Edgar Filing: TARRANT APPAREL GROUP

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

[_] 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: 0-26006

TARRANT APPAREL GROUP
(Exact name of registrant as specified in its charter)

CALIFORNIA 95-4181026
(State or other jurisdiction (I.R.S. Employer
of 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

Securities registered pursuant to Section 12(b) of the Act:

TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock Nasdaq Global Market

Securities registered pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes [_] No [X]

Indicate by check mark if the registration is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. Yes [_] No [X]

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 [_]

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer,"
and "smaller reporting company" in Rule 12b-2 of the Exchange Act).

Large accelerated filer [_] Accelerated filer [_]
Non-accelerated filer [_] Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [_] No [X]

The aggregate market value of the Common Stock held by non-affiliates
of the Registrant is approximately $20,558,997 based upon the closing price of
the Common Stock on June 30, 2007.

Number of shares of Common Stock of the Registrant outstanding as of
March 24, 2008: 32,043,763.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's definitive Proxy Statement to be filed
with the Securities and Exchange Commission pursuant to Regulation 14A in
connection with the 2008 Annual Meeting of Shareholders are incorporated by
reference into Part III of this Report.

TARRANT APPAREL GROUP
INDEX TO FORM 10-K

PART I PAGE

Item 1. Business......................................................... 1

Item 1A. Risk Factors..................................................... 9

Item 1B. Unresolved Staff Comments........................................ 15

Item 2. Properties....................................................... 16

Item 3. Legal Proceedings................................................ 16

Item 4. Submission of Matters to a Vote of Security Holders.............. 17

PART II

Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.............. 18

Item 6. Selected Financial Data.......................................... 20

Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 22

Item 7A. Quantitative and Qualitative Disclosures about Market Risk ...... 42

Item 8. Financial Statements and Supplementary Data...................... 42

Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................ 42

Item 9A(T). Controls and Procedures.......................................... 43

Item 9B. Other Information................................................ 44

PART III

Item 10. Directors and Executive Officers of the Registrant............... 44

Item 11. Executive Compensation........................................... 44

Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters..................... 44

Item 13. Certain Relationships and Related Transactions................... 44

Item 14. Principal Accounting Fees and Services........................... 44

PART IV

Item 15. Exhibits and Financial Statement Schedules....................... 44

PART I

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This 2007 Annual Report on Form 10-K contains statements which
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
both as amended. Those statements include statements regarding our intent,
belief or current expectations. Prospective investors are cautioned that any
such forward-looking statements are not guarantees of future performance and
involve risks and uncertainties, and that actual results may differ materially
from those projected in the forward-looking statements. Such risks and
uncertainties include, among other things, our ability to face stiff
competition, profitably manage a sourcing and distribution business, the
financial strength of our major customers, the continued acceptance of our
existing and new products by our existing and new customers, dependence on key
customers, the risks of foreign manufacturing, competitive and economic factors
in the textile and apparel markets, the availability of raw materials, the
ability to manage growth, weather-related delays, dependence on key personnel,
the successful resolution of pending litigation, general economic conditions,
global manufacturing costs and restrictions, and other risks and uncertainties
that may be detailed herein. See "Item 1A. Risk Factors."

ITEM 1. BUSINESS

OVERVIEW

Tarrant Apparel Group is a design and sourcing company for private
label and private brand casual apparel serving mass merchandisers, department
stores, branded wholesalers and specialty chains located primarily in the United
States. Our major customers include retailers, such as Macy's Merchandising
Group, New York & Co., Chico's, Kohl's, Mothers Work, Mervyn's, Charlotte Russe,
the Avenue, Seven Licensing, Wal-Mart, and Lane Bryant. Our products are
manufactured in a variety of woven and knit fabrications and include jeans wear,
casual pants, shorts, skirts, dresses, t-shirts, shirts and other tops and
jackets.

In 2005 and 2006, our total net sales were $215 million and $232
million, respectively. In 2007, our net sales increased by 5% to $244 million.
In 2005, we experienced net income of $1.0 million. In 2006, we experienced a
net loss of $22.2 million, which included a non-cash charge of $27.1 million of
a loss on notes receivable - related parties. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations." In
2007, our net income was $1.7 million.

We launched our private brands initiative in 2003, and have since
acquired ownership of or license rights to a number of brand names and sold
apparel products under the brand, generally to a single retail company within a
geographic region. At March 24, 2008, we sell apparel products under the
following brands at the following retailers:

BRAND STORES
--------- ---------

American Rag Cie Macy's Merchandising Group
Marisa K. Specialty stores & boutiques

BUSINESS STRATEGY

We believe that the following trends are currently affecting apparel
retailing and manufacturing:

o Consolidation among apparel retailers has increased their
ability to demand value-added services from apparel
manufacturers, including fashion expertise, rapid response,
just-in-time delivery, Electronic Data Interchange and
favorable pricing.

o Increased competition among retailers due to consolidation has
resulted in an increased demand for private label and private
brand apparel, which generally offers retailers higher margins
and permits them to differentiate their products.

o The current fashion cycle requires more design and product
development, in addition to quickly responding to emerging
trends. Apparel manufacturers that offer these capabilities
are in demand.

o A slower US economy or recession will cause consolidation
among apparel manufacturers and wholesalers.

We believe that we have the capabilities to take advantage of these
trends and remain a principal value-added supplier of casual, moderately priced
apparel as well as increase our share of the higher retail, "branded" segment
that the major retailers are pursuing.

DESIGN EXPERTISE. As one of the very few sourcing companies with our
own design team, we believe that we have established a reputation with our
customers as a fashion resource and manufacturer that is capable of providing
design assistance to customers in the face of rapidly changing fashion trends.

RESEARCH AND DEVELOPMENT CAPABILITIES. We believe our design capability
combined with our fabric research and development provide a major advantage that
our customers respond to, and that we have skills in the advanced development of
washes and finishes that give us a position of competitive strength.

MARKETING EXPERTISE. We have the understanding and resources to develop
strong "brand-like" product marketing to support the need to extend traditional
store brands into product presentations that have more value to the consumer in
terms of product design and imaging.

SAMPLE-MAKING AND MARKET-TESTING CAPABILITIES. We seek to support
customers with our design expertise, sample-making capability and ability to
rapidly produce small test orders of products.

ON-TIME DELIVERY. We have developed a diversified network of
international contract manufacturers and fabric suppliers, which enable us to
accept orders of varying sizes and delivery schedules and to produce a broad
range of garments at varying prices depending upon lead time and other
requirements of the customer.

QUALITY AND COMPETITIVELY PRICED PRODUCTS. We believe that our long
time presence in the Far East and our experienced product management teams
provide a superior supply chain that enables us to meet the individual needs of
our customers in terms of quality and lead time.

PRODUCT DIVERSIFICATION. Our experiencing in designing and delivering
complete apparel collections for some of our customers has improved our overall
ability to deliver product classifications beyond our core casual bottoms
offerings, which has further diversified the merchandise we offer to other
customers.

PRIVATE BRANDS. With a private brand relationship, we own and control
the brand and thus build equity in the brand as the product gains acceptance by
consumers. In a private label relationship, we source products for our customers
who own and control the brand and thus benefit from any increase in value of the
brand.

We believe that forming strong alliances with premier retailers allows
us greater penetration of apparel categories in addition to our core casual
bottoms business. In addition to the increased breadth of classifications, we
have improved our ability to compete for private label business based on
expertise gained from our private brand development. We receive higher margins
for development of product by design and marketing assistance.

PRODUCTS

Women's jeans historically have been, and continue to be, our principal
product. Our products also include moderately priced women's apparel in casual,
non-denim fabrications such as twill and other cotton and cotton blends, in
woven tops and bottoms. Our women's apparel products currently include jeans
wear, casual pants, shorts, skirts, dresses, t-shirts, blouses, shirts, other
tops and jackets. These products are manufactured in petite, standard and large
sizes and are sold at a variety of wholesale prices generally ranging from less
than $5 to over $20 per garment. We have produced men's apparel in varying
significance for the last several years.

Over the past three years, approximately 61% of total net sales were
derived from the sales of pants and jeans, approximately 7% from the sale of
shorts, approximately 13% from the sale of shirts, blouses and tops and
approximately 5% from the sale of skirts and skort-alls. The balance of net
sales consisted of sales of dresses, jackets and other products.

CUSTOMERS

We generally market our products to high-volume retailers that we
believe can grow into major accounts. By limiting our customer base to a select
group of larger accounts, we seek to build stronger long-term relationships and
leverage our operating costs against large bulk orders. Although we continue to
diversify our customer base, the majority of sales growth is most predictable
from existing customers.

The following table shows the percentage of our net sales in fiscal
year 2007 attributable to each customer that accounted for more than 10% of net
sales.

PERCENTAGE
OF NET SALES
------------------
CUSTOMER 2007
-------------------------------------------------- ------------------
Macy's Merchandising Group........................ 21.1
New York & Co..................................... 12.5
Chico's........................................... 11.3

We currently serve over 15 major retailers and over 200 specialty
stores, which in addition to those identified above, include, Kohl's, Mothers
Work, Mervyn's, Charlotte Russe, the Avenue, Seven Licensing, Wal-Mart and Lane
Bryant. In 2005, 2006 and 2007, net sales of private brands represented
approximately 26%, 22% and 18%, respectively, of our total net sales. We
launched our private brands initiative in 2003, in which we acquire ownership of
or license rights to a brand name and sell apparel products under this brand,
generally to a single retail company within a geographic region. We sell
products in our brands "American Rag Cie" exclusively to Macy's Merchandising
Group. We sold

products in our licensed brand "Alain Weiz" to Dillard's during 2004 to 2006. We
discontinued the license of this brand after mid 2007.

We do not have long-term contracts with any of our customers except for
Macy's Merchandising Group for American Rag Cie and, therefore, there can be no
assurance that other customers will continue to place orders with us of the same
magnitude as it has in the past, or at all. In addition, the apparel industry
historically has been subject to substantial cyclical variation, with consumer
spending for purchases of apparel and related goods tending to decline during
recessionary periods. To the extent that these financial difficulties occur,
there can be no assurance that our financial condition and results of operations
would not be adversely affected.
See "Item 1A. Risk Factors."

DESIGN, MERCHANDISING AND SALES

While many private label producers only arrange for the bulk production
of styles specified by their customers, we not only design garments, but also
assist some of our customers in market testing new designs. We believe that our
design, sample-production and test-run capabilities give us a competitive
advantage in obtaining bulk orders from our customers. We also often receive
bulk orders for garments we have not designed because many of our customers
allocate bulk orders among more than one producer.

We have developed integrated teams of design, merchandising and support
personnel, some of whom serve on more than one team, that focus on designing and
producing merchandise that reflects the style and image of their customers.
Teams are divided between private label and private brands for sourcing
operations.

Each team is responsible for all aspects of its customer's needs,
including designing products, developing product samples and test items,
obtaining orders, coordinating fabric choices and procurement, monitoring
production and delivering finished products. The team seeks to identify
prevailing fashion trends that meet its customer's retail strategies and design
garments incorporating those trends. The team also works with the buyers of its
customer to revise designs as necessary to better reflect the style and image
that the customer desires to project to consumers. During the production
process, the team is responsible for informing the customer about the progress
of the order, including any difficulties that might affect the timetable for
delivery. In this way, our customer and we can make appropriate arrangements
regarding any delay or other change in the order. We believe that this team
approach enables our employees to develop an understanding of the customer's
distinctive styles and production requirements in order to respond effectively
to the customer's needs.

From time to time and at scheduled seasonal meetings, we present
samples to the customer's buyers who determine which, if any, of the samples
will be produced on a test run or a bulk order. Samples are often presented in
coordinated groupings or as part of a product line. Some customers, particularly
specialty retail stores, may require that a product be tested before placing a
bulk order.

Testing involves the production of as few as several hundred copies of a given
sample in different size, fabric and color combinations. The customer pays for
these test items, which are placed in selected stores to gauge consumer
response. The production of test items enables our customers to identify
garments that may appeal to consumers and also provides us with important
information regarding the cost and feasibility of the bulk production of the
tested garment. If the test is determined to be successful, we generally receive
a significant percentage of the customer's total bulk order of the tested item.
In addition, as is typical in the private label business, we receive bulk
production orders to produce merchandise designed by our competitors or other
designers, since most customers allocate bulk orders among a number of
suppliers.

SOURCING

GENERAL

When bidding for or filling an order, our international or domestic
sourcing network enables us to choose from among a number of suppliers and
manufacturers based on the customer's price requirements, product specifications
and delivery schedules. Historically, we manufactured our products through
independent cutting, sewing and finishing contractors located primarily in Hong
Kong and China, and have purchased our fabric from independent fabric
manufacturers with weaving mills located primarily in Hong Kong and China. In
recent years, we have expanded our network to include suppliers and
manufacturers located in a number of additional countries, including Mongolia,
Vietnam, India, Bangladesh and Thailand. Our sourcing strategy is based on a
strong presence in Asia, in particular, Hong Kong, China and Southeast Asia.

DEPENDENCE ON CONTRACT MANUFACTURERS

The use of contract manufacturers and the resulting lack of direct
control over the production of our products could result in our failure to
receive timely delivery of products of acceptable quality. Although we believe
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 our results of operations until an alternative
source can be located and commence producing our products.

Although we have adopted a code of vendor conduct and monitor the
compliance of our independent contractors with our code of conduct and
applicable labor laws, we do not control our contractors or their labor
practices. The violation of federal, state or foreign labor laws by one of our
contractors can result in us being subject to fines and our goods, which are
manufactured in violation of such laws, being seized or their sale in interstate
commerce being prohibited. Additionally, certain of our customers may refuse to
do business with us based on our contractors' labor practices. 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. To date, we have not been subject to any
sanctions that, individually or in the aggregate, have had or could have a
material adverse effect upon us, and we are not aware of any facts on which any
such sanctions could be based. There can be no assurance, however, that in the
future we will not be subject to sanctions or lose business from our customers
as a result of violations of applicable labor laws by our contractors, or that
such sanctions or loss of business will not have a material adverse effect on
us. In addition, our customers require strict compliance by their apparel
manufacturers, including us, with applicable labor laws. To that end, we are
regularly inspected by some of our major customers. 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.

We do not have any long-term contracts with independent fabric
suppliers. The loss of any of our major fabric suppliers could have a material
adverse effect on our financial condition and results of operations until
alternative arrangements are secured.

DIVERSIFIED PRODUCTION NETWORK

We have a production network that is capable of servicing a wide range
of customer needs. Some customers place a priority on "speed to market," and are
willing to pre-approve several different fabric styles, and pay air freight in
order to quickly get the most current styling into their stores. Other customers
seek lower costs, and are willing to source production from more remote areas
with long lead-times. Although mass merchandisers, such as Wal-Mart, normally
operate on shorter lead times for fashion products, they can give us projections
six months to nine months in advance for basic products that do not change in
styles significantly from season to season. Our ability to operate on different
production schedules helps us to meet our customers' varying needs.

By allocating an order among different manufacturers, we seek to fill
the high-volume orders of our customers, while meeting their delivery
requirements. Upon receiving an order, we determine which of our suppliers and
manufacturers can best fill the order and meet the customer's price, quality and
delivery requirements. We consider, among other things, the price charged by
each manufacturer and the manufacturer's available production capacity to
complete the order, as well as the availability of quota, if applicable, for the
product from various countries and the manufacturer's ability to produce goods
on a timely basis subject to the customer's quality specifications. Our
personnel also consider the transportation lead times required to deliver an
order from a given manufacturer to the customer. In addition, some customers
prefer not to carry excess inventory and therefore require that we stagger the
delivery of products over several weeks.

INTERNATIONAL SOURCING

We conduct and monitor our sourcing operations from our Hong Kong
office. The staff has extensive knowledge about, and experience with, sourcing
and production, including purchasing, manufacturing and quality control. Several
times each year, members of our senior management, including local staff, visit
and inspect the facilities and operations of our international suppliers and
manufacturers.

Foreign manufacturing is subject to a number of risk factors,
including, among other things, transportation delays and interruptions,
political instability, expropriation, currency fluctuations and the imposition
of tariffs, import and export controls, other non-tariff barriers (including
changes in the allocation of quotas), natural disasters and cultural issues.
Each of these factors could have a material adverse effect on us.

While we are in the process of establishing business relationships with
manufacturers and suppliers located in countries other than Hong Kong, Macau or
China, such as in Mongolia, Vietnam, India, Bangladesh and Thailand, we still
primarily contract with manufacturers and suppliers located in Hong Kong and
China for our international sourcing needs, and currently expect that we will
continue to do so for the foreseeable future. Any significant disruption in our
operations or our relationships with our manufacturers and suppliers located in
Hong Kong or China could have a material adverse effect on us.

THE IMPORT SOURCING PROCESS

As is customary in the apparel industry, we do not have any long-term
contracts with our manufacturers. During the manufacturing process, our quality
control personnel visit each factory to

inspect garments when the fabric is cut, as it is being sewn and as the garment
is being finished. Daily information on the status of each order is transmitted
from the various manufacturing facilities to our offices in Hong Kong and Los
Angeles. We, in turn, keep our customers apprised, often through daily telephone
calls and frequent written reports. These calls and reports include candid
assessments of the progress of a customer's order, including a discussion of the
difficulties, if any, that have been encountered and our plans to rectify them.

We often arrange, on behalf of manufacturers, for the purchase of
fabric from a single supplier. We have the fabric shipped directly to the
cutting factory and invoice the factory for the fabric. Generally, the factories
pay us for the fabric with offsets against the price of the finished goods. For
our longstanding program business, we may purchase or produce fabric in advance
of receiving the order, but in accordance with the customer's specifications. By
procuring fabric for an entire order from one source, we believe that production
costs per garment are reduced and customer specifications as to fabric quality
and color can be better controlled.

The anti-terrorist measures adopted by the U.S. government and in
particular, by the U.S. Customs, have meant more stringent inspection processes
before imported goods are cleared for delivery into the U.S. In some instances,
these measures have caused delays in the pre-planned delivery of products to
customers.

DISTRIBUTION

Based on our worldwide sourcing capability and in order to properly
fulfill orders, we have tailored our distribution system to meet the needs of
the customer. Some customers, such as Macy's Merchandising Group, Wal-Mart and
Kohl's, use Electronic Data Interchange, or "EDI", to send orders and receive
merchandise and invoices. The EDI distribution function has been centralized in
our Los Angeles corporate headquarter in order to expedite and control the flow
of merchandise and electronic information, and to insure that the special
requirements of our EDI customers are met.

For orders sourced outside the United States and Mexico, the
merchandise is shipped from the production facility by truck to a port where it
is consolidated and loaded on containerized vessels for ocean transport to the
United States. For customers with West Coast and Midwest distribution centers,
the merchandise is brought into the port of Los Angeles. After Customs
clearance, the merchandise is shipped by truck to either our Los Angeles
warehouse facility, an independent public warehouse or an independent bonded
warehouse in Ohio. Proximity to the customer's distribution center is important
for customer support. For merchandise produced in the Middle East and destined
for an East Coast customer distribution center, the port of entry is New York.
After Customs clearance, the merchandise is trucked to an independent public
warehouse in New Jersey. The independent warehouses are instructed in writing by
the Los Angeles office when to ship the merchandise to the customer.

BACKLOG

As of March 24, 2008, we had unfilled customer orders of approximately
$65 million as compared to approximately $85 million as of March 22, 2007. We
believe that all of our backlog of orders as of March 24, 2008 will be filled
before the end of fiscal year 2008. Backlog is based on our estimates derived
from internal management reports. The amount of unfilled orders at a particular
time is affected by a number of factors, including the scheduling of
manufacturing and shipping of the product, which in some instances, depends on
the customer's requirements. Accordingly, a comparison of unfilled orders from
period to period is not necessarily meaningful and may not be indicative of
eventual annual bookings or actual shipments. Our experience has been that the
cancellations, rejections or returns of orders have not materially reduced the
amount of sales realized from our backlog.

SEGMENT INFORMATION

We operate in a single business segment - the design, distribution and
importation of private label and private brand casual apparel. Substantially all
of our revenues are from the sales of apparel. We are organized into two
geographic regions: the United States and Asia. We evaluate performance of each
region based on profit or loss from operations before income taxes not including
the cumulative effect of change in accounting principles. For information
regarding the revenues and assets associated with our geographic regions, see
Note 18 of the "Notes to Consolidated Financial Statements."

IMPORT RESTRICTIONS

QUOTAS

We imported substantially all of our products sold in 2007. A majority
of the merchandise imported by us in 2007 was manufactured in various countries
(such as China) with which the U.S. had entered into bilateral trade agreements.

As of January 1, 2005, quota on apparel from all WTO countries,
including China (except that certain commodities still require quotas as a
result of "safeguard measures"), was eliminated. As China is now a member of the
WTO, its exports of textiles and apparel to the U.S. are covered by the WTO
Agreement on Textiles and Clothing. In 2006, quota was temporarily reinstated
for China until 2008 for certain import merchandise categories. Quota is traded
on the open market through quota holders who possess the quota holdings. We
purchase quota from the open market. Quota gives us the right within the year to
ship our goods to the U.S. Quota purchased from a third party is not subject to
duties.

DUTIES AND TARIFFS

As with all goods imported into the U.S., our imported merchandise is
subject to duty (unless statutorily exempt from duty) at rates established by
U.S. law. These rates range, depending on the types of product and fabric
content, from approximately 3% to 40% of the FOB value of the product. In
addition to duties, in the ordinary course of our business, we are occasionally
subject to claims by the U.S. Bureau of Customs and Border Protection for
penalties, liquidated damages and other charges relating to import activities.
Similarly, we are at times entitled to refunds from Customs, resulting from the
overpayment of duties.

Products imported from China into the United States receive the same
preferential tariff treatment accorded goods from other countries granted Normal
Trade Relations status. This status has been in place conditionally for a number
of years and is now guaranteed on a more permanent basis by China's accession to
WTO membership in December 2001.

Our continued ability to source products from foreign countries may be
adversely affected or improved by future trade agreements and restrictions,
changes in U.S. trade policy, embargoes, the disruption of trade from exporting
countries as a result of political instability or the imposition of additional
duties, taxes and other charges or restrictions on all imports or specified
classes of imports.

COMPETITION

There is intense competition in the sectors of the apparel industry in
which we participate. We compete with many other manufacturers, many of which
are larger and have greater resources than us. We also face competition from our
own customers and potential customers, many of which have established, or may
establish, their own internal product development and sourcing capabilities. We

believe that we compete favorably on the basis of design and sample
capabilities, the quality and value of our products, price, and the production
flexibility that we enjoy as a result of our sourcing network.

TRADEMARKS

As part of our private brands strategy, we acquire ownership of or
rights to a brand name and sell apparel products under this brand. We have
ownership rights to the registered trademarks "American Rag Cie," "Marisa K",
"NO! Jeans" and "American Star". As described elsewhere in this report, we are
currently involved in litigation with respect to our license rights to the
American Rag Cie trademark. For a further description of this action see "Item
3. Legal Proceedings" of this Annual Report on Form 10-K.

SEASONALITY

We have typically experienced seasonal fluctuations in sales volume.
These seasonal fluctuations result in sales volume decreases in the first and
fourth quarters of each year due to the seasonal fluctuations experienced by the
majority of our customers.

EMPLOYEES

At December 31, 2007, we had approximately 150 full-time employees in
the United States, 150 in Hong Kong and 10 in China. None of our employees are
unionized. We consider our relations with our employees to be satisfactory in
all areas of our operations.

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'S
FINANCIAL POSITION COULD HARM OUR BUSINESS AND FINANCIAL CONDITION.

Three customers accounted for approximately 45% of our net sales in
fiscal year 2007. 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 except for Macy's Merchandising Group for
American Rag Cie. 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 customer's financial position could cause us to limit or
discontinue business with that customer, require us to assume more credit risk
relating to that customer's 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.

OUR GROWTH AND OPERATING RESULTS COULD BE MATERIALLY, ADVERSELY AFFECTED IF WE
ARE UNSUCCESSFUL IN RESOLVING A DISPUTE THAT NOW EXISTS REGARDING OUR RIGHTS
UNDER OUR LICENSE AGREEMENT WITH AMERICAN RAG CIE LLC.

We are currently involved in litigation with American Rag Cie, LLC and
American Rag Cie II with respect to our license rights to the American Rag Cie
trademark. American Rag Cie, LLC owns the trademark "American Rag Cie", which
has been licensed to us on an exclusive basis throughout the world except for
Japan and pursuant to which we sell American Rag Cie branded apparel to Macy's
Merchandising Group and have sub-licensed to Macy's Merchandising Group the
right to manufacture certain categories of American Rag Cie branded apparel in
the United States. American Rag Cie LLC has purported to terminate our license
rights, and we have filed a counterclaim seeking to a declaratory judgment that
the termination was invalid and alleging other causes of action. See Item 3,
"Legal Proceedings" for discussion of this litigation. We derive a significant
portion of our revenues from the sale of American Rag Cie products pursuant to
the license rights. Our business, results of operations and financial condition
could be materially adversely affected if we are unable to reach a settlement in
a manner acceptable to us and ensuing litigation is not resolved in a manner
favorable to us. Additionally, we may incur significant legal fees in this
litigation, and unless the case is settled, we will continue to incur additional
legal fees in increasing amounts as the case moves toward trial.

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.
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.

U.S. 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 "detentions" are unpredictable and cause serious
interruption of normally expected freight movement timetables.

FAILURE TO MANAGE OUR GROWTH AND EXPANSION COULD IMPAIR OUR BUSINESS.

Since our inception, we have experienced periods of rapid growth. No
assurance can be given that we will be successful in maintaining or increasing
our sales in the future. 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
long-term 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.

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' 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. In 2006, quota was
temporarily reinstated for China until 2008 for certain import merchandise
categories. Such disruptions and the temporary measures may continue to affect
us to some extent in the future.

We have voluntarily implemented the guiding principles for the
Customs-Trade Partnership Against Terrorism (C-TPAT) Program as proposed by the
US Customs and Border Protection to protect our supply chain from concealment of
terrorist weapons. While we have a strong commitment to this program, we are not
immune to threats of terrorist activities.

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 contractor's
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 implemented a factory compliance agreement with our suppliers,
and monitor our independent contractors' 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. To date, we have not
been subject to any sanctions that, individually or in the aggregate, have had a
material adverse effect on our business, and we are not aware of any facts on
which any such sanctions could be based. 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 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 BUSINESS IS SUBJECT TO RISKS OF OPERATING IN A FOREIGN COUNTRY AND TRADE
RESTRICTIONS.

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' 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.

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.

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 REQUIREMENTS OF THE SARBANES-OXLEY ACT, INCLUDING SECTION 404, ARE
BURDENSOME, AND OUR FAILURE TO COMPLY WITH THEM COULD HAVE A MATERIAL ADVERSE
AFFECT ON OUR BUSINESS AND STOCK PRICE.

Effective internal control over financial reporting is necessary for us
to provide reliable financial reports and effectively prevent fraud. Section 404
of the Sarbanes-Oxley Act of 2002 requires our management to evaluate and report
on our internal control over financial reporting beginning with our annual
report on Form 10-K for the fiscal year ending December 31, 2007. Our
independent registered public accounting firm will need to annually attest to
our evaluation, and issue their own opinion on our internal control over
financial reporting beginning with our annual report on Form 10-K for the fiscal
year ending December 31, 2008, unless this requirement is further postponed by
the Securities and Exchange Commission. We have prepared for compliance with
Section 404 by strengthening, assessing and testing our system of internal
control over financial reporting to provide the basis for our report. The
process of strengthening our internal control over financial reporting and
complying with Section 404 is expensive and time consuming, and requires
significant management attention. We cannot be certain that the measures we will
undertake will ensure that we will maintain adequate controls over our financial
processes and reporting in the future. Failure to implement required controls,
or difficulties encountered in their implementation, could harm our operating
results or cause us to fail to meet our reporting obligations. If we or our
auditors discover a material weakness in our internal control over financial
reporting, the disclosure of that fact, even if the weakness is quickly
remedied, could diminish investors' confidence in our financial statements and
harm our stock price. In addition, non-compliance with Section 404 could subject
us to a variety of administrative sanctions, including the suspension of
trading, ineligibility for listing on NASDAQ or one of the national securities
exchanges, and the inability of registered broker-dealers to make a market in
our common stock, which would further reduce our stock price.

INSIDERS OWN A SIGNIFICANT PORTION OF OUR COMMON STOCK, WHICH COULD LIMIT OUR
SHAREHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS.

As of March 24, 2008, our executive officers and directors and their
affiliates owned approximately 45% of our common stock. Gerard Guez, our
Chairman and Interim Chief Executive Officer, and Todd Kay, our Vice Chairman,
alone own approximately 32% and 8%, respectively, of our common stock at March
24, 2008. Accordingly, our executive officers and 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. This, in turn, could have a negative effect on the market
price of our common stock. 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 Global Market, 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 company's 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 management's 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.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

At March 24, 2008, we conducted our operations from 9 facilities, 7 of
which were leased. The following table sets forth our facilities, and for leased
facilities the annual rental amount of, expiration of the current lease:

Annual
Location Purpose Rental Amount Expiration
------------------ --------------------- ------------- --------------
Los Angeles, CA Executive offices and $ 656,000 July 2011
(Washington Blvd.) warehouse

New York, NY Showroom $ 576,000 June 2015

Ruleville, MS
(2 facilities) Office and warehouse Owned

Hong Kong Office and warehouse $ 480,000 Month-to-month

Hong Kong Warehouse $ 22,000 July 2009

Shanghai, China Office $ 82,000 December 2008

Tehuacan, Mexico Storage $ 5,000 Month-to-month

Puebla, Mexico Office and Storage $ 5,000 March 2008

We own two facilities in Ruleville, Mississippi with an aggregate of
70,000 square feet.

We entered into a lease agreement in June 2005 for our showroom in New
York through June 2015. This is currently the location used for the private
brands sales, design and technical departments, which functions were moved from
our Los Angeles executive office.

