<PAGE>
 
  AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 25, 1998.
 
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                                 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 (FEE REQUIRED)
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
                                      OR
 
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
   EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
 
         FOR THE TRANSITION PERIOD FROM              TO
 
                        COMMISSION FILE NUMBER: 0-26430
 
                             TARRANT APPAREL GROUP
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                 CALIFORNIA                                      95-4181026
        (STATE OR OTHER JURISDICTION                          (I.R.S. EMPLOYER
      OF INCORPORATION OR ORGANIZATION)                    IDENTIFICATION NUMBER)
</TABLE>
 
                        3151 EAST WASHINGTON BOULEVARD
                         LOS ANGELES, CALIFORNIA 90023
              (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
 
     (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE): (213) 780-8250
 
   SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: COMMON STOCK
 
       SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
 
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]
 
As of February 10, 1998, the aggregate market value of the Common Stock held
by non-affiliates of the registrant was approximately $38,339,361, based upon
the closing price of the Common Stock on that date.
 
Number of shares of Common Stock of the registrant outstanding as of February
10, 1998: 6,609,964.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant's definitive Proxy Statement to be filed with
Securities and Exchange Commission pursuant to Regulation 14A in connection
with the 1998 Annual Meeting are incorporated by reference into Part III of
this Report. Such Proxy Statement will be filed with the Securities and
Exchange Commission not later than 120 days after the registrant's fiscal year
ended December 31, 1997.
 
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<PAGE>
 
                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
 <C>      <S>                                                              <C>
 Item 1.  BUSINESS......................................................     3
          General.......................................................     3
          Business Strategy.............................................     3
          Recent Acquisition............................................     4
          Products......................................................     5
          Customers.....................................................     5
          Design, Merchandising and Sales...............................     6
          Sourcing......................................................     6
          Backlog.......................................................     9
          Import Restrictions...........................................     9
          Competition...................................................    11
          Employees.....................................................    11
 Item 2.  PROPERTIES....................................................    11
 Item 3.  LEGAL PROCEEDINGS.............................................    12
 Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........    12
 Item 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
          MATTERS.......................................................    13
          NASDAQ Listing................................................    13
          Dividend Policy...............................................    13
 Item 6.  SELECTED FINANCIAL DATA.......................................    14
 Item 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
          AND RESULTS OF OPERATIONS.....................................    15
          General.......................................................    15
          Factors That May Affect Future Results........................    15
          Results of Operations.........................................    18
          Quarterly Results of Operations...............................    21
          Liquidity and Capital Resources...............................    21
 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....    22
 Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................    22
 Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
          AND FINANCIAL DISCLOSURE......................................    22
 Item 10. DIRECTORS AND EXECUTIVE OFFICERS..............................    23
 Item 11. EXECUTIVE COMPENSATION........................................    23
 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT....................................................    23
 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................    23
          EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-
 Item 14. K.............................................................    24
</TABLE>
 
                                       2
<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS
        --------

GENERAL
 
  Tarrant Apparel Group (the "Company"), a leading provider of private label
casual apparel, primarily serves both specialty retail and mass merchandise
store chains by designing, merchandising, contracting for the manufacture of
and selling casual, moderately-priced apparel, primarily for women, under
private label. Since 1988, when the Company began designing and supplying
private label denim jeans to a single specialty retail store chain, it has
successfully expanded its product lines and built a private label business
which during 1997 served over [20] customers. The Company's current products
are manufactured in a variety of woven and knit fabrications and include
jeanswear, casual pants, t-shirts, shorts, blouses, shirts and other tops,
dresses, leggings and jackets. See "Business -- Products" and "-- Customers."
 
  Over the past five years, the Company has achieved a compound annual growth
rate in net sales of approximately 15.3% from $147.0 million in 1993 to $260.1
million in 1997. Gross profit margins during this period have consistently
exceeded 15%. Pre-tax income has risen approximately 39.7% on a compound
annual basis, from $4.2 million in 1993 to $16.0 million in 1997.
 
  On February 23, 1998, the Company acquired certain assets of Marshall Gobuty
International U.S.A., Inc. and MGI International Limited which design,
contract for the manufacture of and sell private label apparel for men and
boys to national retailers, including J.C. Penney (the "Gobuty Acquisition").
See "Business -- Recent Acquisition."
 
BUSINESS STRATEGY
 
  The Company believes that there has been a trend over the last several years
toward consumer acceptance of casual, moderately-priced, private label
apparel. For example, more than half of the top twenty-five Fortune 500
companies have instituted "casual Fridays," and other companies are following
this trend. The Company also believes that the number of people who work at
home is increasing substantially and that outside of the workplace, people's
social activities are focusing more on family life and a more casual
lifestyle. In particular, the Company believes that baby boomers are now
rearing children and engaging in more recreational activities or are spending
evenings at home. The Company also believes that in recent years apparel
consumers have become more cost-conscious and are bypassing premium brand name
or designer products in favor of quality products at lower prices. In partial
response, apparel retailers have focused on "private label" apparel bearing
the retailer's own name or a proprietary label. Private label apparel
generally provides higher margins for the retailer than brand name or designer
products, as a result of the lower wholesale costs of such apparel. Suppliers
are able to sell these garments at lower wholesale prices due to the
significant economies which they realize, including lower advertising and
promotional costs, lack of brand name license fees and royalties and absence
of "markdowns" and other risks and expenses inherent in the brand name apparel
industry.
 
  Management believes that the Company has taken advantage of these trends by
developing and refining the following strategies:
 
    Customer-Focused Teams and Design and Test-Marketing Capabilities.  The
  Company serves its major customers through integrated teams of designers,
  merchandisers and support personnel, some of whom serve on more than one
  team. Generally, separate teams exist for domestic (i.e., U.S. and Mexico)
  and international (e.g., Hong Kong and China) sourcing activities. The
  Company believes that this staff alignment fosters strong relationships
  with each major customer's staff and enables its employees to develop an
  in-depth understanding of the fashion, fabric and pricing strategies of the
  customer. The Company also assists many of its customers with the market
  testing of selected designs through its ability to source small quantities
  of selected items for production within a short time frame. The Company
  believes that its design, sample-making and test run capabilities have
  enhanced the likelihood (but does not ensure) that it will
 
                                       3
<PAGE>
 
  receive a significant portion of bulk orders for merchandise designed
  independently by the Company or in collaboration with its customers.
  Management also believes that its design capability is a major competitive
  advantage.
 
    International Sourcing Network.  The Company and its senior executives
  have developed long-standing relationships with a network of contract
  manufacturers and suppliers, who are used by the Company to fulfill most of
  the Company's manufacturing needs. The Company is aggressively expanding
  this network both within the countries where it currently sources goods and
  to other countries including those in which it has not previously sourced
  goods. The Company believes that this network has sufficient production
  capacity and flexibility to enable the Company to accept large orders, work
  on short production schedules and produce a broad range of garments at a
  variety of possible prices depending on the lead times required by the
  customer. Certain of these manufacturers also have the capability to
  produce small quantity test runs for the market test programs of the
  Company's customers.
 
    Product Capabilities That Respond to Changing Fashion Needs.  The Company
  believes that it has established a reputation with its customers as a
  "fashion resource" -- a producer that is capable of designing and producing
  a broad range of quality merchandise and reacting rapidly to changing
  trends in fashion, fabrics and styles. In management's view, this
  reputation has afforded the Company a competitive advantage, because
  customers have been willing to place orders with the Company for an
  expanding range of products not previously sourced by the Company.
 
    Vertical Integration.  In late 1997, the Company commenced the vertical
  integration of its business. Key elements of this strategy include (i)
  establishing cutting, sewing, finishing and packaging operations through
  the acquisition of established contractors or the construction of new
  facilities and (ii) establishing fabric production capability through the
  acquisition of established mills or the construction of new mills. In late
  1997, the Company commenced negotiations to acquire a denim mill in Puebla,
  Mexico and initiated constructing a twill plant. There can be no assurance
  that either such transaction will be consummated.
 
  The Company believes that by employing these strategies, it can attract new
customers and increase sales to existing customers.
 
RECENT ACQUISITION
 
  On February 23, 1998, the Company purchased certain assets of MGI
International Limited, a Turks and Caicos corporation. The assets purchased
consist primarily of pending orders and related inventory. The purchase price
consisted of (i) $4,550,000, together with an amount equal to seller's cost of
the inventory purchased, payable in cash on closing, (ii) $500,000 payable on
July 31, 1998, together with interest at 7% per annum, and (iii) 2% of the net
sales of goods booked by the Company's newly formed Men's Division for
delivery during 1999, provided the orders accepted for delivery in 1999 on
March 1, 1999 meet specified gross profit and gross profit margin
requirements.
 
  On February 23, 1998, the Company also purchased certain assets of Marshall
Gobuty International U.S.A., Inc., a California corporation ("MGI USA"). The
assets purchased consist primarily of pending orders and related inventory.
The purchase price consisted of (i) $500,000, together with an amount equal to
seller's cost of the inventory purchased, payable in cash on closing and (ii)
$500,000 payable on July 31, 1998, together with interest at 7% per annum.
 
  MGI International Limited and MGI USA each designs, contracts for the
manufacture of and sells private label apparel for men and boys, including
knit and woven tops, jackets and other outerwear to national retailers,
including J.C. Penney and Goody's Family Clothing. The purchase price was
financed by the Company from its cash flow from operations.
 
  In connection with this acquisition, the Company entered into employment
agreements with Marshall Gobuty, the President and principal shareholder of
the sellers, and four senior employees of MGI USA. Under his employment
agreement, Mr. Gobuty will be employed as the Vice President -- Men's of the
Company for a
 
                                       4
<PAGE>
 
term commencing on February 23, 1998 and ending on February 23, 1999, unless
extended by the mutual agreement of the Company and Mr. Gobuty, and will be
paid an annual base salary of $375,000 and will receive such benefits and
perquisites as are provided by the Company to its executive officers
generally. In the event the Company terminates his employment without cause,
Mr. Gobuty shall be entitled to receive (i) a lump sum payment equal to his
base salary for the balance of the term and (ii) continuation of group medical
and disability insurance of the balance of the term. In the event the Company
terminates Mr. Gobuty's employment with cause, the Company is obligated to pay
the compensation required by the agreement only through the date of
termination. In addition, the sellers and Mr. Gobuty have agreed not to
compete with the Company during the two years following the termination of his
employment for any reason.
 
PRODUCTS
 
  In 1988, the Company received its first orders for private label women's
denim jeans from Express, a division of The Limited, Inc. ("The Limited").
While women's jeans have historically been, and continue to be, the Company's
principal product, in recent years the Company has expanded its sales of
moderately-priced, women's apparel to include casual, denim and non-denim
woven tops and bottoms and has commenced the sale of men's apparel, including
knit and woven tops, shirts and outerwear (including jackets), as a result of
the Gobuty Acquisition on February 23, 1998. The Company's women's apparel
currently include jeanswear, casual pants, t-shirts, shorts, blouses, shirts
and other tops, dresses, leggings 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 $6.00 to over $25.00 per garment.
 
  Over the past two years, management's best estimate is that approximately
fifty percent of net sales were derived from the sale of pants and jeans,
approximately fifteen percent of net sales were derived from the sale of
shorts and shirts accounted for approximately ten percent of net sales. The
balance of net sales consisted of sales of dresses, jackets, leggings and
other products. These estimates do not include any information relating to
fabric sales, net sales of Tarrant Company Limited, a wholly-owned subsidiary
("Tarrant HK"), or net sales to non-combined affiliates for which, in each
case, the Company does not have data segregated by apparel category.
 
  The Company, in the ordinary course of its business, regularly evaluates new
markets and potential acquisitions and believes that numerous opportunities
exist due, in part, to the adverse effect on the earnings of many apparel
companies of the recent decline in retail sales generally. Such opportunities
could include transactions involving acquisitions or brand affiliations.
Although the Company currently is evaluating several acquisitions, there are
no existing commitments with respect to any acquisition or affiliation, except
as described under "Business -- Recent Acquisition."
 
