| TARRANT APPAREL GROUP Item 1A Risk Factors |
| 10 ITEM 1A RISK FACTORS This Annual Report on Form 10-K contains forward-looking statements, which are subject to a variety of risks and uncertainties |
| Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below |
| RISKS RELATED TO OUR BUSINESS WE DEPEND ON A GROUP OF KEY CUSTOMERS FOR A SIGNIFICANT PORTION OF OUR SALES A SIGNIFICANT ADVERSE CHANGE IN A CUSTOMER RELATIONSHIP OR IN A CUSTOMER &apos S FINANCIAL POSITION COULD HARM OUR BUSINESS AND FINANCIAL CONDITION Four customers accounted for approximately 49prca of our net sales in fiscal year 2005 |
| We believe that consolidation in the retail industry has centralized purchasing decisions and given customers greater leverage over suppliers, like us, and we expect this trend to continue |
| If this consolidation continues, our net sales and results of operations may be increasingly sensitive to deterioration in the financial condition of, or other adverse developments with, one or more of our customers |
| While we have long-standing customer relationships, we generally do not have long-term contracts with them |
| Purchases generally occur on an order-by-order basis, and relationships exist as long as there is a perceived benefit to both parties |
| A decision by a major customer, whether motivated by competitive considerations, financial difficulties, and economic conditions or otherwise, to decrease its purchases from us or to change its manner of doing business with us, could adversely affect our business and financial condition |
| In addition, during recent years, various retailers, including some of our customers, have experienced significant changes and difficulties, including consolidation of ownership, increased centralization of purchasing decisions, restructurings, bankruptcies and liquidations |
| These and other financial problems of some of our retailers, as well as general weakness in the retail environment, increase the risk of extending credit to these retailers |
| A significant adverse change in a customer relationship or in a customerapstas financial position could cause us to limit or discontinue business with that customer, require us to assume more credit risk relating to that customerapstas receivables, limit our ability to collect amounts related to previous purchases by that customer, or result in required prepayment of our receivables securitization arrangements, all of which could harm our business and financial condition |
| FAILURE OF THE TRANSPORTATION INFRASTRUCTURE TO MOVE SEA FREIGHT IN ACCEPTABLE TIME FRAMES COULD ADVERSELY AFFECT OUR BUSINESS Because the bulk of our freight is designed to move through the West Coast ports in predictable time frames, we are at risk of cancellations and penalties when those ports operate inefficiently creating delays in delivery |
| We experienced such delays from June 2004 until November 2004, and we may experience similar delays in the future especially during peak seasons |
| Unpredictable timing for shipping may cause us to utilize air freight or may result in customer penalties for late delivery, any of which could reduce our operating margins and adversely affect our results of operations |
| UNPREDICTABLE DELAYS AS THE RESULT OF INCREASED AND INTENSIFIED CUSTOMS ACTIVITY US Customs has stepped up efforts to scrutinize imports from Hong Kong in order to verify all details of shipments under the OPA rules allowing certain processes to be performed in China without shipping under China country of origin documentation |
| Such "e detentions "e are unpredictable and cause serious interruption of normally expected freight movement timetables |
| 10 FAILURE TO MANAGE OUR GROWTH AND EXPANSION COULD IMPAIR OUR BUSINESS Since our inception, we have experienced periods of rapid growth |
| Any future growth in sales will require additional working capital and may place a significant strain on our management, management information systems, inventory management, sourcing capability, distribution facilities and receivables management |
| Any disruption in our 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 our distribution facilities |
| OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY We have experienced, and expect to continue to experience, substantial variations in our net sales and operating results from quarter to quarter |
| We believe that the factors which influence this variability of quarterly results include the timing of our 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 we participate, 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, the occurrence of charge backs in excess of reserves and the timing of expenditures in anticipation of increased sales and actions of competitors |
| Due to fluctuations in our revenue and operating expenses, we believe that period-to-period comparisons of our results of operations are not a good indication of our future performance |
| It is possible that in some future quarter or quarters, our operating results will be below the expectations of securities analysts or investors |
| In that case, our stock price could fluctuate significantly or decline |
| WE DEPEND ON OUR COMPUTER AND COMMUNICATIONS SYSTEMS As a multi-national corporation, we rely on our computer and communication network to operate efficiently |
| Any interruption of this service from power loss, telecommunications failure, weather, natural disasters or any similar event could have a material adverse affect on our business and operations |
| Additionally, hackers and computer viruses have disrupted operations at many major companies |