Our lease agreement in Puebla, Mexico for our office and storage
expired in March 2008.

We believe that all of our existing facilities are well maintained, in
good operating condition and adequate to meet our current and foreseeable needs.

ITEM 3. LEGAL PROCEEDINGS

manufacture certain categories of American Rag Cie branded apparel in the United
States. The LLC is owned 55% by ARC II and 45% by Tarrant Apparel Group. In the
original complaint the LLC seeks a declaratory judgment that we have breached
the license agreement and that the license agreement has been properly
terminated. Our cross-complaint counters this claim, and seeks a declaration
that the license agreement is valid and continues to be in effect. Additionally,
the cross-complaint seeks relief on a number of causes of action, including
breach of the license agreement, a declaration by the Court imposing a
reasonable term into the agreement for sublicensing royalties, dissolution of
LLC, damages for breach of fiduciary duty, and an accounting of the monies
diverted by defendants' actions. Based upon a clause in the LLC operating
agreement, the causes of action asserted in the cross-complaint for breach of
fiduciary duty and an accounting are subject to determination by a Judicial
Referee, and the parties are currently in the process of selecting one. On March
3, 2008, we dismissed, without prejudice, our claim for dissolution of LLC after
being notified that ARC II had elected to buy out our share in the LLC, a
permitted defense to an action for dissolution. On March 19, 2008, the LLC and
ARC II filed an amended complaint, in which they expanded their claims against
us to include claims for breach of contract, fraud, and breach of fiduciary
duty, and seeking further declaratory relief and compensatory and punitive
damages. The action is in the early stages of discovery.

In April 2006, we commenced an action against the licensor of the
Jessica Simpson brands (captioned TARRANT APPAREL GROUP V. CAMUTO CONSULTING
GROUP, INC., VCJS LLC, WITH YOU, INC. AND JESSICA SIMPSON) in the Supreme Court
of the State of New York, County of New York. The suit named Camuto Consulting
Group, Inc., VCJS LLC, With You, Inc. and Jessica Simpson as defendants, and
asserted that the defendants failed to provide promised support in connection
with our sublicense agreement for the Jessica Simpson brands, as well as fraud
against Camuto Consulting. The complaint was amended to add Vincent Camuto as a
defendant and included nine causes of action, including two seeking a
declaration that the sublicense agreement was exclusive and remains in full
force and effect, as well as claims for breach of contract, breach of the duty
of good faith and fair dealing and fraudulent inducement against Camuto
Consulting, a claim against Vincent Camuto individually for fraudulent
inducement, and a claim against With You, Inc. and Ms. Simpson that we were an
intended third party beneficiary of the license between those defendants and
Camuto Consulting. Camuto Consulting, VCJS and Vincent Camuto filed a
counterclaim against us for breach of the sublicense agreement and alleged
damages of no less than $100 million. With You, Inc. and Jessica Simpson also
filed counterclaims against us alleging trademark infringement, unfair
competition and business practices, violation of the right of privacy and other
claims, and seeking injunctive relief and damages in an amount to be determined
but no less than $100 million plus treble and punitive damages. By Order filed
January 17, 2007, the Court granted the motion of With You, Inc. and Ms. Simpson
to discontinue all of Ms. Simpson's counterclaims, and her personal
counterclaims were dismissed with prejudice. In November 2007, we entered into a
settlement agreement with Camuto Consulting Group, Inc., VCJS LLC, With You,
Inc. and Jessica Simpson with respect to the litigation regarding our previous
agreement to design, manufacture and distribute Jessica Simpson branded jeans
and casual apparel. Pursuant to the settlement agreement, the parties agreed to
dismiss with prejudice all claims relating to these actions or the sublicense
agreement and we received a payment of $3 million.

From time to time, we are involved in various routine legal proceedings
incidental to the conduct of our business. Our management does not believe that
any of these legal proceedings will have a material adverse impact on our
business, financial condition or results of operations, either due to the nature
of the claims, or because our management believes that such claims should not
exceed the limits of the our insurance coverage.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of our shareholders during
the fourth quarter of 2007.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

NASDAQ GLOBAL MARKET

Our common stock is quoted on the NASDAQ Stock Market's Global Market
under the symbol "TAGS." The following table sets forth, for the periods
indicated, the range of high and low sale prices for our common stock as
reported by NASDAQ.

Low High
------- --------
2007
First Quarter........................................... 1.41 2.01
Second Quarter.......................................... 1.01 2.10
Third Quarter........................................... 1.08 1.33
Fourth Quarter.......................................... 1.10 1.27

------- --------
2006
First Quarter........................................... 1.06 1.44
Second Quarter.......................................... 1.25 2.11
Third Quarter........................................... 1.29 2.00
Fourth Quarter.......................................... 1.19 1.60

On March 24, 2008, the last reported sale price of our common stock as
reported by NASDAQ was $0.57. As of March 24, 2008, we had 24 shareholders of
record.

DIVIDEND POLICY

We have not declared dividends on our common stock during either of the
last two fiscal years. We intend to retain any future earnings for use in our
business and, therefore, do not anticipate declaring or paying any cash
dividends in the foreseeable future. The declaration and payment of any cash
dividends in the future will depend upon our earnings, financial condition,
capital needs and other factors deemed relevant by the Board of Directors. In
addition, our credit agreements prohibit the payment of dividends during the
term of the agreements.

PERFORMANCE GRAPH

The following graph sets forth the percentage change in cumulative
total shareholder return of our common stock during the five-year period from
December 31, 2002 to December 31, 2007, compared with the cumulative returns of
the NASDAQ Composite Index and a peer group of companies. The component entities
of the peer group consist of Accesstel Inc., GS Energy Corp., Maidenform Brands
Inc. and Nitches Inc. and were generated by Research Data Group, Inc. The
comparison assumes $100 was invested on December 31, 2002 in our common stock
and in each of the foregoing indices. The stock price performance on the
following graph is not necessarily indicative of future stock price performance.

[PERFORMANCE GRAPH OMITTED]

CUMULATIVE TOTAL RETURN
---------------------------------------------------------------
12/02 12/03 12/04 12/05 12/06 12/07
-------- -------- -------- -------- -------- --------

TARRANT APPAREL GROUP .... 100.00 87.78 59.66 25.92 35.94 28.36
NASDAQ COMPOSITE ......... 100.00 149.75 164.64 168.60 187.83 205.22
PEER GROUP ............... 100.00 18.55 9.62 1.70 2.45 1.74

The information under this "Performance Graph" subheading shall not be
deemed to be "filed" for the purposes of Section 18 of the Securities Exchange
Act of 1934, or otherwise subject to the liabilities of such section, nor shall
such information or exhibit be deemed incorporated by reference in any filing
under the Securities Act of 1933 or the Exchange Act, except as shall be
expressly set forth by specific reference in such a filing.

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data is qualified in its entirety by,
and should be read in conjunction with, the other information and financial
statements, including the notes thereto, appearing elsewhere herein.

YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
2003 2004 2005 2006 2007
--------- --------- --------- --------- ---------
(In thousands, except per share data)

INCOME STATEMENT DATA:
Total net sales ............... $ 320,423 $ 155,453 $ 214,648 $ 232,402 $ 243,721
Total cost of sales ........... 288,445 134,492 169,767 181,760 194,821
--------- --------- --------- --------- ---------

Gross profit .................. 31,978 20,961 44,881 50,642 48,900
Selling and distribution
expenses ................... 11,329 9,291 10,726 11,016 14,724
General and administrative
expenses ................... 31,767 32,084 26,865 26,879 24,312
Royalty expense ............... 242 605 3,665 2,815 1,864
Impairment charges (2) ........ 22,277 77,982 -- -- --
Cumulative translation loss (3) -- 22,786 -- -- --
Loss on notes receivable-
related parties (4) ........ -- -- -- 27,137 --
Terminated acquisition expense. -- -- -- -- 2,000
Adjustment to fair value of
long-term receivable -
related parties ............ -- -- -- -- 808
--------- --------- --------- --------- ---------

Income (loss) from operations . $ (33,637) $(121,787) $ 3,625 $ (17,205) $ 5,192
Interest expense .............. (5,603) (2,857) (4,625) (6,060) (4,118)
Interest income ............... 425 377 2,081 1,181 169
Interest in income of equity
method investee ............ -- 770 560 80 157
Other income (1) .............. 4,784 6,366 354 336 4,094
Adjustment to fair value of
derivative ................. -- -- -- 315 196
Other expense (1) ............. (1,183) (529) -- (436) (4,977)
--------- --------- --------- --------- ---------
Income (loss) before credit
(provision) for income
taxes and minority interest (35,214) (117,660) 1,995 (21,789) 713
Credit (provision) for income
taxes ...................... (4,132) (2,348) (927) (453) 1,041
Minority interest ............. 3,461 15,331 (75) 21 (6)
--------- --------- --------- --------- ---------

Net income (loss) ............. $ (35,885) $(104,677) $ 993 $ (22,221) $ 1,748
Dividend to preferred
stockholders ............... (7,494) -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss) available to
common stockholders (as
restated) .................. $ (43,379) $(104,677) $ 993 $ (22,221) $ 1,748
========= ========= ========= ========= =========

Net income (loss) per share-
Basic ......................... $ (2.38) $ (3.64) $ 0.03 $ (0.73) $ 0.06
Diluted ....................... $ (2.38) $ (3.64) $ 0.03 $ (0.73) $ 0.06

Weighted average shares
outstanding (000)
Basic ...................... 18,215 28,733 29,729 30,546 30,618
Diluted .................... 18,215 28,733 29,734 30,546 30,618

AS OF DECEMBER 31,
-----------------------------------------------------------------
2003 2004 2005 2006 2007
--------- --------- --------- --------- ---------
(In thousands)

BALANCE SHEET DATA:
Working capital ............... $ (18,018) $ (12,295) $ (11,004) $ (9,794) $ 6,826
Total assets .................. 253,105 131,811 151,242 111,132 70,989
Bank borrowings, convertible
debenture and long-term
obligations ................ 68,587 48,455 56,148 44,501 12,748
Shareholders' equity .......... 107,709 30,678 35,360 17,922 21,243

(1) Major components of other income (expense) (as presented above) include
rental and lease income, and foreign currency gains or losses. See
"Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations."

(2) The expense in 2004 was the impairment of long-lived assets of our
Mexico operations due to our decision to sell the manufacturing
operations in Mexico. The expense in 2003 was the impairment of our
goodwill and intangible assets and write-off of prepaid expenses due to
our decision to cease directly operating a substantial majority of our
equipment and fixed assets in Mexico commencing in the third quarter of
2003.

(3) Cumulative translation loss attributable to liquidated Mexico
operations in 2004 was due to our decision to cease our Mexico
operations.

(4) In the third quarter of 2006, we evaluated the recoverability of the
notes receivable - related parties and recorded a reserve on the notes
receivable in an amount equal to the outstanding balance less the value
of the underlying assets securing the notes. The loss was estimated to
be approximately $27.1 million, resulting in a notes receivable balance
at September 30, 2006 of approximately $14 million. We believe there
was no significant change subsequently on the value of the underlying
assets securing the notes; therefore, we did not have additional
reserve after the third quarter of 2006. See Note 5 of the "Notes to
Consolidated Financial Statements."

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis should be read together with the
Consolidated Financial Statements of Tarrant Apparel Group and the "Notes to
Consolidated Financial Statements" included elsewhere in this Form 10-K. This
discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity and cash flows of Tarrant
Apparel Group for the fiscal years ended December 31, 2005, 2006 and 2007.
Except for historical information, the matters discussed in this Management's
Discussion and Analysis of Financial Condition and Results of Operations are
forward looking statements that involve risks and uncertainties and are based
upon judgments concerning various factors that are beyond our control. See
"Cautionary Statement Regarding Forward-Looking Statements" and "Item 1A. Risk
Factors."

OVERVIEW

We generate revenues from the sale of apparel merchandise to our
customers that we have manufactured by third party contract manufacturers
located outside of the United States. Revenues and net income (loss) for the
years ended December 31, 2005, 2006 and 2007 were as follows (dollars in
thousands):

REVENUES AND NET INCOME (LOSS): 2005 2006 2007
--------- --------- ---------
Total net sales ............... $ 214,648 $ 232,402 $ 243,721
Net income (loss) ............. $ 993 $ (22,221) $ 1,748

Cash flows for the years ended December 31, 2005, 2006 and 2007 were as
follows (dollars in thousands):

CASH FLOWS: 2005 2006 2007
-------- -------- --------
Net cash provided by (used in)
operating activities ............... $(12,900) $ 15,047 $ 12,476
Net cash provided by (used in)
investing activities ............... $ 3,555 $ (5,071) $ 21,455
Net cash provided by (used in)
financing activities ............... $ 9,772 $(10,713) $(34,345)

SIGNIFICANT DEVELOPMENTS IN 2007

PRIVATE LABEL

Private label business has been our core competency for over twenty
years, and involves a one to one relationship with a large, centrally controlled
retailer with whom we can develop product lines that fit with the
characteristics of their particular customer. Private label sales in 2007 were
$198.8 million compared to $181.2 million in 2006.

PRIVATE BRANDS

We launched our private brands initiative in 2003, pursuant to which we
acquire ownership of or license rights to a brand name and sell apparel products
under this brand, generally to a single retail company within a geographic
region. Private brands sales in 2007 were $44.9 million compared to $51.2
million in 2006. During 2007, we owned or licensed rights to the following
private brands:

o AMERICAN RAG CIE: During the first quarter of 2005, we
extended our agreement with Macy's Merchandising Group through
2014, pursuant to which we exclusively distribute our American
Rag Cie brand through Macy's Merchandising Group's national
Department Store organization of more than 600 stores. Net
sales of American Rag Cie branded apparel totaled $43.3
million in 2007 compared to $33.2 million in 2006.

o ALAIN WEIZ: We have previously sold Alan Weiz apparel
exclusively to Dillard's Department Stores. From January 1,
2007, we were able to sell our licensed brand "Alain Weiz" to
specialty stores and department stores. Net sales of Alain
Weiz branded apparel totaled $131,000 in 2007 compared to $5.5
million in 2006. The "Alain Weiz" brand was discontinued in
mid 2007 after disappointing performance.

o MARISA K: This brand is being sold to specialty stores and
boutiques. Net sales of Marisa K branded apparel totaled $1.1
million in 2007.

o AMERICAN STAR: This brand is currently sold to Mothers' Work.
Sales in 2007 were insignificant.

THE BUFFALO GROUP

On December 6, 2006, we entered into a definitive stock and asset
purchase agreement to acquire certain assets and entities comprising The Buffalo
Group. The Buffalo Group designs, imports and sells contemporary branded apparel
and accessories, primarily in Canada and the United States.

Pursuant to the purchase agreement, we and our subsidiaries agreed to
acquire (1) all the outstanding capital stock of four principal operating
subsidiaries of The Buffalo Group - Buffalo Inc., 3163946 Canada Inc., 3681441
Canada Inc. and Buffalo Corporation, and (2) certain assets, consisting
primarily of intellectual property rights and licenses, from The Buffalo Trust,
for a total aggregate purchase price of up to approximately $120 million. At
signing of the purchase agreement, we delivered $5.0 million to the sellers as a
deposit against the purchase price payable under the agreement.

On April 19, 2007, we entered into a Mutual Termination and Release
Agreement with The Buffalo Group, pursuant to which we and the other parties to
the purchase agreement mutually agreed to

terminate the purchase agreement. The parties determined that it was in the
mutual best interest of each party to terminate the proposed agreement. Under
the terms of the Mutual Termination and Release Agreement, Buffalo agreed to
return to us $4,750,000 of the $5,000,000 deposit previously provided by us to
The Buffalo Group pursuant to the purchase agreement, and the parties have
released each other from any claims arising under or related to the purchase
agreement. The $5.0 million deposit was previously recorded in other assets in
consolidated balance sheets. We received $4,750,000 in April 2007. The remaining
portion of the deposit of $250,000 and other due diligence fees incurred in the
acquisition process were recorded as terminated acquisition expenses in the
consolidated statements of operations in the first quarter of 2007.

NOTES RECEIVABLE - RELATED PARTY RESERVE

In connection with the sale in 2004 of our assets and real property in
Mexico, the purchasers of the Mexico assets, Solticio, S.A. de C.V.
("Solticio"), and Acabados y Cortes Textiles, S.A. de C.V. ("Acotex"), issued us
unsecured promissory notes of $3,910,000 that matured on November 30, 2007 and
secured promissory notes of $40,204,000 with payments due on December 31, 2005
and every year thereafter until December 31, 2014. The secured notes were
secured by the real and personal property in Mexico that we sold to the
purchasers. As of September 30, 2006, the outstanding balance of the notes and
interest receivables was $41.1 million prior to the reserve. Historically, we
had placed orders for purchases of fabric from the purchasers pursuant to the
purchase commitment agreement we entered into at the time of the sale of the
Mexico assets, and we had satisfied our payment obligations for the fabric by
offsetting the amounts payable against the amounts due to us under the notes.
However, during the third quarter of 2006, the purchasers ceased providing
fabric and were not making payments under the notes. We further evaluated the
recoverability of the notes receivable and recorded a loss on the notes
receivable in the third quarter of 2006 in an amount equal to the outstanding
balance less the value of the underlying assets securing the notes. The loss was
estimated to be approximately $27.1 million, resulting in a net notes receivable
balance at September 30, 2006 of approximately $14 million. We believe there was
no significant change subsequently on the value of the underlying assets
securing the notes; therefore, we did not have additional reserve after the
third quarter of 2006.

On March 21, 2007, our wholly-owned subsidiary, Tarrant Luxembourg
S.a.r.l., entered into a letter agreement with Solticio, Inmobiliaria Cuadros,
S.A. de C.V. ("Inmobiliaria"), and Acotex, (Acotex and together with Solticio
and Inmobiliaria, the "Sellers"), and Tavex Algodonera, S.A. ("Tavex"), which
was subsequently amended. Pursuant to the agreement, as amended, Tavex had the
right and option (but not an obligation), at any time on or prior to September
1, 2007, to pay to Tarrant Luxembourg an aggregate of U.S. $17.75 million in
cash, whereupon, among other things, Tarrant Luxembourg would terminate the
Solticio and Acotex promissory notes described above and release the Sellers
from any further obligations thereunder, and terminate and release all liens on
the collateral securing those notes.

On August 21, 2007, we received a payment of $17.75 million from Tavex
upon the exercise by Tavex of its option in accordance with the agreement among
the parties. In return for the Tavex's payment of $17.75 million, we have taken
the following actions in accordance with the terms of the agreement:

o Tarrant Luxembourg terminated the Solticio and Acotex
promissory notes described above and released the Sellers from
any further obligations thereunder, and terminated and
released all liens on the collateral securing those notes;

o Tarrant Luxembourg and the Sellers terminated all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and

o Tarrant Luxembourg agreed to purchase from Tavex at least U.S.
$1.25 million of fabric prior to the end of 2007, and Tarrant
Luxembourg agreed to deliver an irrevocable letter of credit
for the full purchase price.

Upon closing of the transaction and receiving the payment of $17.75
million, we recorded a gain of $3.75 million on our consolidated statements of
operations as other income in the third quarter of 2007. We placed a fabric
order with Tavex on August 21, 2007 for $1.25 million pursuant to the agreement.
At December 31, 2007, the irrevocable letter of credit expired and we did not
have any further commitment to purchase fabric from Tavex.

CREDIT FACILITY

In June 2006, we entered into a new $65 million credit facility with
Guggenheim Corporate Funding, LLC (as administrative and collateral agent for
certain lenders) and expanded our existing facilities with GMAC Commercial
Finance Credit, LLC from $45 million to $55 million and DBS Bank (Hong Kong)
Limited from $4.5 million to $25 million. The credit facility with Guggenheim
consisted of an initial term loan of $25 million, of which $15.5 million was
advanced at the initial closing. A second term loan of up to $40 million was
available to finance acquisitions acceptable to Guggenheim as agent. On
September 26, 2007, we repaid in full the term loan of $15.5 million outstanding
under the Guggenheim credit facility. In November 2007, we executed a payoff
letter with Guggenheim and the lenders, which released all liens held by
Guggenheim and the lenders.

INTERNAL REVENUE SERVICE AUDIT

In January 2004, the Internal Revenue Service ("IRS") completed its
examination of our Federal income tax returns for the years ended December 31,
1996 through 2001. The IRS had proposed adjustments to increase our income tax
payable for the six years under examination. In addition, in July 2004, the IRS
initiated an examination of our Federal income tax return for the year ended
December 31, 2002. In December 2007, we received a final assessment from the IRS
of $7.4 million for the years ended December 31, 1996 through 2002, and in the
first quarter of 2008, we entered into a final settlement agreement with the
IRS. Under the settlement, which totals $13.9 million, including $6.5 million of
interest, we agreed to pay the IRS $4 million in March 2008 and an additional
$250,000 per month until repayment in full. The settlement with the IRS is
within amounts accrued for as of December 31, 2007 in our financial statements,
and we therefore do not anticipate the settlement to result in any additional
charges to income other than interest on the outstanding balance.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States of America. The preparation of these financial statements requires
us to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities. We are required to make assumptions about matters, which are
highly uncertain at the time of the estimate. Different estimates we could
reasonably have used or changes in the estimates that are reasonably likely to
occur could have a material effect on our financial condition or result of
operations. Estimates and assumptions about future events and their effects

cannot be determined with certainty. On an ongoing basis, we evaluate estimates,
including those related to allowance for returns, discounts and bad debts,
inventory, notes receivable - related parties reserve, valuation of long-lived
and intangible assets and goodwill, accrued expenses, income taxes, stock
options valuation, contingencies and litigation. We base our estimates on
historical experience and on various assumptions believed to be applicable and
reasonable under the circumstances. These estimates may change as new events
occur, as additional information is obtained and as our operating environment
changes. In addition, we are periodically faced with uncertainties, the outcomes
of which are not within our control and will not be known for prolonged period
of time.

We believe our financial statements are fairly stated in accordance
with generally accepted accounting principles in the United States of America
and provide a meaningful presentation of our financial condition and results of
operations.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. For a further discussion on the application of these and
other accounting policies, see Note 1 of the "Notes to Consolidated Financial
Statements."

ACCOUNTS RECEIVABLE--ALLOWANCE FOR RETURNS, DISCOUNTS AND BAD DEBTS

We evaluate the collectibility of accounts receivable and chargebacks
(disputes from the customer) based upon a combination of factors. In
circumstances where we are aware of a specific customer's inability to meet its
financial obligations (such as in the case of bankruptcy filings or substantial
downgrading of credit sources), a specific reserve for bad debts is taken
against amounts due to reduce the net recognized receivable to the amount
reasonably expected to be collected. For all other customers, we recognize
reserves for bad debts and uncollectible chargebacks based on our historical
collection experience. If collection experience deteriorates (for example, due
to an unexpected material adverse change in a major customer's ability to meet
its financial obligations to us), the estimates of the recoverability of amounts
due to us could be reduced by a material amount.

As of December 31, 2007, the balance of the allowance for returns,
discounts and bad debts was $2.0 million, compared to $2.1 million at December
31, 2006.

INVENTORY

Our inventories are stated (valued) at the lower of cost (first-in,
first-out) or market. Under certain market conditions, we use estimates and
judgments regarding the valuation of inventory to properly value inventory.
Inventory adjustments are made for the difference between the cost of the
inventory and the estimated market value and charged to operations in the period
in which the facts that give rise to the adjustments become known.

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL

We have adopted Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets." We assess the need for
impairment of identifiable intangibles, long-lived assets and goodwill with a
fair-value-based test on an annual basis or more frequently if an event occurs
or circumstances change that would more likely than not reduce the fair value of
a reporting unit below its carrying amount. Factors considered important that
could trigger an impairment review include, but are not limited to, the
following:

o a significant underperformance relative to expected historical
or projected future operating results;

o a significant change in the manner of the use of the acquired
asset or the strategy for the overall business; or

o a significant negative industry or economic trend.

We utilized the discounted cash flow methodology to estimate fair
value. At December 31, 2007, we had a goodwill balance of $9.9 million, and a
net property and equipment balance of $1.5 million, as compared to a goodwill
balance of $9.9 million and a net property and equipment balance of $1.4 million
at December 31, 2006. During the years ended December 31, 2006 and 2007, we did
not recognize any impairment related to goodwill and property and equipment.

FOREIGN CURRENCY TRANSLATION

Assets and liabilities of our Hong Kong 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
functional currency in which we transact business in Hong Kong is the Hong Kong
dollar. At December 31, 2006, we had one open foreign exchange forward contract
with a maturity of less than one year. Hedge ineffectiveness resulted in a loss
totaling $196,000 during 2006. At December 31, 2007, we had no open foreign
exchange forward contracts. Hedge ineffectiveness resulted in a gain of $196,000
during 2007.

Transaction gains or losses, other than inter-company debt deemed to be
of a long-term nature, are included in net income (loss) in the period in which
they occur. Foreign currency gains and losses resulting from translation of
assets and liabilities related to our Hong Kong subsidiaries were insignificant
in 2006 and 2007.

REVENUE RECOGNITION

Revenue is recognized at the point of shipment for all merchandise sold
based on FOB shipping point. For merchandise shipped on landed duty paid (or
"LDP") terms, revenue is recognized at the point of either leaving Customs for
direct shipments or at the point of leaving our warehouse where title is
transferred, net of an estimate of returned merchandise and discounts. Customers
are allowed the rights of return or non-acceptance only upon receipt of damaged
products or goods with quality different from shipment samples. We do not
undertake any after-sale warranty or any form of price protection.

STOCK-BASED COMPENSATION

On January 1, 2006, we adopted SFAS No. 123 (revised 2004),
"Share-Based Payment," ("SFAS No. 123(R)") which requires the measurement and
recognition of compensation expense for all share-based payment awards made to
employees and directors based on estimated fair values. SFAS No. 123(R)
supersedes our previous accounting under Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees" for periods beginning
in fiscal 2006. In March 2005, the SEC issued Staff Accounting Bulletin ("SAB")
No. 107 relating to SFAS No. 123(R). We have applied the provisions of SAB No.
107 in our adoption of SFAS No. 123(R).

We adopted SFAS No. 123(R) using the modified prospective transition
method, which requires the application of the accounting standard as of January
1, 2006, the first day of our fiscal year 2006. Our financial statements as of
and for the years ended December 31, 2006 and 2007 reflect the impact of SFAS
No. 123(R). In accordance with the modified prospective transition method, our
financial statements for prior periods have not been restated to reflect, and do
not include, the impact of SFAS No. 123(R). Stock-based compensation expense
recognized under SFAS No. 123(R) during the years ended December 31, 2006 and
2007 was $187,000 and $771,000, respectively. Basic and dilutive earnings per
share for the year ended December 31, 2006 were decreased by $0.01 from $(0.72)
to $(0.73) by the additional stock-based compensation recognized. Basic and
dilutive earnings per share for the year ended December 31, 2007 were decreased
by $0.02 from $0.08 to $0.06 by the additional stock-based compensation
recognized.

The fair value of each option granted to employees and directors is
estimated on the date of grant using the Black-Scholes option-pricing model
("Black-Scholes model") with the following weighted average assumptions used for
grants in 2005, 2006 and 2007: weighted-average volatility factors of the
expected market price of our common stock of 0.55 for 2005, 0.7 for 2006 and 0.7
for 2007, weighted-average risk-free interest rates of 4% for 2005, 5.075% for
2006 and 3.9% to 4.67% for 2007, dividend yield of 0% for 2005, 2006 and 2007,
and weighted-average expected life of the options of 4 years for 2005, 6.25
years for 2006 and 0.06 years to 6.18 years for 2007.

INCOME TAXES

As part of the process of preparing our consolidated financial
statements, we are required to estimate income taxes in each of the
jurisdictions in which we operate. The process involves estimating actual
current tax expense along with assessing temporary differences resulting from
differing treatment of items for book and tax purposes. These timing differences
result in deferred tax assets and liabilities, which are included in our
consolidated balance sheets. We record a substantial valuation allowance to
reduce its deferred tax assets to the amount that is more likely than not to be
realized. We have considered future taxable income and ongoing tax planning
strategies in assessing the need for the valuation allowance. Increases in the
valuation allowance result in additional expense to be reflected within the tax
provision in the consolidated statement of operations.

In addition, accruals are also estimated for ongoing audits regarding
U.S. Federal tax issues that are currently unresolved, based on our estimate of
whether, and the extent to which, additional taxes will be due. We routinely
monitor the potential impact of these situations and believe that amounts are
properly accrued for. If we ultimately determine that payment of these amounts
is unnecessary, we will reverse the liability and recognize a tax benefit during
the period in which we determine that the liability is no longer necessary. We
will record an additional charge in our provision for taxes in any period we
determine that the original estimate of a tax liability is less than we expect
the ultimate assessment to be. See Note 12 of the "Notes to Consolidated
Financial Statements" for a discussion of current tax matters.

In June 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - An
Interpretation of FASB Statement No. 109" ("FIN48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with SFAS No. 109, "Accounting for Income
Taxes." FIN 48 also prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return that results in a tax benefit.
Additionally, FIN 48 provides guidance on de-recognition, income statement
classification of interest and penalties, accounting in interim periods,
disclosure, and transition. We adopted the provisions of FIN 48 on January 1,
2007. As a result of the implementation of FIN 48, we recognized no material
adjustment for unrecognized tax benefits but reduced retained earnings as of
January 1, 2007 by approximately $1 million attributable to penalties accrued as
a component of income tax payable. As of the date of adoption, our unrecognized
tax benefits totaled approximately $8.9 million.

We and several of our subsidiaries file income tax returns in the U.S.,
Hong Kong, Luxembourg, Mexico and various state jurisdictions. We are currently
subject to an audit by the State of New York for the years 2002 to 2005, but are
not currently being audited by other states or subject to non-U.S. income tax
jurisdictions for years open in those taxing jurisdictions.