CUSTOMERS
 
  For the year ended December 31, 1997, affiliated stores owned by The
Limited, including Express, Lerner New York, Limited Stores and Lane Bryant,
accounted for approximately 70% of the Company's net sales and one mass
merchandise store chain accounted for approximately 20% of the Company's net
sales. No other customer accounted for more than 10% of the Company's net
sales in 1997. In the same period, the predominant portion of the Company's
sales were of private label apparel. The Company currently serves over 20
customers. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- General."
 
  The Company does not have long-term contracts with any of its customers and,
therefore, there can be no assurance that any customer will continue to place
orders with the Company 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.
Various retailers, including divisions of The Limited, have experienced
sluggish sales and declines in revenue and profits in recent periods. To the
extent that these financial difficulties continue or worsen, there can be no
assurance that the Company's financial condition and results of operations
would not be adversely affected. As a result of the importance of The Limited
to the operations of the Company, The Limited and its divisions have the
ability to exert significant influence over the Company's business decisions.
 
                                       5
<PAGE>
 
DESIGN, MERCHANDISING AND SALES
 
  While many private label producers only arrange for the bulk production of
styles specified by their customers, the Company not only designs garments,
but also assists some of its customers in market testing new designs. The
Company believes that its design, sample-production and test-run capabilities
give it a competitive advantage in obtaining bulk orders from its customers.
The Company also often receives bulk orders for garments it has not designed
because many of its customers allocate bulk orders among more than one
producer.
 
  The Company has 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 generally are divided between import and domestic 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. In particular, 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 wishes 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, the Company and its customer can make
appropriate arrangements regarding any delay or other change in the order. The
Company believes that this team approach enables its employees to develop an
understanding of the customer's distinctive styles and production requirements
in order to respond effectively to the customer's needs.
 
  As part of the Company's merchandising strategy, the Company produces, at
its own expense, one or more samples of garments embodying new designs. The
Company produces samples at its facilities in Guangdong Province, China, Hong
Kong and Los Angeles. The Chinese facility, which has 120 employees, currently
furnishes a significant portion of the Company's sample requirements.
 
  From time to time and at scheduled seasonal meetings, the Company presents
its samples to the customer's buyers, who determine which, if any, of those
samples will be produced on a test run or a bulk scale. Samples are often
presented in coordinated groupings or as part of a product line. Some
customers, particularly specialty retail stores such as divisions of The
Limited, 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 the Company's customers to
identify garments that may appeal to consumers and also provides the Company
with important information regarding the cost and feasibility of the bulk
production of the tested garment. If the test is determined to be successful,
the Company generally receives a significant percentage of the customer's
total bulk order of the tested item. In addition, as is typical in the private
label business, the Company receives bulk production orders to produce
merchandise designed by its competitors or other designers, since most
customers allocate bulk orders among a number of suppliers.
 
SOURCING
 
 General
 
  When bidding for or filling an order, the Company's international sourcing
network enables it to choose from among a number of suppliers and
manufacturers based on the customer's price requirements, product
specifications and delivery schedules. Historically, the Company has
manufactured its products through independent cutting, sewing and finishing
contractors located primarily in Hong Kong and China and has purchased its
fabric from independent fabric manufacturers with weaving mills located
primarily in Hong Kong and China. In recent years, the Company has expanded
its network to include suppliers and manufacturers located in a number of
additional countries, including Mexico. Key elements of the Company's sourcing
strategy include (i) continuing to expand its production of basic denim and
twill products in Mexico and Central America
 
                                       6
<PAGE>
 
through both independent contractors and the acquisition or construction of
cutting, sewing and finishing facilities and (ii) seeking to acquire or
construct denim and twill weaving mills in Mexico. The following table sets
forth the percent of the Company's merchandise, on the basis of the free on
board cost at the suppliers's plant ("FOB Basis"), by country for the periods
indicated:
 
<TABLE>
<CAPTION>
                                                               1995  1996  1997
                                                               ----  ----  ----
     <S>                                                       <C>   <C>   <C>
     International Sourcing
      Hong Kong and China..................................... 64.8% 78.3% 60.5%
      Other(1)................................................ 12.7   7.7  13.7
     Domestic Sourcing
      United States........................................... 22.5  13.8  14.9
      Mexico and Central America..............................  --    0.2  10.9
</TABLE>
----------
(1) In 1997, such countries consisted of Thailand (3.0%), Macau (4.0%),
    Philippines (2.6%), UAE/Oman (1.4%) and Indonesia (1.3%).
 
  In late 1997, the Company commenced negotiations to acquire a denim mill in
Puebla, Mexico and initiated constructing a twill plant. There can be no
assurance that either such transaction will be consummated.
 
 Dependence on Contract Manufacturers
 
  All of the Company's products, with the exception of certain test runs and
samples, currently are manufactured by independent cutting, sewing and
finishing contractors. The use of contract manufacturers and the resulting
lack of direct control over the production of its products could result in the
Company's failure to receive timely delivery of products of acceptable
quality. Although the Company believes that alternative sources of cutting,
sewing and finishing services are readily available, the loss of one or more
contract manufacturers could have a materially adverse effect on the Company's
results of operations until an alternative source is located and has commenced
producing the Company's products.
 
  Although the Company monitors the compliance of its independent contractors
with applicable labor laws, the Company does not control its contractors or
their labor practices. The violation of federal or state labor laws by one of
the Company's contractors can result in the Company being subject to fines and
the Company's goods which are manufactured in violation of such laws being
seized or their sale in interstate commerce being prohibited. From time to
time, the Company has been notified by federal or state authorities that
certain of its contractors are the subject of investigations or have been
found to have violated applicable labor laws. To date, the Company has not
been subject to any sanctions that, individually or in the aggregate, could
have a material adverse effect upon the Company, and the Company is not aware
of any facts on which any such sanctions could be based. There can be no
assurance, however, that in the future the Company will not be subject to
sanctions as a result of violations of applicable labor laws by its
contractors, or that such sanctions will not have a material adverse effect on
the Company. In addition, certain of the Company's customers, including The
Limited and Target Stores, require strict compliance by their apparel
manufacturers, including the Company, with applicable labor laws. There can be
no assurance that the violation of applicable labor laws by one of the
Company's contractors will not have a material adverse effect on the Company's
relationship with its customers.
 
  In addition, as is customary in the industry, the Company does not have any
long-term contracts with its fabric suppliers. The loss of any of its major
contractors or fabric suppliers could have a material adverse effect on the
Company's financial condition and results of operations until alternative
supplier arrangements are secured.
 
 Diversified Production Network
 
  The Company believes that it has the ability, through its production
network, to operate on production schedules with lead times as short as 30
days. Typically, the Company's specialty retail customers attempt to respond
quickly to changing fashion themes and are increasingly less willing to assume
the risk that goods
 
                                       7
<PAGE>
 
ordered on long lead times will be out of fashion when delivered. These
retailers, including divisions of The Limited, frequently require production
schedules with lead times ranging from 30 to 120 days. Although mass
merchandisers, such as Target, are beginning to operate on shorter lead times,
they are occasionally able to estimate their needs as much as six months to
one year in advance for "program" business -- basic products that do not
change in style significantly from season to season. The Company's ability to
operate on production schedules with a wide range of lead times helps it to
meet its customers' varying needs.
 
  By allocating an order among different manufacturers, the Company can fill
the high-volume orders of its customers, while meeting their delivery
requirements. Upon receiving an order, the Company determines which of its
suppliers and manufacturers can best fill the order and meet the customer's
price, quality and delivery requirements. The Company considers, 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 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. The Company's 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 the Company stagger the delivery
of products over several weeks.
 
 International Sourcing
 
  The Company conducts and monitors the majority of its international sourcing
operations from its offices in Hong Kong. At January 31, 1998, the Company had
approximately 180 full-time employees in Hong Kong, many of whom have
extensive knowledge about and experience with sourcing and production in Hong
Kong and China, including purchasing, manufacturing and quality control.
Several times each year, members of the Company's senior management, including
those resident in Hong Kong and China, visit and inspect the facilities and
operations of the Company's 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 and other non-tariff barriers (including
changes in the allocation of quotas). In addition to these risk factors, the
Company faces additional risks arising from the uncertainty regarding the
future status of Hong Kong since resumption of Chinese sovereignty on July 1,
1997, the continuation of favorable trade relations between the U.S. and China
(in particular the continuation of China's Most Favored Nation ("MFN") status
for tariff purposes), and the continuation of economic reform programs in
China which encourage private economic activity. Each of these factors could
have a material adverse effect on the Company.
 
  While the Company is in the process of establishing business relationships
with manufacturers and suppliers located in countries other than Hong Kong or
China, the Company still contracts with manufacturers and suppliers located
primarily in Hong Kong and China, and currently expects that it will continue
to do so for the foreseeable future. Any significant disruption in the
Company's operations or its relationships with its manufacturers and suppliers
located in Hong Kong or China could have a material adverse effect on the
Company.
 
 Domestic Sourcing
 
  The Company commenced manufacturing basic denim and twill products through
independent contractors in Mexico and Central America in the second quarter of
1997, and anticipates continuing to expand its use of manufacturing facilities
in this region. The Company believes that the further diversification of its
international sourcing network by increasing the use of manufacturing
facilities in the United States, Mexico and Central America will (i) reduce
its cost of goods, (ii) enhance the proximity of the Company's sourcing
operations to the Company's customers and the Company's executive offices,
thereby improving delivery times and increasing management's control, (iii)
lessen certain risks of doing business in Asia and (iv) enable the Company to
provide products to customers who require a "Made in USA" label.
 
                                       8
<PAGE>
 
  The Company currently conducts its domestic, Mexico and Central American
sourcing from its Los Angeles facilities. The Company also manufactures
samples at one of its Los Angeles facilities. Samples are produced at the
Company's expense and embody a particular design idea that can be presented to
a customer as a means of soliciting an order. See "Business -- Design,
Merchandising and Sales." Because of its local sample-making capacity, the
Company is capable of responding quickly to customers' requests for revisions
to samples. As a result, management believes that this capability gives the
Company a competitive advantage.
 
 The Sourcing Process
 
  As is customary in the industry, the Company does not have any long-term
contracts with its manufacturers. The Company typically contracts (on the
basis of a written purchase order) with one to three manufacturers to produce
a bulk order. The Company often arranges on behalf of these manufacturers for
the purchase of fabric from one supplier for the entire order, in which case
the Company deducts the cost of the fabric when paying the manufacturer's
invoice. By procuring fabric for an entire order from one source, the Company
believes that production costs per garment are reduced and customer
specifications as to fabric quality and color can be controlled. In 1997, an
aggregate of approximately $59.5 million (on an FOB Basis) or approximately
46.1% of the Company's imported products were purchased from five
manufacturers with facilities in Hong Kong and China.
 
  During the manufacturing process, the Company's 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 the
Company's offices in Hong Kong and Los Angeles. The Company, in turn, keeps
its 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 the Company's plans to rectify them.
 
  The Company often purchases fabric to meet the specifications of the
customer's order. The Company has the fabric shipped directly to the factory
and invoices the factory for the fabric. Generally the factories pay the
Company for the fabric with offsets against the price of the finished goods.
For its longstanding program business, the Company may purchase fabric in
advance of receiving the order, but in accordance with the customer's
specifications. The Company's primary sources of working capital are cash flow
from operations and borrowings under the Company's bank credit agreements and
factoring agreement. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
 
BACKLOG
 
  At February 23, 1998, the Company had unfilled customer orders of
approximately $125 million as compared to approximately $82 million as of
February 15, 1997. The Company believes that all of its backlog of orders as
of February 23, 1998 will be filled within the current fiscal year. Backlog is
based on the Company's 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 manufacture and shipping of the product
which, in some instances, depends on the customer's demands. Accordingly, a
comparison of unfilled orders from period to period is not necessarily
meaningful and may not be indicative of eventual actual shipments. The
Company's experience has been that the cancellations, rejections or returns of
orders have not materially reduced the amount of sales realized from its
backlog.
 
