of 2000.
Selling and Distribution Expenses increased from $3.8 million in the third
quarter of 1999 to $4.7 million in the third quarter of 2000. As a percentage of
net sales, these expenses increased from 3.4% in 1999 to 4.3% in 2000. General
and Administrative Expenses (which include amortization of excess of cost over
fair value of net assets acquired) increased from $6.4 million in the third
quarter of 1999 to $11.9 million in the third quarter of 2000. As a percentage
of net sales, these expenses increased from 5.8% in the third quarter of 1999 to
11.2% in the third quarter of 2000. This increase is the result of the Company's
continuing transition from primarily a Far East sourcing company, to a company
that produces approximately 50% of its sales as a fully vertically integrated
manufacturer in Mexico. To accomplish this task the Company has significantly
increased its corporate overhead to properly manage the transition and support
the ongoing business model. Also, the Company has increased overhead in
Selling, Distribution, General and Administrative expenses in Jane Doe. These
increases are in preparation for next season at which time the Company will
begin to realize increased revenues associated with this increase in expense.
Operating Income in the third quarter of 2000 was $4.6 million, or 4.3% of net
sales, compared to $9.0 million, or 8.2% of net sales, in the comparable prior
period as a result of the factors discussed above.
Net Interest Expense increased 83% from $1.4 million in the third quarter of
1999 to $2.5 million in the third quarter of 2000 as a result of the Company's
capital investment program in Mexico. Other Income/(Expense) increased from
$78,304 in the third quarter of 1999 to $103,818 in the third quarter of 2000.
Minority Interest of $502,947 for the third quarter of 2000 represents the
elimination of 49% of the results of JDI, which the Company acquired a 51%
interest in on April 12, 2000.
11
<PAGE>
First Nine Months 2000 Compared to First Nine Months 1999
Net Sales increased by $9.4 million, or 3.1%, from $304.4 million in the first
nine months of 1999 to $313.8 million in the first nine months of 2000. The
increase in net sales included an aggregate decrease in sales of $28.0 million
to mass merchandisers, an increase of $18.1 million to divisions of The Limited,
an increase of $7.1 million in branded business, and an increase of $9.2 million
as a result of the acquisition of Jane Doe. The decrease in net sales to mass
merchandisers is primarily the result of a dispute with a contractor leading to
late deliveries and quality control problems. The Company has taken corrective
action by replacing this contract vendor. In addition, the Company believes that
its long term vertical integration strategy will reduce its exposure to outside
contractors in the future. Overall, sales to divisions of The Limited in the
first nine months of 2000 amounted to 45% of net sales, as compared to 40% in
the comparable prior year.
Gross Profit (which consists of net sales less product costs, duties and direct
costs attributable to production) for the first nine months of 2000 was $57.5
million, or 18.3% of net sales, compared to $54.3 million, or 17.8% of net
sales, in the comparable prior period. The increase in the gross profit was
generated as the Company continues to develop efficiencies at the Company's
Mexico denim plant.
Selling and Distribution Expenses increased from $9.6 million in the first nine
months of 1999 to $13.3 million in the first nine months of 2000. As a
percentage of net sales, these expenses increased from 3.1% in 1999 to 4.2% in
2000. General and Administrative Expenses (which include amortization of excess
of cost over fair value of net assets acquired) increased from $17.9 million in
the first nine months of 1999 to $29.6 million in the first nine months of 2000.
As a percentage of net sales, these expenses increased from 5.9% in the first
nine months of 1999 to 9.4% in the first nine months of 2000. This increase is
the result of the Company's continuing transition from primarily a Far East
sourcing company, to a company that produces approximately 50% of its sales as a
fully vertically integrated manufacturer in Mexico. To accomplish this task the
Company has increased its corporate overhead to properly manage the transition
and support the ongoing business model. Also, the Company has increased overhead
in Selling, Distribution, General and Administrative expenses in Jane Doe.
These increases are in preparation for next season at which time the Company
will begin to realize increased revenues associated with this increase in
expense.
Operating Income in the first nine months of 2000 was $14.6 million, or 4.7% of
net sales, compared to $26.7 million, or 8.8% of net sales, in the comparable
prior period as a result of the factors discussed above.