In January 2004, the IRS completed its examination of our Federal
income tax returns for the years ended December 31, 1996 through 2001. The IRS
had proposed adjustments to increase our income tax payable for these years
under examination. In addition, in July 2004, the IRS initiated an examination
of our Federal income tax return for the year ended December 31, 2002. In
December 2007, we received a final assessment from the IRS of $7.4 million for
the years ended December 31, 1996 through 2002, and in the first quarter of
2008, we entered into a final settlement agreement with the IRS. Under the
settlement, which totals $13.9 million, including $6.5 million of interest, we
agreed to pay the IRS $4 million in March 2008, and an additional $250,000 per
month until repayment in full. The settlement with the IRS is within amounts
accrued for as of December 31, 2007 in our financial statements, and we
therefore do not anticipate the settlement to result in any additional charges
to income other than interest on the outstanding balance. Due to the negotiated
settlement, we reclassified the IRS and state tax liabilities from uncertain tax
position to current payable on December 31, 2007.

The total unrecognized tax benefits as of January 1, 2007 were $8.9
million, excluding interest, penalties and related income tax benefits and would
be recorded as a component of income tax expense if recognized. We recognize
interest accrued related to unrecognized tax benefits and penalties as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties were $8.0 million and $1.2 million, respectively, excluding any
related income tax benefits. During 2007, we de-recognized a previous uncertain
tax position through negotiations with the state tax jurisdiction. The
negotiated settlement resulted in a decrease of $1.5 million in unrecognized tax
benefits and $1.0 million in penalties. During 2007, we also de-recognized a
previous uncertain tax position through settlement with the IRS. The negotiated
settlement resulted in a decrease of $7.4 million in unrecognized tax benefits.
After the above adjustments, there was no unrecognized tax benefit as of
December 31, 2007. As of December 31, 2007, the accrued interest and penalties
were $7.2 million and $142,000, respectively.

In many cases, the uncertain tax positions are related to tax years
that remain subject to examination by the relevant tax authorities. Federal and
state statutes are open from 2003 through the present period. Hong Kong statutes
are open from 2001, Luxembourg from 2003 and Mexico from 2001.

DEBT COVENANTS

Our debt agreements require certain covenants including a minimum level
of EBITDA and specified tangible net worth; and required interest coverage ratio
and leverage ratio as discussed in Note 9 of the "Notes to Consolidated
Financial Statements." If our results of operations erode and we are not able to
obtain waivers from the lenders, the debt would be in default and callable by
our lenders. In addition, due to cross-default provisions in our debt
agreements, substantially all of our long-term debt would become due in full if
any of the debt is in default. In anticipation of us not being able to meet the
required covenants due to various reasons, we either negotiate for changes in
the relative covenants or an advance waiver or reclassify the relevant debt as
current. We also believe that our lenders would provide waivers if necessary.
However, our expectations of future operating results and continued compliance
with other debt covenants cannot be assured and our lenders' actions are not
controllable by us. If projections of future operating results are not achieved
and the debt is placed in default, we would be required to reduce our expenses,
including by curtailing operations, and to raise capital through the sale of

assets, issuance of equity or otherwise, any of which could have a material
adverse effect on our financial condition and results of operations. As of
December 31, 2007, we were in violation of the EBITDA and tangible net worth
covenants and waivers of the defaults were obtained in March 2008 from our
lenders.

DERIVATIVE ACTIVITIES

WARRANT DERIVATIVES

SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities" requires measurement of certain derivative instruments at their fair
value for accounting purposes. In determining the appropriate fair value, we use
the Black-Scholes model. Derivative liabilities are adjusted to reflect fair
value at each period end, with any increase or decrease in the fair value being
recorded in consolidated statements of operations as adjustment to fair value of
derivative. At December 31, 2006, there was an income of $511,000 recorded as
adjustment to fair value of derivative on our consolidated statements of
operations. See Note 9 of the "Notes to Consolidated Financial Statements"

FOREIGN CURRENCY FORWARD CONTRACT

We source our products in a number of countries throughout the world,
as a result, are exposed to movements in foreign currency exchange rates. The
primary purpose of our foreign currency hedging activities is to manage the
volatility associated with foreign currency purchases of materials in the normal
course of business. We utilize derivative financial instruments consisting
primarily of forward currency contracts. These instruments are intended to
protect against exposure related to financing transactions and income from
international operations. We do not enter into derivative financial instruments
for speculative or trading purposes. We may enter into certain foreign currency
derivative instruments that do not meet hedge accounting criteria.

SFAS No. 133 requires measurement of certain derivative instruments at
their fair value for accounting purposes. All derivative instruments are
recorded on our balance sheet at fair value; as a result, we mark to market all
derivative instruments. Derivative liabilities are adjusted to reflect fair
value at each period end, with any increase or decrease in the fair value being
recorded in consolidated statements of operations as adjustment to fair value of
derivative. During the year ended December 31, 2006, we entered into foreign
currency forward contracts to hedge against the effect of exchange rate
fluctuations on cash flows denominated in foreign currencies and certain
inter-company financing transactions. This transaction is undesignated and as
such an ineffective hedge. At December 31, 2006, we had one open foreign
exchange forward contract which has a maturity of less than one year. Hedge
ineffectiveness resulted in a loss of $196,000 in our consolidated statements of
operations as of December 31, 2006. At December 31, 2007, we had no open foreign
exchange forward contracts. Hedge ineffectiveness resulted in a gain of $196,000
in our consolidated statements of operations as of December 31, 2007.

NEW ACCOUNTING PRONOUNCEMENTS

For a description of recent accounting pronouncements including the
respective expected dates of adoption and effects on results of operations and
financial condition, see Note 1 of the "Notes to Consolidated Financial
Statements."

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain
items in our consolidated statements of income as a percentage of net sales:

YEARS ENDED DECEMBER 31,
----------------------------
2005 2006 2007
-------- -------- --------

Net sales ...................................... 100.0% 98.1% 92.0%
Net sales to related party ..................... -- 1.9 8.0
-------- -------- --------
Total net sales ................................ 100.0 100.0 100.0

Cost of sales .................................. 79.1 76.6 72.7
Cost of sales to related party ................. -- 1.6 7.2
-------- -------- --------
Total cost of sales ............................ 79.1 78.2 79.9

Gross profit ................................... 20.9 21.8 20.1
Selling and distribution expenses .............. 5.0 4.7 6.0
General and administration expenses ............ 12.5 11.6 10.0
Royalty expenses ............................... 1.7 1.2 0.8
Loss on notes receivable-related parties ....... -- 11.7 --
Terminated acquisition expenses ................ -- -- 0.8
Adjustment to fair value of long-term
receivable - related parties .............. -- -- 0.3
-------- -------- --------

Income (loss) from operations .................. 1.7 (7.4) 2.2
Interest expense ............................... (2.2) (2.6) (1.7)
Interest income ................................ 1.0 0.5 0.0
Interest in income of equity method investee ... 0.3 0.0 0.0
Other income ................................... 0.1 0.2 1.7
Adjustment to fair value of derivative ......... 0.0 0.1 0.1
Other expense .................................. (0.0) (0.2) (2.0)
-------- -------- --------

Income (loss) before provision (credit) for
income taxes and minority interest ........ 0.9 (9.4) 0.3
Provision (credit) for income taxes ............ 0.4 0.2 (0.4)
Minority interest .............................. 0.0 0.0 0.0
-------- -------- --------

Net Income (loss) .............................. 0.5% (9.6)% 0.7%
======== ======== ========

COMPARISON OF 2007 TO 2006

Total net sales increased by $11.3 million, or 4.9%, from $232.4
million in 2006 to $243.7 million in 2007. The increase in total net sales was
primarily due to increased sales in our private label business which amounted to
$198.8 million in 2007 compared to $181.2 million in 2006. The increase in 2007
came primarily from sales to New York & Co and Seven Licensing, and was
partially offset by decreased sales to Kohl's and Mervyn's. Private brands sales
in 2007 totaled $44.9 million compared to $51.2 million in 2006. Sales of
"Jessica Simpson", "House of Dereon" and "Alain Weiz" brands were discontinued
in 2007, compared to sales of these brands amounting to $16.7 million in 2006.
The loss in the sales of these brands was partially offset by an increase of
$9.6 million in the sales of the "American Rag Cie" brand in 2007.

Gross profit consists of total net sales less product costs, direct
labor, duty, quota, freight in, brokerage, warehouse handling and markdown.
Gross profit for 2007 was $48.9 million, or 20.1% of total net sales, compared
to $50.6 million, or 21.8 % of total net sales for 2006, representing a decrease
of $1.7 million or 3.4%. The decrease in gross profit for 2007 was primarily
caused by a $1.5 million loss on the sale of Mexico fabric inventory in 2007
after the completion of the Tavex transaction selling all our assets in Mexico
for cash.

Selling and distribution expenses increased by $3.7 million, or 33.7%,
from $11.0 million in 2006 to $14.7 million in 2007. As a percentage of total
net sales, these variable expenses increased from 4.7% in 2006 to 6.0% in 2007.
The increase in selling and distribution expenses was primarily caused by the
increased expenses incurred in establishing new brands such as "Marisa K" and
increased advertising expenses on "American Rag Cie" brand in 2007 due to more
advertising efforts.

General and administrative expenses decreased by $2.6 million, or 9.5%,
from $26.9 million in 2006 to $24.3 million in 2007. As a percentage of total
net sales, these expenses decreased from 11.6% in 2006 to 10.0% in 2007. The
main reduction in general and administrative expenses in 2007 resulted from the
settlement of the Jessica Simpson litigation and the reimbursement to us of $3.0
million of legal expenses we previously incurred in the litigation. This
reduction was partially offset by a $1.0 million reserve on a long-term
receivable - related parties.

Adjustment to fair value of long-term receivable - related party was
$0.8 million, or 0.3% of total net sales in 2007 compared to $0 in 2006. Based
on the repayment history of the related parties and litigation they are
currently subject to, we estimated that our receivable of $3.4 million will take
approximately three years for collection in full. We therefore made a $1.0
million reserve and then fair-valued the balance of this asset using our
weighted average cost of capital as the discount rate and a term of three years
as the discount period. See "Related party transactions."

Royalty and marketing allowance expenses decreased by $951,000, or
33.8%, from $2.8 million in 2006 to $1.9 million in 2007. The decrease was
caused by the discontinued sales under the Jessica Simpson license in 2007,
compared to $1.1 million of royalty paid on the brand in 2006. As a percentage
of total net sales, these expenses decreased from 1.2% in 2006 to 0.8% in 2007.

Loss on notes receivable - related parties was $27.1 million or 11.7%
of total net sales in 2006, compared to no such expense in 2007. During 2006,
the purchasers of our Mexico assets ceased providing fabric and were not making
payments under the notes. We evaluated the recoverability of the notes
receivable and recorded a loss on the notes receivable in an amount equal to the
outstanding balance less the value of the underlying assets securing the notes.
See Note 5 of the "Notes to Consolidated Financial Statements".

Terminated acquisition expenses in 2007 were $2.0 million, or 0.8% of
total net sales, compared to no such expense in 2006. These expenses consisted
of the non-refunded portion of a deposit in the amount of $250,000 and other
expenses including due diligence and legal fees incurred in connection with our
proposed acquisition of The Buffalo Group. The transaction was mutually
terminated on April 19, 2007. See Note 7 of the "Notes to Consolidated Financial
Statements".

Loss from operations was $17.2 million in 2006, or (7.4)% of total net
sales, compared to income from operation of $5.2 million in 2007, or 2.2% of
total net sales. The higher revenue in 2007 as well as the absence of any
further charge for the write-down on notes receivable accounted for the
improvement in the operating results in 2007 compared to 2006.

Interest expense decreased by $1.9 million, or 32.0%, from $6.1 million
in 2006 to $4.1 million in 2007. As a percentage of total net sales, this
expense decreased from 2.6% in 2006 to 1.7% in 2007. The decrease was primarily
due to decreased borrowings under our credit facilities and the repayment of our
term loan facility in September 2007. Also included in interest expense in 2006
was $711,000 of debt discount related to intrinsic value of the conversion
option of debentures and the remaining value of the warrants issued to holders
of debentures as a result of the repayment of the debentures in June 2006.

Interest income decreased by $1.0 million, or 85.7%, from $1.2 million
in 2006 to $169,000 in 2007. Interest earned from the notes receivable-related
party amounted to $901,000 in 2006, compared to no such income in 2007.

Interest in income of equity method investee represented our 45% share
of equity interest in the owner of the trademark "American Rag Cie" and the
operator of American Rag retail stores. Interest in income of equity method
investee increased by $76,000 or 96.3%, from $80,000 in 2006 to $156,000 in
2007. The increase came mainly from increased royalty paid by our subsidiary
Private Brands, Inc. on increased sales to Macy's.

Other income increased by $3.8 million, or 1,119.5%, from $336,000 in
2006 to $4.1 million in 2007. Included in other income in 2007 was a gain of
$3.8 million on notes receivable - related parties. See Note 5 of the "Notes to
Consolidated Financial Statements". Adjustment to fair value of derivative was
$196,000 in 2007, compared to $315,000 in 2006.

Other expenses increased by $4.5 million, or 1,042.6%, from $436,000 in
2006 to $5.0 million in 2007. Other expenses in 2006 consisted of a payment of
$400,000 upon the termination of the license agreements with Cynthia Rowley.
Other expenses of $5 million in 2007 consisted of expensing all the financing
and related expenses and the remaining value of the warrants issued to lenders
and the placement agent upon repaying our term loan in full. See Note 9 of the
"Notes to Consolidated Financial Statements".

Income (loss) before provision (credit) for income taxes and minority
interest was $(21.8) million in 2006 and $713,000 in 2007, representing (9.4)%
and 0.3% of total net sales, respectively. Loss before provision for income
taxes in 2006 included the loss on notes receivable - related parties of $27.1
million.

Provision for income taxes was $453,000 in 2006 compared to credit for
income taxes of $1.0 million in 2007, representing 0.2% and (0.4)% of total net
sales, respectively. The tax credit in 2007 was primarily a result of
write-backs of FIN 48 accruals after our settlements of some uncertain tax
positions with the State and Federal tax authorities.

Loss allocated to minority interest in 2006 was $21,000, for the
minority partner's 25% share in the loss of PBG7, LLC. Income allocated to
minority interest in 2007 was $6,000, for the minority partner in PBG7, LLC's
25% share in the income.

Net income (loss) was $(22.2) million in 2006 as compared to $1.7
million in 2007, representing (9.6)% and 0.7% of total net sales, respectively.
Included in the $22.2 million net loss in 2006 was a loss on notes receivable -
related parties of $27.1 million.

COMPARISON OF 2006 TO 2005

Total net sales increased by $17.8 million, or 8.3%, from $214.6
million in 2005 to $232.4 million in 2006. The increase in total net sales was
primarily due to increased sales of our private label business, which was $181.2
million in 2006 compared to $159.6 million in 2005, with the increase in 2006

resulting primarily from higher sales to Mothers Work and Charlotte Russe which
was a new customer. Private brands sales in 2006 were $51.2 million compared to
$55.0 million in 2005 with the decrease resulting primarily from no sales of
Gear 7 in 2006, compared to $14.4 million in 2005, and offset by an increase in
sales to Macy's Merchandising Group of $11.6 million which included $1.5 million
of sublicensing royalty income in 2006.

Gross profit consists of total net sales less product costs, direct
labor, duty, quota, freight in, brokerage, warehouse handling and markdown.
Gross profit for 2006 was $50.6 million, or 21.8% of total net sales, compared
to $44.9 million, or 20.9 % of total net sales for 2005, representing an
increase of $5.8 million or 12.8%. The increase in gross profit for 2006
occurred primarily because of an increase in sales volume, including $1.5
million of sublicensing royalty income, and gross margin. The improvement in
gross margin is primarily attributable to the change of relative product mix in
private label business and improved sourcing in private brand business in 2006.

Selling and distribution expenses increased by $290,000, or 2.7%, from
$10.7 million in 2005 to $11.0 million in 2006. As a percentage of total net
sales, these variable expenses decreased from 5.0% in 2005 to 4.7% in 2006 due
to the increase in sales volume in 2006.

General and administrative expenses increased by $14,000, or 0.1%, from
$26.86 million in 2005 to $26.88 million in 2006. As a percentage of total net
sales, these expenses decreased from 12.5% in 2005 to 11.6% in 2006 due to the
increase in sales volume in 2006. Included in general and administrative
expenses in 2006 was $187,000 stock-based compensation as compared to no such
expense in 2005.

Royalty and marketing allowance expenses decreased by $850,000, or
23.2%, to $2.8 million in 2006 from $3.7 million in 2005. The decrease was
primarily due to the royalty payment to House of Dereon in 2005 as compared to
no such expense in 2006. As a percentage of total net sales, these expenses
decreased to 1.2% in 2006 from 1.7% in 2005.

Loss on notes receivable - related parties was $27.1 million or 11.7%
of total net sales in 2006, compared to no such expense in 2005. During 2006,
the purchasers of our Mexico assets ceased providing fabric and were not
currently making payments under the notes. We evaluated the recoverability of
the notes receivable and recorded a loss on the notes receivable in an amount
equal to the outstanding balance less the value of the underlying assets
securing the notes. See Note 5 of the "Notes to Consolidated Financial
Statements".

Loss from operations was $17.2 million in 2006, or (7.4)% of total net
sales, compared to income from operation of $3.6 million in 2005, or 1.7% of
total net sales, due to the factors described above.

Interest expense increased by $1.4 million, or 31.0%, from $4.6 million
in 2005 to $6.1 million in 2006. As a percentage of total net sales, this
expense increased to 2.6% in 2006 from 2.2% in 2005. The increase was primarily
due to an interest expense of $1.6 million in 2006 related to interest payments
and amortization of debt discount arising from the credit facility from
Guggenheim Corporate Funding LLC. Included in the interest expense was $1.3
million in 2005 and $1.1 million in 2006 related to interest payments to holders
of convertible debentures and amortization of debt discount arising from
convertible debentures issued in 2005. Interest income decreased by $900,000, or
43.2%, from $2.1 million in 2005 to $1.2 million in 2006. The decrease was
primarily due to the interest earned from the notes receivable related to the
sale of our fixed assets in Mexico of $1.9 million in 2005, compared to $901,000
in 2006 due to the purchasers of the Mexico assets discontinuing making payments
under the notes. Other income decreased by $19,000, or 5.3%, from $354,000 in
2005 to $336,000 in 2006. Other expenses were $1,000 in 2005, compared to
$436,000 in 2006 due to a payment of $400,000 upon the termination of the
license agreements with Cynthia Rowley.

Interest in income of equity method investee represented our 45% share
of equity interest in the owner of the trademark "American Rag Cie" and the
operator of American Rag retail stores. Interest in income of equity method
investee decreased by $480,000 or 85.8%, from $560,000 in 2005 to $80,000 in
2006. This decrease of interest in income of equity method investee could be
attributed to an increase of $230,000 in markdown on slow-moving inventory, an
increase in occupancy and depreciation expenses by $546,000 and an increase in
personnel expenses by $270,000 due to the opening of a new retail store.

Income (loss) before provision for income taxes and minority interest
was $(21.8) million in 2006 and $2.0 million in 2005, representing (9.4)% and
0.9% of total net sales, respectively. The increase in loss before provision for
income taxes was primarily due to the loss on notes receivable - related parties
of $27.1 million recorded in 2006 and the other factors discussed above.

Provision for income taxes was $453,000 in 2006 compared to $927,000 in
2005, representing 0.2% and 0.4% of total net sales, respectively.

In 2005, we allocated $75,000 of profit to minority interest, which
consisted of profit shared with the minority partner in the PBG7, LLC. Loss
allocated to minority interest in 2006 was $21,000, for its 25% share in the
loss.

Net income (loss) was $(22.2) million in 2006 as compared $1.0 million
in 2005, representing (9.6)% and 0.5% of total net sales, respectively. Included
in the $22.2 million net loss in 2006 was a loss on notes receivable - related
parties of $27.1 million. There was no such expense in 2005.

QUARTERLY RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain
items in our consolidated statements of income in millions of dollars and as a
percentage of total net sales:

QUARTER ENDED
-------------------------------------------------------------------------------
MAR. 31 JUN. 30 SEP. 30 DEC. 31 MAR. 31 JUN. 30 SEP. 30 DEC. 31
2006 2006 2006 2006 2007 2007 2007 2007
------- ------- ------- ------- ------- ------- ------- -------

Total net Sales ....... $ 61.3 $ 59.1 $ 54.6 $ 57.4 $ 56.1 $ 60.1 $ 70.2 $ 57.3
Gross profit .......... 12.5 12.7 11.8 13.6 12.3 12.6 12.9 11.1
Operating income (loss) 1.6 2.6 (24.7) 3.3 0.1 2.5 2.7 (0.1)
Net income (loss) ..... 0.8 0.6 (25.3) 1.7 (1.0) 0.8 1.6 0.3

Total net sales ....... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit .......... 20.4 21.4 21.6 23.8 22.0 20.9 18.4 19.3
Operating income (loss) 2.7 4.4 (45.3) 5.7 0.1 4.2 3.8 (0.1)
Net income (loss) ..... 1.4 1.0 (46.4) 2.9 (1.8) 1.3 2.3 0.5

As is typical for us, quarterly total net sales fluctuated
significantly because our customers typically place bulk orders with us, and a
change in the number of orders shipped in any one period may have a material
effect on the total net sales for that period.

LIQUIDITY AND CAPITAL RESOURCES

We had cash and cash equivalents of approximately $491,000 at December
31, 2007.

We significantly strengthened our balance sheet and improved our
liquidity in 2007. The sale of all our Mexico assets for cash enabled us to
repay our most expensive loans and as a result our financing cost has since
substantially decreased. The IRS settlement and installment repayment plan has
removed a significant uncertainty in our financial condition which we have
operated under for the past several years.

Our liquidity requirements arise from the funding of our working
capital needs, principally inventory, finished goods shipments-in-transit,
work-in-process and accounts receivable, including receivables from our contract
manufacturers that relate primarily to fabric we purchase for use by those
manufacturers. Our primary sources for working capital and capital expenditures
are cash flow from operations, borrowings under our bank and other credit
facilities, issuance of long-term debt, sales of equity and debt securities, and
vendor financing. In the near term, we expect that our operations and borrowings
under bank and other credit facilities will provide sufficient cash to fund our
operating expenses, capital expenditures and interest payments on our debt. In
the long-term, we expect to use internally generated funds and external sources
to satisfy our debt and other long-term liabilities.

Our liquidity is dependent, in part, on customers paying on time. Any
abnormal chargebacks or returns may affect our source of short-term funding. Any
changes in credit terms given to major customers may have an impact on our cash
flow. Suppliers' credit is another major source of short-term financing and any
adverse changes in their terms will have negative impact on our cash flow.

Other principal factors that could affect the availability of our
internally generated funds include:

o deterioration of sales due to weakness in the markets in which
we sell our products;

o decreases in market prices for our products;

o increases in costs of raw materials;

o loss of rights to the American Rag Cie trademark if litigation
in which are involved is resolved in a matter unfavorable to
us; and

o changes in our working capital requirements.

Principal factors that could affect our ability to obtain cash from
external sources include:

o financial covenants contained in our current or future bank
and debt facilities; and

o volatility in the market price of our common stock or in the
stock markets in general.

Certain of our private brands product lines are generally associated
with higher selling, general and administrative expenses, due to significant
design, development, and marketing costs compared to our private label business.

Cash flows for the years ended December 31, 2005, 2006 and 2007 were as
follows (dollars in thousands):

CASH FLOWS: 2005 2006 2007
-------- -------- --------

Net cash provided by (used in) operating activities $(12,900) $ 15,047 $ 12,476
Net cash provided by (used in) investing activities $ 3,555 $ (5,071) $ 21,455
Net cash provided by (used in) financing activities $ 9,772 $(10,713) $(34,345)

Net cash provided by operating activities was $12.5 million in 2007, as
compared to net cash provided by operating activities in 2006 of $15.0 million
and net cash used in operating activities in 2005 of $12.9 million. Net cash
provided by operating activities in 2007 resulted primarily from a net income of
$1.7 million, $1.9 million of depreciation and amortization of fixed assets and
deferred financing cost, $5.0 million write-off of deferred financing cost and
debt discount and a decrease of $14.1 million in accounts receivable and $4.6
million in inventory, offset by a gain on notes receivable - related parties of
$3.8 million and a decrease of $10.9 million in accounts payable. The decrease
in inventory was primarily due to the increase in sales in 2007, the decrease in
accounts payable resulted from the pay down of payables and the decrease in
accounts receivable was due to increased collections.

During 2007, net cash provided by investing activities was $21.5
million, as compared to net cash used in investing activities of $5.1 million
and net cash provided by investing activities of $3.6 million in 2005. Net cash
provided by investing activities in 2007 resulted primarily from $17.8 million
proceeds from notes receivable and a return of a $4.8 million of deposit in
connection with the termination of our previously proposed acquisition of The
Buffalo Group, offset by approximately $700,000 of due diligence fees incurred
in connection with that proposed acquisition.

During 2007, net cash used in financing activities was $34.3 million as
compared to net cash used in financing activities of $10.7 million in 2006 and
net cash provided by financing activities of $9.8 million in 2005. Net cash used
in financing activities in 2007 resulted primarily from the re-payment of $15.5
million of our term loan, $16.6 million of our long-term borrowings and $3.9
million on our short-term bank borrowings, offset by proceeds from exercises of
stock options of $1.7 million.

DEBT OBLIGATIONS

The following table summarizes our debt obligations:

DECEMBER 31,
-----------------------------
2006 2007
------------ ------------

Short-term bank borrowings:
Import trade bills payable - DBS Bank and Aurora Capital $ 5,844,887 $ 4,600,293
Bank direct acceptances - DBS Bank ..................... 3,368,054 1,222,998
Other Hong Kong credit facilities - DBS Bank ........... 4,483,241 3,921,927
------------ ------------
$ 13,696,182 $ 9,745,218
============ ============
Long-term obligations:
Equipment financing .................................... $ 38,148 $ 5,338
Credit facility - Guggenheim, net ...................... 11,212,724 --
Debt facility and factoring agreement - GMAC CF ........ 19,553,755 2,997,793
------------ ------------
30,804,627 3,003,131
Less current portion ................................... (19,586,565) (3,003,131)
------------ ------------
$ 11,218,062 $ 0.00
============ ============

DBS BANK CREDIT FACILITY

In June 2006, our subsidiaries in Hong Kong, Tarrant Company Limited,
Marble Limited and Trade Link Holdings Limited, entered into a new credit
facility with DBS Bank (Hong Kong) Limited ("DBS"), which replaced our prior
letter of credit facility for up to HKD 30 million (equivalent to US $3.9
million). Under this facility, we may arrange for letters of credit and
acceptances. The maximum amount our Hong Kong subsidiaries may borrow under this
facility at any time is US $25 million. The interest rate under the letter of
credit facility is equal to the Standard Bills Rate quoted by DBS minus 0.5% if
paid in Hong Kong Dollars, which the interest rate was 7.5% per annum at
December 31, 2007, or the Standard Bills Rate quoted by DBS plus 0.5% if paid in
any other currency, which the interest rate was 8.12% per annum at December 31,
2007. This is a demand facility and is secured by a security interest in all the
assets of the Hong Kong subsidiaries, by a pledge of our office property where
our Hong Kong office is located, which is owned by Gerard Guez and Todd Kay and
by our guarantee. The DBS facility includes customary default provisions. In
addition, we are subject to certain restrictive covenants, including that we
maintain a specified tangible net worth, and a minimum level of EBITDA at
December 31, 2006 and 2007, interest coverage ratio, leverage ratio and
limitations on additional indebtedness. As of December 31, 2007, we were in
violation with the EBITDA and tangible net worth covenants and a waiver was
obtained on March 18, 2008. As of December 31, 2007, $8.6 million was
outstanding under this facility. In addition, $11.3 million of open letters of
credit was outstanding and $5.1 million was available for future borrowings as
of December 31, 2007.

In September 2006, a tax loan for HKD 8.438 million (equivalent to US
$1.1 million) was also made available by DBS to our Hong Kong subsidiaries and
bore interest at the rate equal to the Hong Kong prime rate plus 1% and were
subject to the same security. The interest rate was 8.75% per annum at October
31, 2007. We paid off this tax loan in October 2007. As of December 31, 2007, $0
was outstanding under this tax loan.

REVOLVING CREDIT FACILITY - GMAC COMMERCIAL FINANCE

On June 16, 2006, we expanded our previously existing credit facility
with GMAC CF by entering into a new Loan and Security Agreement and amending and
restating our previously existing Factoring Agreement with GMAC CF. UPS Capital
Corporation is also a lender under the Loan and Security Agreement. This is a
revolving credit facility and has a term of 3 years. The amount we may borrow
under this credit facility is determined by a percentage of eligible accounts
receivable and inventory, up to a maximum of $55 million, and includes a letter
of credit facility of up to $4 million. Interest on outstanding amounts under
this credit facility is payable monthly and accrues at the rate of the "prime
rate" plus 0.5%. Our obligations under the GMAC CF credit facility are secured
by a lien on substantially all our domestic assets, including a first priority
lien on our accounts receivable and inventory. This credit facility contains
customary financial covenants, including covenants that we maintain minimum
levels of EBITDA and interest coverage ratios and limitations on additional
indebtedness. This facility includes customary default provisions, and all
outstanding obligations may become immediately due and payable in the event of a
default. The facility bore interest at 7.75% per annum at December 31, 2007. As
of December 31, 2007, we were in violation with the EBITDA covenant and a waiver
was obtained on March 25, 2008. A total of $3.0 million was outstanding with
respect to receivables factored under the GMAC CF facility at December 31, 2007.

The amount we can borrow under the factoring facility with GMAC is
determined based on a defined borrowing base formula related to eligible
accounts receivable. A significant decrease in eligible accounts receivable due
to the aging of receivables, can have an adverse effect on our borrowing
capabilities under our credit facility, which may adversely affect the adequacy
of our working capital. In addition, we have typically experienced seasonal
fluctuations in sales volume. These seasonal fluctuations result in sales volume

decreases in the first and fourth quarters of each year due to the seasonal
fluctuations experienced by the majority of our customers. During these
quarters, borrowing availability under our credit facility may decrease as a
result of decrease in eligible accounts receivables generated from our sales.