IMPORT RESTRICTIONS
 
 Quotas
 
  The Company imported approximately 85% of its products (on an FOB Basis) in
1997, including approximately 10% imported from Mexico. Most of the products
imported were manufactured in a foreign
 
                                       9
<PAGE>
 
jurisdiction (e.g., Hong Kong and China) with which the U.S. has entered into
a bilateral textile agreement that, among other restrictions, imposes specific
quantitative restraints, or "quotas," on the amounts of various categories of
textiles and apparel that can be imported into the U.S. from that foreign
jurisdiction during a particular quota year. These bilateral textile
agreements also include provisions which allow the U.S. to impose quotas on
categories of textiles and apparel not previously under quota or to "charge"
(i.e., impose deductions upon) the quotas for origin-related violations.
Accordingly, the Company's operations are subject to the restrictions imposed
by these bilateral agreements.
 
  Until recently, the Arrangement Regarding International Trade in Textiles,
known as the Multifiber Arrangement ("MFA"), provided the international
framework for the global regulation of the textile and apparel trade. Pursuant
to the MFA, the U.S. entered into these bilateral textile agreements for the
purpose of imposing quotas on the imports of textiles and apparel. However,
under "The Final Act Embodying the Results of the Uruguay Round of
Multilateral Trade Negotiations" (the "Uruguay Round Agreement") which was
agreed to on a preliminary basis in December 1993 by 117 member nations of the
General Agreement on Tariffs and Trade ("GATT"), and enacted into U.S.
domestic law in December 1994 under the Uruguay Round Agreements Act (the
"URAA"), the MFA has been replaced by the World Trade Organization Agreement
on Textiles and Clothing (the "ATC"). Under the ATC, quotas implemented under
the MFA on the importation of textiles and apparel from countries that are
members of the World Trade Organization (the "WTO," which is the successor
organization to GATT under the Uruguay Round Agreement) will be phased out
over a ten-year period that commenced on January 1, 1995 (with the U.S.
phasing out quotas on most of the sensitive categories at the end of this
period). However, a member country may, under the Uruguay Round Agreement on
Safeguards, re-impose quotas on textiles and apparel under certain specified
conditions.
 
  China is a signatory to the MFA, but was not a member of GATT and,
therefore, was not a party to the Uruguay Round Agreement. China has not been
admitted as a member of the WTO, although it is in the process of trying to
negotiate its accession to the WTO at this time. Because China is not a member
of the WTO, its exports of textiles and apparel to the U.S. are not covered by
the ATC. Accordingly, the U.S. continues to control imports of textiles and
apparel from China under the existing bilateral agreement between the U.S. and
China. On January 17, 1994, the U.S. and China signed a three-year agreement
which set the 1994 textile and apparel quotas from China at their 1993 levels
and increased the quota by 1.0% for each of 1995 and 1996. A new agreement, to
replace the expiring 1994 Agreement, was signed in February 1997, covering the
period January 1, 1997 to December 31, 2000. This agreement continues to
permit some growth in most quota categories.
 
  In the event that China eventually becomes a member of the WTO, it will be
afforded the rights granted other members under the ATC, including the phase-
out of textile and apparel quotas over the ten-year period that commenced on
January 1, 1995. However, there can be no assurance that China will become a
member of the WTO, particularly since the U.S. has expressed dissatisfaction
with China's progress in opening its domestic market in a number of areas.
 
  In 1997, products imported using Hong Kong quota accounted for approximately
67% of the Company's imported net sales (on an FOB Basis). Under the U.S. and
Hong Kong rules of origin currently in effect, the Company conducts certain,
non-origin conferring manufacturing operations in China for a significant
portion of the products it imports using Hong Kong quota. As part of the URAA,
the U.S. implemented new rules of origin which become effective on July 1,
1996. These new rules of origin had little actual impact on the country of
origin of the merchandise imported by the Company. The Company is nevertheless
attempting to diversify its sourcing network to reduce reliance on Hong Kong
sources, in part to minimize the potential effects of this change in the rule
of origin. It is also taking steps to obtain additional quota from China in
the event that these new rules of origin result in changing the origin of the
products presently subject to Hong Kong quota.
 
 Duties and Tariffs
 
  Merchandise imported by the Company into the U.S. is subject to rates of
duty established by U.S. statute. In general, these rates vary, depending on
the type of product, from 3.0% to 34.6% of the appraised value of the
 
                                      10
<PAGE>
 
product. In addition to duties, in the ordinary course of its business, the
Company, from time to time, may become subject to claims by the U.S. Customs
Service for penalties, liquidated damage claims and other charges relating to
import activities. Similarly, from time to time, the Company may be entitled
to refunds from the U.S. Customs Service due to the overpayment of duties.
 
  Products imported from China into the U.S. currently receive the same
preferential tariff treatment accorded goods from countries granted MFN
status. China's MFN status, which is granted on an annual basis, expires in
July 1998. China's MFN status has been a contentious political issue for
several years because of concerns regarding labor and human rights practices,
weapons proliferation, trade policies and failure to protect U.S. intellectual
property rights. Previous legislation attaching conditions to China's MFN
status has been passed by both houses of the Congress, but did not survive
presidential vetoes. There can be no assurance that the U.S. will not revoke
China's MFN status entirely or place greater conditions or restrictions on
this status, but absent a major deterioration in U.S.-China relations, it is
anticipated that China will maintain its MFN status. If China's MFN status
were to terminate, and Chinese origin products had to enter the U.S. without
the benefit of MFN status, such goods will be subject to significantly higher
duties than at present. Any such increased duties would increase the cost or
reduce the supply of the Company's goods imported from China. In 1997,
products imported using China quota accounted for approximately 15% of the
Company's imported net sales (on an FOB Basis). The Company is taking steps to
diversify its sourcing network to reduce its dependence on Chinese-origin
products.
 
  The Company's continued ability to source products from foreign
jurisdictions may be adversely affected by additional bilateral and
multilateral agreements, unilateral trade restrictions, changes in trade
policy, significant decreases in import quotas, 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
imports.
 
COMPETITION
 
  There is intense competition in the sectors of the apparel industry in which
the Company participates. The Company competes with many other manufacturers,
many of which are larger and have greater resources than the Company. The
Company also faces competition from its own customers and potential customers,
many of which have established, or may establish, their own internal product
development and sourcing capabilities. For example, The Limited's wholly-owned
subsidiary, Mast Industries, Inc., competes with the Company and other private
label apparel suppliers for orders from divisions of The Limited. The Company
believes that it competes favorably on the basis of design and sample
capabilities, quality and value of its products, price, the production
flexibility that it enjoys as a result of its sourcing network and the long-
term customer relationships it has developed.
 
EMPLOYEES
 
  At January 31, 1998, the Company had approximately 150 full-time employees
in Los Angeles, 180 full-time employees in Hong Kong and 120 in China. None of
the Company's employees is subject to a collective bargaining agreement. The
Company considers its relations with its employees to be good.
 
ITEM 2. PROPERTIES
        ----------
 
  The Company currently conducts its operations from three facilities, all of
which are leased. The Company's executive offices and warehouse facilities are
located at 3151 East Washington Boulevard, Los Angeles, California 90023. The
Company leases this facility for an annual rent of $595,000 from a California
corporation which is owned by Gerard Guez and Todd Kay, the Company's Chief
Executive Officer and President (the "Original Shareholders"). The base rent
is subject to increase on January 1, 2000 and every two years thereafter by an
amount equal to at least five percent but no greater than ten percent. The
lease for this facility, under which the Company is responsible for the
payment of taxes, utilities and insurance, terminates in December 2003 subject
to a renewal option for five additional years. The Company also leases 146,000
square feet of warehouse
 
                                      11
<PAGE>
 
space in South Gate, California for an annual rent of $170,000 from an
unrelated third party. The Company also leases approximately 36,000 square
feet of warehouse and office space in Hong Kong for an annual rent of $674,000
from a Hong Kong corporation that is owned by the Original Shareholders. The
base rent is subject to increase every two years in accordance with market
rates. The lease for this facility, under which the Company is responsible for
the payment of taxes, utilities and insurance, expires in June 2004. See Note
8 of Notes to Consolidated Financial Statements for additional information
with respect to these leases.
 
  The Company believes that its other existing facilities are well maintained,
in good operating condition and adequate to meet its current and foreseeable
needs.
 
ITEM 3. LEGAL PROCEEDINGS
        -----------------
 
  On December 22, 1997, the Federal judge in the civil lawsuit brought by the
American Textile Manufacturers Institute ("ATMI") against, among others, the
Company, Gerard Guez, its Chairman and Chief Executive Officer, and Todd Kay,
its President, granted ATMI's motion to excuse himself from the case. At the
same time, the judge denied the motion to vacate the decision and judgment
previously entered dismissing the case. Consequently, a new judge will
consider whether the decision should be altered or amended.
 
  The Company is not involved in any other pending or threatened legal
proceedings which the Company believes could reasonably be expected to have a
material adverse effect on the its financial condition or results of
operations.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
        --------------------------------------------------- 

  No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of fiscal 1997.
 
                                      12
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
        ---------------------------------------------------------------------
 
NASDAQ LISTING
 
  The Company's Common Stock began trading on The Nasdaq Stock Market's
National Market ("NASDAQ") under the symbol "TAGS" on July 24, 1995.
 
  The following table sets forth, for the periods indicated, the range of high
and low sale prices for the Company's Common Stock as reported by NASDAQ.
 
<TABLE>
<CAPTION>
                                                                   LOW    HIGH
                                                                  ------ ------
     <S>                                                          <C>    <C>
     1996
     First Quarter............................................... $ 5.75 $ 8.25
     Second Quarter.............................................. $ 7.50 $10.62
     Third Quarter............................................... $ 7.25 $10.25
     Fourth Quarter.............................................. $ 9.12 $14.75
     1997
     First Quarter............................................... $12.25 $19.75
     Second Quarter.............................................. $13.75 $18.00
     Third Quarter............................................... $13.94 $19.25
     Fourth Quarter.............................................. $11.50 $17.50
     1998
     First Quarter (through February 10)......................... $14.75 $17.75
</TABLE>
 
  On February 10, 1997, the last reported sale price of the Company's Common
Stock as reported on NASDAQ was $17.75. Shareholders are urged to obtain
current market quotations for the Common Stock. As of February 10, 1997, there
were approximately 16 shareholders of record of the Company. However, proxy
data indicates that there are over 1,000 beneficial owners of shares of the
Common Stock.
 
DIVIDEND POLICY
 
  The Company intends to retain future earnings for use in its business and
therefore does 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 the Company's earnings, financial condition, capital
needs and other factors deemed relevant by the Board of Directors.
 
                                      13
<PAGE>
 
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.
 