Net Interest Expense increased 121% from $3.1 million in the first nine months
of 1999 to $6.9 million in the first nine months of 2000 as a result of the
Company's capital investment program in Mexico. Other Income increased from
$319,581 in the first nine months of 1999, to $473,807 in the first nine months
of 2000.
Minority Interest of $224,517 for the first nine months of 2000 represents the
elimination of 49% of the results of JDI, which the Company acquired a 51%
interest in on April 12, 2000.
Liquidity and Capital Resources
The Company's liquidity requirements arise from the funding of its working
capital needs, principally inventory, finished goods shipments-in-transit, work-
in-process 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. In Hong Kong 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 has financed its operations from its cash flow from operations,
borrowings under its bank credit facilities, issuance of long-term debt
(including debt to or arranged by vendors of equipment purchased for the Mexican
twill and production facility), and the proceeds from the exercise of stock
options. The Company believes these sources of working capital will be
sufficient to finance its existing operations for the foreseeable future.
During the first nine months of fiscal year 2000, net cash provided by operating
activities was $10.3 million, which resulted primarily from net income of $5.3
million plus depreciation and amortization of $9.1 million, as offset by a net
decrease in working capital items of $5.1 million including an increase of $18.9
million in accounts receivable, a $6.1 million increase in accounts payable and
an decrease in inventory of $0.4 million.
During 2000, cash flow used in investing activities was $21.4 million, which was
primarily for equipment purchased for Mexico to build production facilities, a
$5.4 million increase in other assets associated with non operating assets in
Mexico awaiting installation, and the $1.2 million acquisition of Jane Doe.
In 2000, cash flow provided by financing activities equaled $9.8 million,
including $29.3 million of net reduction of bank borrowings, issuance of $60.2
million debt pursuant to the new debt facility and $7.4 million repaid on
various equipment financing. The Company paid back a shareholder $13.7 million
of interim bridge financing provided in the fourth quarter of fiscal 1999.
12
<PAGE>
The Company has credit facilities of $33 million and $13 million with the Hong
Kong 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, 2000, HKSB's U.S. dollar prime rate
equaled nine 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, 2000, SCB's Hong Kong dollar prime rate equaled nine and one-half
percent. These facilities are subject to certain restrictive covenants including
a provision that the aggregate net worth, as adjusted, of the Company will
exceed $100 million, the Company will not incur two consecutive quarterly losses
and the Company will maintain a certain debt to equity ratio and interest
coverage. As of September 30, 2000, there were $19.0 million of outstanding
borrowings under these facilities. Standard Chartered Bank has given notice to
the Company of its intention to term out this note. The $13.0 million facility
to the Company will be reduced by $1.0 million per month commencing June, 2000.
The Company guarantees a $2.5 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.
The Company assumed certain bank liabilities of Grupo Famian upon its
acquisition during the third quarter of 1999. As of September 30, 2000, these
amounted to $700,000 due to Banco Bilbao.
The Company had two equipment loans for $16.25 million and $5.2 million from GE
Capital Leasing and Bank of America Leasing, respectively. The leases are
secured by equipment located in Puebla and Tlaxcala Mexico. The outstanding
amounts as of September 30, 2000 were $13.5 million due to GE Capital and $4.6
million due to Bank of America. Interest accrues at a rate of 2 1/2% over LIBOR.
The loan from GE Capital will mature in the year 2005 and the loan from Bank of
America in the year 2004. These facilities are subject to the same restrictive
covenants as applicable to the HKSB and SCB facilities.
During 1999, the Company financed equipment purchases for the new manufacturing
facility with certain vendors of the related equipment. A total of $16.9 million
was financed with five year promissory notes which bear interest ranging from
7.0% to 7.5%, and are payable in semiannual payments commencing in February
2000. Due to additional purchases, $16.4 million was outstanding as of September
30, 2000, of which $7.8 million is denominated in Deutsch Marks and $0.9 million
is denominated in the Euro. The remainder is payable in U.S. dollars. The
Company bears the risk of any foreign currency fluctuation with regards to this
debt.