TERM LOAN FACILITY - GUGGENHEIM CORPORATE FUNDING LLC

On June 16, 2006, we entered into a Credit Agreement with certain
lenders and Guggenheim Corporate Funding LLC ("Guggenheim"), as administrative
agent and collateral agent for the lenders. This credit facility provided for
borrowings of up to $65 million. This facility consisted of an initial term loan
of up to $25 million, of which we borrowed $15.5 million at the initial funding,
to be used to repay certain existing indebtedness and fund general operating and
working capital needs. An additional term loan of up to $40 million would be
available under this facility to finance acquisitions acceptable to Guggenheim.
All amounts under the term loans became due and payable in December 2010.
Interest under this facility was payable monthly, with the interest rate equal
to the LIBOR rate plus an applicable margin based on our debt leverage ratio (as
defined in the credit agreement). Our obligations under the Guggenheim credit
facility were secured by a lien on substantially all of our assets and our
domestic subsidiaries, including a pledge of the equity interests of our
domestic subsidiaries and 65% of our Luxembourg subsidiary.

On September 26, 2007, we repaid in full the term loan of $15.5 million
outstanding under the Guggenheim credit facility. Upon paying off the loan, the
unamortized loan fee paid to Guggenheim of $401,000 and the unamortized value of
the warrants to purchase 3.5 million shares of our common stock of $3.5 million
was expensed. The unamortized loan fee paid to Durham of $178,000 and the
unamortized value of the warrants to purchase 70,000 shares of our common stock
of $75,000 was also expensed. Other unamortized expenses of $822,000 related to
obtaining the loan were also expensed. All the above expenses amounted to $5.0
million were recorded on our consolidated statements of operations as other
expense in the third quarter of 2007. On November 2, 2007, we executed a payoff
letter with Guggenheim and the lenders, which released all liens held by
Guggenheim and the lenders.

EQUIPMENT LOANS

We had three equipment loans outstanding during 2007. One of these
equipment loans bore interest at 15.8% payable in installments through 2007,
which we paid off in December 2007. The second loan bore interest at 6.15%
payable in installment through 2007, which we paid off in December 2007. The
third loan bears interest at 4.75% payable in installment through 2008. As of
December 31, 2007, $5,000 was outstanding under the remaining loan.

LETTERS OF CREDIT

From time to time, we open letters of credit under an uncommitted line
of credit from Aurora Capital Associates which issues these letters of credits
out of Israeli Discount Bank. As of December 31, 2007, $1.2 million was
outstanding under this facility and $903,000 of letters of credit was open under
this arrangement. We pay a commission fee of 2.25% on all letters of credits
issued under this arrangement.

The effective interest rates on bank borrowings as of December 31, 2006
and 2007 were 10.9% and 12.7%, respectively.

making other distributions to us. The credit facility with DBS Bank prohibits
our Hong Kong subsidiaries from paying any dividends or making other
distributions or cash advances to us.

We have financed our operations from our cash flow from operations,
borrowings under our bank and other credit facilities, issuance of long-term
debt, and sales of equity and debt securities. Our short-term funding relies
very heavily on our major customers, banks and suppliers. From time to time, we
have had temporary over-advances from our banks. Any withdrawal of support from
these parties will have serious consequences on our liquidity.

We may seek to finance future capital investment programs through
various methods, including, but not limited to, borrowings under our bank credit
facilities, issuance of long-term debt, sales of equity securities, leases and
long-term financing provided by the sellers of facilities or the suppliers of
certain equipment used in such facilities.

We do 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.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

Following is a summary of our contractual obligations and commercial
commitments available to us as of December 31, 2007 (in millions):

PAYMENTS DUE BY PERIOD
-------------------------------------------------------------
Less than Between Between After
CONTRACTUAL OBLIGATIONS Total 1 year 2-3 years 4-5 years 5 years
---------------------------------- --------- --------- --------- --------- ---------

Long-term debt(1) ................ $ 3.2 $ 3.2 $ -- $ -- $ --
Operating leases ................. $ 7.6 $ 1.4 $ 2.6 $ 1.8 $ 1.8
Minimum royalties ................ $ 7.6 $ 0.9 $ 2.2 $ 2.8 $ 1.7
--------- --------- --------- --------- ---------
Total Contractual Cash Obligations $ 18.4 $ 5.5 $ 4.8 $ 4.6 $ 3.5

----------
(1) Includes interest on long-term debt obligations. Based on outstanding
borrowings as of December 31, 2007, and assuming all such indebtedness
remained outstanding during 2007 and the interest rates remained
unchanged, we estimate that our interest cost on long-term debt would
be approximately $233,000.

TOTAL AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
AMOUNTS ------------------------------------------------
COMMERCIAL COMMITTED Less than Between Between After
COMMITMENTS AVAILABLE TO US TO US 1 year 2-3 years 4-5 years 5 years
------------------------------------------- --------- --------- --------- --------- ---------

Lines of credit .......................... $ 80.0 $ 80.0 -- -- --
Letters of credit (within lines of credit) $ 25.0 $ 25.0 -- -- --
Total Commercial Commitments ............. $ 80.0 $ 80.0 -- -- --

OFF-BALANCE SHEET ARRANGEMENTS

At December 31, 2007 and 2006, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, we are not exposed
to any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.

RELATED PARTY TRANSACTIONS

We lease our executive offices and warehouse in Los Angeles, California
from GET and office space and warehouse in Hong Kong from Lynx International
Limited. GET and Lynx International Limited are each owned by Gerard Guez, our
Chairman and Interim Chief Executive Officer, and Todd Kay, our Vice Chairman.
We believe, at the time the leases were entered into, the rents on these
properties were comparable to then prevailing market rents. Our lease for the
Los Angeles offices and warehouse has a term of five years expiring in 2011,
with an option to renew for an additional five year term. Our lease for the
office space and warehouse in Hong Kong has expired and we are currently renting
on a month to month basis. We paid $1.0 million, $1.1 million and $1.1 million,
respectively, in 2005, 2006 and 2007 in rent for office and warehouse facilities
at these locations. On May 1, 2006, we sublet a portion of our executive office
in Los Angeles, California and our sales office in New York to Seven Licensing
Company, LLC ("Seven Licensing") for a monthly payment of $25,000 on a month to
month basis. Seven Licensing is beneficially owned by Gerard Guez. We received
$200,000 and $300,000, respectively, in rental income from this sublease for the
years ended December 31, 2006 and 2007.

From time to time in the past, we had advanced funds to Mr. Guez. These
were net advances to Mr. Guez or payments paid on his behalf before the
enactment of the Sarbanes-Oxley Act in 2002. The promissory note documenting
these advances contains a provision that the entire amount together with accrued
interest is immediately due and payable upon our written demand. The greatest
outstanding balance of such advances to Mr. Guez during 2007 was approximately
$2,151,000. At December 31, 2007, the entire balance due from Mr. Guez totaling
$1.9 million was reflected as a reduction of shareholders' equity. All amounts
due from Mr. Guez bore interest at the rate of 7.75% during the period. Total
interest paid by Mr. Guez was $209,000, $171,000 and $158,000 for the years
ended December 31, 2005, 2006 and 2007, respectively. Mr. Guez paid expenses on
our behalf of approximately $397,000, $299,000 and $365,000 for the years ended
December 31, 2005, 2006 and 2007, respectively, which amounts were applied to
reduce accrued interest and principal on Mr. Guez's loan. These amounts included
fuel and related expenses incurred by 477 Aviation, LLC, a company owned by Mr.
Guez, when our executives used this company's aircraft for business purposes.
Since the enactment of the Sarbanes-Oxley Act in 2002, no further personal loans
(or amendments to existing loans) have been or will be made to our officers or
directors.

On July 1, 2001, we formed an entity to jointly market, share certain
risks and achieve economies of scale with Azteca Production International, Inc.
("Azteca"), called United Apparel Ventures, LLC ("UAV"). This entity was created
to coordinate the production of apparel for a single customer of our branded
business. Azteca is owned by the brothers of Gerard Guez. UAV made purchases
from a related party in Mexico, an affiliate of Azteca. UAV was owned 50.1% by
Tag Mex, Inc., our wholly owned subsidiary, and 49.9% by Azteca. Results of the
operation of UAV had been consolidated into our results since July 2001 with the
minority partner's share of gain and losses eliminated through the minority
interest line in our financial statements until 2004. Due to the restructuring
of our Mexico operations, we discontinued manufacturing for UAV customers in
2004. We had been consolidating 100% of the results of the operation of UAV into
our results since 2005. UAV was dissolved on February 27, 2007. We purchased
$135,000, $1.1 million and $499,000 of finished goods, fabric and service from
Azteca and its affiliates for the years ended December 31, 2005, 2006 and 2007,
respectively. Our total sales of fabric and service to Azteca in 2005, 2006 and
2007 were $88,000, $9,000 and $0, respectively. Based on the repayment history
of Azteca and litigation which Azteca is currently subject to, we estimated that
our receivable of $3.4 million will take approximately three years for
collection in full. We therefore made a $1.0 million reserve and then
fair-valued the balance of this asset using our weighted average cost of capital
as the discount rate and a term of three years as the discount period. Net
amounts due from this related party as of December 31, 2006 and 2007 were $4.0
million and $1.5 million, respectively.

On September 1, 2006, our subsidiary in Hong Kong, Tarrant Company
Limited, entered into an agreement with Seven Licensing to be its buying agent
to source and purchase apparel merchandise. Seven Licensing is beneficially
owned by Gerard Guez. Total sales to Seven Licensing for the years ended
December 31, 2006 and 2007 were $4.4 million and $19.4 million, respectively.
Net amounts due from this related party as of December 31, 2006 and 2007 were
$3.5 million and $6.8 million, respectively.

We believe that each of the transactions described above has been
entered into on terms no less favorable to us than could have been obtained from
unaffiliated third parties. We have adopted a policy that any transactions
between us and any of our affiliates or related parties, including our executive
officers, directors, the family members of those individuals and any of their
affiliates, must (i) be approved by a majority of the members of the Board of
Directors and by a majority of the disinterested members of the Board of
Directors and (ii) be on terms no less favorable to us than could be obtained
from unaffiliated third parties.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

FOREIGN CURRENCY RISK. Our 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 foreign jurisdictions. As a result, we bear the risk of exchange
rate gains and losses that may result in the future. At times we use forward
exchange contracts to reduce the effect of fluctuations of foreign currencies on
purchases and commitments. These short-term assets and commitments are
principally related to trade payables positions. At December 31, 2007, we had no
open foreign exchange forward contracts. We do not utilize derivative financial
instruments for trading or other speculative purposes. We actively evaluate the
creditworthiness of the financial institutions that are counter parties to
derivative financial instruments, and we do not expect any counter parties to
fail to meet their obligations.

INTEREST RATE RISK. Because our obligations under our various credit
agreements bear interest at floating rates, we are sensitive to changes in
prevailing interest rates. Any major increase or decrease in market interest
rates that affect our financial instruments would have a material impact on
earning or cash flows during the next fiscal year.

Our 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 our debt. A majority of our credit facilities are at variable
rates. As of December 31, 2006, we had $228,000 of fixed-rate borrowings and
$48.6 million of variable-rate borrowings outstanding. As of December 31, 2007,
we had $1.2 million of fixed-rate borrowings and $11.6 million of variable-rate
borrowings outstanding. A one percentage point increase in interest rates would
result in an annualized increase to interest expense of approximately $486,000
and $116,000 on our variable-rate borrowings for 2006 and 2007, respectively.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See "Item 15. Exhibits, Financial Statement Schedules" for our
financial statements, and the notes thereto, and the financial statement
schedules filed as part of this report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH THE ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

ITEM 9A(T). CONTROLS AND PROCEDURES

EVALUATION OF CONTROLS AND PROCEDURES

Members of our management, including our Chief Executive Officer and
Chief Financial Officer, have evaluated the effectiveness of our disclosure
controls and procedures, as defined by paragraph (e) of Exchange Act Rules
13a-15 or 15d-15, as of December 31, 2007, the end of the period covered by this
report. Members of the our management, including our Chief Executive Officer and
Chief Financial Officer, also conducted an evaluation of our internal control
over financial reporting to determine whether any changes occurred during the
fourth quarter of 2007 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures are effective.

CHANGES IN CONTROLS AND PROCEDURES

During the fourth quarter ended December 31, 2007, there were no
changes in our internal control over financial accounting that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.

MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate
internal control over financial reporting as defined in Rule 13a-15(f) under the
Securities Exchange Act of 1934. Internal control over financial reporting is a
process designed by, or under the supervision of, our Chief Executive Officer
and Chief Financial Officer and effected by our board of directors, management
and other personnel, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Our
internal control over financial reporting includes those policies and procedures
that:

(i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect our transactions and
dispositions of our assets;

(ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that our receipts and expenditures are being made only in
accordance with authorizations of our management and
directors; and

(iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of
our assets that could have a material effect on our financial
statements.

Because of its inherent limitations, internal control over financial
reporting determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and may not prevent or detect all
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.

Our management assessed the effectiveness of our internal control over
financial reporting as of December 31, 2007 based on the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission in
"Internal Control-Integrated Framework". Based on management's evaluation and
those criteria, we concluded that our internal control over financial reporting
was effective as of December 31, 2007.

This annual report does not include an attestation report of our
registered public accounting firm regarding internal control over financial
reporting. Management's report was not subject to attestation by our registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit us to provide only management's report in this
annual report.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information concerning our directors and executive officers will
appear in our definitive Proxy Statement to be filed pursuant to Regulation 14A
within 120 days after the end of our last fiscal year (the "Proxy Statement"),
and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information concerning executive compensation will appear in our
definitive Proxy Statement and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The information concerning the security ownership of certain beneficial
owners and management and related stockholder matters will appear in our
definitive Proxy Statement and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE

The information concerning certain relationships and related
transactions will appear in our definitive Proxy Statement and is incorporated
herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information concerning principal accounting fees and services will
appear in our definitive Proxy Statement and is incorporated herein by
reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) List the following documents filed as a part of this report:

(1) FINANCIAL STATEMENTS.

(2) FINANCIAL STATEMENT SCHEDULES.

Reference is made to the Index to Financial Statements and Schedule on
page F-1 for a list of financial statements and the financial statement schedule
filed as part of this Annual Report on Form 10-K. All other schedules are
omitted because they are not applicable or the required information is shown in
the Company's financial statements or the related notes thereto.

(3) EXHIBITS.

See the Exhibit Index attached to this Annual Report on Form 10-K,
which is incorporated herein by reference..

INDEX TO FINANCIAL STATEMENTS AND SCHEDULE

PAGE
----

Financial Statements

Report of Independent Registered Public Accounting Firm,
Singer Lewak Greenbaum & Goldstein LLP..................................F-2

Consolidated Balance Sheets--December 31, 2006 and 2007.................F-3

Consolidated Statements of Operations --Three year period
ended December 31, 2007.................................................F-4

Consolidated Statements of Shareholders' Equity--Three year
period ended December 31, 2007..........................................F-5

Consolidated Statements of Cash Flows--Three year period
ended December 31, 2007.................................................F-6

Notes to Consolidated Financial Statements..............................F-7

Financial Statement Schedule

Schedule II--Valuation and Qualifying Accounts.........................F-40

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
Tarrant Apparel Group
Los Angeles, California

We have audited the consolidated balance sheets of Tarrant Apparel Group and
subsidiaries (collectively, the "Company") as of December 31, 2007 and 2006, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2007. Our
audits also included the financial statement schedule of Tarrant Apparel Group
listed in Item 15(a). These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Tarrant Apparel
Group and subsidiaries as of December 31, 2007 and 2006, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2007, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.

As discussed in Note 1 to the consolidated financial statements, the Company has
adopted the provisions of Statement of Financial Accounting Standards
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of FASB Statement No. 109" on January 1, 2007.

We were not engaged to examine management's assertion about the effectiveness of
Tarrant Apparel Group's internal control over financial reporting as of December
31, 2007 included in the accompanying Management's Annual Report on Internal
Control over Financial Reporting and, accordingly, we do not express an opinion
thereon.

/s/ Singer Lewak Greenbaum & Goldstein LLP
--------------------------------------------
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP

Los Angeles, California
March 27, 2008

F-2

TARRANT APPAREL GROUP

CONSOLIDATED BALANCE SHEETS

DECEMBER 31,
-------------------------------
2006 2007
------------- -------------

ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 904,553 $ 491,416
Accounts receivable, net of $2.1 million and $2.0 million allowance for
returns, discounts and bad debts at December 31, 2006 and 2007,
respectively ....................................................... 48,079,527 34,622,119
Due from related parties .............................................. 3,688,355 6,812,951
Inventory ............................................................. 17,774,103 13,140,598
Temporary quota rights ................................................ 32,217 5,028
Prepaid expenses ...................................................... 1,515,087 1,277,361
Deferred tax assets ................................................... 123,607 161,818
Income taxes receivable ............................................... 25,468 --
------------- -------------
Total current assets ................................................ 72,142,917 56,511,291

Property and equipment, net of $9.4 million and $8.3 million accumulated
depreciation at December 31, 2006 and 2007, respectively .............. 1,414,354 1,531,322
Notes receivable - related parties, net of $27.1 million reserve at
December 31, 2006 ..................................................... 14,000,000 --
Due from related parties, net of $1.0 million reserve and $0.8 million
adjustment to fair value at December 31, 2007 ......................... 4,168,205 1,740,707
Equity method investment ................................................ 788,901 945,342
Deferred financing cost, net of $1.7 million and $226,000 accumulated
amortization at December 31, 2006 and 2007, respectively .............. 2,448,526 213,876
Other assets ............................................................ 6,223,816 101,692
Goodwill, net ........................................................... 9,945,005 9,945,005
------------- -------------

Total assets ........................................................ $ 111,131,724 $ 70,989,235
============= =============

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Short-term bank borrowings ............................................ $ 13,696,182 $ 9,745,218
Accounts payable ...................................................... 22,685,674 11,784,534
Accrued expenses ...................................................... 8,907,658 8,627,445
Derivative liability .................................................. 195,953 --
Income taxes .......................................................... 16,865,125 16,525,237
Current portion of long-term obligations and factoring arrangement .... 19,586,565 3,003,131
------------- -------------
Total current liabilities ........................................... 81,937,157 49,685,565

Term loan, net of $4.3 million debt discount at December 31, 2006 ....... 11,212,724 --
Other long-term obligations ............................................. 5,338 --
Deferred tax liabilities ................................................ -- --
------------- -------------
Total liabilities ................................................... 93,155,219 49,685,565

Minority interest in PBG7 ............................................... 54,338 60,520
Commitments and contingencies

Shareholders' equity:
Preferred stock, 2,000,000 shares authorized;
no shares at December 31, 2006 and 2007 issued and outstanding ........ -- --
Common stock, no par value, 100,000,000 shares authorized; 30,543,763
shares and 32,043,763 shares at December 31, 2006 and 2007 issued and
outstanding, respectively ............................................. 114,977,465 116,672,465
Warrants to purchase common stock ....................................... 7,314,239 7,314,239
Contributed capital ..................................................... 10,191,511 10,862,902
Accumulated deficit ..................................................... (112,410,363) (111,662,856)
Notes receivable from officer/shareholder ............................... (2,150,685) (1,943,600)
------------- -------------

Total shareholders' equity .......................................... 17,922,167 21,243,150
------------- -------------

Total liabilities and shareholders' equity .......................... $ 111,131,724 $ 70,989,235
============= =============

See accompanying notes.

F-3

TARRANT APPAREL GROUP

CONSOLIDATED STATEMENTS OF OPERATIONS

YEAR ENDED DECEMBER 31,
-------------------------------------------------
2005 2006 2007
------------- ------------- -------------

Net sales .................................... $ 214,648,218 $ 228,038,373 $ 224,289,591
Net sales to related party ................... -- 4,363,316 19,431,054
------------- ------------- -------------
Total net sales .............................. 214,648,218 232,401,689 243,720,645

Cost of sales ................................ 169,767,051 178,100,779 177,109,432
Cost of sales to related party ............... -- 3,658,806 17,711,950
------------- ------------- -------------
Total cost of sales .......................... 169,767,051 181,759,585 194,821,382

Gross profit ................................. 44,881,167 50,642,104 48,899,263
Selling and distribution expenses ............ 10,726,425 11,016,352 14,723,837
General and administrative expenses .......... 26,864,789 26,878,871 24,312,038
Royalty expenses ............................. 3,664,454 2,814,929 1,863,507
Loss on notes receivable - related parties ... -- 27,137,297 --
Terminated acquisition expenses .............. -- -- 2,000,000
Adjustment to fair value of long-term
receivable - related parties ............... -- -- 807,875
------------- ------------- -------------

Income (loss) from operations ................ 3,625,499 (17,205,345) 5,192,006
Interest expense ............................. (4,624,590) (6,059,628) (4,117,914)
Interest income .............................. 2,081,456 1,181,437 168,690
Interest in income of equity method investee.. 559,634 79,696 156,441
Other income ................................. 354,347 335,731 4,094,317
Adjustment to fair value of derivative ....... -- 315,134 195,953
Other expense ................................ (580) (435,586) (4,976,813)
------------- ------------- -------------

Income (loss) before provision (credit) for
income taxes and minority interest ......... 1,995,766 (21,788,561) 712,680
Provision (credit) for income taxes .......... 927,181 453,090 (1,041,010)
Minority interest ............................ 75,241 (20,903) 6,183
------------- ------------- -------------

Net income (loss) ............................ $ 993,344 $ (22,220,748) $ 1,747,507
============= ============= =============

Net income (loss) per share - Basic .......... $ 0.03 $ (0.73) $ 0.06
============= ============= =============

Net income (loss) per share - Diluted ........ $ 0.03 $ (0.73) $ 0.06
============= ============= =============

Weighted average common and common equivalent
shares outstanding:
Basic ........................................ 29,728,997 30,545,599 30,617,736
============= ============= =============

Diluted ...................................... 29,734,291 30,545,814 30,617,736
============= ============= =============

See accompanying notes.

F-4

TARRANT APPAREL GROUP

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007

PREFERRED NUMBER COMMON NUMBER
STOCK OF SHARES STOCK OF SHARES WARRANTS
------------- ------------- ------------- ------------- -------------

Balance at January 1, 2005 ................. $ -- -- $ 111,515,091 28,814,763 $ 2,846,833
Net income .............................. -- -- -- -- --
Compensation expense .................... -- -- -- -- --
Issuance of common stock ................ -- -- 375,000 195,313 --
Conversion of debentures ................ -- -- 3,087,374 1,543,687 --
Repayment from shareholder .............. -- -- -- -- --
------------- ------------- ------------- ------------- -------------

Balance at December 31, 2005 ............... $ -- -- $ 114,977,465 30,553,763 $ 2,846,833
Net loss ................................ -- -- -- -- --
Stock-based compensation ................ -- -- -- -- --
Cancellation of common stock ............ -- -- -- (10,000) --
Issuance of warrants with debentures .... -- -- -- -- 4,467,406
Repayment from shareholder .............. -- -- -- -- --
------------- ------------- ------------- ------------- -------------

Balance at December 31, 2006 ............... $ -- -- $ 114,977,465 30,543,763 $ 7,314,239
Accounting for uncertain tax position ... -- -- -- -- --
Net income .............................. -- -- -- -- --
Stock-based compensation ................ -- -- -- -- --
Exercise of stock options ............... -- -- 1,695,000 1,500,000 --
Dissolution of a partnership ............ -- -- -- -- --
Repayment from shareholder .............. -- -- -- -- --
------------- ------------- ------------- ------------- -------------

Balance at December 31, 2007 ............... $ -- -- $ 116,672,465 32,043,763 $ 7,314,239
============= ============= ============= ============= =============

RETAINED
EARNINGS TOTAL
CONTRIBUTED (ACCUMULATED NOTES FROM SHAREHOLDERS'
CAPITAL DEFICIT) SHAREHOLDERS EQUITY
------------- ------------- ------------- -------------

Balance at January 1, 2005 ................. $ 9,965,591 $ (91,182,959) $ (2,466,062) $ 30,678,494
Net income .............................. -- 993,344 -- 993,344
Compensation expense .................... 38,740 -- -- 38,740
Issuance of common stock ................ -- -- -- 375,000
Conversion of debentures ................ -- -- -- 3,087,374
Repayment from shareholder .............. -- -- 187,359 187,359
------------- ------------- ------------- -------------

Balance at December 31, 2005 ............... $ 10,004,331 $ (90,189,615) $ (2,278,703) $ 35,360,311
Net loss ................................ -- (22,220,748) -- (22,220,748)
Stock-based compensation ................ 187,180 -- -- 187,180
Cancellation of common stock ............ -- -- -- --
Issuance of warrants with debentures .... -- -- -- 4,467,406
Repayment from shareholder .............. -- -- 128,018 128,018
------------- ------------- ------------- -------------

Balance at December 31, 2006 ............... $ 10,191,511 $(112,410,363) $ (2,150,685) $ 17,922,167
Accounting for uncertain tax position ... -- (1,000,000) -- (1,000,000)
Net income .............................. -- 1,747,507 -- 1,747,507
Stock-based compensation ................ 771,391 -- -- 771,391
Exercise of stock options ............... -- -- -- 1,695,000
Dissolution of a partnership ............ (100,000) -- -- (100,000)
Repayment from shareholder .............. -- -- 207,085 207,085
------------- ------------- ------------- -------------

Balance at December 31, 2007 ............... $ 10,862,902 $(111,662,856) $ (1,943,600) $ 21,243,150
============= ============= ============= =============

See accompanying notes.

F-5

TARRANT APPAREL GROUP

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEAR ENDED DECEMBER 31,
-------------------------------------------------
2005 2006 2007
------------- ------------- -------------

Operating activities:
Net Income (loss) ....................................... $ 993,344 $ (22,220,748) $ 1,747,507
Adjustments to reconcile net income (loss) to net cash
provided by (used in)
Operating activities:
Deferred taxes ....................................... (166,686) 237,045 (38,211)
Depreciation and amortization of fixed assets ........ 727,233 455,124 414,909
Amortization of deferred financing cost .............. 1,399,352 2,525,210 1,532,295
Write-off of deferred financing cost and debt discount -- -- 4,950,616
Receipt of merchandise in lieu of interest on notes
receivable, related party .......................... (1,742,540) -- --
Adjustment to fair value of derivative ............... -- (315,134) (195,953)
Reserve of long-term receivable - related parties .... -- -- 1,000,000
Adjustment to fair value of long-term receivable -
related parties ................................... -- -- 807,875
Loss (gain) on notes receivable - related parties .... -- 27,137,297 (3,750,000)
Terminated acquisition expenses ...................... -- -- 2,000,000
Prepaid royalties write-off .......................... 1,165,970 -- --
Income from equity method investment ................. (559,634) (79,696) (156,441)
Loss (gain) on sale of fixed assets .................. (124,041) 35,587 20,048
Minority interest .................................... 75,241 (20,903) 6,183
Compensation expense related to stock options ........ 38,740 -- --
Stock-based compensation ............................. -- 187,180 771,392
Change in the provision for returns and discounts .... (78,060) 292,356 (333,648)
Change in the provision for bad debts ................ 591,945 (1,167,248) 234,066
Changes in operating assets and liabilities:
Accounts receivable ............................... (17,352,985) 6,528,104 14,056,128
Due to/from related parties ....................... 2,702,047 (1,160,821) (3,118,230)
Inventory ......................................... (8,503,086) 13,305,121 4,633,506
Temporary quota rights ............................ -- (32,217) 27,189
Prepaid expenses .................................. 47,055 900,886 263,193
Other assets ...................................... -- -- 125,000
Accounts payable .................................. 9,248,667 (10,593,284) (10,901,140)
Accrued expenses and income tax payable ........... (1,362,218) (967,312) (1,620,101)
------------- ------------- -------------
Net cash provided by (used in) operating activities .. (12,899,656) 15,046,547 12,476,183

Investing activities:
Purchase of fixed assets ................................ (559,081) (208,571) (553,060)
Proceeds from sale of fixed assets ...................... 130,552 6,346 1,134
Collection on notes receivable - related parties ........ 1,194,722 1,086,110 --
Proceeds from notes receivable .......................... -- -- 17,750,000
Distribution from equity method investee ................ 301,050 67,500 --
Deposit in acquisition .................................. -- (5,000,000) --
Refund of deposit in acquisition ........................ -- -- 4,750,000
Due diligence fees in acquisition ....................... -- (1,050,256) (699,744)
Trademark ............................................... -- (100,000) --
Collection of advances from shareholders/officers ....... 2,487,360 128,018 207,086
------------- ------------- -------------
Net cash provided by (used in) investing activities .. 3,554,603 (5,070,853) 21,455,416

Financing activities:
Short-term bank borrowings, net ......................... (4,117,625) (137,351) (3,950,964)
Proceeds from long-term obligations ..................... 218,367,495 235,101,785 205,837,789
Payment of financing costs .............................. -- (2,405,201) --
Payment of long-term obligations and bank borrowings .... (204,477,993) (236,359,516) (222,426,561)
Repayment of term loan .................................. -- -- (15,500,000)
Proceeds (repayments) from convertible debentures ....... -- (6,912,626) --
Exercise of stock options ............................... -- -- 1,695,000
------------- ------------- -------------
Net cash provided by (used in) financing activities .. 9,771,877 (10,712,909) (34,344,736)
------------- ------------- -------------

Increase (decrease) in cash and cash equivalents ........ 426,824 (737,215) (413,137)
Cash and cash equivalents at beginning of year .......... 1,214,944 1,641,768 904,553
------------- ------------- -------------

Cash and cash equivalents at end of year ................ $ 1,641,768 $ 904,553 $ 491,416
============= ============= =============

See accompanying notes

F-6

TARRANT APPAREL GROUP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BASIS OF CONSOLIDATION

The accompanying financial statements consist of the consolidation of Tarrant
Apparel Group, a California corporation, and its majority owned subsidiaries
located primarily in the U.S., Asia, Mexico, and Luxembourg. At December 31,
2007, we own 75% of PBG7, LLC ("PBG7"). We previously owned 50.1% of United
Apparel Ventures ("UAV"), which was dissolved on February 27, 2007. The
dissolution of UAV did not have a material impact on our consolidated financial
statements. We consolidate these entities and reflect the minority interests in
earnings (losses) of the ventures in the accompanying financial statements. All
inter-company amounts are eliminated in consolidation. The 49.9% minority
interest in UAV was owned by Azteca Production International, a corporation
owned by the brothers of our Chairman and Interim Chief Executive Officer,
Gerard Guez. The 25% minority interest in PBG7 is owned by BH7, LLC, an
unrelated party.