<TABLE>
<CAPTION>
                                     YEAR ENDED DECEMBER 31,
                           ----------------------------------------------------
                             1993      1994        1995        1996      1997
                           --------  --------    --------    --------  --------
                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                        <C>       <C>         <C>         <C>       <C>
INCOME STATEMENT DATA:
Net sales................  $147,017  $177,108    $205,174    $229,861  $260,093
Cost of sales............   121,971   148,740     172,959     192,288   220,996
                           --------  --------    --------    --------  --------
  Gross profit...........    25,046    28,368      32,215      37,573    39,097
Selling and distribution
 expenses................     5,360     6,118       6,761       7,124     8,499
General and
 administrative expenses.    11,636    12,359      13,493      13,990    13,518
Officers' bonus(1).......     3,000        --          --          --        --
LDA Option(2)............        --        --       1,734          --        --
                           --------  --------    --------    --------  --------
  Income from operations.     5,050     9,891      10,227      16,459    17,080
Interest expense.........    (3,410)   (3,696)     (4,003)     (1,865)  (1,471)
Interest income..........       210        78         773         337       171
Other
 income/(expense)(3).....     2,359     1,367       1,274        (302)      242
                           --------  --------    --------    --------  --------
Income before provision
 for income taxes and
 cumulative effect of
 accounting change.......     4,209     7,640       8,271      14,629    16,022
Provision for income
 taxes(4)................      (478)     (597)       (961)     (4,627)   (5,235)
                           --------  --------    --------    --------  --------
Income before cumulative
 effect of accounting
 change..................     3,731     7,043       7,310      10,002    10,787
Cumulative effect of
 accounting change(5)....        --        94          --          --        --
                           --------  --------    --------    --------  --------
Net income...............  $  3,731  $  7,137    $  7,310    $ 10,002  $ 10,787
                           ========  ========    ========    ========  ========
PRO FORMA DATA(6):
Pro forma net income.....  $  3,033  $  5,358    $  7,408(7) $ 10,002  $ 10,787
Pro forma net income per
 common share
  Basic..................  $   0.67  $   1.19(7) $   1.38(7) $   1.54  $   1.64
  Diluted................  $   0.67  $   1.19(7) $   1.38(7) $   1.53  $   1.59
Pro forma weighted
 average shares
 outstanding(8)
  Basic..................     4,500     4,500(9)    5,353       6,508     6,588
  Diluted................     4,500     4,500(9)    5,353       6,548     6,784
<CAPTION>
                                        AS OF DECEMBER 31,
                           ----------------------------------------------------
                             1993      1994        1995        1996      1997
                           --------  --------    --------    --------  --------
                                          (IN THOUSANDS)
<S>                        <C>       <C>         <C>         <C>       <C>
BALANCE SHEET DATA:
Working capital..........  $  3,242  $  2,594    $ 23,003    $ 34,029  $ 45,304
Total assets.............    44,376    44,017      57,840      63,420    71,861
Bank borrowings and long-
 term obligations........    20,371    19,313      15,940       6,810     4,288
Shareholders' equity.....     7,163     7,848      26,416      36,953    48,335
</TABLE>
---------
 
(1) Consists of bonuses paid to enable the Original Shareholders to pay their
    income taxes, including personal income taxes resulting from the Company's
    S Corporation status.
(2) On the effective date of its initial public offering, the Company incurred
    a non-recurring charge to earnings related to a grant by the Original
    Shareholders to Limited Direct Associates, L.P., an affiliate of The
    Limited, Inc., of a four-year option (the "LDA Option") to purchase an
    aggregate of 649,999 shares, or 10% of the Company's Common Stock, at an
    exercise price equal to $7.20 per share.
(3) Major components of Other income/(expense) (as presented above) include
    fees paid by affiliate entities for management and administrative services
    provided by the Company and royalty income. See "Management's Discussion
    and Analysis of Financial Condition and Results of Operations."
(4) For federal and state tax purposes, Tarrant Apparel Group and certain of
    the companies included in the historical results of operations were
    treated as S Corporations under Subchapter S of the Internal Revenue Code
    of 1986, as amended, and comparable provisions of state income tax laws.
(5) See Note 1 to Consolidated Financial Statements.
(6) Reflects an income tax provision which is the sum of (i) U.S. income taxes
    computed as if the Company had been taxed as a C Corporation at an
    effective tax rate of 40% for federal and state tax purposes for the
    period it was an S Corporation and (ii) the historical tax provision of
    the Company and its non-U.S. consolidated subsidiaries for all other
    periods. 1996 and 1997 have no adjustments since the Company was a C
    Corporation in such years.
(7) The 1994 amount has been adjusted from the $1.09 per share previously
    reported in the Registration Statement on Form S-1, as amended, dated May
    4, 1995 (File No. 33-91874) (the "Form S-1") to reflect the elimination of
    a 400,000 share adjustment, as described in Note 9 to this table. The 1995
    amounts reflect a $1.7 million adjustment related to the grant of the LDA
    Option. The pro forma net income and pro forma net income per common share
    amounts reflecting only the adjustment for pro forma income taxes for 1995
    would be $5.7 million and $1.06, respectively. See "Consolidated
    Statements of Income," page F-4.
(8) Adjusted to give effect to a stock dividend of 14,999 shares for each
    outstanding share and the sale by the Company of 2,000,000 shares in its
    initial public offering (the "Offering") in July 1995.
(9) The 1994 amount has been adjusted from the 4,900,000 shares previously
    reported in the Form S-1 due to the elimination of a 400,000 share
    adjustment originally made to account for the capital in excess of
    earnings which was withdrawn by the Original Shareholders prior to the
    Offering. Additional earnings recorded subsequent to the Offering have
    necessitated that this adjustment be eliminated.
 
                                      14
<PAGE>  
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        ---------------------------------------------------------------
        RESULTS OF OPERATIONS
        ---------------------
 
GENERAL
 
  The Company primarily serves both specialty retail and mass merchandise
store chains by designing, merchandising, contracting for the manufacture of
and selling casual, moderately-priced apparel, primarily for women, under
private label. The Company's major customers include specialty retailers, such
as Lerner New York, Limited Stores, Lane Bryant and Express, all of which are
divisions of The Limited, and mass merchandisers. The Company's products are
manufactured in a variety of woven and knit fabrications and include
jeanswear, casual pants, t-shirts, shorts, blouses, shirts and other tops,
dresses, leggings and jackets.
 
  On July 28, 1995, the Company completed an initial public offering (the
"Offering") of 2,000,000 shares of the Company's Common Stock at a price of
$9.00 per share. The proceeds to the Company, net of underwriting discounts
and commissions and offering expenses, were $14.8 million.
 
  The Company continues to geographically diversify its worldwide sourcing
operations. During the third quarter of 1997, the Company substantially
expanded its use of independent cutting, sewing and finishing contractors in
Mexico, primarily for its increasing sales of commodity products.
 
  The Company intends to continue to attempt to geographically balance its
sourcing operations. The Company believes that the benefits of a more
diversified sourcing base will include increasing the Company's access to
emerging providers of low cost production, enhancing the proximity of the
Company's sourcing base to the Company's customers and principal executive
offices and lessening certain risks associated with doing business abroad
(including transportation delays, economic or political instability, currency
fluctuations, restrictions on the transfer of funds and the imposition of
tariffs, export duties, quotas and other trade restrictions).
 
  On February 23, 1998, the Company acquired certain assets of Marshall Gobuty
International U.S.A., Inc. and MGI International Limited which design,
contract for the manufacture of and sell private label apparel for men and
boys to national retailers, including J.C. Penney (the "Gobuty Acquisition").
See "Business--Recent Acquisition."
 
FACTORS THAT MAY AFFECT FUTURE RESULTS
 
  This Report on Form 10-K contains forward-looking statements which are
subject to a variety of risks and uncertainties. The Company's actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below.
 
  Variability of Quarterly Results.  The Company has experienced, and expects
to continue to experience, a substantial variation in its net sales and
operating results from quarter to quarter. The Company believes that the
factors which influence this variability of quarterly results include the
timing of the Company's introduction of new product lines, the level of
consumer acceptance of each new product line, general economic and industry
conditions that affect consumer spending and retailer purchasing, the
availability of manufacturing capacity, the seasonality of the markets in
which the Company participates, the timing of trade shows, the product mix of
customer orders, the timing of the placement or cancellation of customer
orders, the occurrence of chargebacks in excess of reserves and the timing of
expenditures in anticipation of increased sales and actions of competitors.
Accordingly, a comparison of the Company's results of operations from period
to period is not necessarily meaningful, and the Company's results of
operations for any period are not necessarily indicative of future
performance.
 
  Economic Conditions.  The apparel industry historically has been subject to
substantial cyclical variation, and a recession in the general economy or
uncertainties regarding future economic prospects that affect consumer
spending habits have in the past had, and may in the future have, a materially
adverse effect on the Company results of operations. In addition, certain
retailers, including some of the Company customers, have experienced in the
past, and may experience in the future, financial difficulties which increase
the risk of extending credit to such retailers. These retailers have attempted
to improve their own operating efficiencies by concentrating their purchasing
power among a narrowing group of vendors. There can be no assurance that the
Company will remain a preferred vendor for its existing customers. A decrease
in business from or loss of a major customer could
 
                                      15
<PAGE>
 
have a material adverse effect on the Company's results of operations. The
Company has a non-recourse accounts receivable factoring agreement. There can
be no assurance that the Company's factor will approve the extension of credit
to certain retail customers in the future. If a customer's credit is not
approved by the factor, the Company could either assume the collection risk on
sales to the customer itself, require that the customer provide a letter of
credit or choose not to make sales to the customer.
 
  Reliance on Key Customers.  Affiliated stores owned by The Limited
(including Lerner New York, Limited Stores, Express and Lane Bryant) accounted
for approximately 70% of the Company's net sales in 1997 and 1996. The loss of
such customer could have a material adverse effect on the Company's results of
operations. From time to time, certain of the Company's major customers have
experienced financial difficulties. The Company does not have long-term
contracts with any of its customers and, accordingly, there can be no
assurance that any customer will continue to place orders with the Company to
the same extent it has in the past, or at all. In addition, the Company's
results of operations will depend to a significant extent upon the commercial
success of its major customers.
 
  Dependence on Contract Manufacturers.  All of the Company's products, with
the exception of certain test runs and samples, are manufactured by
independent cutting, sewing and finishing contractors. The use of contract
manufacturers and the resulting lack of direct control over the production of
its products could result in the Company's failure to receive timely delivery
of products of acceptable quality. Although the Company believes that
alternative sources of cutting, sewing and finishing services are readily
available, the loss of one or more contract manufacturers could have a
materially adverse effect on the Company's results of operations until an
alternative source is located and has commenced producing the Company's
products.
 
  Although the Company monitors the compliance of its independent contractors
with applicable labor laws, the Company does not control its contractors or
their labor practices. The violation of federal or state labor laws by one of
the Company's contractors can result in the Company being subject to fines and
the Company's goods which are manufactured in violation of such laws being
seized or their sale in interstate commerce being prohibited. From time to
time, the Company has been notified by federal or state authorities that
certain of its contractors are the subject of investigations or have been
found to have violated applicable labor laws. To date, the Company has not
been subject to any sanctions that, individually or in the aggregate, could
have a material adverse effect upon the Company, and the Company is not aware
of any facts on which any such sanctions could be based. There can be no
assurance, however, that in the future the Company will not be subject to
sanctions as a result of violations of applicable labor laws by its
contractors, or that such sanctions will not have a material adverse effect on
the Company. In addition, certain of the Company's customers, including The
Limited and Target Stores, require strict compliance by their apparel
manufacturers, including the Company, with applicable labor laws. There can be
no assurance that the violation of applicable labor laws by one of the
Company's contractors will not have a material adverse effect on the Company's
relationship with its customers.
 
  Price and Availability of Raw Materials.  Cotton fabric is the principal raw
material used in the Company's apparel. Although the Company believes that its
suppliers will continue to be able to procure a sufficient supply of cotton
fabric for its production needs, the price and availability of cotton may
fluctuate significantly depending on supply, world demand and currency
fluctuations, each of which may affect the price and availability of cotton
fabric. There can be no assurance that fluctuations in the price and
availability of cotton fabric or other raw materials used by the Company will
not have a material adverse effect on the Company's results of operations.
 
  Management of Growth.  Since its inception, the Company has experienced
rapid growth in sales. No assurance can be given that the Company will be
successful in maintaining or increasing its sales in the future. Any future
growth in sales will require additional working capital and may place a
significant strain on the Company's management, management information
systems, inventory management, production capability, distribution facilities
and receivables management. Any disruption in the Company's order processing,
sourcing or distribution systems could cause orders to be shipped late, and
under industry practices, retailers generally can cancel orders or refuse to
accept goods due to late shipment. Such cancellations and returns would result
in a reduction in revenue, increased administrative and shipping costs and a
further burden on the Company's
 
                                      16
<PAGE>
 
distribution facilities. In addition, the failure to timely enhance the
Company's operating systems, or unexpected difficulties in implementing such
enhancements, could have a material adverse effect on the Company's results of
operations.
 
  Foreign Manufacturing.  Approximately 85% of the Company products were
imported in 1997. As a result, the Company's operations are subject to the
customary risks of doing business abroad, including, among other things,
transportation delays, economic or political instability, currency
fluctuations, restrictions on the transfer of funds and the imposition of
tariffs, export duties, quotas and other trade restrictions.
 