On January 21, 2000, the Company entered into a new revolving credit, factoring
and security agreement (the "Debt Facility") with a syndicate of lending
institutions. The Debt Facility provides a revolving facility of $105.0 million,
including a letter of credit facility not to exceed $20.0 million, and matures
on January 31, 2005. The Debt Facility provides for interest at LIBOR plus LIBOR
rate margin determined by the Total Leverage Ratio as defined. The Facility is
secured by receivables, intangibles, inventory and various other specified
non-equipment assets of the Company. In addition, the Facility is subject to
various financial covenants including requirements for tangible net worth, fixed
charge coverage ratios, interest coverage ratios, among others, and prohibits
the payment of dividends. A total of $65.5 million was outstanding under the
Facility at September 30, 2000. The Company was either in compliance or had
received commitments for waivers and loan amendments to the Debt Facility with
regards to the September 30, 2000 covenants.
The Company has commenced a capital investment program in Mexico under which the
Company projects it will invest approximately $190 million in the acquisition of
a denim mill and the construction of a new facility which when fully operational
will spin, weave and dye twill fabric, and provide the capability to cut,
launder, finish and ship finished garments. The Company may seek to finance
these and future capital investment programs through various methods, including,
but not limited to, borrowings under the Company's bank credit facilities,
issuance of long-term debt, leases and long-term financing provided by the
sellers of facilities or the suppliers of certain equipment used in such
facilities. To date, capital expenditures aggregating approximately $130 million
have been made with respect to vertical integration programs initiated by the
Company. Subsequent to the end of the third quarter on October 16, 2000, the
Company revised its agreement regarding the turn-key facility. Under the terms
of the amended agreement, the Company has extended its option to purchase the
facility until September 30, 2000. With this amendment, the Company has also
sold certain assets associated with the facility and received a secured
promissory rate of approximately $48 million payable over 5 years at eight and
one-half percent on a 10 year amortization. Equipment and 1,724,000 shares of
stock in the Company have been pledged as collateral for this note.
The Company does not believe that the moderate levels of inflation in the United
States in the last three years have had a significant effect on net sales or
profitability.
13
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
----------------------------------------------------------
The Company's earnings are affected by fluctuations in the value of the U.S.
dollar as compared to foreign currencies as a result of doing business in Mexico
as well as certain debt denominated in the Deutsch Mark and the Euro. As a
result, the Company bears the risk of exchange rate gains and losses that may
result in the future as a result of this financing structure.
The Company's interest expense is sensitive to changes in the general level of
U.S. interest rates. In this regard, changes in U.S. interest rates affect
interest paid on the Company's debt. A majority of the Company's credit
facilities are at variable rates.
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
-------------------------
In September 1999, the Company was served with a complaint in an action brought
in the Supreme Court of the State of New York, New York County, by DLLC and
Direct Corp., LLC ("Direct"), as plaintiffs. The complaint alleges that the
Company and DLLC entered into a joint venture for the purpose of producing and
selling apparel products. The complaint further alleges that the Company
breached its obligations under the joint venture. The complaint seeks monetary
damages of $50,000,000, plus interest and further seeks permanent injunctive
relief. The Company has submitted its Answer to the Complaint, which generally
denies the principal allegations therein, denies any liability to the plaintiffs
and alleges a number of affirmative defenses to the claims made by the
plaintiffs. No discovery has taken place in the action to date. The Company
believes that it has valid defenses to the claims set forth in the plaintiff's
complaint and intends to vigorously defend against these claims. A subsidiary
of the Company has commenced a separate action against the plaintiffs in the
Superior Court of the State of California, Los Angeles County, seeking damages
of $623,138.90 for goods sold and delivered to the plaintiffs.
Item 2. Changes in Securities. None.
----------------------
Item 3. Defaults Upon Senior Securities. None.
--------------------------------
Item 4. Submission of Matters to a Vote of Security Holders. None.
----------------------------------------------------
Item 5. Other Information. None.
------------------
Item 6. Exhibits and Reports on Form 8-K.
----------------------------------
Exhibit 27 Financial Data Summary
(a) Exhibits: Reference is made to the Index to Exhibits on page 16 for a
description of the exhibits filed as part of this Report on Form 10-Q.
(b) Reports on Form 8-K: Current Report on Form 8-K filed with the
Securities and Exchange Commission on October 31, 2000.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TARRANT APPAREL GROUP
Date: November 14, 2000 By: /s/ Scott Briskie
---------------------
Scott Briskie
Vice President-Finance and
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
15