We serve specialty, retail, mass merchandisers, department store chains and
branded wholesalers by designing, merchandising, contracting for the manufacture
of, and selling casual apparel for women, men and children under private label
and private brand.

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.
Generally, the second and third quarters are stronger than the first and fourth
quarters. There can be no assurance that the historic operating patterns will
continue in future periods.

RISK AND UNCERTAINTIES - IRS EXAMINATION

In January 2004, the Internal Revenue Service ("IRS") completed its examination
of our Federal income tax returns for the years ended December 31, 1996 through
2001. The IRS had proposed adjustments to increase our income tax payable for
these years under examination. In addition, in July 2004, the IRS initiated an
examination of our Federal income tax return for the year ended December 31,
2002. In December 2007, we received a final assessment from the IRS of $7.4
million for the years ended December 31, 1996 through 2002, and in the first
quarter of 2008 we entered into a final settlement agreement with the IRS. Under
the settlement, which totals $13.9 million, including $6.5 million of interest,
we agreed to pay the IRS $4 million in March 2008 and an additional $250,000 per
month until repayment in full. The settlement with the IRS is within amounts
previously reserved for in our financial statements, and we therefore do not
anticipate the settlement to result in any additional charges to income other
than interest on the outstanding balance.

RISK AND UNCERTAINTIES - DEBT COVENANTS

As discussed in Note 9 of the "Notes to Consolidated Financial Statements," our
debt agreements require certain covenants including a minimum level of EBITDA
and specified tangible net worth; and required interest coverage ratio and
leverage ratio. If our results of operations erode and we are not able to obtain
waivers from the lenders, the debt would be in default and callable by our
lenders. In addition, due to cross-default provisions in our debt agreements,
substantially all of our long-term debt would become due in full if any of the
debt is in default. In anticipation of us not being able to meet the required
covenants due to various reasons, we either negotiate for changes in the
relative covenants or an advance waiver or reclassify the relevant debt as
current. We also believe that our lenders would provide waivers if necessary.
However, our expectations of future operating results and continued compliance
with other debt covenants cannot be assured and our lenders' actions are not
controllable by us. If projections of future operating results are not achieved
and the debt is placed in default, we would be required to reduce our expenses,
including by curtailing operations, and to raise capital through the sale of
assets, issuance of equity or otherwise, any of which could have a material
adverse effect on our financial condition and results of operations. See Note 9
of the "Notes to Consolidated Financial Statements" for a further discussion of
the credit facilities and related debt covenants. As of December 31, 2007, we
were in violation of the EBITDA and tangible net worth covenants and waivers of
the defaults were obtained in March 2008 from our lenders.

F-7

REVENUE RECOGNITION

Revenue is recognized at the point of shipment for all merchandise sold based on
FOB shipping point. For merchandise shipped on landed duty paid ("LDP") terms,
revenue is recognized at the point of either leaving Customs for direct
shipments or at the point of leaving our warehouse where title is transferred,
net of an estimate of returned merchandise and discounts. Customers are allowed
the rights of return or non-acceptance only upon receipt of damaged products or
goods with quality different from shipment samples. We do not undertake any
after-sale warranty or any form of price protection.

We often arrange, on behalf of manufacturers, for the purchase of fabric from a
single supplier. We have the fabric shipped directly to the cutting factory.
Generally, the factories pay us for the fabric with offsets against the price of
the finished goods.

SHIPPING AND HANDLING COSTS

Freight charges are included in selling and distribution expenses in the
statements of operations and amounted to $667,000, $781,000 and $641,000 for the
years ended December 31, 2005, 2006 and 2007, respectively. In 2005, 2006 and
2007, we did some billing for freight to specialty stores although the amount
was insignificant.

CASH AND CASH EQUIVALENTS

Cash equivalents consist of cash and highly liquid investments with an original
maturity of three months or less when purchased. Cash and cash equivalents held
in foreign financial institutions totaled $260,000 and $262,000 as of December
31, 2006 and 2007, respectively. Cash is deposited with what we believe are
highly credited quality financial institutions and may exceed FDIC insured
limits. As of December 31, 2006 and 2007, cash deposited in financial
institutions that exceeded FDIC insured limits was $1.4 million and $660,000,
respectively.

ACCOUNTS RECEIVABLE--ALLOWANCE FOR RETURNS, DISCOUNTS AND BAD DEBTS

We evaluate the collectibility of accounts receivable and chargebacks (disputes
from the customer) based upon a combination of factors. In circumstances where
we are aware of a specific customer's inability to meet its financial
obligations (such as in the case of bankruptcy filings or substantial
downgrading of credit sources), a specific reserve for bad debts is taken
against amounts due to reduce the net recognized receivable to the amount
reasonably expected to be collected. For all other customers, we recognize
reserves for bad debts and uncollectible chargebacks based on our historical
collection experience. If collection experience deteriorates (for example, due
to an unexpected material adverse change in a major customer's ability to meet
its financial obligations to us), the estimates of the recoverability of amounts
due to us could be reduced by a material amount. As of December 31, 2006 and
2007, the balance of the allowance for returns, discounts and bad debts was $2.1
million and $2.0 million, respectively.

INVENTORY

Our inventories are stated (valued) at the lower of cost (first-in, first-out)
or market. Under certain market conditions, we use estimates and judgments
regarding the valuation of inventory to properly value inventory. Inventory
adjustments are made for the difference between the cost of the inventory and
the estimated market value and charged to operations in the period in which the
facts that give rise to the adjustments become known.

COST OF SALES

Cost of sales includes costs related to product costs, direct labor, duty,
quota, freight in, brokerage, warehouse handling and markdown.

F-8

SELLING AND DISTRIBUTION EXPENSES

Selling and distribution expenses include expenses related to samples, travel
and entertainment, salaries, rent, warehouse handling, other office expenses,
professional fees, freight out, and selling commissions incurred in the sales
process.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses include expenses related to research and
product development, travel and entertainment, salaries, rent, other office
expenses, depreciation and amortization, professional fees and bank charges.

LICENSE AGREEMENTS AND ROYALTY EXPENSES

We enter into license agreements from time to time that allow us to use certain
trademarks and trade names on certain of its products. These agreements require
us to pay royalties, generally based on the sales of such products, and may
require guaranteed minimum royalties, a portion of which may be paid in advance.
Our accounting policy is to match royalty expense with revenue by recording
royalties at the time of sale at the greater of the contractual rate or an
effective rate calculated based on the guaranteed minimum royalty and our
estimate of sales during the contract period. If a portion of the guaranteed
minimum royalty is determined not to be recoverable, the unrecoverable portion
is charged to expense at that time. See Note 13 of the "Notes to Consolidated
Financial Statements" regarding various agreements we have entered into.

Royalty expense for each of the three fiscal years ended December 31, 2005, 2006
and 2007 were $3.7 million, $2.8 million and $1.9 million, respectively.

DEFERRED RENT PROVISION

When a lease requires fixed escalation of the minimum lease payments, rental
expense is recognized on a straight line basis over the initial term of the
lease, and the difference between the average rental amount charged to expense
and amounts payable under the lease is included in deferred amount. As of
December 31, 2006 and 2007, deferred rent of $93,000 and $260,000, respectively
was recorded under accrued expense in our consolidated financial statements.

DERIVATIVE ACTIVITIES

WARRANT DERIVATIVES

Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for
Derivative Instruments and Hedging Activities" requires measurement of certain
derivative instruments at their fair value for accounting purposes. In
determining the appropriate fair value, we use the Black-Scholes model.
Derivative liabilities are adjusted to reflect fair value at each period end,
with any increase or decrease in the fair value being recorded in consolidated
statements of operations as adjustment to fair value of derivative. At December
31, 2006, there was an income of $511,000 recorded as adjustment to fair value
of derivative on our consolidated statements of operations. See Note 9 of the
"Notes to Consolidated Financial Statements"

FOREIGN CURRENCY FORWARD CONTRACT

We source our product in a number of countries throughout the world, as a
result, are exposed to movements in foreign currency exchange rates. The primary
purpose of our foreign currency hedging activities is to manage the volatility
associated with foreign currency purchases of materials in the normal course of
business. We utilize derivative financial instruments consisting primarily of
forward currency contracts. These instruments are intended to protect against
exposure related to financing transactions and income from international
operations. We do not enter into derivative financial instruments for
speculative or trading purposes. We may enter into certain foreign currency
derivative instruments that do not meet hedge accounting criteria.

F-9

SFAS No. 133 requires measurement of certain derivative instruments at their
fair value for accounting purposes. All derivative instruments are recorded on
our balance sheet at fair value; as a result, we mark to market all derivative
instruments. Derivative liabilities are adjusted to reflect fair value at each
period end, with any increase or decrease in the fair value being recorded in
consolidated statements of operations as adjustment to fair value of derivative.
During the year ended December 31, 2006, we entered into foreign currency
forward contracts to hedge against the effect of exchange rate fluctuations on
cash flows denominated in foreign currencies and certain inter-company financing
transactions. This transaction is undesignated and as such an ineffective hedge.
At December 31, 2006, we had one open foreign exchange forward contract which
has a maturity of less than one year. Hedge ineffectiveness resulted in a loss
of $196,000 in our consolidated statements of operations as of December 31,
2006. At December 31, 2007, we had no open foreign exchange forward contracts.
Hedge ineffectiveness resulted in a gain of $196,000 in our consolidated
statements of operations as of December 31, 2007.

PRODUCT DESIGN, ADVERTISING AND SALES PROMOTION COSTS

Product design, advertising and sales promotion costs are expensed as incurred.
Product design, advertising and sales promotion costs included in selling,
general and administrative expenses in the accompanying statements of operations
(excluding the costs of manufacturing production samples) amounted to
approximately $3.0 million, $2.7 million and $3.9 million in 2005, 2006 and
2007, respectively.

PROPERTY AND EQUIPMENT

Property and equipment is recorded at cost. Additions and betterments are
capitalized while repair and maintenance costs are charged to operations as
incurred. Depreciation of property and equipment is provided for by the
straight-line method over their estimated useful lives. Leasehold improvements
are amortized using the straight-line method over the lesser of their estimated
useful lives or the term of the lease. Upon retirement or disposal of property
and equipment, the cost and related accumulated depreciation are eliminated from
the accounts and any gain or loss is reflected in the statement of operations.
The estimated useful lives of the assets are as follows:

Buildings......................................... 35 to 40 years
Equipment......................................... 5 to 15 years
Furniture and Fixtures............................ 5 to 7 years
Vehicles.......................................... 5 years
Leasehold Improvements........ Term of lease or Estimated useful life

IMPAIRMENT OF LONG-LIVED ASSETS

The carrying value of long-lived assets are reviewed when events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If it is determined that an impairment loss has occurred based on
the lowest level of identifiable expected future cash flow, then a loss is
recognized in the statement of operations using a fair value based model.

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL

We have adopted SFAS No. 142, "Goodwill and Other Intangible Assets." We assess
the need for impairment of identifiable intangibles, long-lived assets and
goodwill with a fair-value-based test on an annual basis or more frequently if
an event occurs or circumstances change that would more likely than not reduce
the fair value of a reporting unit below its carrying amount. Factors considered
important that could trigger an impairment review include, but are not limited
to, the following:

o a significant underperformance relative to expected historical
or projected future operating results;

o a significant change in the manner of the use of the acquired
asset or the strategy for the overall business; or

o a significant negative industry or economic trend.

F-10

We utilized the discounted cash flow methodology to estimate fair value. At
December 31, 2006, we had a goodwill balance of $9.9 million, and a net property
and equipment balance of $1.4 million, as compared to a goodwill balance of $9.9
million and a net property and equipment balance of $1.5 million at December 31,
2007. See Note 6 and Note 8 of the "Notes to Consolidated Financial Statements."

During the years ended December 31, 2006 and 2007, we did not recognize any need
for impairment related to goodwill and property and equipment.

DEFERRED FINANCING COST

Deferred financing costs were $2.4 million and $214,000 at December 31, 2006 and
2007, respectively. These costs of obtaining financing and issuance of debt
instruments are being amortized on a straight-line basis over the term of the
related debt. Amortization expenses for deferred charges were $1.4 million, $2.5
million and $1.5 million for the years ended December 31, 2005, 2006 and 2007,
respectively.

INCOME TAXES

We utilize SFAS No. 109, "Accounting for Income Taxes," which prescribes the use
of the liability method to compute the differences between the tax basis of
assets and liabilities and the related financial reporting amounts using
currently enacted tax laws and rates. A valuation allowance is recorded to
reduce deferred taxes to the amount that is more likely than not to be realized.

Our foreign subsidiary had an accumulated earning and profit deficit at December
31, 2006 and 2007. Any current year foreign earning and profit will be reported
by us as dividends on our tax returns.

In June 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - An
Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with SFAS No. 109, "Accounting for Income
Taxes." FIN 48 also prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return that results in a tax benefit.
Additionally, FIN 48 provides guidance on de-recognition, income statement
classification of interest and penalties, accounting in interim periods,
disclosure, and transition. We adopted the provisions of FIN 48 on January 1,
2007. As a result of the implementation of FIN 48, we recognized no material
adjustment for unrecognized tax benefits but reduced retained earnings as of
January 1, 2007 by approximately $1 million attributable to penalties accrued as
a component of income tax payable. As of the date of adoption, our unrecognized
tax benefits totaled approximately $8.9 million.

We and several of our subsidiaries file income tax returns in the U.S., Hong
Kong, Luxembourg, Mexico and various state jurisdictions. We are currently
subject to an audit by the State of New York for the years 2002 to 2005 but are
not currently being audited by other states or subject to non-U.S. income tax
jurisdictions for years open in those taxing jurisdictions.

In January 2004, the IRS completed its examination of our Federal income tax
returns for the years ended December 31, 1996 through 2001. The IRS had proposed
adjustments to increase our income tax payable for these years under
examination. In addition, in July 2004, the IRS initiated an examination of our
Federal income tax return for the year ended December 31, 2002. In December
2007, we received a final assessment from the IRS of $7.4 million for the years
ended December 31, 1996 through 2002, and in the first quarter of 2008, we
entered into a final settlement agreement with the IRS. Under the settlement,
which totals $13.9 million, including $6.5 million of interest, we agreed to pay
the IRS $4 million in March 2008 and an additional $250,000 per month until
repayment in full. The settlement with the IRS is within amounts accrued for as
of December 31, 2007 in our financial statements, and we therefore do not
anticipate the settlement to result in any additional charges to income other
than interest on the outstanding balance. Due to the negotiated settlement, we
reclassified the IRS and state tax liabilities from uncertain tax position to
current payable on December 31, 2007.

F-11

interest accrued related to unrecognized tax benefits and penalties as a
component of income tax expense. As of January 1, 2007, the accrued interest and
penalties were $8.0 million and $1.2 million, respectively, excluding any
related income tax benefits. During 2007, we de-recognized a previous uncertain
tax position through negotiations with the state tax jurisdiction. The
negotiated settlement resulted in a decrease of $1.5 million in unrecognized tax
benefits and $1.0 million in penalties. During 2007, we also de-recognized a
previous uncertain tax position through settlement with the IRS. The negotiated
settlement resulted in a decrease of $7.4 million in unrecognized tax benefits.
After the above adjustments, there was no unrecognized tax benefit as of
December 31, 2007. As of December 31, 2007, the accrued interest and penalties
were $7.2 million and $142,000, respectively.

In many cases, the uncertain tax positions are related to tax years that remain
subject to examination by the relevant tax authorities. Federal and state
statutes are open from 2003 through the present period. Hong Kong statutes are
open from 2001, Luxembourg from 2003 and Mexico from 2001.

NET INCOME (LOSS) PER SHARE

Basic and diluted income (loss) per share has been computed in accordance with
SFAS No. 128, "Earnings Per Share". A reconciliation of the numerator and
denominator of basic income (loss) per share and diluted income (loss) per share
is as follows:

YEAR ENDED DECEMBER 31,
---------------------------------------------
2005 2006 2007
------------ ------------ ------------

Basic EPS Computation:
Numerator:
Reported net income (loss) ................. $ 993,344 $(22,220,748) $ 1,747,507

Denominator:
Weighted average common shares outstanding.. 29,728,997 30,545,599 30,617,736

Basic EPS .................................. $ 0.03 $ (0.73) $ 0.06
============ ============ ============

Diluted EPS Computation:
Numerator:
Reported net income (loss) ................. $ 993,344 $(22,220,748) $ 1,747,507

Denominator:
Weighted average common shares outstanding.. 29,728,997 30,545,599 30,617,736
Incremental shares from assumed exercise of
warrants ................................... -- -- --
convertible debentures ..................... -- -- --
options .................................... 5,294 215 --
------------ ------------ ------------
Total shares ............................... 29,734,291 30,545,814 30,617,736

Diluted EPS ................................ $ 0.03 $ (0.73) $ 0.06
============ ============ ============

The following potentially dilutive securities were not included in the
computation of income (loss) per share, because to do so would have been
anti-dilutive:

2005 2006 2007
---------- ---------- ----------

Options ..................... 6,727,756 7,673,444 8,214,209
Warrants .................... 2,361,732 5,931,732 5,931,732
Convertible debentures ...... 3,456,313 -- --
---------- ---------- ----------
Total .................... 12,545,801 13,605,176 14,145,941

F-12

DIVIDENDS

We did not declare or pay any cash dividends in 2005, 2006 or 2007. We intend to
retain any future earnings for use in our business and, therefore, do not
anticipate declaring or paying any cash dividends in the foreseeable future. The
declaration and payment of any cash dividends in the future will depend upon our
earnings, financial condition, capital needs and other factors deemed relevant
by the Board of Directors. In addition, our credit agreements prohibit the
payment of dividends during the term of the agreements.

FOREIGN CURRENCY TRANSLATION

Transaction gains or losses, other than inter-company debt deemed to be of a
long-term nature, are included in net income (loss) in the period in which they
occur. Foreign currency gains and losses resulting from translation of assets
and liabilities related to our Hong Kong subsidiaries were insignificant in 2006
and 2007.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of financial instruments is determined by reference to various
market data and other valuation techniques as appropriate. Considerable judgment
is required in estimating fair values. Accordingly, the estimates may not be
indicative of the amounts that we could realize in a current market exchange.
The carrying amounts of cash and cash equivalents, receivables, inventory,
prepaid expenses, accounts payable and accrued expenses approximate fair values.
The carrying amounts of our variable rate borrowings under the various
short-term borrowings and long-term debt arrangements approximate fair value.

CONCENTRATION OF CREDIT RISK

Financial instruments, which potentially expose us to concentration of credit
risk, consist primarily of cash equivalents, trade accounts receivable, related
party receivables and amounts due from factor.

Our products are primarily sold to mass merchandisers and specialty retail
stores. These customers can be significantly affected by changes in economic,
competitive or other factors. We make substantial sales to a relatively few,
large customers. In order to minimize the risk of loss, we assign certain of our
domestic accounts receivable to a factor without recourse or require letters of
credit from our customers prior to the shipment of goods. For non-factored
receivables, account-monitoring procedures are utilized to minimize the risk of
loss. Collateral is generally not required. At December 31, 2006 and 2007,
approximately 23% and 31%, respectively of accounts receivable were due from two
customers. The following table presents the percentage of net sales concentrated
with certain customers.

PERCENTAGE OF NET SALES
------------------------------------
CUSTOMER 2005 2006 2007
--------------------- ------- ------- -------
Macy's Merchandising Group............ 13.4 18.9 21.1
New York & Co. ....................... 8.6 4.5 12.5
Chico's .............................. 8.3 8.5 11.3
Kohl's................................ 13.5 14.1 8.5
Mervyn's.............................. 11.2 11.9 8.3
Wal-Mart.............................. 11.1 4.5 3.5

We maintain demand deposits with several major banks. At times, cash balances
may be in excess of Federal Deposit Insurance Corporation or equivalent foreign
insurance limits.

F-13

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires us to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Significant estimates used by us in
preparation of the financial statements include allowance for returns, discounts
and bad debts, inventory, notes receivable - related parties reserve, valuation
of long-lived and intangible assets and goodwill, accrued expenses, income
taxes, stock options valuation, contingencies and litigation. Actual results
could differ from those estimates.

IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". SFAS
No. 157 establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements.
SFAS No. 157 is effective for financial statements issued for fiscal years
beginning after November 15, 2007. We are required to adopt the provision of
SFAS No. 157, as applicable, beginning in fiscal year 2008. We are currently
assessing the impact of SFAS No. 157 on our results of operations and financial
condition.

In September 2006, the FASB issued SFAS No. 158, "Employer's Accounting for
Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB
Statements No. 87, 88, 106 and 132(R)". SFAS No. 158 requires us to (a)
recognize a plan's funded status in the statement of financial position, (b)
measure a plan's assets and its obligations that determine its funded status as
of the end of the employer's fiscal year and (c) recognize changes in the funded
status of a defined postretirement plan in the year in which the changes occur
through other comprehensive income. SFAS No. 158 was effective for fiscal years
ending after December 15, 2006. The adoption of SFAS No. 158 did not have a
material impact on our results of operations and financial condition.

In September 2006, the SEC issued SAB No. 108, "Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements", to address diversity in practice in quantifying financial statement
misstatements. SAB No. 108 requires the quantification of misstatements based on
their impact on both the balance sheet and the income statement to determine
materiality. The guidance provides for a one-time cumulative effect adjustment
to correct for misstatements that were not deemed material under a company's
prior approach but are material under the SAB No. 108 approach. SAB No. 108 was
effective for fiscal years ending after November 15, 2006. The adoption of SAB
108 did not have a material impact on our results of operations and financial
condition.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Liabilities- Including an amendment of FASB Statement No.
115". SFAS No. 159 permits entities to choose to measure certain financial
assets and liabilities at fair value (the "fair value option"). Unrealized gains
and losses, arising subsequent to adoption, are reported in earnings. SFAS No.
159 is effective for fiscal years beginning after November 15, 2007. We are
currently assessing the impact of SFAS No. 159 on our results of operations and
financial condition.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations". The objective of SFAS No. 141(R) is to improve the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial reports about a business combination
and its effects. The new standard requires the acquiring entity in a business
combination to recognize all (and only) the assets acquired and liabilities
assumed in the transaction; establishes the acquisition-date fair value as the
measurement objective for all assets acquired and liabilities assumed; and
requires the acquirer to disclose to investors and other users all of the
information they need to evaluate and understand the nature and financial effect
of the business combination. SFAS No. 141(R) is effective for fiscal years
beginning after December 15, 2008. We are currently assessing the impact of SFAS
No. 141(R) on our results of operations and financial condition.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No.51". The objective of
SFAS No. 160 is to improve the relevance, comparability, and transparency of the
financial information that a reporting entity provides in its consolidated
financial statements by establishing accounting and reporting standards by
requiring all entities to report noncontrolling (minority) interests in
subsidiaries in the same way - as an entity in the consolidated financial
statements. Moreover, SFAS No. 160 eliminates the diversity that currently
exists in accounting for transactions between an entity and noncontrolling
interests by requiring they be treated as equity transactions. SFAS No. 160 is
effective for fiscal years beginning after December 15, 2008. We are currently
assessing the impact of SFAS No. 160 on our results of operations and financial
condition.

F-14

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the current year
presentation. Equity method investment of $1.4 million has been reclassified to
goodwill in fiscal 2006 to conform to the fiscal 2007 presentation.

2. ACCOUNTS RECEIVABLE

Accounts receivable consists of the following:

DECEMBER 31,
-----------------------------
2006 2007
------------ ------------

U.S. trade accounts receivable ............... $ 2,975,840 $ 4,277,218
Foreign trade accounts receivable ............ 16,986,357 6,809,971
Factored accounts receivable ................. 29,697,935 25,294,525
Other receivables ............................ 496,253 217,681
Allowance for returns, discounts and bad debts (2,076,858) (1,977,276)
------------ ------------
$ 48,079,527 $ 34,622,119
============ ============

At December 31, 2007, substantially all trade receivables, irrespective of their
debt ratings, were factored under our credit facility with GMAC and GMAC
advances up to 90% of the invoice value to us immediately upon the submission of
invoices. See Note 9 of "Notes to Consolidated Financial Statements."

3. INVENTORY

Inventory consists of the following:

DECEMBER 31,
-----------------------------
2006 2007
------------ ------------

Raw materials - fabric and trim accessories .. $ 3,271,610 $ 558,996
Work-in-process .............................. -- 5,040
Finished goods shipments-in-transit .......... 7,331,422 7,023,981
Finished goods ............................... 7,171,071 5,552,581
------------ ------------
$ 17,774,103 $ 13,140,598
============ ============

F-15

4. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

DECEMBER 31,
-----------------------------
2006 2007
------------ ------------

Land ......................................... $ 85,000 $ 85,000
Buildings .................................... 819,372 819,372
Equipment .................................... 4,621,339 3,820,098
Furniture and fixtures ....................... 2,197,648 1,801,508
Leasehold improvements ....................... 2,727,243 2,932,366
Vehicles ..................................... 333,311 384,661
------------ ------------
10,783,913 9,843,005

Less accumulated depreciation and amortization (9,369,559) (8,311,683)
------------ ------------

$ 1,414,354 $ 1,531,322
============ ============

Depreciation expense, including amortization of assets recorded under capital
leases, totaled $727,000, $455,000 and $415,000 for the years ended December 31,
2005, 2006 and 2007, respectively.

5. NOTES RECEIVABLE - RELATED PARTY RESERVE

In connection with the sale in 2004 of our assets and real property in Mexico,
the purchasers of the Mexico assets, Solticio, S.A. de C.V. ("Solticio"), and
Acabados y Cortes Textiles, S.A. de C.V. ("Acotex"), issued us unsecured
promissory notes of $3,910,000 that matured on November 30, 2007 and secured
promissory notes of $40,204,000 with payments due on December 31, 2005 and every
year thereafter until December 31, 2014. The secured notes were secured by the
real and personal property in Mexico that we sold to the purchasers. As of
September 30, 2006, the outstanding balance of the notes and interest
receivables was $41.1 million prior to the reserve. Historically, we had placed
orders for purchases of fabric from the purchasers pursuant to the purchase
commitment agreement we entered into at the time of the sale of the Mexico
assets, and we had satisfied our payment obligations for the fabric by
offsetting the amounts payable against the amounts due to us under the notes.
However, during the third quarter of 2006, the purchasers ceased providing
fabric and were not making payments under the notes. We further evaluated the
recoverability of the notes receivable and recorded a loss on the notes
receivable in the third quarter of 2006 in an amount equal to the outstanding
balance less the value of the underlying assets securing the notes. The loss was
estimated to be approximately $27.1 million, resulting in a net notes receivable
balance at September 30, 2006 of approximately $14 million. We believe there was
no significant change subsequently on the value of the underlying assets
securing the notes; therefore, we did not have additional reserve after the
third quarter of 2006.

On March 21, 2007, our wholly-owned subsidiary, Tarrant Luxembourg S.a.r.l.,
entered into a letter agreement with Solticio, Inmobiliaria Cuadros, S.A. de
C.V. ("Inmobiliaria"), and Acotex, (Acotex and together with Solticio and
Inmobiliaria, the "Sellers"), and Tavex Algodonera, S.A. ("Tavex"), which was
subsequently amended. Pursuant to the agreement, as amended, Tavex had the right
and option (but not an obligation), at any time on or prior to September 1,
2007, to pay to Tarrant Luxembourg an aggregate of U.S. $17.75 million in cash,
whereupon, among other things, Tarrant Luxembourg would terminate the Solticio
and Acotex promissory notes described above and release the Sellers from any
further obligations thereunder, and terminate and release all liens on the
collateral securing those notes.

On August 21, 2007, we received a payment of $17.75 million from Tavex upon the
exercise by Tavex of its option in accordance with the agreement among the
parties. In return for the Tavex's payment of $17.75 million, we have taken the
following actions in accordance with the terms of the agreement:

F-16

o Tarrant Luxembourg and the Sellers terminated all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and

Upon closing of the transaction and receiving the payment of $17.75 million, we
recorded a gain of $3.75 million on our consolidated statements of operations as
other income in the third quarter of 2007. We placed a fabric order with Tavex
on August 21, 2007 for $1.25 million pursuant to the agreement. At December 31,
2007, the irrevocable letter of credit expired and we did not have any further
commitment to purchase fabric from Tavex.