  Impact of Year 2000.  The Year 2000 Issue is the result of computer programs
being written using two digits rather than four to define the applicable year.
Any of the Company's computer programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
 
  The Company has determined that it will be required to modify or replace
portions of its software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The Company also has
initiated formal communications with its significant suppliers and large
customers to determine the extent to which the Company's interface systems are
vulnerable to those third parties' failure to remediate their own Year 2000
Issues. The Company presently believes that with modifications to existing
software and conversions to new software, the cost of which is not expected to
be material to the Company's results of operation or financial position, the
Year 2000 Issue will not pose significant operational problems for its
computer systems. The Company will use both internal and external resources to
reprogram, or replace, and test the software for Year 2000 modifications. The
Company anticipates completing the Year 2000 project prior to any anticipated
impact on its operating systems. However, if such modifications and
conversions are not made, or are not completed timely, the Year 2000 Issue
could have a material adverse effect on the operations of the Company.
Likewise, there can be no assurance that the systems of other companies on
which the Company's systems rely will be timely converted and would not have a
material adverse effect on the Company's systems.
 
                                      17
<PAGE>
 
RESULTS OF OPERATIONS
 
  The following table sets forth, for the periods indicated, certain items in
the Company's consolidated statements of income as a percentage of net sales
and as adjusted in the pro forma manner set forth in the footnotes to the
table:
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED
                                                              DECEMBER 31,
                                                            -------------------
                                                            1995   1996   1997
                                                            -----  -----  -----
   <S>                                                      <C>    <C>    <C>
   Net sales............................................... 100.0% 100.0% 100.0%
   Cost of sales...........................................  84.3   83.7   84.9
                                                            -----  -----  -----
   Gross profit............................................  15.7   16.3   15.1
   Selling and distribution expenses.......................   3.3    3.1    3.3
   General and administration expenses.....................   6.6    6.1    5.2
   Non-recurring charge related to LDA Option(1)...........   0.8     --     --
                                                            -----  -----  -----
   Operating income........................................   5.0    7.1    6.6
   Interest expense........................................  (2.0)  (0.8)  (0.6)
   Other income............................................   1.0    0.0    0.2
                                                            -----  -----  -----
   Income before income taxes..............................   4.0    6.3    6.2
   Income taxes(2).........................................  (1.3)  (2.0)  (2.0)
                                                            -----  -----  -----
   Net income..............................................   2.7%   4.3%   4.2%
                                                            =====  =====  =====
</TABLE>
----------
(1) On the effective date of the Offering, the Company incurred a non-
    recurring charge to earnings related to a grant by the Original
    Shareholders to Limited Direct Associates, L.P., an affiliate of The
    Limited, Inc., of a four-year option to purchase an aggregate of 649,999
    shares, or approximately 10% of the Company's then outstanding Common
    Stock, at an exercise price equal to $7.20 per share.
 
(2) The 1995 amount reflects a pro forma income tax provision which is the sum
    of (i) U.S. income taxes computed as if the Company had been taxed as a C
    Corporation at an effective tax rate of 40% for federal and state tax
    purposes for the period it was an S Corporation and (ii) the historical
    tax provision of the Company and its non-U.S. consolidated subsidiaries
    for all other periods.
 
 Comparison of 1997 to 1996
 
  Net sales increased by $30.2 million, or 13.2%, from $229.9 million in 1996
to $260.1 million in 1997. The increase in net sales included an aggregate
increase in sales of $27.2 million to divisions of The Limited and
$3.6 million to mass merchandisers.
 
  Certain of the Company's customers, including divisions of The Limited,
experienced sluggish sales and declines in revenue and profits in 1997. To the
extent that these financial difficulties continue or worsen, the Company's
revenues and gross profit margins could be adversely affected.
 
  Gross profit (which consists of net sales less product costs, duties and
direct costs attributable to production) for 1997 was $39.1 million, or 15.1%
of net sales, compared to $37.6 million, or 16.3% of net sales, in 1996, an
increase of 4.1% in gross profit. The decrease in the gross profit margin
primarily resulted from nonrecurring costs and inefficiencies related to the
Company's domestic sourcing. The increase in the absolute amount of gross
profit was primarily due to the increase in net sales.
 
  Selling and distribution expenses increased from $7.1 million in 1996 to
$8.5 million in 1997. As a percentage of net sales, these expenses increased
from 3.1% in 1996 to 3.3% in 1997. This percentage increase is primarily due
to an increase in freight and commission expenses, each of which amounted to
0.1% of net sales.
 
  General and administrative expenses decreased from $14.0 million in 1996 to
$13.5 million in 1997. As a percentage of net sales, these expenses declined
from 6.1% in 1996 to 5.2% in 1997. This percentage decrease was primarily due
to a $608,000 decrease in discretionary bonuses awarded to executive officers
in 1997, which amounted to 0.2% of net sales, combined with the effect of the
increase in net sales. After adjusting for the
 
                                      18
<PAGE>
 
decrease in executive bonuses, general and administrative expenses increased
by $136,000 and were 5.4% of net sales in 1997 as compared to 6.1% in 1996.
 
  Operating income was $16.5 million in 1996, or 7.1% of net sales, compared
to $17.1 million in 1997, or 6.6% of net sales, due to the factors described
above. This decrease in operating income as a percentage of net sales was due
to the decrease in the gross profit margin, which amounted to 1.2% of net
sales, an increase in selling and distribution expenses, which amounted to
0.2% of net sales, and a decrease in general and administrative expenses,
which amounted to 0.9% of net sales.
 
  Other income increased from $35,000 in 1996 to $413,000, or 0.2% of net
sales, in 1997. This increase is primarily the result of interest income of
$337,000 in 1996 compared to $171,000 in 1997, the realization of no gains on
the sale of securities in 1996 as compared to $237,000 of such income in 1997,
management fee income of $60,000 in 1996 compared to no such income in 1997
and a non-operating expense accrual of $400,000 in 1996 compared to no similar
accrual in 1997. (See Note 8 to Consolidated Financial Statements.) Management
fee income was derived from an agreement with FIS which sourced and sold
garments under the B.U.M. Equipment label until it ceased operations in the
second quarter of 1996.
 
  Income before income taxes was $14.6 million in 1996 and $16.0 million in
1997, representing 6.3% and 6.2% of net sales, respectively. This decrease in
income before taxes as a percentage of net sales was due to the decrease in
the gross profit margin, which amounted to 1.2% of net sales, an increase in
selling and distribution expenses, which amounted to 0.2% of net sales, a
decrease in general and administrative expenses, which amounted to 0.9% of net
sales, and the decrease in interest expense, which amounted to 0.2% of net
sales, as offset by the increase in other income, which amounted to 0.2% of
net sales.
 
 Comparison of 1996 to 1995
 
  Net sales increased by $24.7 million, or 12.0%, from $205.2 million in 1995
to $229.9 million in 1996. The increase in net sales included an aggregate
increase in sales of $40.7 million to divisions of The Limited and
$27.9 million to mass merchandisers.
 
  Gross profit (which consists of net sales less product costs, duties and
direct costs attributable to production) for 1996 was $37.6 million, or 16.3%
of net sales, compared to $32.2 million, or 15.7% of net sales, in 1995, an
increase of 16.6%. The increase in the gross profit margin primarily resulted
from the reduction of low margin sales to Kmart. The increase in the absolute
amount of gross profit was primarily due to the increase in net sales.
 
  Selling and distribution expenses increased from $6.8 million in 1995 to
$7.1 million in 1996. As a percentage of net sales, these expenses declined
from 3.3% in 1995 to 3.1% in 1996. This percentage decrease is primarily due
to a decrease in commission expenses.
 
  General and administrative expenses increased from $13.5 million in 1995 to
$14.0 million in 1996. As a percentage of net sales, these expenses declined
from 6.6% in 1995 to 6.1% in 1996. This percentage decrease was primarily due
to a decrease in the provision for bad debt, which includes an estimated
provision for returns and discounts as well as bad debt expense. The estimated
provision for returns and discounts is primarily based on a percentage of
receivables which increases with the age of the receivables, but is not a
reflection on the credit worthiness of the customer. The decrease in the
estimated provision for returns and discounts during 1996 was $180,000, or
0.1% of net sales, compared to an increase in such provision of $314,000, or
0.2% of net sales, during 1995. The most significant portions of the decrease
in the estimated provision for returns and discounts resulted from changes in
the amount and aging of accounts receivable. An additional favorable variance
in the provision for bad debt resulted from $179,000 of bad debt expense in
1996 compared to $532,000 of such expense in 1995. After adjusting for the
decrease in the provision for bad debt of $847,000, general and administrative
expenses increased by $1.3 million and were 6.2% of net sales in 1995 as
compared to 6.1% in 1996.
 
                                      19
<PAGE>
 
  Operating income was $10.2 million in 1995, or 5.0% of net sales, compared
to $16.5 million in 1996, or 7.1% of net sales, due to the factors described
above. After adjusting for the decrease in the provision for bad debt expense
and the $1.7 million non-recurring charge related to the grant of the LDA
Option during 1995, operating income as a percentage of net sales increased
from 6.2% in 1995 to 7.1% in 1996. This increase in operating income as a
percentage of net sales was due to the increase in the gross profit margin,
which amounted to 0.6% of net sales, a decrease in selling and distribution
expenses, which amounted to 0.2% of net sales and a decrease in general and
administrative expenses, which amounted to 0.1% of net sales.
 
  Other income decreased from $2.0 million, or 1.0% of net sales, in 1995 to
$35,000 in 1996. This decrease is primarily the result of interest income of
$337,000 in 1996 compared to $773,000 in 1995, management fee income of
$60,000 in 1996 compared to $1.1 million in 1995 and a non-operating expense
accrual of $400,000 in 1996 compared to no similar accrual in 1995. (See Note
8 to Consolidated Financial Statements.) Management fee income was derived
from an agreement with FIS which sourced and sold garments under the B.U.M.
Equipment label until it ceased operations in the second quarter of 1996.
 
  Income before income taxes was $8.3 million in 1995 and $14.6 million in
1996, representing 4.0% and 6.3% of net sales, respectively. After adjusting
for the decrease in the provision for bad debt expense and the $1.7 million
non-recurring charge related to the grant of the LDA Option during 1995,
income before income taxes as a percentage of net sales increased from 5.2% in
1995 to 6.3% in 1996. This increase in income before taxes as a percentage of
net sales was due to the increase in the gross profit margin, which amounted
to 0.6% of net sales, a decrease in selling and distribution expenses, which
amounted to 0.2% of net sales, a decrease in general and administrative
expenses, which amounted to 0.1% of net sales, and the decrease in interest
expense, which amounted to 1.2% of net sales, as offset by the decrease in
other income, which amounted to 1.0% of net sales.
 