| We may be vulnerable to similar acts of sabotage, which could have a material adverse effect on our business and operations |
| WE MAY REQUIRE ADDITIONAL CAPITAL IN THE FUTURE We may not be able to fund our future growth or react to competitive pressures if we lack sufficient funds |
| Currently, we believe we have sufficient cash on hand and cash available through our bank credit facilities, issuance of debt and equity securities, and proceeds from the exercise of stock options to fund existing operations for the foreseeable future |
| However, in the future we may need to raise additional funds through equity or debt financings or collaborative relationships |
| This additional funding may not be available or, if available, it may not be available on economically reasonable terms |
| In addition, any additional funding may result in significant dilution to existing shareholders |
| If adequate funds are not available, we may be required to curtail our operations or obtain funds through collaborative partners that may require us to release material rights to our products |
| OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH IMPORTING PRODUCTS 11 Substantially all of our import operations are subject to tariffs imposed on imported products, safeguards and growth targets imposed by trade agreements |
| In addition, the countries in which our products are manufactured or imported may from time to time impose additional new duties, tariffs or other restrictions on our imports or adversely modify existing restrictions |
| Adverse changes in these import costs and restrictions, or our suppliers &apos failure to comply with customs or similar laws, could harm our business |
| We cannot assure that future trade agreements will not provide our competitors with an advantage over us, or increase our costs, either of which could have an adverse effect on our business and financial condition |
| Our operations are also subject to the effects of international trade agreements and regulations such as the North American Free Trade Agreement, and the activities and regulations of the World Trade Organization |
| Generally, these trade agreements benefit our business by reducing or eliminating the duties assessed on products manufactured in a particular country |
| However, trade agreements can also impose requirements that adversely affect our business, such as limiting the countries from which we can purchase raw materials and setting duties or restrictions on products that may be imported into the United States from a particular country |
| In addition, the World Trade Organization may commence a new round of trade negotiations that liberalize textile trade by further eliminating or reducing tariffs |
| The elimination of quotas on World Trade Organization member countries in 2005 has resulted in explosive growth in textile imports from China, and subsequent safeguard measures including embargo of certain China country of origin products |
| Actions taken to avoid these measures caused disruption, and a negative impact on margins |
| Such disruption may continue to affect us to some extent in the future |
| OUR DEPENDENCE ON INDEPENDENT MANUFACTURERS REDUCES OUR ABILITY TO CONTROL THE MANUFACTURING PROCESS, WHICH COULD HARM OUR SALES, REPUTATION AND OVERALL PROFITABILITY We depend on independent contract manufacturers to secure a sufficient supply of raw materials and maintain sufficient manufacturing and shipping capacity in an environment characterized by declining prices, labor shortage, continuing cost pressure and increased demands for product innovation and speed-to-market |
| This dependence could subject us to difficulty in obtaining timely delivery of products of acceptable quality |
| In addition, a contractorapstas failure to ship products to us in a timely manner or to meet the required quality standards could cause us to miss the delivery date requirements of our customers |
| The failure to make timely deliveries may cause our customers to cancel orders, refuse to accept deliveries, impose non-compliance charges through invoice deductions or other charge-backs, demand reduced prices or reduce future orders, any of which could harm our sales, reputation and overall profitability |
| We do not have material long-term contracts with any of our independent contractors and any of these contractors may unilaterally terminate their relationship with us at any time |
| To the extent we are not able to secure or maintain relationships with independent contractors that are able to fulfill our requirements, our business would be harmed |
| We have initiated a factory compliance agreement with our suppliers, and monitor our independent contractors &apos compliance with applicable labor laws, but we do not control our contractors or their labor practices |
| The violation of federal, state or foreign labor laws by one of the our contractors could result in our being subject to fines and our goods that are manufactured in violation of such laws being seized or their sale in interstate commerce being prohibited |
| From time to time, we have been notified by federal, state or foreign authorities that certain of our contractors are the subject of investigations or have been found to have violated applicable labor laws |
| There can be no assurance, however, that in the future we will not be subject to sanctions as a result of violations of applicable labor laws by our contractors, or that such sanctions will not have a material adverse effect on our business and results of operations |