6. EQUITY METHOD INVESTMENT - AMERICAN RAG

In 2003, we acquired a 45% equity interest in the owner of the trademark
"American Rag Cie" and the operator of American Rag retail stores for $1.4
million, and our subsidiary, Private Brands, Inc., acquired a license to certain
exclusive rights to this trademark. We have guaranteed the payment to the
licensor of minimum royalties of $10.4 million over the initial 10-year term of
the agreement. The guaranteed annual minimum royalty is payable in advance in
monthly installments during the term of the agreement. The royalty owed to the
licensor in excess of the guaranteed minimum, if any, is payable no later than
30 days after the end of the preceding full quarter with the amount for last
quarter adjusted based on actual royalties owed for the year. If a portion of
the guaranteed minimum royalty is determined not to be recoverable, the
unrecoverable portion is charged to expense at that time. The guaranteed annual
minimum royalty for 2007 is $760,000. At December 31, 2007, the total commitment
on royalties remaining on the term was $7.6 million. Private Brands also entered
into a multi-year exclusive distribution agreement with Macy's Merchandising
Group, LLC, the sourcing arm of Federated Department Stores, to supply Macy's
Merchandising Group with American Rag Cie, a casual sportswear collection for
juniors and young men. Under this arrangement, Private Brands designs and
manufactures American Rag apparel, which is distributed by Macy's Merchandising
Group exclusively to Federated stores across the country. Beginning in August
2003, the American Rag collection was available in select Macy's locations and
is currently available in approximately 600 Macy's stores nationally. The
investment in American Rag Cie, LLC totaling $789,000 and $945,000 at December
31, 2006 and 2007, respectively, is accounted for under the equity method and
included in equity method investment on the accompanying consolidated balance
sheets. In 2007, we re-classed $1,362,160 from equity method investment to
goodwill to rectify the goodwill portion arrived from the excess of the initial
investment over our 45% share of the net assets of American Rag. Income from the
equity method investment is recorded in the United States geographical segment.
The change in investment in American Rag for 2006 and 2007 is as follows:

Balance as of December 31, 2005 .... $ 2,138,865
Reclassification to goodwill ....... (1,362,160)
Share of income..................... 79,696
Distribution ....................... (67,500)
-------------
Balance as of December 31, 2006 .... $ 788,901
Share of income..................... 156,441
-------------
Balance as of December 31, 2007..... $ 945,342
=============

We hold a 45% member interest in American Rag Cie, LLC. The remaining 55%
belongs to an unrelated third party entity who contributed the American Rag
trademark and other assets and liabilities relating to two retail stores
operating under the name of "American Rag". Royalty incomes paid by us to
American Rag is classified as its other income and is ancillary to its primary
operations. Reported revenues from the retail business in fiscal 2005, 2006 and
2007 were approximately $10 million, $10 million and $11 million, respectively.
Royalty income paid to American Rag in 2005, 2006 and 2007 were $575,000, $1.1
million and $1.7 million, respectively.

We have determined that we are not the primary beneficiary of American Rag Cie,
LLC under FIN 46. There is no guaranteed return on our investment. American Rag
Cie, LLC has sufficient equity to finance its activities without any financial
support from us. We are not involved in its day to day management decisions and
it is effectively controlled by its Chief Executive Officer who is also the
majority shareholder of the 55% owners. In June 2006, we signed a guarantee of

F-17

certain liabilities of American Rag Cie, LLC to California United Bank to the
aggregate amount equal at all times to the lesser of (A) 45% of the aggregate
amount of the outstanding liabilities or (B) $675,000, which guarantee was
re-affirmed in September 2007. Upon execution of the guarantee, we re-evaluated
our investment under the provisions of FIN 46 and concluded that consolidation
under FIN 46 is still not appropriate. Our variable interest will not absorb a
majority of the VIE's expected losses. We record our proportionate share of
income and losses but are not obligated nor do we intend to absorb losses beyond
our 45% investment interest. Additionally, we do not expect to receive the
entity's expected residual returns, other than their 45% ownership interest.

We are currently involved in litigation with American Rag Cie, LLC and American
Rag Cie II with respect to our license rights to the American Rag Cie trademark.
See Note 21 of these "Notes to Consolidated Financial Statements".

7. OTHER ASSETS AND WRITE OFF OF ACQUISITION EXPENSES

THE BUFFALO GROUP

On December 6, 2006, we entered into a definitive stock and asset purchase
agreement (the "Purchase Agreement") to acquire certain assets and entities
comprising The Buffalo Group. The Buffalo Group designs, imports and sells
contemporary branded apparel and accessories, primarily in Canada and the United
States.

Pursuant to the Purchase Agreement, we and our subsidiaries agreed to acquire
(1) all the outstanding capital stock of four principal operating subsidiaries
of The Buffalo Group - Buffalo Inc., 3163946 Canada Inc., 3681441 Canada Inc.
and Buffalo Corporation, and (2) certain assets, consisting primarily of
intellectual property rights and licenses, from The Buffalo Trust, for a total
aggregate purchase price of up to approximately $120 million. At signing of the
Purchase Agreement, we delivered $5.0 million to the sellers as a deposit
against the purchase price payable under the agreement.

On April 19, 2007, we entered into a Mutual Termination and Release Agreement
with The Buffalo Group, pursuant to which we and the other parties to the
Purchase Agreement mutually agreed to terminate the Purchase Agreement. The
parties determined that it was in the mutual best interest of each party to
terminate the proposed agreement. Under the terms of the Mutual Termination and
Release Agreement, Buffalo agreed to return to us $4,750,000 of the $5,000,000
deposit previously provided by us to The Buffalo Group pursuant to the Purchase
Agreement, and the parties have released each other from any claims arising
under or related to the Purchase Agreement. The $5.0 million deposit was
previously recorded in other assets in consolidated balance sheets. We received
$4,750,000 in April 2007. The remaining portion of the deposit of $250,000 and
other due diligence fees incurred in the acquisition process were recorded as
terminated acquisition expenses in the consolidated statements of operations in
the first quarter of 2007.

8. IMPAIRMENT OF ASSETS

IMPAIRMENT OF GOODWILL

Goodwill on the accompanying consolidated balance sheets represents the "excess
of costs over fair value of net assets acquired in previous business
combination". SFAS No. 142, "Goodwill and Other Intangible Assets," requires
that goodwill and other intangibles be tested for impairment using a two-step
process. The first step is to determine the fair value of the reporting unit,
which may be calculated using a discounted cash flow methodology, and compare
this value to its carrying value. If the fair value exceeds the carrying value,
no further work is required and no impairment loss would be recognized. The
second step is an allocation of the fair value of the reporting unit to all of
the reporting unit's assets and liabilities under a hypothetical purchase price
allocation.

The following table displays the change in the gross carrying amount of goodwill
by reporting units for the years ended December 31, 2006 and 2007. The reporting
units below are one level below the reportable segments included in Note 18,
"Operations by Geographic Areas". The reporting units FR TCL - Chazzz & MGI
Division and Private Brands - American Rag Division were included within the
United States geographical segment of Note 18 of the "Notes to the Consolidated
Financial Statements."

F-18

REPORTING UNITS
---------------
FR TCL - PRIVATE BRANDS -
CHAZZZ & MGI DIVISION AMERICAN RAG DIVISION
--------------------- ---------------------
Balance as of January 1, 2006 .... $8,582,845 $1,362,160
Activities for the year .......... 0 0
---------- ----------
Balance as of December 31, 2006 .. $8,582,845 $1,362,160
Activities for the year .......... 0 0
---------- ----------
Balance as of December 31, 2007 .. $8,582,845 $1,362,160
========== ==========

9. DEBT

Debt consists of the following:

DECEMBER 31,
-----------------------------
2006 2007
------------ ------------

IMPORT TRADE BILLS PAYABLE, BANK DIRECT ACCEPTANCES AND OTHER HONG KONG CREDIT
FACILITIES

In June 2006, our subsidiaries in Hong Kong, Tarrant Company Limited, Marble
Limited and Trade Link Holdings Limited, entered into a new credit facility with
DBS Bank (Hong Kong) Limited ("DBS"), which replaced our prior letter of credit
facility for up to HKD 30 million (equivalent to US $3.9 million). Under this
facility, we may arrange for letters of credit and acceptances. The maximum
amount our Hong Kong subsidiaries may borrow under this facility at any time is
US $25 million. The interest rate under the letter of credit facility is equal
to the Standard Bills Rate quoted by DBS minus 0.5% if paid in Hong Kong
Dollars, which the interest rate was 7.5% per annum at December 31, 2007, or the
Standard Bills Rate quoted by DBS plus 0.5% if paid in any other currency, which
the interest rate was 8.12% per annum at December 31, 2007. This is a demand
facility and is secured by a security interest in all the assets of the Hong
Kong subsidiaries, by a pledge of our office property where our Hong Kong office
is located, which is owned by Gerard Guez and Todd Kay and by our guarantee. The
DBS facility includes customary default provisions. In addition, we are subject
to certain restrictive covenants, including that we maintain a specified
tangible net worth, and a minimum level of EBITDA at December 31, 2006 and 2007,
interest coverage ratio, leverage ratio and limitations on additional
indebtedness. As of December 31, 2007, we were in violation with the EBITDA and
tangible net worth covenants and a waiver was obtained on March 18, 2008. As of
December 31, 2007, $8.6 million was outstanding under this facility. In
addition, $11.3 million of open letters of credit was outstanding and $5.1
million was available for future borrowings as of December 31, 2007.

As of December 31, 2007, the total balance outstanding under the DBS Bank credit
facilities was $8.6 million (classified above as follows: $3.5 million in import
trade bills payable, $1.2 million in bank direct acceptances and $3.9 million in
other Hong Kong credit facilities).

F-19

In September 2006, a tax loan for HKD 8.438 million (equivalent to US $1.1
million) was also made available by DBS to our Hong Kong subsidiaries and bore
interest at the rate equal to the Hong Kong prime rate plus 1% and were subject
to the same security. The interest rate was 8.75% per annum at October 31, 2007.
We paid off this tax loan in October 2007. As of December 31, 2007, $0 was
outstanding under this tax loan.

From time to time, we open letters of credit under an uncommitted line of credit
from Aurora Capital Associates which issues these letters of credits out of
Israeli Discount Bank. As of December 31, 2007, $1.2 million was outstanding
under this facility (classified above under import trade bills payable) and
$903,000 of letters of credit was open under this arrangement. We pay a
commission fee of 2.25% on all letters of credits issued under this arrangement.

EQUIPMENT FINANCING

We had three equipment loans outstanding during 2007. One of these equipment
loans bore interest at 15.8% payable in installments through 2007, which we paid
off in December 2007. The second loan bore interest at 6.15% payable in
installment through 2007, which we paid off in December 2007. The third loan
bears interest at 4.75% payable in installment through 2008. As of December 31,
2007, $5,000 was outstanding under the remaining loan.

DEBT FACILITY AND FACTORING AGREEMENT - GMAC CF

On June 16, 2006, we expanded our previously existing credit facility with GMAC
Commercial Finance Credit, LLC ("GMAC CF") by entering into a new Loan and
Security Agreement and amending and restating our previously existing Factoring
Agreement with GMAC CF. UPS Capital Corporation is also a lender under the Loan
and Security Agreement. This is a revolving credit facility and has a term of 3
years. The amount we may borrow under this credit facility is determined by a
percentage of eligible accounts receivable and inventory, up to a maximum of $55
million, and includes a letter of credit facility of up to $4 million. Interest
on outstanding amounts under this credit facility is payable monthly and accrues
at the rate of the "prime rate" plus 0.5%. Our obligations under the GMAC CF
credit facility are secured by a lien on substantially all our domestic assets,
including a first priority lien on our accounts receivable and inventory. This
credit facility contains customary financial covenants, including covenants that
we maintain minimum levels of EBITDA and interest coverage ratios and
limitations on additional indebtedness. This facility includes customary default
provisions, and all outstanding obligations may become immediately due and
payable in the event of a default. The facility bore interest at 7.75% per annum
at December 31, 2007. As of December 31, 2007, we were in violation with the
EBITDA covenant and a waiver was obtained on March 25, 2008. A total of $3.0
million was outstanding with respect to receivables factored under the GMAC CF
facility at December 31, 2007.

CREDIT FACILITY FROM GUGGENHEIM CORPORATE FUNDING LLC AND WARRANTS

On June 16, 2006, we entered into a Credit Agreement with certain lenders and
Guggenheim Corporate Funding LLC ("Guggenheim"), as administrative agent and
collateral agent for the lenders. This credit facility provided for borrowings
of up to $65 million. This facility consisted of an initial term loan of up to
$25 million, of which we borrowed $15.5 million at the initial funding, to be
used to repay certain existing indebtedness and fund general operating and
working capital needs. An additional term loan of up to $40 million would be
available under this facility to finance acquisitions acceptable to Guggenheim.
All amounts under the term loans became due and payable in December 2010.
Interest under this facility was payable monthly, with the interest rate equal
to the LIBOR rate plus an applicable margin based on our debt leverage ratio (as
defined in the credit agreement). Our obligations under the Guggenheim credit
facility were secured by a lien on substantially all of our assets and our
domestic subsidiaries, including a pledge of the equity interests of our
domestic subsidiaries and 65% of our Luxembourg subsidiary.

In connection with Guggenheim credit facility, on June 16, 2006, we issued the
lenders under this facility warrants to purchase up to an aggregate of 3,857,143
shares of our common stock. These warrants have a term of 10 years. These
warrants are exercisable at a price of $1.88 per share with respect to 20% of
the shares, $2.00 per share with respect to 20% of the shares, $3.00 per share
with respect to 20% of the shares, $3.75 per share with respect to 20% of the
shares and $4.50 per share with respect to 20% of the shares. The exercise
prices are subject to adjustment for certain dilutive issuances pursuant to the
terms of the warrants. These warrants are exercisable for 3,500,000 shares, and

F-20

the remaining 357,143 shares of the warrants will not become exercisable because
a specified portion of the initial term loan was not funded by the lenders. The
warrants were evaluated under SFAS No. 133 and Emerging Issues Task Force
("EITF") No. 00-19, "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" and determined to be a
derivative instrument due to certain registration rights. As such, the warrants
excluding the ones not exercisable were valued at $4.9 million using the
Black-Scholes model with the following assumptions: risk-free interest rate of
5.1%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.70; and contractual term of ten years. We also paid to
Guggenheim 2.25% of the committed principal amount of the loans which was
$563,000 on June 16, 2006. The $563,000 fee paid to Guggenheim was included in
the deferred financing cost, and the value of the warrants to purchase 3.5
million shares of our common stock of $4.9 million was recorded as debt
discount, both of them were amortized over the life of the loan. For the years
ended December 31, 2006 and 2007, $654,000 and $906,000 was amortized,
respectively.

Durham Capital Corporation ("Durham") acted as our advisor in connection with
the Guggenheim credit facility. As compensation for its services, we agreed to
pay Durham a cash fee in an amount equal to 1% of the committed principal amount
of the loans under the Guggenheim credit facility. As a result, $250,000 was
paid on June 16, 2006. In addition, we issued Durham a warrant to purchase
77,143 shares of our common stock. This warrant has a term of 10 years and is
exercisable at a price of $1.88 per share, subject to adjustment for certain
dilutive issuances. This warrant is exercisable for 70,000 shares, and the
remaining 7,143 shares of this warrant will not become exercisable because a
specified portion of the initial term loan was not funded by the lenders. The
warrants were evaluated under SFAS No. 133 and EITF No. 00-19 and determined to
be a derivative instrument due to certain registration rights. As such, the
warrants excluding the ones not exercisable were valued at $105,000 using the
Black-Scholes model with the following assumptions: risk-free interest rate of
5.1%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.70; and contractual term of ten years. The $250,000 fee
paid to Durham and the value of the warrants to purchase 70,000 shares of our
common stock of $105,000 was included in the deferred financing cost, and was
amortized over the life of the loan. For the years ended December 31, 2006 and
2007, $43,000 and $59,000 was amortized, respectively.

As of June 30, 2006, the warrants were being accounted for as a liability
pursuant to the provisions of SFAS No. 133 and EITF No. 00-19. This was because
we granted the warrant holders certain registration rights that were outside our
control. In accordance with SFAS No. 133, the warrants were being valued at each
reporting period. Changes in fair value were recorded as adjustment to fair
value of derivative in the statements of operations. The outstanding warrants
were fair valued on June 16, 2006, the date of the transaction, at $5.0 million
and we, in accordance with SFAS No. 133, revaluated the warrants on June 30,
2006 at the closing stock price on June 30, 2006 to $5.2 million; as a result,
an expense of $218,000 was recorded as an adjustment to fair value of derivative
on our consolidated statements of operations. On August 11, 2006, the
registration rights agreement relating to the warrants was amended to provide
that if we were unable to file or have the registration statement declared
effective by the required deadlines, we would be required to pay the warrant
holders cash payments as partial liquidated damages each month until the
registration statement was filed and/or declared effective. The liquidated
damages payable by us to the warrant holders were limited to 20% of the purchase
price of the shares underlying the warrants, which we determined to be a
reasonable discount for restricted stock as compared to registered stock. As a
result of amending the registration rights relating to the warrants on August
11, 2006, the warrants were reclassified from debt to equity in accordance with
EITF No. 00-19 in the third quarter of 2006. The outstanding warrants were
revaluated on August 11, 2006 at the closing stock price on August 11, 2006 to
$4.5 million; as a result, income of $729,000 was recorded as an adjustment to
fair value of derivative on our consolidated statements of operations. As such,
a net gain of $511,000 was recognized in our statements of operations as an
adjustment to fair value of derivative in 2006.

F-21

The credit facility with GMAC CF prohibits us from paying dividends or making
other distributions on our common stock. In addition, GMAC CF prohibits our
subsidiaries that are borrowers under the facility from paying dividends or
other distributions to us, and the credit facility with DBS prohibits our Hong
Kong subsidiaries from paying any dividends or making other distributions or
advances to us.

GUARANTEES

In June 2006, we signed a guarantee of certain liabilities of American Rag Cie
to California United Bank to the aggregate amount equal at all times to the
lesser of (A) 45% of the aggregate amount of the outstanding liabilities or (B)
$675,000, which guarantee was re-affirmed in September 2007.

10. CONVERTIBLE DEBENTURES AND WARRANTS

On December 14, 2004, we completed a $10 million financing through the issuance
of (i) 6% Secured Convertible Debentures ("Debentures") and (ii) warrants to
purchase up to 1,250,000 shares of our common stock. Prior to maturity, the
investors could convert the Debentures into shares of our common stock at a
price of $2.00 per share. The warrants have a term of five years and an exercise
price of $2.50 per share. The warrants were valued at $866,000 using the
Black-Scholes model with the following assumptions: risk-free interest rate of
4%; dividend yields of 0%; volatility factors of the expected market price of
our common stock of 0.55; and an expected life of four years. The Debentures
bore interest at a rate of 6% per annum and had a term of three years. We could
elect to pay interest on the Debentures in shares of our common stock if certain
conditions were met, including a minimum market price and trading volume for our
common stock. The Debentures contained customary events of default and permitted
the holder thereof to accelerate the maturity if the full principal amount
together with interest and other amounts owing upon the occurrence of such
events of default. The Debentures were secured by a subordinated lien on certain
of our accounts receivable and related assets. The closing market price of our
common stock on the closing date of the financing was $1.96. The Debentures were
thus valued at $8,996,000, resulting in an effective conversion price of $1.799
per share. The intrinsic value of the conversion option of $804,000 was being
amortized over the life of the loan.

The placement agent in the financing, received compensation for its services in
the amount of $620,000 in cash and issuance of five year warrants to purchase up
to 200,000 shares of our common stock at an exercise price of $2.50 per share.
The warrants to purchase 200,000 shares of our common stock were valued at
$138,000 using the Black-Scholes model with the following assumptions: risk-free
interest rate of 4%; dividend yields of 0%; volatility factors of the expected
market price of our common stock of 0.55; and an expected life of four years.
The financing cost paid to the placement agent of $620,000, and the value of the
warrants to purchase 200,000 shares of our common stock of $138,000 were
included in the deferred financing cost, net on our accompanying balance sheets
and was amortized over the life of the loan.

In June 2005, holders of our Debentures converted an aggregate of $2.3 million
of Debentures into 1,133,687 shares of our common stock. In August 2005, holders
of our Debentures converted an aggregate of $820,000 of Debentures into 410,000
shares of our common stock. The Debentures were converted at the option of the
holders at a price of $2.00 per share. Debt discount of $248,000 related to the
intrinsic value of the conversion option of $804,000 was expensed upon the
conversion. Of the $620,000 financing cost paid to the placement agent, $191,000
was expensed upon the conversion. The intrinsic value of the conversion option,
and the value of the warrant amortized in 2006 was $237,000. Total deferred
financing cost amortized in 2006 was $95,000. Total interest paid to the holders
of the Debentures in 2006 was $198,000. On June 26, 2006, we paid off the
remaining balance of the outstanding Debentures of $6.9 million plus all accrued
and unpaid interest and a prepayment penalty of $171,000. As a result of the
repayment, the Debentures were terminated effective June 26, 2006. Upon paying
off the Debentures, debt discount of $278,000 related to the intrinsic value of
the conversion option of $804,000 was expensed, and of the $620,000 financing
cost paid to the placement agent, $214,000 was expensed. The remaining value of
the warrants to holders of our Debentures of $433,000 and warrants to the
placement agent of $69,000 was also expensed.

11. DERIVATIVES AND OTHER FINANCIAL INSTRUMENTS

We use forward currency contracts to manage volatility associated with foreign
currency purchases of materials in the normal course of business. During the
year ended December 31, 2006, we entered into foreign currency forward contracts

F-22

to hedge against the effect of exchange rate fluctuations on cash flows
denominated in foreign currencies and certain inter-company financing
transactions. This transaction is undesignated and as such an ineffective hedge.
At December 31, 2006, we had one open foreign exchange forward which has a
maturity of less than one year. Hedge ineffectiveness resulted in a loss of
$196,000 in our consolidated statements of operations as of December 31, 2006.
At December 31, 2007, we had no open foreign exchange forward contracts. Hedge
ineffectiveness resulted in a gain of $196,000 in our consolidated statements of
operations as of December 31, 2007.

12. INCOME TAXES

The provision (credit) for domestic and foreign income taxes is as follows:

YEAR ENDED DECEMBER 31,
------------------------------------------------
2005 2006 2007
------------ ------------ ------------
Current:
Federal ................ $ -- $ 6,968 $ (1,666,729)
State .................. 2,425 6,400 42,150
Foreign ................ 1,091,442 202,677 621,780
------------ ------------ ------------
1,093,867 216,045 (1,002,799)
Deferred:
Federal ................ -- -- --
State .................. -- -- --
Foreign ................ (166,686) 237,045 (38,211)
------------ ------------ ------------
(166,686) 237,045 (38,211)
------------ ------------ ------------

Total ................ $ 927,181 $ 453,090 $ (1,041,010)
============ ============ ============

The source of income (loss) before the provision (credit) for taxes and minority
interest is as follows:

YEAR ENDED DECEMBER 31,
----------------------------------------------------
2005 2006 2007
------------ ------------ ------------

Federal ............. $ (4,406,638) $ 1,415,652 $ 320,755
Foreign ............. 6,402,404 (23,204,213) 391,925
------------ ------------ ------------

Total ...... $ 1,995,766 $(21,788,561) $ 712,680
============ ============ ============

Our effective tax rate differs from the statutory rate principally due to the
following reasons: (1) a substantial valuation allowance has been provided for
deferred tax assets as a result of the operating losses in the United States and
Mexico, since recoverability of those assets has not been assessed as more
likely than not; and (2) the earnings of our Hong Kong subsidiary are taxed at a
rate of 17.5% versus the 35% U.S. federal rate. The impairment charge in Mexico
did not result in a tax benefit due to an increase in the valuation allowance
against the future tax benefit. We believe it is more likely than not that the
tax benefit will not be realized based on our future business plans in Mexico.

F-23

A reconciliation of the statutory federal income tax provision (benefit) to the
reported tax provision (credit) on income (loss) is as follows:

YEAR ENDED DECEMBER 31,
-------------------------------------------
2005 2006 2007
----------- ----------- -----------

Income tax (benefit) based on federal
statutory rate ........................ $ 672,184 $(7,618,680) $ 247,274
State income taxes, net of federal benefit (246,978) 190,152 100,560
Effect of foreign income taxes ........... (1,316,085) 8,561,197 446,395
FIN48 adjustments ........................ -- -- (1,676,729)
Increase in valuation allowance
and other ............................. 1,818,060 (679,579) (158,510)
----------- ----------- -----------
Reported tax provision (credit) .......... $ 927,181 $ 453,090 $(1,041,010)
=========== =========== ===========

Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
deferred tax assets (liabilities) are as follows:

DECEMBER 31,
-----------------------------
2006 2007
------------ ------------

Deferred tax assets:
Provision for doubtful accounts and
unissued credits ....................... $ 501,546 $ 452,822
Provision for other reserves .............. 1,808,092 2,242,256
Domestic and foreign loss carry forwards
and foreign tax credits ................ 13,867,841 11,984,024
Goodwill .................................. 4,240,274 3,671,620
------------ ------------
Total deferred tax assets .............. 20,417,753 18,350,722

Deferred tax liabilities:
Other ..................................... -- --
------------ ------------
Valuation allowance for deferred tax assets .. (20,294,146) (18,188,904)
------------ ------------

Net deferred tax assets (liabilities) ........ $ 123,607 $ 161,818
============ ============

At December 31, 2007, we had $31.8 million of federal net operating loss carry
forwards that will expire beginning in 2023. We also had foreign tax credits
carry forwards totaling $815,000 that will expire beginning in 2010.

In January 2004, the IRS completed its examination of our Federal income tax
returns for the years ended December 31, 1996 through 2001. The IRS had proposed
adjustments to increase our income tax payable for these years under
examination. In addition, in July 2004, the IRS initiated an examination of our
Federal income tax return for the year ended December 31, 2002. In December
2007, we received a final assessment from the IRS of $7.4 million for the years
ended December 31, 1996 through 2002, and in the first quarter of 2008 we
entered into a final settlement agreement with the IRS. Under the settlement,
which totals $13.9 million, including $6.5 million of interest, we agreed to pay
the IRS $4 million in March 2008 and an additional $250,000 per month until
repayment in full. The settlement with the IRS is within amounts accrued for as
of December 31, 2007 in our financial statements, and we therefore do not
anticipate the settlement to result in any additional charges to income other
than interest on the outstanding balance. Due to the negotiated settlement, we
reclassified the IRS and state tax liabilities from uncertain tax position to
current payable on December 31, 2007.

We adopted the provisions of FIN 48 on January 1, 2007. The total unrecognized
tax benefits as of January 1, 2007 were $8.9 million, excluding interest,
penalties and related income tax benefits and would be recorded as a component
of income tax expense if recognized. We recognize interest accrued related to
unrecognized tax benefits and penalties as a component of income tax expense. As
of January 1, 2007, the accrued interest and penalties were $8.0 million and
$1.2 million, respectively, excluding any related income tax benefits. During

F-24

2007, we de-recognized a previous uncertain tax position through negotiations
with the state tax jurisdiction. The negotiated settlement resulted in a
decrease of $1.5 million in unrecognized tax benefits and $1.0 million in
penalties. During 2007, we also de-recognized a previous uncertain tax position
through settlement with the IRS. The negotiated settlement resulted in a
decrease of $7.4 million in unrecognized tax benefits. After the above
adjustments, there was no unrecognized tax benefit as of December 31, 2007. As
of December 31, 2007, the accrued interest and penalties were $7.2 million and
$142,000, respectively.

The reconciliation of our unrecognized tax benefits is as follow:

Balance at January 1, 2007 ................................. $ 8,902,660
Decrease related to negotiated settlement with
the state tax jurisdiction .............................. (1,520,162)
Decrease related to negotiated settlement with
the IRS ................................................. (7,382,498)
-----------
Balance at December 31, 2007 ............................... $ 0
===========

13. COMMITMENTS AND CONTINGENCIES

We have entered into various non-cancelable operating lease agreements,
principally for executive office, warehousing facilities and showrooms with
unexpired terms in excess of one year. Certain of these leases provided for
scheduled rent increases. We record rent expense on a straight-line basis over
the term of the lease. The future minimum lease payments under these
non-cancelable operating leases are as follows:

2008.......................................................... $ 1,422,000
2009.......................................................... 1,301,000
2010.......................................................... 1,315,000
2011.......................................................... 1,061,000
2012.......................................................... 680,000
Thereafter.................................................... 1,787,000
------------

Total future minimum lease payments..................... $ 7,566,000
============

Included in the future minimum lease payments are, $40,000 payable to Lynx
International Limited, a Hong Kong corporation that is owned by Messrs. Guez and
Kay for leasing our office space and warehouse in Hong Kong, and $2,352,000
payable to GET a corporation which is owned by Messrs. Gerard Guez and Todd Kay
for leasing the Los Angeles offices and warehouse. See Note 17 of the "Notes to
Consolidated Financial Statements."

Several of the operating leases contain provisions for additional rent based
upon increases in the operating costs, as defined, per the agreement. Total rent
expense under the operating leases amounted to approximately $1.3 million, $1.9
million and $2.0 million for 2005, 2006 and 2007, respectively.

We entered into a new lease agreement in June 2005 for our showroom in New York
through June 2015. This is currently the location used for the private brands
sales, design and technical departments, which functions were moved from our Los
Angeles executive office.

Our lease agreement in Mexico for our office and storage expired in March 2008.

On August 1, 2006, we entered into a lease agreement with GET for the Los
Angeles offices and warehouse, which lease has a term of five years with an
option to renew for an additional five year term. On February 1, 2007, we
entered into a one year lease agreement with Lynx International Limited for our
office space and warehouse in Hong Kong.

We had open letters of credit of $9.5 million, $4.6 million and $12.2 million as
of December 31, 2005, 2006 and 2007, respectively.

We had two employment contracts dated January 1, 1998, and subsequently amended,
with two executives providing for base compensation and other incentives. On
April 1, 2004, we amended each of these contracts to extend the term through
March 31, 2006, and to provide one contract for base salary per annum of

F-25

$500,000 for the period from April 1, 2003 to March 31, 2006, and the other
contract for base salary per annum of $50,000 from April 1, 2003 to March 31,
2006. Additionally, we agreed to pay each of these executives an annual bonus
(the "Annual Bonus") for fiscal years ended December 31, 2003, 2004 and 2005 in
an amount, if any, equal to ten percent (10%) of the amount by which our actual
pre-tax income for such fiscal year exceeds the amount of projected pre-tax
income set forth in our annual budget for the same fiscal year as approved by
our Board of Directors. No bonuses were paid to these executives for the fiscal
year ended December 31, 2005 and 2007. Bonus of $150,000 was paid to one of the
executives in 2006.