                                      20
<PAGE>
 
QUARTERLY RESULTS OF OPERATIONS
 
  The following table sets forth, for the periods indicated, certain items in
the Company's consolidated statements of income in millions of dollars and as
a percentage of net sales, as adjusted in the pro forma manner described in
the footnotes to the tables:
 
<TABLE>
<CAPTION>
                                                                 QUARTER ENDED
                 ---------------------------------------------------------------------------------------------------------------
                 MAR. 31, JUNE 30, SEPT. 30,  DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
                   1995     1995     1995       1995     1996     1996     1996      1996     1997     1997     1997      1997
                 -------- -------- ---------  -------- -------- -------- --------- -------- -------- -------- --------- --------
                                                                 (IN MILLIONS)
<S>              <C>      <C>      <C>        <C>      <C>      <C>      <C>       <C>      <C>      <C>      <C>       <C>
Net sales.......  $45.3    $57.6     $58.1     $44.2    $42.1    $68.9     $50.0    $68.9    $53.6    $73.9     $69.2    $63.4
Gross profit....    6.9      9.2       8.9       7.2      7.1     11.3       8.2     11.0      8.8     11.1       9.7      9.6
Operating
 income.........    2.0      3.7       2.8(2)    1.8      2.4      5.5       3.7      4.9      3.4      5.1       4.1      4.5
Net income......    1.4      2.6       2.0(2)    1.4      1.5      3.6       2.2      2.7      2.0      3.3       2.7      2.8
Pro forma net
 income(1)......    1.1      2.2       1.0(2)    1.4      1.5      3.6       2.2      2.7      2.0      3.3       2.7      2.8
<CAPTION>
                                                                 QUARTER ENDED
                 ---------------------------------------------------------------------------------------------------------------
                 MAR. 31, JUNE 30, SEPT. 30,  DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
                   1995     1995     1995       1995     1996     1996     1996      1996     1997     1997     1997      1997
                 -------- -------- ---------  -------- -------- -------- --------- -------- -------- -------- --------- --------
<S>              <C>      <C>      <C>        <C>      <C>      <C>      <C>       <C>      <C>      <C>      <C>       <C>
Net sales.......  100.0%   100.0%    100.0%    100.0%   100.0%   100.0%    100.0%   100.0%   100.0%   100.0%    100.0%   100.0%
Gross profit....   15.3     16.0      15.3      16.3     16.8     16.4      16.5     16.0     16.4     15.0      14.0     15.1
Operating
 income.........    4.5      6.3       4.7(2)    4.0      5.6      8.0       7.5      7.1      6.3      6.9       5.9      7.2
Net income......    3.1      4.5       3.4(2)    3.1      3.5      5.2       4.4      4.0      3.8      4.4       3.9      4.4
Pro forma net
 income(1)......    2.4      3.8       1.8(2)    3.1      3.5      5.2       4.4      4.0      3.8      4.4       3.9      4.4
</TABLE>
---------
(1) The first three quarters of 1995 reflect an income tax provision which is
    the sum of (i) U.S. income taxes for the Company computed as if the
    Company had been taxed as a C Corporation at an effective tax rate of 40%
    for federal and state tax purposes for the period it was an S Corporation
    and (ii) the historical tax provision of the Company and its non-U.S.
    consolidated subsidiaries for all other periods.
 
(2) Includes $1.7 million, or 3.0% of net sales, non-recurring charge in the
    third quarter of 1995 related to the grant of the LDA Option by the
    Original Shareholders.
 
  As is typical for the Company, quarterly net sales fluctuated significantly
because the Company's customers typically place bulk orders with the Company,
and a change in the number of orders shipped in any one period may have a
material effect on the net sales for that period.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company's liquidity requirements arise from the funding of its working
capital needs, principally inventory, finished goods shipments-in-transit, and
accounts receivable, including receivables from the Company's contract
manufacturers that relate primarily to fabric purchased by the Company for use
by those manufacturers. (The Company generally purchases fabric for delivery
directly to the manufacturer's factory. The Company then invoices the
manufacturer for the fabric, and reduces payments to the manufacturer for
finished goods by the amount of outstanding invoices.) The Company's primary
sources for working capital are cash flow from operations and borrowings under
the Company's bank credit agreements and factoring agreement.
 
  During 1997, net cash provided by operating activities was $7.0 million,
which resulted primarily from net income of $10.8 million, as partially offset
by a net increase in working capital items, including a decrease of $10.8
million in accounts receivable, as partially offset by an increase in
inventory of $12.4 million and an increase in cash of $4.2 million. The
increase in accounts receivable resulted from an increase in sales as
partially offset by an increase in advances from the factor, which advances
are accounted for as an offset to accounts receivable. At December 31, 1997,
advances from the factor were approximately $11.8 million as compared to $2.1
million of such advances at December 31, 1996.
 
  During 1997, cash flow used in investing activities was $906,000, which was
used for capital expenditures and the purchase of permanent quota.
 
  In 1997, cash flow used in financing activities equaled $1.9 million,
primarily as a result of the repayment of bank borrowings.
 
                                      21
<PAGE>
 
  The Company has credit facilities of $33 million and $10 million with the
Hongkong and Shanghai Banking Corporation Limited ("HKSB") and Standard
Chartered Bank ("SCB"), respectively, for borrowings and the purchase and
exportation of finished goods. Under these facilities, the Company may arrange
for the issuance of letters of credit and acceptances, as well as cash
advances. These facilities are subject to review at any time and the right of
either lender to demand payment at any time. Interest on cash advances under
HKSB's facility accrues at HKSB's prime rate for lending U.S. dollars plus
one-half to three-quarters percent per annum. As of December 31, 1997, HKSB's
U.S. dollar prime rate equaled seven and one-quarter percent. Interest on cash
advances under SCB's facility accrues at SCB's prime rate for lending Hong
Kong dollars. As of December 31, 1997, SCB's Hong Kong dollar prime rate
equaled nine and one-half percent. These facilities are subject to certain
restrictive covenants including a provision that the aggregate net worth, as
adjusted, of the Company will exceed $30 million, that the Company will not
incur two consecutive quarterly losses and that the Company will maintain a
certain debt to equity ratio.
 
  The Company has accounts receivable-secured credit facilities with
NationsBanc Commercial Corporation ("NBCC") and The CIT Group/Commercial
Services, Inc. ("CIT"). Prior to January 1, 1998, NBCC acted as the Company's
factor for accounts receivable. Effective January 1, 1998, the Company
substantially eliminated its use of the factor. The Company may receive an
advance from NBCC of up to 90% of accounts receivable, except receivables from
Lerner New York and Target Stores. CIT will advance up to 100% of the amount
of accounts receivable from Lerner New York and Target Stores plus an over-
advance of up to $10 million, up to a maximum amount of $25 million. The CIT
facility is subject to the same restrictive covenants as apply to the HKSB and
SCB facilities. Interest on advances from both NBCC and CIT accrues at the
rate of one and one-quarter percent below the bank's respective prime rates
or, at the option of the Company, one and one-quarter percent over the
respective LIBOR rates. As of December 31, 1997, the prime rates equaled eight
and one-half percent and the LIBOR rates equaled six percent.
 
  The Company has financed its operations to date from its cash flow from
operations, borrowings under its financing facilities and the proceeds from
its initial public offering in July 1995. The Company believes that its cash
flow from operations and borrowings under its current financing facilities
should be sufficient to fund its current operations for the foreseeable
future.
 
  In late 1997, the Company commenced the vertical integration of its
business. Key elements of this strategy include (i) establishing cutting,
sewing, finishing and packaging operations through the acquisition of
established contractors or the construction of new facilities and (ii)
establishing fabric production capability through the acquisition of
established mills or the construction of new mills. See "Item 1. Business --
 General -- Business Strategy -- Vertical Integration" and "Item 1.
Business -- Sourcing." The success of the Company's vertical integration
strategy may depend, in part, on its ability to obtain financing therefor.
There can be no assurance that additional capital, if and when required, will
be available on terms acceptable to the Company, or at all.
 
  The Company does not believe that the moderate levels of inflation in the
United States in the last three years have had a significant effect on net
sales or profitability.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
  Not applicable.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
  See "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-
K" for the Company's financial statements, and the notes thereto, and the
financial statement schedules filed as part of this report.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
       FINANCIAL DISCLOSURE
 
  Not applicable.
 
                                      22
<PAGE>  
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
 
  The information concerning the directors and executive officers of the
Company is incorporated herein by reference from the section entitled
"Proposal 1 -- Election of Directors" contained in the definitive Proxy
Statement of the Company to be filed pursuant to Regulation 14A within 120
days after the end of the Company's last fiscal year (the "Proxy Statement").
 
  Effective as of July 29, 1997, Cora R. Reyes resigned as a director of the
Company for personal reasons and was replaced by James R. Miller. Effective as
of February 28, 1998, Donald Hecht resigned as a director of the Company for
personal reasons and was not replaced. Concurrently with his resignation as a
director, Mr. Hecht entered into a three-year consulting arrangement with the
Company pursuant to which he will provide such financial and accounting
services as the Company may from time to time request and, in consideration
therefor, has been granted an option to purchase up to 100,000 shares of
Common Stock of the Company at an exercise price of $16.63, the last reported
sales price on the day of grant. The option will vest in four equal annual
installments commencing on the date of the grant, and each of the first three
anniversary dates thereof, and shall have a term of ten years.
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The information concerning executive compensation is incorporated herein by
reference from the section entitled "Proposal 1 -- Election of Directors"
contained in the Proxy Statement.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The information concerning the security ownership of certain beneficial
owners and management is incorporated herein by reference from the sections
entitled "General Information -- Security Ownership of Principal Shareholders
and Management" and "Proposal 1 -- Election of Directors" contained in the
Proxy Statement.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  The information concerning certain relationships and related transactions is
incorporated herein by reference from the section entitled "Proposal 1 --
Election of Directors -- Certain Relationships and Related Transactions"
contained in the Proxy Statement.
 
                                      23
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
  (a) Financial Statements and Schedule.  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 report.
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.
 
  (b) Reports on Form 8-K.  None.
 
  (c) Exhibits.  The following is a list of exhibits filed as a part of this
report.
 
<TABLE>
<CAPTION>
                                                                   SEQUENTIALLY
 EXHIBIT                                                             NUMBERED
 NUMBER                        DESCRIPTION                             PAGE
 -------                       -----------                         ------------
 <C>     <S>                                                       <C>
  3.1    Restated Articles of Incorporation of the Company(/1/).
  3.2    Restated Bylaws of the Company(/1/)....................
  4.1    Specimen of Common Stock Certificate(/2/)..............
 10.1    Note in the principal amount of $2,600,000 dated March
         15, 1995 in favor of Imperial Bank(/1/)................
 10.2    General Security Agreement dated March 15, 1995, by and
         between the Company and Imperial Bank(/1/).............
 10.3    Factoring Agreement effective as of September 28, 1993,
         as amended, by and between the Company and NationsBanc
         Commercial Corporation(/1/)............................
 10.4    1995 Stock Option Plan dated as of May 1, 1995(/1/)....
 10.5    Letter Agreement dated February 17, 1995 between
         Tarrant Company Limited and The Hongkong and Shanghai
         Banking Corporation Limited(/1/).......................
 10.6    Letter dated April 18, 1995 from The Hongkong and
         Shanghai Banking Corporation Limited to Tarrant Company
         Limited regarding the release of certain security
         interests(/1/).........................................
 10.7    Commercial Lease dated January 1, 1994 and GET and the
         Company(/1/)...........................................
 10.8    Tenancy Agreement dated July 15, 1994 between Lynx
         International Limited and Tarrant Company Limited, as
         amended by that certain Supplementary Tenancy Agreement
         dated December 30, 1994 and that certain Second
         Supplementary Tenancy Agreement dated December 31,
         1994(/1/)..............................................
 10.9    Lease Agreement dated June 10, 1994, between Yip Sik
         Kin and Tarrant Company Limited (translated from
         Chinese)(/1/)..........................................
 10.10   Tenancy Contract effective as of December 24, 1994,
         between Khalifa al Muhairi and Tarrant Trading Co.
         Ltd.(/1/)..............................................
 10.11   Agreement dated as of June 1, 1995, by and among Pret-
         A-Porter, the Company, French Designers, Inc., Bernard
         Aidan, Gerard Guez and Todd Kay(/5/)...................
 10.12   Services Agreement dated as of April 1, 1995, by and
         between F.I.S., Inc. and the Company(/2/)..............
 10.13   Services Agreement dated as of October 1, 1994, by and
         between the Company and GET(/1/).......................
 10.14   Services Agreement dated as of October 1, 1994, by and
         between the Company and Lynx International
         Limited(/1/)...........................................
</TABLE>
 