| In addition, certain of our customers, require strict compliance by 12 their apparel manufacturers, including us, with applicable labor laws and visit our facilities often |
| There can be no assurance that the violation of applicable labor laws by one of our contractors will not have a material adverse effect on our relationship with our customers |
| OUR DEPENDENCE ON THIRD PARTIES FOR BRANDED APPAREL PRODUCTS REDUCES OUR ABILITY TO CONTROL THE MARKETING PROCESS, WHICH COULD HARM OUR SALES, REPUTATION AND OVERALL PROFITABILITY For certain branded apparel lines, in particular celebrity brands, we depend on the cooperation and efforts of the celebrity personality and/or master licensor to support our design and marketing efforts for apparel products |
| A celebrityapstas failure to adequately support our marketing efforts could adversely affect the sales for new products and lines |
| In addition, we are subject to the terms of our agreements with the master licensor for licensed brands, and our rights to exploit certain brands may therefore be limited |
| Further, we may, from time to time, become involved in disputes with the master licensor with respect to our contractual relationship |
| To the extent we are not able to receive adequate support from the master licensor and/or celebrity or maintain good working relationships with master licensors, our business would be harmed |
| OUR BUSINESS IS SUBJECT TO RISKS OF OPERATING IN A FOREIGN COUNTRY AND TRADE RESTRICTIONS Approximately 90prca of our products were imported from outside the US in fiscal 2005 |
| We are subject to the risks associated with doing business in foreign countries, including, but not limited to, transportation delays and interruptions, political instability, expropriation, currency fluctuations and the imposition of tariffs, import and export controls, other non-tariff barriers and cultural issues |
| Any changes in those countries &apos labor laws and government regulations may have a negative effect on our profitability |
| RISK ASSOCIATED WITH OUR INDUSTRY OUR SALES ARE HEAVILY INFLUENCED BY GENERAL ECONOMIC CYCLES Apparel is a cyclical industry that is heavily dependent upon the overall level of consumer spending |
| Purchases of apparel and related goods tend to be highly correlated with cycles in the disposable income of our consumers |
| Our customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and canceling orders |
| As a result, any substantial deterioration in general economic conditions, increases in interest rates, acts of war, terrorist or political events that diminish consumer spending and confidence in any of the regions in which we compete, could reduce our sales and adversely affect our business and financial condition |
| OUR BUSINESS IS HIGHLY COMPETITIVE AND DEPENDS ON CONSUMER SPENDING PATTERNS The apparel industry is highly competitive |
| We face a variety of competitive challenges including: o anticipating and quickly responding to changing consumer demands; o developing innovative, high-quality products in sizes, colors and styles that appeal to consumers of varying age groups and tastes; o competitively pricing our products and achieving customer perception of value; and o the need to provide strong and effective marketing support |
| WE MUST SUCCESSFULLY GAUGE FASHION TRENDS AND CHANGING CONSUMER PREFERENCES TO SUCCEED 13 Our success is largely dependent upon our ability to gauge the fashion tastes of our customers and to provide merchandise that satisfies retail and customer demand in a timely manner |
| The apparel business fluctuates according to changes in consumer preferences dictated in part by fashion and season |
| To the extent we misjudge the market for our merchandise, our sales may be adversely affected |
| Our ability to anticipate and effectively respond to changing fashion trends depends in part on our ability to attract and retain key personnel in our design, merchandising and marketing staff |
| Competition for these personnel is intense, and we cannot be sure that we will be able to attract and retain a sufficient number of qualified personnel in future periods |
| OUR BUSINESS IS SUBJECT TO SEASONAL TRENDS Historically, our operating results have been subject to seasonal trends when measured on a quarterly basis |
| This trend is dependent on numerous factors, including the markets in which we operate, holiday seasons, consumer demand, climate, economic conditions and numerous other factors beyond our control |
| There can be no assurance that our historic operating patterns will continue in future periods as we cannot influence or forecast many of these factors |
| OTHER RISKS RELATED TO AN INVESTMENT IN OUR COMMON STOCK THE ULTIMATE RESOLUTION OF THE INTERNAL REVENUE SERVICE &apos S EXAMINATION OF OUR TAX RETURNS MAY REQUIRE US TO INCUR AN EXPENSE BEYOND WHAT HAS BEEN RESERVED FOR ON OUR BALANCE SHEET OR MAKE CASH PAYMENTS BEYOND WHAT WE ARE THEN ABLE TO PAY In January 2004, the Internal Revenue Service proposed adjustments to increase our federal income tax payable for the years ended December 31, 1996 through 2001 |
| This adjustment would also result in additional state taxes, penalties and interest |
| In addition, in July 2004, the IRS initiated an examination of our Federal income tax return for the year ended December 31, 2002 |
| In March 2005, the IRS proposed an adjustment to our taxable income of approximately dlra6 million related to similar issues identified in their audit of the 1996 through 2001 federal income tax returns |