On October 17, 2004, our subsidiary Private Brands, Inc entered into an
agreement with J. S. Brand Management to design, manufacture and distribute
Jessica Simpson branded jeans and casual apparel. This agreement has an initial
three-year term, and provided we are in compliance with the terms of the
agreement, is renewable for one additional two-year term. Minimum net sales are
$20 million in year 1, $25 million in year 2 and $30 million in year 3. The
agreement provides for payment of a sales royalty and advertising commitment at
the rate of 8% and 3%, respectively, of net sales, for a total minimum payment
obligation of $8.3 million over the initial term of the agreement. On July 19,
2005, Camuto Consulting Group replaced J.S. Brand Management as the master
licensor. In December 2004, we advanced $2.2 million as payment for the first
year's minimum royalties. We applied $1.1 million from the above advance against
the royalty and marketing expenses in 2005 and $884,000 in the first three
months of 2006. In March 2006, we had written off the capitalized balance of
$192,000 and recognized a corresponding loss. The loss was classified as royalty
expense on our consolidated statements of operations. In March 2006, we became
involved in a dispute with the licensor of the Jessica Simpson brands over our
continued rights to these brands, and we had been in litigation with the
licensor. See Note 21 of the "Notes to Consolidated Financial Statements". The
licensor refused to accept payments and maintained that the agreement had been
terminated. There had been no sales of new products since the licensor started
refusing to approve products for manufacture and sale. As a result of this
litigation, in 2006 and in the first nine months of 2007, we did not accrue for
the payments of minimum royalty, sales royalty and advertising commitment of
$4.4 million pursuant to the agreement. In November 2007, we entered into a
settlement agreement with the licensor, Jessica Simpson and related parties with
respect to the litigation, pursuant to which the parties agreed to dismiss with
prejudice all claims relating to these actions or the sublicense agreement. As a
result, we are no longer required to make the guaranteed payments contemplated
under the agreement.

On January 3, 2005, Private Brands, Inc, our wholly owned subsidiary, entered
into a term sheet exclusive licensing agreement with Beyond Productions, LLC and
Kids Headquarters to collaborate on the design, manufacturing and distribution
of women's contemporary, large sizes and junior apparel bearing the brand name
"House of Dereon", Couture, Kick and Soul. This agreement was a three-year
contract, and providing compliance with all terms of the license, was renewable
for one additional three-year term. The agreement also provided payment of
royalty at the rate of 8% on net sales and 3% on net sales for marketing fund
commitments. In the first quarter of 2005, we advanced $1.2 million as payment
for the first year's minimum royalty and marketing fund commitment. We had
applied $34,000 from the above advance against the royalty and marketing
expenses in 2005. In March 2006, we agreed to terminate our agreement to design,
market and sell House of Dereon by Tina Knowles branded apparel and we agreed to
sell all remaining inventory to the licensor or its designee. As a result, we
were no longer involved in the sales of this private brand. Prior to December
31, 2005, we had written off the capitalized balance of $1.2 million related to
agreement and recognized a loss accordingly in 2005. The loss was classified as
royalty expense on our consolidated statements of operations.

In July 2006, we terminated our License Agreements and the parent guaranty with
Cynthia Rowley. In consideration of termination of the License Agreements,
$400,000 was paid to Cynthia Rowley in July 2006.

In August 2004, we entered into an Agreement for Purchase of Assets with
affiliates of Mr. Kamel Nacif; a shareholder at the time of the transaction,
with agreement was amended in October 2004. Pursuant to the agreement, as
amended, on November 30, 2004, we sold to the purchasers substantially all of
our assets and real property in Mexico, including the equipment and facilities

F-26

we previously leased to Mr. Nacif's affiliates. Upon consummation of the sale,
we entered into a purchase commitment agreement with the purchasers, pursuant to
which we agreed to purchase annually over the ten-year term of the agreement, $5
million of fabric manufactured at our former facilities acquired by the
purchasers at negotiated market prices. We purchased $6.4 million of fabric, of
which $2.4 million was paid in cash and $4.0 million was offset against the
notes receivable principal and accrued interest on the note receivable from the
affiliates of Mr. Kamel Nacif in 2005. We did not purchase any fabric in 2006
and 2007. On August 21, 2007, we received a payment of $17.75 million from Tavex
upon the exercise by Tavex of its option, and this fabric purchase commitment
agreement was terminated. Instead, Tarrant Luxembourg agreed to purchase from
Tavex at least U.S. $1.25 million of fabric prior to the end of 2007 and to
deliver an irrevocable letter of credit for the full purchase price. We placed a
fabric order with Tavex on August 21, 2007 for $1.25 million pursuant to the
agreement. At December 31, 2007, the irrevocable letter of credit expired and we
did not have any further commitment to purchase fabric from Tavex. See Note 17
of the "Notes to Consolidated Financial Statements."

On September 1, 2006, our subsidiary in Hong Kong, Tarrant Company Limited,
entered into an agreement with Seven Licensing Company, LLC to be its buying
agent to source and purchase apparel merchandise. Seven Licensing is
beneficially owned by Gerard Guez.

We are involved from time to time in routine legal matters incidental to our
business. In our opinion, resolution of such matters will not have a material
effect on our financial position or results of operations.

14. STOCK-BASED COMPENSATION

Our Employee Incentive Plan, formerly the 1995 Stock Option Plan (the "1995
Plan"), authorized the grant of both incentive and non-qualified stock options
to our officers, employees, directors and consultants for shares of our common
stock. As of December 31, 2007, there were outstanding options to purchase a
total of 1,041,000 shares of common stock granted under the 1995 Plan. No
further grants may be made under the 1995 Plan. On May 25, 2006, we adopted the
Tarrant Apparel Group 2006 Stock Incentive Plan (the "2006 Plan"), which
authorizes the issuance of up to 5,100,000 shares of our common stock pursuant
to options or awards granted under the 2006 Plan. As of December 31, 2007, there
were outstanding options to purchase a total of 1,773,000 shares of common
stock, and 1,827,000 shares remained available for issuance pursuant to award
granted under the 2006 Plan. The exercise price of options under the plan must
be equal to 100% of fair market value of common stock on the date of grant. The
2006 Plan also permits other types of awards, including stock appreciation
rights, restricted stock and other performance-based benefits.

On January 1, 2006, we adopted SFAS No. 123 (revised 2004), "Share-Based
Payment," ("SFAS No. 123(R)") which requires the measurement and recognition of
compensation expense for all share-based payment awards made to employees and
directors based on estimated fair values. SFAS No. 123(R) supersedes our
previous accounting under Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees" for periods beginning in fiscal 2006.
In March 2005, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 107 relating to SFAS No. 123(R). We have applied
the provisions of SAB No. 107 in our adoption of SFAS No. 123(R).

We adopted SFAS No. 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of January 1, 2006,
the first day of our fiscal year 2006. Our financial statements as of and for
the years ended December 31, 2006 and 2007 reflect the impact of SFAS No.
123(R). SFAS No. 123(R) requires companies to estimate the fair value of
share-based payment awards to employees and directors on the date of grant using
an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service
periods in our consolidated statements of operations. Prior to the adoption of
SFAS No. 123(R), we accounted for stock-based payment awards to employees and
directors using the intrinsic value method in accordance with APB No. 25 as
allowed under SFAS No. 123, "Accounting for Stock-Based Compensation". Under the
intrinsic value method, no stock-based compensation expense had been recognized
in our consolidated statements of operations for awards to employees and
directors because the exercise price of our stock options equaled the fair
market value of the underlying stock at the date of grant. In accordance with
the modified prospective transition method, our financial statements for prior
periods have not been restated to reflect, and do not include, the impact of
SFAS No. 123(R).

F-27

The following table illustrates the effect on net income and net income per
share if we had applied the fair value recognition provisions of SFAS No. 123 to
stock-based payment awards granted under our stock option plans for the year
ended December 31, 2005:

2005
------------

Net income as reported........................... $ 993,344
Add stock-based employee compensation charges
reported in net income........................ $ 38,740
Pro forma compensation expense, net of tax....... $ (4,298,193)
------------
Pro forma net loss............................... $ (3,266,109)
============

Net income per share - Basic..................... $ 0.03
Add stock-based employee compensation charges
reported in net income - Basic................ $ 0.00
Pro forma compensation expense per share......... $ (0.14)
------------
Pro forma loss per share - Basic................. $ (0.11)
============

Net income per share - Diluted................... $ 0.03
Add stock-based employee compensation charges
reported in net income - Diluted.............. $ 0.00
Pro forma compensation expense per share......... $ (0.14)
------------
Pro forma loss per share - Diluted............... $ (0.11)
============

On September 23, 2005, the Board of Directors approved the acceleration of
vesting of all our unvested stock options, including those not issued under the
plan. In total, 1.7 million stock options with an average exercise price of
$3.69 and an average remaining contractual life of 7.9 years were subject to
this acceleration. The exercise prices and number of shares subject to the
accelerated options were unchanged. The acceleration was effective as of
September 23, 2005. Had the acceleration of these stock options not been
undertaken, the future compensation expense we would recognize in the fiscal
years of 2006, 2007, 2008 and 2009 would be $1.4 million, $810,000, $10,000 and
$3,000, respectively. Our decision to accelerate the vesting of these stock
options was based upon the accounting of this $2.2 million of compensation
expense from disclosure-only in 2005 to being included in our statement of
operations in 2006 to 2009 based on our anticipated adoption of SFAS No. 123(R)
effective in January 2006. As a result, there were no stock options granted
prior to, but not yet vested as of January 1, 2006.

F-28

A summary of our stock option activity and related information for the year
ended December 31, 2005, 2006 and 2007 is as follows:

EMPLOYEES
-----------------------------
NUMBER OF EXERCISE
SHARES PRICE
---------- ------------

Options outstanding at December 31, 2004 .... 8,331,962 $1.39-$45.50
Granted ..................................... 42,000 $1.95-$3.68
Exercised ................................... -- --
Forfeited ................................... (1,573,300) $1.95-$25.00
Expired ..................................... (67,612) $ 4.50
---------- ------------
Options outstanding at December 31, 2005 .... 6,733,050 $1.39-$45.50
Granted ..................................... 1,233,259 $1.84-$1.94
Exercised ................................... -- --
Forfeited ................................... (19,650) $1.94-$33.13
Expired ..................................... (273,000) $6.75-$7.38
---------- ------------
Options outstanding at December 31, 2006 .... 7,673,659 $1.39-$45.50
Granted ..................................... 2,630,000 $1.13-$1.99
Exercised ................................... (1,500,000) $ 1.13
Forfeited ................................... (87,450) $1.63-$18.50
Expired ..................................... (502,000) $1.13-$8.50
---------- ------------
Options outstanding at December 31, 2007 .... 8,214,209 $1.39-$45.50
========== ============

We had no stock option outstanding to non-employees as of December 31, 2005,
2006 and 2007.

The following table summarizes information about stock options outstanding,
expected to vest and exercisable at December 31, 2006 and 2007:

WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
NUMBER OF EXERCISE CONTRACTUAL INTRINSIC
SHARES PRICE LIFE (YEARS) VALUE
------------ ------------ ------------ ------------

As of December 31, 2006:
Employees - Outstanding .......... 7,673,659 $ 5.52 5.9 $ 0
Employees - Expected to vest ..... 7,579,083 $ 5.57 5.9 $ 0
Employees - Exercisable .......... 6,445,400 $ 6.22 5.3 $ 0

As of December 31, 2007:
Employees - Outstanding .......... 8,214,209 $ 5.28 5.2 $ 0
Employees - Expected to vest ..... 8,078,438 $ 5.34 5.2 $ 0
Employees - Exercisable .......... 6,748,015 $ 6.01 4.5 $ 0

The following table summarizes our non-vested options as of December 31, 2007
and changes during the year ended December 31, 2007.

WEIGHTED
AVERAGE
NUMBER OF GRANT-DATE
NON-VESTED OPTIONS SHARES FAIR VALUE
--------------------------------------------------- ---------- ----------

Non-vested at January 1, 2007 ..................... 1,228,259 $ 1.26
Granted ......................................... 2,630,000 1.23
Vested .......................................... (2,307,065) 1.22
Forfeited ....................................... (85,000) 1.15
---------- ----------
Non-vested at December 31, 2007 ................... 1,466,194 $ 1.28
========== ==========

F-29

The following table shows the fair value of each option granted to employees and
directors estimated on the date of grant using the Black-Scholes model with the
following weighted average assumptions used for grants in 2005, 2006 and 2007.

YEARS ENDED DECEMBER 31,
----------------------------------------
2005 2006 2007
---- ---- ----
Expected dividend ............... 0.0% 0.0% 0.0%
Risk free interest rate ......... 4% 5.075% 3.90% to 4.67%
Expected volatility ............. 55% 70% 70%
Expected term (in years) ........ 4 6.25 0.06 to 6.18

Stock-based compensation expense recognized during the period is based on the
value of the portion of share-based payment awards that is ultimately expected
to vest during the period. Stock-based compensation expense recognized in the
consolidated statements of operations for the years of 2006 and 2007 consisted
of compensation expense for the share-based payment awards granted subsequent to
January 1, 2006 based on the grant date fair value estimated in accordance with
the provisions of SFAS No. 123(R). For stock-based payment awards issued to
employees and directors, stock-based compensation is attributed to expense using
the straight-line single option method, which is consistent with how the
prior-period pro-formas were provided. As stock-based compensation expense
recognized in the consolidated statements of operations for the years of 2006
and 2007 is based on awards ultimately expected to vest, it has been reduced for
estimated forfeitures which we estimate to be 7.7%. SFAS No. 123(R) requires
forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those estimates. In our
pro-forma information for the period fiscal 2005, we accounted for forfeitures
as they occurred.

Our determination of fair value of share-based payment awards to employees and
directors on the date of grant using the Black-Scholes model, which is affected
by our stock price as well as assumptions regarding a number of highly complex
and subjective variables. These variables include, but are not limited to our
expected stock price volatility over the term of the awards. When valuing
awards, we estimate its expected terms using the "safe harbor" provisions
provided in SAB No. 107 and its volatility using historical data. We granted
options to purchase 1,233,259 and 2,630,000 shares of common stock during 2006
and 2007, respectively. The options granted were fair valued in the aggregate at
$1.6 million and $3.2 million or the weighted-average exercise price of $1.86
and $1.32 during 2006 and 2007, respectively. Stock-based compensation expense
related to employees or director stock options recognized during 2006 and 2007
was $187,000 and $771,000, respectively. Basic and dilutive earnings per share
for the year ended December 31, 2006 were decreased by $0.01 from $(0.72) to
$(0.73) by the additional stock-based compensation recognized. Basic and
dilutive earnings per share for the year ended December 31, 2007 were decreased
by $0.02 from $0.08 to $0.06 by the additional stock-based compensation
recognized.

The total intrinsic value of options exercised during 2006 and 2007 was $0 and
$120,000, respectively. Cash received from stock options exercised during 2006
and 2007 was $0 and $1.7 million, respectively. The total fair value of shares
vested during the years ended December 31, 2005, 2006 and 2007, were
approximately $5.7 million, $0, and $2.8 million, respectively.

As of December 31, 2007, there was $1.4 million of total unrecognized
compensation cost related to non-vested share-based compensation arrangements
granted under the plans. That cost is expected to be recognized over the
weighted-average period of 2.5 years.

When options are exercised, our policy is to issue previously un-issued shares
of common stock to satisfy share option exercises. As of December 31, 2007, we
had 68.0 million shares of un-issued shares of common stock.

15. EQUITY TRANSACTIONS

In March 2005, in connection with a settlement of a dispute involving a former
employee named Nicolas Nunez, we agreed to compensate Mr. Nunez in the total
amount of $875,000. In April 2005, we issued 195,313 shares of our common stock
(having a value of $375,000) to Mr. Nunez pursuant to the terms of an agreement
and plan of reorganization and paid Mr. Nunez $500,000 in settlement of all
remaining claims by Mr. Nunez against us. In connection with this settlement, in
March 2006, we cancelled 10,000 shares of our common stock previously issued to
him.

F-30

On June 16, 2006, we entered into a Credit Agreement with certain lenders and
Guggenheim, as administrative agent and collateral agent for the lenders. This
credit facility provides for borrowings of up to $65 million. This facility
consists of an initial term loan of up to $25 million, of which we borrowed
$15.5 million at the initial funding. An additional term loan of up to $40
million will be available under this facility to finance acquisitions acceptable
to Guggenheim. In connection with Guggenheim credit facility, on June 16, 2006,
we issued the lenders under this facility warrants to purchase up to an
aggregate of 3,857,143 shares of our common stock. 357,143 shares of the
warrants will not become exercisable unless and until a specified portion of the
initial term loan is actually funded by the lenders. Durham acted as our advisor
in connection with the Guggenheim credit facility. As compensation for its
services, we agreed to pay Durham a cash fee in an amount equal to 1% of the
committed principal amount of the loans under the Guggenheim credit facility. In
addition, we issued Durham a warrant to purchase 77,143 shares of our common
stock. 7,143 shares of this warrant will not become exercisable unless and until
a specified portion of the initial term loan is actually funded by the lenders.
See Note 9 of the "Notes to Consolidated Financial Statements."

In November 2007, we granted an award to purchase 2 million shares of our common
stock at $1.13 to one of our employees, which offer had to be accepted by the
employee on or before December 15, 2007. The award was immediately vested and
was granted under the 2006 Plan. On December 14, 2007, the employee exercised
his right to purchase 1.5 million of the shares subject to the award at $1.13
for a total of $1.7 million.

We previously owned 50.1% of United Apparel Ventures, which was dissolved on
February 27, 2007. Upon dissolution, we distributed $100,000 initial capital to
the 49.9% minority interest owner.

In November 2003, our board of directors adopted a shareholders rights plan.
Pursuant to the plan, we issued a dividend of one right for each share of our
common stock held by shareholders of record as of the close of business on
December 12, 2003. Each right initially entitled shareholders to purchase a
fractional share of our Series B Preferred Stock for $25.00. However, the rights
are not immediately exercisable and will become exercisable only upon the
occurrence of certain events. Generally, if a person or group acquires, or
announces a tender or exchange offer that would result in the acquisition of 15%
or more of our common stock while the shareholder rights plan remains in place,
then, unless the rights are redeemed by us for $0.001 per right, the rights will
become exercisable, by all rights holders other than the acquiring person or
group, for our shares or shares of the third party acquirer having a value of
twice the right's then-current exercise price. The shareholder rights plan is
designed to guard against partial tender offers and other coercive tactics to
gain control of our company without offering a fair and adequate price and terms
to all of our shareholders. The plan was not adopted in response to any efforts
to acquire our company, and we are not aware of any such efforts.

Our credit agreement prohibits the payment of dividends during the term of the
agreement.

16. SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION

YEAR ENDED DECEMBER 31,
------------------------------------------
2005 2006 2007
---------- ---------- ----------

Cash paid for interest ......... $3,335,000 $4,246,000 $3,261,000
========== ========== ==========

Cash paid for income taxes ..... $ 875,000 $1,153,000 $ 35,000
========== ========== ==========

F-31

In 2005, we purchased $6.4 million of fabric from Acabados y Terminados, of
which $2.4 million was paid in cash and $4.0 million was offset against the
notes receivable principal and accrued interest on the note receivable from the
affiliates of Mr. Kamel Nacif.

In 2006, we purchased $1.1 million of fabric from Azteca Production
International, Inc. ("Azteca"), a corporation owned by the brothers of Gerard
Guez, our Chairman and Interim Chief Executive Officer, of which $0.5 million
was paid in cash and $0.6 million was offset against amount due from Azteca. In
2007, we purchased $499,000 of fabric from Azteca which was offset against
amount due from Azteca.

17. RELATED-PARTY TRANSACTIONS

Related-party transactions, consisting primarily of purchases and sales of
finished goods and raw materials, are as follows:

YEAR ENDED DECEMBER 31,
-----------------------------------------
2005 2006 2007
----------- ----------- -----------

Sales to related parties .......... $ 88,000 $ 4,417,000 $19,430,000
Purchases from related parties .... $ 6,987,000 $10,035,000 $10,914,000

As of December 31, 2006 and 2007, related party affiliates were indebted to us
in the amounts of $10.0 million and $10.5 million, respectively. These include
amounts due from Gerard Guez, our Chairman and Interim Chief Executive Officer,
of $2.2 million and $1.9 million at December 31, 2006 and 2007, respectively,
which have been shown as reductions to shareholders' equity in the accompanying
financial statements.

F-32

Guez bore interest at the rate of 7.75% during the period. Total interest paid
by Mr. Guez was $209,000, $171,000 and $158,000 for the years ended December 31,
2005, 2006 and 2007, respectively. Mr. Guez paid expenses on our behalf of
approximately $397,000, $299,000 and $365,000 for the years ended December 31,
2005, 2006 and 2007, respectively, which amounts were applied to reduce accrued
interest and principal on Mr. Guez's loan. These amounts included fuel and
related expenses incurred by 477 Aviation, LLC, a company owned by Mr. Guez,
when our executives used this company's aircraft for business purposes. Since
the enactment of the Sarbanes-Oxley Act in 2002, no further personal loans (or
amendments to existing loans) have been or will be made to our officers or
directors.

On July 1, 2001, we formed an entity to jointly market, share certain risks and
achieve economies of scale with Azteca Production International, Inc.
("Azteca"), called United Apparel Ventures, LLC ("UAV"). This entity was created
to coordinate the production of apparel for a single customer of our branded
business. Azteca is owned by the brothers of Gerard Guez. UAV made purchases
from a related party in Mexico, an affiliate of Azteca. UAV was owned 50.1% by
Tag Mex, Inc., our wholly owned subsidiary, and 49.9% by Azteca. Results of the
operation of UAV had been consolidated into our results since July 2001 with the
minority partner's share of gain and losses eliminated through the minority
interest line in our financial statements until 2004. Due to the restructuring
of our Mexico operations, we discontinued manufacturing for UAV customers in
2004. We had been consolidating 100% of the results of the operation of UAV into
our results since 2005. UAV was dissolved on February 27, 2007. We purchased
$135,000, $1.1 million and $499,000 of finished goods, fabric and service from
Azteca and its affiliates for the years ended December 31, 2005, 2006 and 2007,
respectively. Our total sales of fabric and service to Azteca in 2005, 2006 and
2007 were $88,000, $9,000 and $0, respectively. Based on the repayment history
of Azteca and litigation Azteca is currently subject to, we estimated that our
receivable of $3.4 million will take approximately three years for collection in
full. We therefore made a $1.0 million reserve and then fair-valued the balance
of this asset using our weighted average cost of capital as the discount rate
and a term of three years as the discount period. Net amounts due from this
related party as of December 31, 2006 and 2007 were $4.0 million and $1.5
million, respectively.

On September 1, 2006, our subsidiary in Hong Kong, Tarrant Company Limited,
entered into an agreement with Seven Licensing Company, LLC ("Seven Licensing")
to be its buying agent to source and purchase apparel merchandise. Seven
Licensing is beneficially owned by Gerard Guez. Total sales to Seven Licensing
for the years ended December 31, 2006 and 2007 were $4.4 million and $19.4
million, respectively. Net amounts due from this related party as of December
31, 2006 and 2007 were $3.5 million and $6.8 million, respectively.

We purchased $8.7 million and $10.4 million of finished goods from Star Source,
LLC and AJG Inc. dba Astrologie for the years ended December 31, 2006 and 2007,
respectively. Star Source, LLC and AJG Inc. dba Astrologie are beneficially
owned by an adult son of one of our employees. As of December 31, 2007, we
advanced $327,000 to Star Source, LLC for fabric purchase.

In August 2004, we entered into an Agreement for Purchase of Assets with
affiliates of Mr. Kamel Nacif, a shareholder at the time of the transaction,
which agreement was amended in October 2004. Pursuant to the agreement, as
amended, on November 30, 2004, we sold to the purchasers substantially all of
our assets and real property in Mexico, including the equipment and facilities
we previously leased to Mr. Nacif's affiliates in October 2003, for an aggregate
purchase price consisting of: a) $105,400 in cash and $3,910,000 by delivery of
unsecured promissory notes bearing interest at 5.5% per annum; and b)
$40,204,000, by delivery of secured promissory notes bearing interest at 4.5%
per annum, with payments due on December 31, 2005 and every year thereafter
until December 31, 2014. As of September 30, 2006, the outstanding balance of
the notes and interest receivables were $41.1 million prior to the reserve.
Historically, we had placed orders for purchases of fabric from the purchasers
pursuant to the purchase commitment agreement we entered into at the time of the
sale of the Mexico assets, and we had satisfied our payment obligations for the
fabric by offsetting the amounts payable against the amounts due to us under the
notes. However, during the third quarter of 2006, the purchasers ceased
providing fabric and were not making payments under the notes. We further
evaluated the recoverability of the notes receivable and recorded a loss on the
notes receivable in the third quarter of 2006 in an amount equal to the
outstanding balance less the value of the underlying assets securing the notes.
The loss was estimated to be approximately $27.1 million, resulting in a notes
receivable balance at September 30, 2006 of approximately $14 million. We
believe there was no significant change subsequently on the value of the
underlying assets securing the notes; therefore, we did not have additional
reserve after the third quarter of 2006.

F-33

Upon consummation of the sale, we entered into a purchase commitment agreement
with the purchasers, pursuant to which we agreed to purchase annually over the
ten-year term of the agreement, $5 million of fabric manufactured at our former
facilities acquired by the purchasers at negotiated market prices. We purchased
$6.4 million of fabric, of which $2.4 million was paid in cash and $4.0 million
was offset against the notes receivable principal and accrued interest on the
note receivable from the affiliates of Mr. Kamel Nacif in 2005. We did not
purchase any fabric in 2006 and 2007. Net amount due from Mr. Kamel Nacif and
his affiliates as of December 31, 2006 and 2007 was $116,000 and $0,
respectively.

On March 21, 2007, our wholly-owned subsidiary, Tarrant Luxembourg S.a.r.l.,
entered into a letter agreement with Solticio, Inmobiliaria Cuadros, S.A. de
C.V. ("Inmobiliaria"), and Acotex, (Acotex and together with Solticio and
Inmobiliaria, the "Sellers"), and Tavex Algodonera, S.A. ("Tavex"), which was
subsequently amended. On August 21, 2007, we received a payment of $17.75
million from Tavex upon the exercise by Tavex of its option in accordance with
the agreement among the parties. In return for the Tavex's payment of $17.75
million, we have taken the following actions in accordance with the terms of the
agreement:

o Tarrant Luxembourg and the Sellers terminated all other
executory obligations among the parties, including any
obligation of ours to purchase fabric from Soliticio and
Acotex; and

Upon closing of the transaction and receiving the payment of $17.75 million, we
recorded a gain of $3.75 million on our consolidated statements of operations as
other income in the third quarter of 2007. We placed a fabric order with Tavex
on August 21, 2007 for $1.25 million pursuant to the agreement. At December 31,
2007, the irrevocable letter of credit expired and we did not have any further
commitment to purchase fabric from Tavex.

We lease our executive offices and warehouse in Los Angeles, California from
GET, a corporation which is owned by Gerard Guez, our Chairman and Interim Chief
Executive Officer, and Todd Kay, our Vice Chairman. Additionally, we lease our
office space and warehouse in Hong Kong from Lynx International Limited, a Hong
Kong corporation that is owned by Messrs. Guez and Kay. Our lease for the Los
Angeles offices and warehouse has a term of five years expiring in 2011, with an
option to renew for an additional five year term. Our lease for the office space
and warehouse in Hong Kong has expired and we are currently renting on a month
to month basis. We paid $1.0 million, $1.1 million and $1.1 million,
respectively, in 2005, 2006 and 2007 in rent for office and warehouse facilities
at these locations. On May 1, 2006, we sublet a portion of our executive office
in Los Angeles, California and our sales office in New York to Seven Licensing
for a monthly payment of $25,000 on a month to month basis. Seven Licensing is
beneficially owned by Gerard Guez. We received $200,000 and $300,000,
respectively, in rental income from this sublease for the years ended December
31, 2006 and 2007.

At December 31, 2006 and 2007, we had various employees receivable totaling
$250,000 and $220,000, respectively, included in due from related parties.

We believe the each of the transactions described above has been entered into on
terms no less favorable to us than could have been obtained from unaffiliated
third parties.

F-34

18. OPERATIONS BY GEOGRAPHIC AREAS

Our predominant business is the design, distribution and importation of private
label and private brand casual apparel. Substantially all of our revenues are
from the sales of apparel. We are organized into two geographic regions: the
United States and Asia. We evaluate performance of each region based on profit
or loss from operations before income taxes not including the cumulative effect
of change in accounting principles. Information about our operations in the
United States, Asia, Mexico and Luxembourg is presented below. Inter-company
revenues and assets have been eliminated to arrive at the consolidated amounts.