                                      24
<PAGE>
 
<TABLE>
<CAPTION>
                                                                   SEQUENTIALLY
 EXHIBIT                                                             NUMBERED
 NUMBER                        DESCRIPTION                             PAGE
 -------                       -----------                         ------------
 <C>     <S>                                                       <C>
 10.15   Indemnification Agreement dated as of March 14, 1995,
         by and among the Company, Gerard Guez and Todd
         Kay(/2/)...............................................
 10.16   Promissory Note in the initial principal amount of $2
         million dated February 8, 1995, by Gerard Guez in favor
         of the Company(/2/)....................................
 10.17   Promissory Note in the initial principal amount of $1
         million dated February 8, 1995, by Todd Kay in favor of
         the Company(/2/).......................................
 10.18   Promissory Note in the principal amount of
         $1,334,566.71 dated December 31, 1994, by F.I.S., Inc.
         in favor of the Company(/2/)...........................
 10.19   Release dated as of June 1, 1995, by and between the
         Company and certain other parties signatory
         thereto(/2/)...........................................
 10.20   Option Agreement dated as of July 28, 1995, by and
         among Limited Direct Associates, L.P., Gerard Guez,
         Todd Kay and the Company(/5/)..........................
 10.21   Registration Rights Agreement dated as of July 28,
         1995, by and among the Company and Limited Direct
         Associates, L.P.(/5/)..................................
 10.22   Reorganization and Tax Indemnification Agreement dated
         as of June 13, 1995, by and among the Company and its
         shareholders(/5/)......................................
 10.23   Employment Agreement dated as of January 1, 1995, by
         and between the Company and Gerard Guez(/2/)...........
 10.24   Agreement dated as of January 1, 1995, by and between
         the Company and Todd Kay(/1/)..........................
 10.25   Employment Agreement dated as of January 1, 1994, by
         and between the Company and Jimmy Esebag, as amended,
         by that certain Amendment No. 1 dated as of June 1,
         1995(/2/)..............................................
 10.26   Employment Agreement dated as of November 18, 1994, by
         and between the Company and Mark B. Kristof(/1/).......
 10.27   Employment Agreement dated as of July 5, 1994, by and
         between the Company and Bradley R. Kenson(/1/).........
 10.28   License Agreement dated January 1, 1994, by and between
         the Company and GET(/1/)...............................
 10.29   Assignment dated as of June 1, 1995 with respect to the
         GET! trademark, executed by GET in favor of the
         Company(/2/)...........................................
 10.30   Amendment No. 1 to Commercial Lease dated as of April
         1, 1995, by and between GET and the Company(/2/).......
 10.31   Lease and Services Agreement dated as of June 1, 1995,
         by and between Tarrant Company Limited and French
         Designers, Inc.(/2/)...................................
 10.32   Note in the principal amount of $2,600,000 dated May
         15, 1995, by the Company in favor of Imperial
         Bank(/2/)..............................................
 10.33   Letter Agreement dated May 17, 1995, by and between
         Tarrant Company Limited and The Hongkong and Shanghai
         Banking Corporation Limited(/2/).......................
 10.34   Buying Agency Agreement executed as of December 19,
         1992, between F.I.S., Inc. and Tarrant Company
         Ltd.(/2/)..............................................
 10.35   Buying Agency Agreement executed as of April 4, 1995,
         by Azteca Production International, Inc. and Tarrant
         Company Ltd., with the Company acknowledging as to
         certain matters(/2/)...................................
</TABLE>
 
                                       25
<PAGE>
 
<TABLE>
<CAPTION>
                                                                   SEQUENTIALLY
 EXHIBIT                                                             NUMBERED
 NUMBER                        DESCRIPTION                             PAGE
 -------                       -----------                         ------------
 <C>     <S>                                                       <C>
 10.36   Tripartite Agreement Assignment of Factoring Proceeds
         (Advances) executed and delivered June 6, 1995, by the
         Company, and accepted and agreed to by The Hongkong and
         Shanghai Banking Corporation Limited and NationsBanc
         Commercial Corporation(/2/)............................
 10.36.1 Amendment to Three Party Special Deposit Account
         Agreement(/8/).........................................
 10.37   Security Agreement (Guaranty of Tarrant Co. Ltd. Debt)
         entered into as of June 6, 1995, by and between The
         Hongkong and Shanghai Banking Corporation Limited and
         the Company(/2/).......................................
 10.38   Security Agreement (Tarrant Co. Ltd. Draft Acceptance)
         entered into as of June 6, 1995, by and between The
         Hongkong and Shanghai Banking Corporation Limited and
         the Company(/2/).......................................
 10.39   Agreement dated March 14, 1995, by and among Tarrant
         Company Limited, Cheung Shing Hong Holding Ltd., Yip
         Sik Kin and Lam Kin Fong(/3/)..........................
 10.40   Agreement dated March 17, 1995, by and among Tarrant
         Company Limited, Cheung Shing Hong Holding Ltd., Yip
         Sik Kin and Lam Kin Fong(/3/)..........................
 10.41   Underwriting Agreement dated as of July 24, 1995, by
         and among the Company, Gerard Guez, Todd Kay and
         Prudential Securities Incorporated(/5/)................
 10.42   Letter agreement dated August 10, 1995, by and among
         the Company and NationsBanc Commercial
         Corporation(/4/).......................................
 10.42.1 Amendment dated June 9, 1997 to Factoring Agreement
         effective as of September 28, 1993, as amended, by and
         between the Company and NationsBanc Commercial
         Corporation(/8/).......................................
 10.43   Letter agreement dated January 30, 1996, by and between
         Tarrant Company Limited and The Hongkong Shanghai
         Banking Corporation Limited(/5/).......................
 10.43.1 Letter agreement dated May 28, 1996, by and between
         Tarrant Company Limited and The Hongkong and Shanghai
         Banking Corporation Limited(/8/).......................
 10.44   Promissory Note in the principal amount of $3 million
         dated March 25, 1996, by GET in favor of the
         Company(/6/)...........................................
 10.45   Deed of Trust dated March 25, 1996 by and between GET
         and the Company(/6/)...................................
 10.46   Guaranty, Pledge & Security Agreement entered into as
         of March 25, 1996, by and between Gerard Guez and the
         Company(/6/)...........................................
 10.47   Guaranty, Pledge & Security Agreement entered into as
         of March 25, 1996, by and between Todd Kay and the
         Company(/6/)...........................................
 10.48   Letter agreement dated February 22, 1996, by and
         between Tarrant Company Limited and Standard Chartered
         Bank(/7/)..............................................
 10.49   Letter agreement dated March 8, 1996, by and between
         Tarrant Company Limited and Standard Chartered
         Bank(/7/)..............................................
 10.50   Guarantee Agreement entered into as of August 30, 1996,
         by and between Standard Chartered Bank and the
         Company(/7/)...........................................
 10.51   Letter of Undertaking entered into as of August 30,
         1996, by and between Standard Chartered Bank and the
         Company(/7/)...........................................
 10.52   Intercreditor Agreement entered into as of November 1,
         1996, between The Hongkong and Shanghai Banking
         Corporation Limited, Standard Chartered Bank and
         Tarrant Company Limited(/7/)...........................
</TABLE>
 
                                       26
<PAGE>
 
<TABLE>
<CAPTION>
                                                                   SEQUENTIALLY
 EXHIBIT                                                             NUMBERED
 NUMBER                        DESCRIPTION                             PAGE
 -------                       -----------                         ------------
 <C>     <S>                                                       <C>
 10.53   Security Agreement entered into as of November 1, 1996,
         by and between Standard Chartered Bank and the
         Company(/7/)...........................................
 10.54   Amendment to Security Agreement (Guaranty of Tarrant
         Co. Ltd. Debt) entered into as of November 1, 1996,
         between The Hongkong and Shanghai Banking Corporation
         Limited and the Company(/7/)...........................
 10.55   Agreement dated January 29, 1997 by and among Tarrant
         Company Limited, Cheung Shing Hong Holding Ltd., Yip
         Sik Kin and Lam Kin Fong(/7/)..........................
 10.56   Form of Indemnification Agreement with directors and
         certain executive officers(/8/)........................
 10.57   Special Deposit Account Agreement(/8/).................
 10.58   Accounts Receivable Financing Agreement dated June 13,
         1997, by and between the Company and The CIT
         Group/Commercial Services, Inc.(/8/)...................
 10.58.1 Letter Agreement dated October 1, 1997 regarding
         Accounts Receivable Financing Agreement, by and between
         the Company and The CIT Group/Commercial Services,
         Inc.(/9/)..............................................
 10.59*+ Asset Purchase Agreement dated February 18, 1998, by
         and between Marble Limited and MGI International
         Limited................................................
 10.60*+ Asset Purchase Agreement dated February 18, 1998, by
         and between the Company and Marshall Gobuty
         International U.S.A., Inc..............................
 10.61   Employment Agreement dated February 23, 1998, by and
         between the Company and Marshall Gobuty................
 10.62   Noncompetition Agreement dated February 23, 1998, by
         and between Marshall Gobuty International U.S.A., Inc.
         and Marshall Gobuty, on the one hand, and the Company,
         on the other hand......................................
 10.63   Noncompetition Agreement dated February 23, 1998, by
         and between MGI International Limited and Marshall
         Gobuty, on the one hand, and the Company, on the other
         hand...................................................
 23      Consent of Ernst & Young LLP...........................
 27      Financial Data Summary.................................
</TABLE>
----------
 * Confidential treatment has been requested for portions of this document.
 
 + All schedules and exhibits have been omitted. Any omitted schedule or
   exhibit will be furnished supplementally to the Securities and Exchange
   Commission upon request.
 
(1) Filed as an exhibit to the Company's Registration Statement on Form S-1
    filed with the Securities and Exchange Commission on May 4, 1995 (File No.
    33-91874).
 
(2) Filed as an exhibit to Amendment No. 1 to Registration Statement on Form
    S-1 filed with the Securities and Exchange Commission on June 15, 1995.
 
(3) Filed as an exhibit to Amendment No. 2 to Registration Statement on Form
    S-1 filed with the Securities and Exchange Commission on July 11, 1995.
 
(4) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1995.
 
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
    year ended December 30, 1995.
 
(6) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
    quarter ended March 31, 1996.
 
(7) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
    year ended December 31, 1996.
 
(8) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1997.
 
(9) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1997.
 
                                      27
<PAGE>
 
                   INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
Financial Statements
 Report of Independent Auditors -- Ernst & Young, LLP.....................  F-2
 Consolidated Balance Sheets -- December 31, 1996 and 1997................  F-3
 Consolidated Statements of Income -- Three year period ended December 31,
  1997....................................................................  F-4
 Consolidated Statements of Shareholders' Equity -- Three year period
  ended December 31, 1997.................................................  F-5
 Consolidated Statements of Cash Flows -- Three year period ended December
  31, 1997................................................................  F-6
 Notes to Consolidated Financial Statements...............................  F-7
Financial Statement Schedule
 Schedule II -- Valuation and Qualifying Accounts......................... F-22
</TABLE>
 
                                      F-1
<PAGE>
 
                        REPORT OF INDEPENDENT AUDITORS
 
Board of Directors
Tarrant Apparel Group
 
  We have audited the accompanying consolidated balance sheets of Tarrant
Apparel Group and subsidiaries as of December 31, 1996 and 1997, and the
related consolidated statements of income, shareholders' equity, and cash
flows for each of the three years ended December 31, 1997. Our audits also
included the financial statement schedule for each of the three years in the
period ended December 31, 1997, listed in the Index at Item 14(a). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Tarrant
Apparel Group and subsidiaries at December 31, 1996 and 1997 and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule for each of the three years in the period ended December
31, 1997, when considered in relation to the basic financial statements, taken
as a whole, presents fairly in all material respects the information set forth
therein.
 