| We believe that we have meritorious defenses to and intend to vigorously contest the proposed adjustments made to our federal income tax returns for the years ended 1996 through 2002 |
| If the proposed adjustments are upheld through the administrative and legal process, they could have a material impact on our earnings and cash flow |
| We believe we have provided adequate reserves for any reasonably foreseeable outcome related to these matters on the consolidated balance sheets included in the Consolidated Financial Statements |
| The maximum amount of loss in excess of the amount accrued in the financial statements is dlra7dtta7 million |
| If the amount of any actual liability, however, exceeds our reserves, we would experience an immediate adverse earnings impact in the amount of such additional liability, which could be material |
| Additionally, we anticipate that the ultimate resolution of these matters will require that we make significant cash payments to the taxing authorities |
| Presently we do not have sufficient cash or borrowing ability to make any future payments that may be required |
| No assurance can be given that we will have sufficient surplus cash from operations to make the required payments |
| Additionally, any cash used for these purposes will not be available for other corporate purposes, which could have a material adverse effect on our financial condition and results of operations |
| INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR SHAREHOLDERS &apos ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS As of March 31, 2006, our executive officers and directors and their affiliates owned approximately 43prca of the outstanding shares of our common stock |
| Gerard Guez, our Chairman, and Todd Kay, our Vice Chairman, alone own approximately 33dtta1prca and 8dtta4prca, respectively, of the outstanding shares of our common stock at March 31, 2006 |
| Accordingly, our executive officers and 14 directors have the ability to affect the outcome of, or exert considerable influence over, all matters requiring shareholder approval, including the election and removal of directors and any change in control |
| This concentration of ownership of our common stock could have the effect of delaying or preventing a change of control of us or otherwise discouraging or preventing a potential acquirer from attempting to obtain control of us |
| It could also prevent our shareholders from realizing a premium over the market prices for their shares of common stock |
| WE HAVE ADOPTED A NUMBER OF ANTI-TAKEOVER MEASURES THAT MAY DEPRESS THE PRICE OF OUR COMMON STOCK Our shareholders rights plan, our ability to issue additional shares of preferred stock and some provisions of our articles of incorporation and bylaws could make it more difficult for a third party to make an unsolicited takeover attempt of us |
| These anti-takeover measures may depress the price of our common stock by making it more difficult for third parties to acquire us by offering to purchase shares of our stock at a premium to its market price without approval of our board of directors |
| OUR STOCK PRICE HAS BEEN VOLATILE Our common stock is quoted on the NASDAQ National Market System, and there can be substantial volatility in the market price of our common stock |
| The market price of our common stock has been, and is likely to continue to be, subject to significant fluctuations due to a variety of factors, including quarterly variations in operating results, operating results which vary from the expectations of securities analysts and investors, changes in financial estimates, changes in market valuations of competitors, announcements by us or our competitors of a material nature, loss of one or more customers, additions or departures of key personnel, future sales of common stock and stock market price and volume fluctuations |
| In addition, general political and economic conditions such as a recession, or interest rate or currency rate fluctuations may adversely affect the market price of our common stock |
| In addition, the stock market in general has experienced extreme price and volume fluctuations that have affected the market price of our common stock |
| Often, price fluctuations are unrelated to operating performance of the specific companies whose stock is affected |
| In the past, following periods of volatility in the market price of a companyapstas stock, securities class action litigation has occurred against the issuing company |
| If we were subject to this type of litigation in the future, we could incur substantial costs and a diversion of our managementapstas attention and resources, each of which could have a material adverse effect on our revenue and earnings |
| Any adverse determination in this type of litigation could also subject us to significant liabilities |
| ABSENCE OF DIVIDENDS COULD REDUCE OUR ATTRACTIVENESS TO YOU Some investors favor companies that pay dividends, particularly in general downturns in the stock market |
| We have not declared or paid any cash dividends on our common stock |
| We currently intend to retain any future earnings for funding growth, and we do not currently anticipate paying cash dividends on our common stock in the foreseeable future |
| Additionally, we cannot pay dividends on our common stock unless the terms of our bank credit facilities and outstanding preferred stock, if any, permit the payment of dividends on our common stock |
| Because we may not pay dividends, your return on this investment likely depends on your selling our stock at a profit |