ADJUSTMENTS
AND
UNITED STATES ASIA ELIMINATIONS TOTAL
------------- ------------- ------------- -------------

2005
Sales ..................... $ 213,366,000 $ 1,282,000 $ -- $ 214,648,000
Inter-company sales ....... -- 135,531,000 (135,531,000) --
------------- ------------- ------------- -------------
Total revenue ............. $ 213,366,000 $ 136,813,000 $(135,531,000) $ 214,648,000
============= ============= ============= =============

Income (loss) from
operations ............. $ (1,446,000) $ 5,071,000 $ -- $ 3,625,000
============= ============= ============= =============
Interest income (1) ....... $ 2,079,000 $ 2,000 $ -- $ 2,081,000
============= ============= ============= =============
Interest expense .......... $ 4,222,000 $ 403,000 $ -- $ 4,625,000
============= ============= ============= =============
Provision for depreciation
and amortization ....... $ 2,025,000 $ 102,000 $ -- $ 2,127,000
============= ============= ============= =============
Capital expenditures ...... $ 335,000 $ 224,000 $ -- $ 559,000
============= ============= ============= =============

Total assets .............. $ 136,904,000 $ 129,737,000 $(115,399,000) $ 151,242,000
============= ============= ============= =============

2006
Sales ..................... $ 226,851,000 $ 5,551,000 $ -- $ 232,402,000
Inter-company sales ....... -- 112,393,000 (112,393,000) --
------------- ------------- ------------- -------------
Total revenue ............. $ 226,851,000 $ 117,944,000 $(112,393,000) $ 232,402,000
============= ============= ============= =============

Income (loss) from
operations (2) ......... $ (21,210,000) $ 4,005,000 $ -- $ (17,205,000)
============= ============= ============= =============
Interest income (3) ....... $ 1,178,000 $ 3,000 $ -- $ 1,181,000
============= ============= ============= =============
Interest expense .......... $ 5,848,000 $ 212,000 $ -- $ 6,060,000
============= ============= ============= =============
Provision for depreciation
and amortization ....... $ 2,872,000 $ 108,000 $ -- $ 2,980,000
============= ============= ============= =============
Capital expenditures ...... $ 134,000 $ 75,000 $ -- $ 209,000
============= ============= ============= =============

Total assets .............. $ 97,196,000 $ 119,531,000 $(105,595,000) $ 111,132,000
============= ============= ============= =============

2007
Sales ..................... $ 223,028,000 $ 20,693,000 $ -- $ 243,721,000
Inter-company sales ....... -- 117,064,000 (117,064,000) --
------------- ------------- ------------- -------------
Total revenue ............. $ 223,028,000 $ 137,757,000 $(117,064,000) $ 243,721,000
============= ============= ============= =============

Income from operations (4). $ 1,408,000 $ 3,784,000 $ -- $ 5,192,000
============= ============= ============= =============
Interest income ........... $ 166,000 $ 3,000 $ -- $ 169,000
============= ============= ============= =============
Interest expense .......... $ 3,935,000 $ 183,000 $ -- $ 4,118,000
============= ============= ============= =============
Provision for depreciation
and amortization ....... $ 1,812,000 $ 135,000 $ -- $ 1,947,000
============= ============= ============= =============
Capital expenditures ...... $ 303,000 $ 250,000 $ -- $ 553,000
============= ============= ============= =============

Total assets .............. $ 56,559,000 $ 116,566,000 $(102,136,000) $ 70,989,000
============= ============= ============= =============

(1) Interest income in the U.S. included $1,856,000 interest earned from the
notes receivable related to the sale of our fixed assets in Mexico of which
notes were recorded in Luxembourg
(2) Income (loss) from operations in the U.S. included a loss of $27,156,000
recorded in Luxembourg; of which $27,137,000 related to loss on notes
receivable - related parties.
(3) Interest income in the U.S. included $901,000 interest earned from the
notes receivable related to the sale of our fixed assets in Mexico of which
notes were recorded in Luxembourg.
(4) Income from operations in the U.S. included a loss of $1,477,000 recorded
in Luxembourg; of which $1,458,000 related to loss on sales of fabric.

F-35

19. EMPLOYEE BENEFIT PLANS

Tarrant Hong Kong has adopted a defined contribution retirement benefits scheme
-- the National Mutual Central Provident Fund Scheme (the "Provident Fund
scheme") which has been approved under Section 87A of the Inland Revenue
Ordinance of Hong Kong since 1992. This scheme has been registered as a
Mandatory Provident Fund exempted Occupational Retirement Schemes Ordinance
scheme under the Mandatory Provident Fund Schemes Ordinance. From August 1992,
an employee, upon completion of one full year's service with Tarrant Hong Kong,
is entitled to enroll in the Provident Fund scheme on voluntary basis. Since
December 1, 2000, no new members have been allowed to enroll in this scheme.
Monthly contributions are made based on 5% of the employees' basic salary. The
employees having completed more than 3 years of service with Tarrant Hong Kong
are entitled to the vested benefits according the vesting scale of the Provident
Fund scheme.

Tarrant Hong Kong has adopted a Mandatory Provident Fund Scheme - AIA-JF Premium
MPF Scheme under the Mandatory Provident Fund Schemes Ordinance, in which the
employees who have joined Tarrant Hong Kong since December 1, 2000 are eligible
to enroll. Monthly contributions are made based on 5% of the employees' relevant
income. Costs of the plan charged to operations for 2005, 2006 and 2007 amounted
to approximately $160,000, $178,000 and $188,000, respectively.

On July 1, 1994, we established a defined contribution retirement plan covering
all of our U.S. employees whose period of service exceeds 12 months. Plan assets
are monitored by a third-party investment manager and are segregated from those
of ours. Participants may contribute from 1% to 15% of their pre-tax
compensation up to effective limitations specified by the Internal Revenue
Service. Our contributions to the plan are based on a 50% (100% effective July
1, 1995) matching of participants' contributions, not to exceed 6% (5% effective
July 1, 1995) of the participants' annual compensation. In addition, we may also
make a discretionary annual contribution to the plan. Costs of the plan charged
to operations for 2005, 2006 and 2007 amounted to approximately $199,000,
$251,000 and $294,000, respectively.

20. OTHER INCOME AND EXPENSE

Other income and expense consists of the following:

YEAR ENDED DECEMBER 31,
--------------------------------------
2005 2006 2007
---------- ---------- ----------

Rental income ........................... $ 193,000 $ 298,000 $ 300,000
Gain on sale of fixed assets ............ 124,000 -- --
Gain on notes receivable-related parties. -- -- 3,750,000
Other items ............................. 37,000 38,000 44,000
---------- ---------- ----------
Total other income ...................... $ 354,000 $ 336,000 $4,094,000
========== ========== ==========

Loss on sale of fixed assets ............ -- 36,000 25,000
Termination of license agreement ........ -- 400,000 --
Write-off of deferred financing cost and
debt discount ........................ -- -- 4,951,000
Other items ............................. 1,000 -- 1,000
---------- ---------- ----------
Total other expense ..................... $ 1,000 $ 436,000 $4,977,000
========== ========== ==========

21. LEGAL PROCEEDINGS

1. AMERICAN RAG CIE, LLC & AMERICAN RAG CIE II, INC.

F-36

original action had been filed on January 28, 2008 against Private Brands by the
LLC. The LLC owns the trademark "American Rag Cie", which mark has been licensed
to Private Brands on an exclusive basis throughout the world except for Japan
and pursuant to which Private Brands sells American Rag Cie branded apparel to
Macy's Merchandising Group and has sub-licensed to Macy's Merchandising Group
the right to manufacture certain categories of American Rag Cie branded apparel
in the United States. The LLC is owned 55% by ARC II and 45% by Tarrant Apparel
Group. In the original complaint the LLC seeks a declaratory judgment that we
have breached the license agreement and that the license agreement has been
properly terminated. Our cross-complaint counters this claim, and seeks a
declaration that the license agreement is valid and continues to be in effect.
Additionally, the cross-complaint seeks relief on a number of causes of action,
including breach of the license agreement, a declaration by the Court imposing a
reasonable term into the agreement for sublicensing royalties, dissolution of
LLC, damages for breach of fiduciary duty, and an accounting of the monies
diverted by defendants' actions. Based upon a clause in the LLC operating
agreement, the causes of action asserted in the cross-complaint for breach of
fiduciary duty and an accounting are subject to determination by a Judicial
Referee, and the parties are currently in the process of selecting one. On March
3, 2008, we dismissed, without prejudice, our claim for dissolution of LLC after
being notified that ARC II had elected to buy out our share in the LLC, a
permitted defense to an action for dissolution. On March 19, 2008, the LLC and
ARC II filed an amended complaint, in which they expanded their claims against
us to include claims for breach of contract, fraud, and breach of fiduciary
duty, and seeking further declaratory relief and compensatory and punitive
damages. The action is in the early stages of discovery.

2. JESSICA SIMPSON & CAMUTO CONSULTING GROUP

In April 2006, we commenced an action against the licensor of the Jessica
Simpson brands (captioned TARRANT APPAREL GROUP V. CAMUTO CONSULTING GROUP,
INC., VCJS LLC, WITH YOU, INC. AND JESSICA SIMPSON) in the Supreme Court of the
State of New York, County of New York. The suit named Camuto Consulting Group,
Inc., VCJS LLC, With You, Inc. and Jessica Simpson as defendants, and asserted
that the defendants failed to provide promised support in connection with our
sublicense agreement for the Jessica Simpson brands, as well as fraud against
Camuto Consulting. The complaint was amended to add Vincent Camuto as a
defendant and included nine causes of action, including two seeking a
declaration that the sublicense agreement was exclusive and remains in full
force and effect, as well as claims for breach of contract, breach of the duty
of good faith and fair dealing and fraudulent inducement against Camuto
Consulting, a claim against Vincent Camuto individually for fraudulent
inducement, and a claim against With You, Inc. and Ms. Simpson that we were an
intended third party beneficiary of the license between those defendants and
Camuto Consulting. On or about Camuto Consulting, VCJS and Vincent Camuto filed
a counterclaim against us for breach of the sublicense agreement and alleged
damages of no less than $100 million. With You, Inc. and Jessica Simpson also
filed counterclaims against us alleging trademark infringement, unfair
competition and business practices, violation of the right of privacy and other
claims, and seeking injunctive relief and damages in an amount to be determined
but no less than $100 million plus treble and punitive damages. By Order filed
January 17, 2007, the Court granted the motion of With You, Inc. and Ms. Simpson
to discontinue all of Ms. Simpson's counterclaims, and her personal
counterclaims were dismissed with prejudice. In November 2007, we entered into a
settlement agreement with Camuto Consulting Group, Inc., VCJS LLC, With You,
Inc. and Jessica Simpson with respect to the litigation regarding our previous
agreement to design, manufacture and distribute Jessica Simpson branded jeans
and casual apparel. Pursuant to the settlement agreement, the parties agreed to
dismiss with prejudice all claims relating to these actions or the sublicense
agreement and we received a payment of $3 million.

3. BAZAK INTERNATIONAL CORPORATION

Shortly before May 2004, Bazak International Corp. commenced an action against
us in the New York County Supreme Court claiming that we breached an oral
contract to sell a quantity of close-out goods, as a consequence of which Bazak
was damaged to the extent of $1.3 million. Bazak International Corp. claimed
that our liability exists under a theory of breach of contract or unjust
enrichment. A non-jury trial was held in the United States District Court for
the Southern District of New York beginning on November 27, 2006 and ending on
February 1, 2007. On June 12, 2007, the Court dismissed the case against us. We
settled with Bazak International Corp. for $25,000.

F-37

business, financial condition or results of operations, either due to the nature
of the claims, or because our management believes that such claims should not
exceed the limits of the our insurance coverage.

22. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

QUARTER ENDED
----------------------------------------------
MAR. 31 JUN. 30 SEP. 30 DEC. 31
-------- -------- -------- --------
(In thousands, except per share data)

2006
Total net sales .................... $ 61,261 $ 59,083 $ 54,645 $ 57,413
Gross profit ....................... 12,519 12,662 11,801 13,660
Operating income (loss) ............ 1,646 2,609 (24,719) 3,259
Net income (loss) .................. $ 836 $ 611 $(25,352) $ 1,684
Net income (loss) per common share:
Basic ........................... $ 0.03 $ 0.02 $ (0.83) $ 0.05
Diluted ......................... $ 0.03 $ 0.02 $ (0.83) $ 0.05
Weighted average shares outstanding:
Basic ........................... 30,551 30,544 30,544 30,544
Diluted ......................... 30,551 30,544 30,544 30,544

2007
Total net sales .................... $ 56,107 $ 60,101 $ 70,203 $ 57,310
Gross profit ....................... 12,346 12,555 12,948 11,050
Operating income (loss) ............ 63 2,529 2,661 (61)
Net income (loss) .................. $ (1,001) $ 809 $ 1,615 $ 325
Net income (loss) per common share:
Basic ........................... $ (0.03) $ 0.03 $ 0.05 $ 0.01
Diluted ......................... $ (0.03) $ 0.03 $ 0.05 $ 0.01
Weighted average shares outstanding:
Basic ........................... 30,544 30,544 30,544 30,837
Diluted ......................... 30,544 30,544 30,544 30,837

F-38

23. SUBSEQUENT EVENTS

On February 1, 2008, Tarrant Apparel Group and our wholly-owned subsidiary,
Private Brands, Inc., filed and served a cross-complaint against American Rag
Cie, LLC (the "LLC") and American Rag Cie II ("ARC II") in the, in the action
AMERICAN RAG CIE V. PRIVATE BRANDS, INC., Superior Court of the State of
California, County of Los Angeles, Central District, Case No. BC 384428. The
original action had been filed on January 28, 2008 against Private Brands by the
LLC. The LLC owns the trademark "American Rag Cie", which mark has been licensed
to Private Brands on an exclusive basis throughout the world except for Japan
and pursuant to which Private Brands sells American Rag Cie branded apparel to
Macy's Merchandising Group and has sub-licensed to Macy's Merchandising Group
the right to manufacture certain categories of American Rag Cie branded apparel
in the United States. The LLC is owned 55% by ARC II and 45% by Tarrant Apparel
Group. In the original complaint the LLC seeks a declaratory judgment that we
have breached the license agreement and that the license agreement has been
properly terminated. Our cross-complaint counters this claim, and seeks a
declaration that the license agreement is valid and continues to be in effect.
Additionally, the cross-complaint seeks relief on a number of causes of action,
including breach of the license agreement, a declaration by the Court imposing a
reasonable term into the agreement for sublicensing royalties, dissolution of
LLC, damages for breach of fiduciary duty, and an accounting of the monies
diverted by defendants' actions. Based upon a clause in the LLC operating
agreement, the causes of action asserted in the cross-complaint for breach of
fiduciary duty and an accounting are subject to determination by a Judicial
Referee, and the parties are currently in the process of selecting one. On March
3, 2008, we dismissed, without prejudice, our claim for dissolution of LLC after
being notified that ARC II had elected to buy out our share in the LLC, a
permitted defense to an action for dissolution. On March 19, 2008, the LLC and
ARC II filed an amended complaint, in which they expanded their claims against
us to include claims for breach of contract, fraud, and breach of fiduciary
duty, and seeking further declaratory relief and compensatory and punitive
damages. The action is in the early stages of discovery.

F-39

SCHEDULE II

TARRANT APPAREL GROUP

VALUATION AND QUALIFYING ACCOUNTS

ADDITIONS ADDITIONS
BALANCE AT CHARGED TO CHARGED BALANCE
BEGINNING COSTS AND TO OTHER AT END
OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR
------------ ------------ ------------ ------------ ------------

For the year ended December 31, 2005
Allowance for returns and discounts $ 1,063,321 $ 871,208 $ -- $ (949,268) $ 985,261
Allowance for bad debt ............. $ 1,374,544 $ 637,210 $ -- $ (45,265) $ 1,966,489
Inventory reserve .................. $ 1,116,662 $ -- $ -- $ (1,032,836) $ 83,826
============ ============ ============ ============ ============

For the year ended December 31, 2006
Allowance for returns and discounts $ 985,261 $ 1,189,090 $ -- $ (896,734) $ 1,277,617
Allowance for bad debt ............. $ 1,966,489 $ 13,445 $ -- $ (1,180,693) $ 799,241
Inventory reserve .................. $ 83,826 $ 375,000 $ -- $ (83,826) $ 375,000
Notes receivable - related parties
reserve ......................... $ -- $ 27,137,297 $ -- $ -- $ 27,137,297
============ ============ ============ ============ ============

For the year ended December 31, 2007
Allowance for returns and discounts $ 1,277,617 $ 527,838 $ -- $ (861,486) $ 943,969
Allowance for bad debt ............. $ 799,241 $ 243,561 $ -- $ (9,495) $ 1,033,307
Inventory reserve .................. $ 375,000 $ 550,000 $ -- $ -- $ 925,000
Notes receivable - related parties
reserve ......................... $ 27,137,297 $ -- $ -- $(27,137,297) $ --
============ ============ ============ ============ ============

F-40

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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

By: /S/ GERARD GUEZ
-------------------------------
Gerard Guez
Interim Chief Executive Officer

POWER OF ATTORNEY

The undersigned directors and officers of Tarrant Apparel Group do
hereby constitute and appoint Gerard Guez and Patrick Chow, and each of them,
with full power of substitution and resubstitution, as their true and lawful
attorneys and agents, to do any and all acts and things in our name and behalf
in our capacities as directors and officers and to execute any and all
instruments for us and in our names in the capacities indicated below, which
said attorney and agent, may deem necessary or advisable to enable said
corporation to comply with the Securities Exchange Act of 1934, as amended and
any rules, regulations and requirements of the Securities and Exchange
Commission, in connection with this Annual Report on Form 10-K, including
specifically but without limitation, power and authority to sign for us or any
of us in our names in the capacities indicated below, any and all amendments
(including post-effective amendments) hereto, and we do hereby ratify and
confirm all that said attorneys and agents, or either of them, shall do or cause
to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
--------- ----- ----

Chairman of the Board of March 28, 2008
/S/ GERARD GUEZ Directors and Interim Chief
------------------------- Executive Officer (Principal
Gerard Guez Executive Officer)

/S/ TODD KAY Vice Chairman of the Board March 28, 2008
------------------------- of Directors
Todd Kay

/S/ PATRICK CHOW Chief Financial Officer and March 28, 2008
------------------------- Director (Principal Financial
Patrick Chow and Accounting Officer)

/S/ MILTON KOFFMAN Director March 28, 2008
-------------------------
Milton Koffman

/S/ STEPHANE FAROUZE Director March 28, 2008
-------------------------
Stephane Farouze

/S/ MITCHELL SIMBAL Director March 28, 2008
-------------------------
Mitchell Simbal

/S/ JOSEPH MIZRACHI Director March 28, 2008
-------------------------
Joseph Mizrachi

/S/ SIMON MANI Director March 28, 2008
-------------------------
Simon Mani

S-1

TARRANT APPAREL GROUP

EXHIBIT INDEX

EXHIBIT
NUMBER DESCRIPTION
------- -------------------------------------------------------------------

2.1+ Stock and Asset Purchase Agreement, dated December 6, 2006, among
Tarrant Apparel Group, 4366883 Canada Inc., 3681441 Canada Inc.,
Buffalo Inc., 3163946 Canada Inc., Buffalo Corporation, Buffalo
International Inc., 4183517 Canada Inc., 3975912 Canada Inc. and
The Buffalo Trust. (Incorporated by reference to the Company's
Current Report on Form 8-K filed on December 12, 2006.)

2.1.1 Amendment No. 1 to Stock and Asset Purchase Agreement, dated March
20, 2007, by and among Tarrant Apparel Group, 4366883 Canada Inc.,
3681441 Canada Inc., Buffalo Inc., 3163946 Canada Inc., Buffalo
Corporation, BFL Management Inc. in its capacity as the sole
trustee of The Buffalo Trust and each stockholder of Target
Companies. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2007.)

2.1.2 Mutual Termination and Release Agreement, dated April 19, 2007, by
and among Tarrant Apparel Group, 4366883 Canada Inc., 3681441
Canada Inc., Buffalo Inc., 3163946 Canada Inc., Buffalo
Corporation, BFL Management Inc. in its capacity as the sole
trustee of The Buffalo Trust and each stockholder of Target
Companies. (Incorporated by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed on April 20, 2007.)

3.1 Restated Articles of Incorporation. (Incorporated by reference to
the Company's Registration Statement on Form S-1 filed on May 4,
1995 (File No. 33-91874).)

3.1.1 Certificate of Amendment of Restated Articles of Incorporation.
(Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ending June 30, 2002.)

3.1.2 Certificate of Amendment of Restated Articles of Incorporation.
(Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ending June 30, 2002.)

3.1.3 Certificate of Amendment of Restated Articles of Incorporation.
(Incorporated by reference to the Company's Current Report on Form
8-K dated December 4, 2003.)

3.2 Restated Bylaws. (Incorporated by reference to the Company's
Registration Statement on Form S-1 filed on May 4, 1995 (File No.
33-91874).)

3.2.1 Amendment to Restated Bylaws of Tarrant Apparel Group, dated August
9, 2007. (Incorporated by reference to the Company's Current Report
on Form 8-K filed on August 10, 2007.)

4.1 Specimen of Common Stock Certificate. (Incorporated by reference to
Amendment No. 1 to Registration Statement on Form S-1 filed on July
15, 1995.)

4.2 Rights Agreement dated as of November 21, 2003, between Tarrant
Apparel Group and Computershare Trust Company, as Rights Agent,
including the Form of Rights Certificate and the Summary of Rights
to Purchase Preferred Stock, attached thereto as Exhibits B and C,
respectively. (Incorporated by reference to the Company's Current
Report on Form 8-K dated November 12, 2003.)

4.3 Certificate of Determination of Preferences, Rights and Limitations
of Series B Preferred Stock. (Incorporated by reference to the
Company's Amendment to Current Report on Form 8-K/A, filed December
12, 2003.)

EX-1

EXHIBIT
NUMBER DESCRIPTION
------- -------------------------------------------------------------------

10.1* Tarrant Apparel Group Employee Incentive Plan. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ending June 30, 2004.)

10.2 Indemnification Agreement dated as of March 14, 1995, by and among
Tarrant Apparel Group, Gerard Guez and Todd Kay. (Incorporated by
reference to Amendment No. 1 to Registration Statement on Form S-1
filed on July 15, 1995.)

10.3 Form of Indemnification Agreement with directors and certain
executive officers. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.)

10.4 Exclusive Distribution Agreement dated April 1, 2003, between
Federated Merchandising Group, an unincorporated division of
Federated Department Stores, and Private Brands, Inc. (Incorporated
by reference to the Company's Quarterly Report on Form 10-Q for the
quarter ending March 31, 2003.)

10.4.1 Amendment No. 1 to Exclusive Distribution Agreement dated as of
June 22, 2004, between Federated Merchandising Group, an
unincorporated division of Federated Department Stores, and Private
Brands, Inc. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ending June 30, 2004.)

10.4.2 Amendment No. 2 to Exclusive Distribution Agreement dated as of
March 7, 2005, between Macy's Merchandising Group, LLC and Private
Brands, Inc. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ending March 31, 2005.)

10.4.3 Trademark Sublicense Agreement dated as of March 3, 2005, between
Macy's Merchandising Group, LLC and Private Brands, Inc.
(Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ending March 31, 2005.)

10.5 Unconditional Guaranty of Performance dated April 1, 2003, by
Tarrant Apparel Group. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ending March 31,
2003.)

10.6 Promissory Note dated May 31, 2003 made by Gerard Guez in favor of
Tarrant Apparel Group. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ending June 30,
2003.)

10.7 Indemnification Agreement dated April 10, 2003 between Tarrant
Apparel Group and Seven Licensing Company, LLC. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ending June 30, 2003.)

10.8 Common Stock Purchase Warrant dated October 17, 2003, by and
between Tarrant Apparel Group and Sanders Morris Harris Inc.
(Incorporated by reference to the Company's Current Report on Form
8-K dated October 16, 2003.)

10.9* Employment Agreement, dated September 16, 2005, between Tarrant
Company Limited and Henry Chu. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ending
September 30, 2005.)

10.10 Common Stock Purchase Warrant dated January 26, 2004 between
Tarrant Apparel Group and Sanders Morris Harris Inc. (Incorporated
by reference to the Company's Current Report on Form 8-K dated
January 23, 2004.)

10.11 Common Stock Purchase Warrant dated December 14, 2004 issued by
Tarrant Apparel Group in favor of T.R. Winston & Company, LLC.
(Incorporated by reference to the Company's Current Report on Form
8-K dated December 14, 2004.)

EX-2

EXHIBIT
NUMBER DESCRIPTION
------- -------------------------------------------------------------------

10.12 Form of Common Stock Purchase Warrant. (Incorporated by reference
to the Company's Current Report on Form 8-K dated December 14,
2004.)

10.13 Debenture, dated June 9, 2006, by and among Tarrant Company
Limited, Trade Link Holdings Limited and Marble Limited and DBS
Bank (Hong Kong) Limited. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ending June
30, 2006.)

10.14 Form of Guaranty and Indemnity of Tarrant Apparel Group in favor of
DBS Bank (Hong Kong) Limited. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ending June
30, 2006.)

10.15 Loan and Security Agreement, dated June 16, 2006, by and among GMAC
Commercial Finance LLC, the Lenders signatory thereto, Tarrant
Apparel Group, Fashion Resource (TCL), Inc., Tag Mex, Inc., United
Apparel Ventures, LLC, Private Brands, Inc., and NO! Jeans, Inc.
(Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarter ending June 30, 2006.)

10.15.1 Consent and Amendment No. 1 to Agreements, dated February 22, 2007,
by and among GMAC Commercial Finance LLC, the Lenders signatory
thereto, Tarrant Apparel Group, Fashion Resource (TCL), Inc., Tag
Mex, Inc., United Apparel Ventures, LLC, Private Brands, Inc., and
NO! Jeans, Inc. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ending March 31,
2007.)

10.15.2 Amendment No. 2 to Loan and Security Agreement, dated May 9, 2007,
by and among GMAC Commercial Finance LLC, the Lenders signatory
thereto, Tarrant Apparel Group, Fashion Resource (TCL), Inc., Tag
Mex, Inc., and Private Brands, Inc. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarter ending
June 30, 2007.)

10.15.3 Amendment No. 3 to Loan and Security Agreement, dated November 2,
2007, by and among GMAC Commercial Finance LLC, the Lenders
signatory thereto, Tarrant Apparel Group, Fashion Resource (TCL),
Inc., Tag Mex, Inc., and Private Brands, Inc..

10.16 Amended and Restated Factoring Agreement, dated June 16, 2006, GMAC
Commercial Finance LLC and Tarrant Apparel Group, Fashion Resource
(TCL), Inc., Tag Mex, Inc., United Apparel Ventures, LLC, Private
Brands, Inc., and NO! Jeans, Inc. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ending June
30, 2006.)

10.17 Credit Agreement, dated June 16, 2006, by and among Tarrant Apparel
Group, Fashion Resource (TCL), Inc., Tag Mex, Inc., United Apparel
Ventures, LLC, Private Brands, Inc. and NO! Jeans, Inc., the
Guarantors a party thereto, the Lenders a party thereto and
Guggenheim Corporate Funding, LLC. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q for the quarter ending
June 30, 2006.)

10.17.1 Amendment No. 1 to Credit Agreement, dated July 5, 2006, by and
among Tarrant Apparel Group, Fashion Resource (TCL), Inc., Tag Mex,
Inc., United Apparel Ventures, LLC, Private Brands, Inc. and NO!
Jeans, Inc., the Guarantors a party thereto, the Lenders a party
thereto and Guggenheim Corporate Funding, LLC. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ending September 30, 2006.)

10.18 Security Agreement, dated June 16, 2006, by and among Tarrant
Apparel Group, the other Credit Parties and Guggenheim Corporate
Funding, LLC. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ending June 30, 2006.)

10.19 Pledge Agreement, dated June 16, 2006, by and among Tarrant Apparel
Group, the other Pledgors party thereto and Guggenheim Corporate
Funding, LLC. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q for the quarter ending June 30, 2006.)

EX-3

EXHIBIT
NUMBER DESCRIPTION
------- -------------------------------------------------------------------

10.20 Warrants Purchase Agreement dated June 16, 2006, by and among
Tarrant Apparel Group, Orpheus Holdings, LLC, North American
Company for Life and Health Insurance, Midland National Life
Insurance Company and Durham Capital Corporation. (Incorporated by
reference to the Company's Registration Statement on Form S-3 filed
on August 10, 2006.)

10.21 Registration Rights Agreement, dated as of June 16, 2006, by and
among Tarrant Apparel Group, Orpheus Holdings, LLC, North American
Company for Life and Health Insurance, Midland National Life
Insurance Company and Durham Capital Corporation. (Incorporated by
reference to the Company's Registration Statement on Form S-3 filed
on August 10, 2006.)

10.22 Form of Warrants to Purchase Common Stock issued June 16, 2006.
(Incorporated by reference to the Company's Registration Statement
on Form S-3 filed on August 10, 2006.)

10.23 Warrant dated June 16, 2006, issued by the Registrant to Durham
Capital Corporation. (Incorporated by reference to the Company's
Registration Statement on Form S-3 filed on August 10, 2006.)

10.24* Tarrant Apparel Group 2006 Stock Incentive Plan. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ending June 30, 2006.)

10.25 Commercial Lease, dated August 1, 2006, between Tarrant Apparel
Group and GET. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ending June 30,
2006.)

10.26 Tenancy Agreement, dated February 1, 2007, between Tarrant Company
Limited and Lynx International Limited. (Incorporated by reference
to Exhibit 10.30 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2006.)

10.27 Letter Agreement, dated March 21, 2007, among Tarrant Luxembourg
S.a.r.l., Solticio, S.A. de C.V., Inmobiliaria Cuadros, S.A. de
C.V. , Acabados y Cortes Textiles, S.A. de. C.V., and Tavex
Algodonera, S.A. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarter ending March 31,
2007.)

10.27.1 Amendment, dated July 19, 2007, to Letter Agreement dated March 21,
2007, among Tarrant Luxembourg S.a.r.l., Solticio, S.A. de C.V.,
Inmobiliaria Cuadros, S.A. de C.V. , Acabados y Cortes Textiles,
S.A. de. C.V., and Tavex Algodonera, S.A. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q for the
quarter ending September 30, 2007.)

14.1 Code of Ethical Conduct. (Incorporated by reference to the
Company's Annual Report on Form 10-K for year ending December 31,
2003.)

21.1 Subsidiaries.

23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP.

31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities and Exchange Act of 1934, as amended.

31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a)
under the Securities and Exchange Act of 1934, as amended.

32.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(b)
under the Securities and Exchange Act of 1934, as amended.

32.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(b)
under the Securities and Exchange Act of 1934, as amended.

-------------------
* Management contract or compensatory plan or arrangement.

+ Schedules and exhibits have been omitted from the exhibit. A list of
omitted schedules and exhibits is set forth immediately following the
table of contents of the exhibit. Copies will be provided to the
Securities and Exchange Commission upon request.

EX-4