                                          Ernst & Young LLP
 
Los Angeles, California
February 20, 1998
 
                                      F-2
<PAGE>
 
                             TARRANT APPAREL GROUP
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                        -----------------------
                                                           1996        1997
                                                        ----------- -----------
<S>                                                     <C>         <C>
                        ASSETS
Current assets:
 Cash and cash equivalents............................. $ 1,120,456 $ 5,305,129
 Accounts receivable, net (Note 2).....................  44,483,884  34,078,352
 Due from affiliates (Note 12).........................      96,416       3,470
 Due from officers (Note 12)...........................          --   1,601,670
 Inventory (Note 3)....................................  10,820,169  23,266,196
 Temporary quota.......................................   1,723,085   2,874,382
 Prepaid expenses......................................     458,087   1,203,931
 Prepaid income taxes..................................     990,771     478,050
 Deferred tax asset....................................     803,482          --
                                                        ----------- -----------
    Total current assets...............................  60,496,350  68,811,180
Property and equipment, net (Note 4)...................   2,618,869   2,707,257
Permanent quota, net...................................     211,085     145,268
Other assets...........................................      93,394     196,973
                                                        ----------- -----------
    Total assets....................................... $63,419,698 $71,860,678
                                                        =========== ===========
         LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
 Bank borrowings (Note 6).............................. $ 6,809,676 $ 4,287,518
 Accounts payable......................................  14,200,229  12,549,961
 Accrued expenses......................................   4,880,115   5,117,183
 Income taxes..........................................     576,947     969,115
 Deferred tax liability................................          --     582,957
                                                        ----------- -----------
    Total current liabilities..........................  26,466,967  23,506,734
Commitments and contingencies (Note 8)
Shareholders' equity:
 Preferred stock, 2,000,000 shares authorized; none
  issued and outstanding...............................          --          --
 Common stock, no par value, 10,000,000 shares
  authorized;
  6,552,276 shares (1996) and 6,609,964 (1997) issued
  and outstanding......................................  15,485,734  16,100,483
 Contributed capital...................................   1,434,259   1,434,259
 Retained earnings.....................................  20,032,738  30,819,202
                                                        ----------- -----------
    Total shareholders' equity.........................  36,952,731  48,353,944
                                                        ----------- -----------
    Total liabilities and shareholders' equity......... $63,419,698 $71,860,678
                                                        =========== ===========
</TABLE>
 
                            See accompanying notes.
 
                                      F-3
<PAGE>
 
                             TARRANT APPAREL GROUP
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                             YEAR ENDED DECEMBER 31,
                                      ----------------------------------------
                                          1995          1996          1997
                                      ------------  ------------  ------------
<S>                                   <C>           <C>           <C>
Net sales............................ $205,173,716  $229,861,024  $260,092,777
Cost of sales........................  172,959,246   192,287,596   220,995,754
                                      ------------  ------------  ------------
Gross profit.........................   32,214,470    37,573,428    39,097,023
Selling and distribution expenses....    6,761,320     7,124,732     8,498,976
General and administrative expenses..   13,492,382    13,989,826    13,518,441
Nonrecurring charge related to LDA
 option..............................    1,734,259            --            --
                                      ------------  ------------  ------------
Income from operations...............   10,226,509    16,458,870    17,079,606
Interest expense.....................   (4,002,518)   (1,864,734)   (1,470,762)
Interest income......................      772,766       336,785       171,385
Other income (expense) (Note 8)......    1,273,777      (301,509)      241,235
                                      ------------  ------------  ------------
Income before provision for income
 taxes...............................    8,270,534    14,629,412    16,021,464
Provision for income taxes (Note 7)..      960,256     4,627,786     5,235,000
                                      ------------  ------------  ------------
Net income........................... $  7,310,278  $ 10,001,626  $ 10,786,464
                                      ============  ============  ============
Net income per share:
 Basic............................... $       1.37  $       1.54  $       1.64
                                      ============  ============  ============
 Diluted............................. $       1.37  $       1.53  $       1.59
                                      ============  ============  ============
Pro forma data--1995 (Note 16,
 unaudited)
 Income before provision for income
  taxes.............................. $  8,270,534
 Pro forma adjustment to eliminate
  LDA option.........................    1,734,259
                                      ------------
 Pro forma income before income
  taxes..............................   10,004,793
 Pro forma provision for income
  taxes..............................   (2,596,562)
                                      ------------
 Pro forma net income after
  adjustment for nonrecurring charge
  and pro forma provision for income
  taxes.............................. $  7,408,231
                                      ============
 Pro forma net income per share...... $       1.38
                                      ============
 Income before provision for income
  taxes.............................. $  8,270,534
 Pro forma provision for income
  taxes..............................   (2,596,562)
                                      ------------
 Pro forma net income after
  adjustment for pro forma taxes..... $  5,673,972
                                      ============
 Pro forma net income per share...... $       1.06
                                      ============
Weighted average shares outstanding:
 Basic...............................    5,353,261     6,507,933     6,587,628
 Diluted.............................    5,353,261     6,547,831     6,783,627
</TABLE>
 
                            See accompanying notes.
 
                                      F-4
<PAGE>
 
                             TARRANT APPAREL GROUP
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                                      TOTAL
                               COMMON    CONTRIBUTED  RETAINED    SHAREHOLDERS'
                                STOCK      CAPITAL    EARNINGS       EQUITY
                             ----------- ----------- -----------  -------------
<S>                          <C>         <C>         <C>          <C>
Balance at December 31,
 1994....................... $   126,923 $       --  $ 7,720,834   $ 7,847,757
 Net income.................          --         --    7,310,278     7,310,278
 LDA option.................          --  1,434,259           --     1,434,259
 Initial public offering....  14,823,299         --           --    14,823,299
 Distribution to Original
  Shareholders..............          --         --   (5,000,000)   (5,000,000)
                             ----------- ----------  -----------   -----------
Balance at December 31,
 1995.......................  14,950,222  1,434,259   10,031,112    26,415,593
 Net income.................          --         --   10,001,626    10,001,626
 Exercise of stock options..     446,634         --           --       446,634
 Income tax benefit from
  exercise
  of stock options..........      88,878         --           --        88,878
                             ----------- ----------  -----------   -----------
Balance at December 31,
 1996.......................  15,485,734  1,434,259   20,032,738    36,952,731
 Net income.................          --         --   10,786,464    10,786,464
 Exercise of stock options..     495,254         --           --       495,254
 Income tax benefit from
  exercise of stock options.     119,495         --           --       119,495
                             ----------- ----------  -----------   -----------
Balance at December 31,
 1997....................... $16,100,483 $1,434,259  $30,819,202   $48,353,944
                             =========== ==========  ===========   ===========
</TABLE>
 
 
                            See accompanying notes.
 
                                      F-5
<PAGE>
 
                             TARRANT APPAREL GROUP
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                             YEAR ENDED DECEMBER 31,
                                      ----------------------------------------
                                          1995          1996          1997
                                      ------------  ------------  ------------
<S>                                   <C>           <C>           <C>
OPERATING ACTIVITIES
Net income........................... $  7,310,278  $ 10,001,626  $ 10,786,464
Adjustments to reconcile net income
 to net cash provided by (used in)
 operating activities:
  Nonrecurring charge related to LDA
   option............................    1,734,259            --            --
  Deferred taxes.....................     (866,577)      127,372       598,273
  Depreciation and amortization......      881,924       905,786       867,022
  (Gain) loss on sale of fixed
   assets............................           --        57,375         3,698
  Stock compensation expense.........           --        66,050            --
  Provision for returns and
   discounts.........................    1,097,499      (432,594)     (359,344)
  Changes in operating assets and
   liabilities:
   Accounts receivable...............  (14,275,674)  (14,818,441)   10,764,877
   Due from affiliates and officers..     (354,070)      764,689    (1,508,724)
   Inventory.........................   (2,319,707)    2,988,492   (12,446,028)
   Temporary quota...................     (116,799)     (349,717)   (1,151,297)
   Prepaid expenses..................    1,329,633      (147,000)     (849,422)
   Prepaid income taxes..............      264,225      (990,771)    1,300,887
   Accounts payable..................      (10,272)    3,076,430    (1,650,268)
   Accrued expenses and income tax
    payable..........................      549,869     1,031,877       629,236
                                      ------------  ------------  ------------
    Net cash (used in) provided by
     operating activities............   (4,775,412)    2,281,174     6,985,374
INVESTING ACTIVITIES
Purchase of fixed assets.............     (658,495)     (466,272)     (764,087)
Sale of fixed assets.................       94,874       218,306            --
Purchase of permanent quota..........     (341,928)     (133,002)     (129,205)
Investment in and advances to joint
 venture.............................    1,346,854            --            --
                                      ------------  ------------  ------------
    Net cash provided by (used in)
     investing activities............      441,305      (380,968)     (893,292)
FINANCING ACTIVITIES
Bank borrowings, net.................   (2,772,863)   (9,130,422)   (2,522,158)
Restricted cash......................    4,760,900            --            --
Long-term obligations................      (98,584)           --            --
Distribution to Original
 Shareholders........................   (5,000,000)           --            --
Net proceeds from issuance of common
 stock...............................   14,823,299            --            --
Exercise of stock options including
 related tax benefit.................           --       469,462       614,749
                                      ------------  ------------  ------------
    Net cash provided by (used in)
     financing activities............   11,712,752    (8,660,960)   (1,907,409)
                                      ------------  ------------  ------------
Increase (decrease) in cash and cash
 equivalents.........................    7,378,645    (6,760,754)    4,184,673
Cash and cash equivalents at
 beginning of year...................      502,565     7,881,210     1,120,456
                                      ------------  ------------  ------------
Cash and cash equivalents at end of
 year................................ $  7,881,210  $  1,120,456  $  5,305,129
                                      ============  ============  ============
</TABLE>
 
                            See accompanying notes.
 
                                      F-6
<PAGE>
 
                             TARRANT APPAREL GROUP
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               DECEMBER 31, 1997
 
 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Organization and Basis of Consolidation
 
  On July 28, 1995, Tarrant Apparel Group, a California Corporation (formerly
Fashion Resource, Inc.) (the Parent Company or the Company) completed an
initial public offering (the Offering) of 2,000,000 shares of the Parent
Company's common stock at a price of $9.00 per share. The net proceeds to the
Company, net of underwriting discounts and commissions and offering expenses,
were $14.8 million.
 
  The accompanying financial statements for fiscal 1995 through the
Reorganization, as defined below, in July 1995 consist of the combination of
Tarrant Apparel Group; the following affiliated United States corporations:
Alpine Summit Licensing Co. Inc. (Alpine), G.T.S. Fabrics, Inc. (GTS), NO!
Jeans, Inc. (NO) and GET, Inc. (GET); the following Hong Kong corporations:
Tarrant Company Limited (Tarrant HK), Tarrant International Company Limited
(Tarrant International) and Marble Limited (Marble); and Tarrant Trading
Limited, a United Arab Emirates corporation (Tarrant UAE). NO and Marble are
wholly-owned subsidiaries of Tarrant HK. Tarrant HK owns a 49% interest in
Tarrant UAE. However, since Tarrant HK effectively controls Tarrant UAE, the
results of Tarrant UAE had been consolidated. The third-party interest in
Tarrant UAE is immaterial.
 
  Prior to the Reorganization, these entities were collectively referred to as
Tarrant Apparel Group and Affiliates (the Combined Group). Alpine, GTS, GET
and Tarrant International, which became inactive, were distributed to Gerard
Guez and Todd Kay (the Original Shareholders) in September 1994 and
accordingly, ceased to be included in the Combined Group.
 
  In order to facilitate the Offering, the Original Shareholders of the
affiliates contributed all of the capital stock of the affiliates and their
minority interest in Tarrant UAE to Tarrant Apparel Group and as a result, the
affiliates became direct or indirect wholly-owned subsidiaries of the Company
(the Reorganization). In addition, a stock dividend of 14,999 shares for each
outstanding share of Tarrant Apparel Group was effected.
 
  The Company serves both specialty retail and mass merchandise store chains
by designing, merchandising and contracting for the manufacture and selling of
casual, moderately priced apparel, primarily for women under private label.
 
  The accompanying financial statements have been prepared on a combined basis
through the Reorganization due to common ownership and business. The
combination of companies was accounted for in a manner similar to a pooling of
interest. All significant intercompany investments, transactions and balances
have been eliminated. The combination excludes certain other entities under
common ownership or control of the Original Shareholders, since these entities
engage in unrelated business lines and, in certain instances, have ceased
operations.
 
  Revenue Recognition
 
  Revenues are recorded, net of anticipated returns, at the time of shipment
of merchandise. Licensing revenues are recognized on an accrual basis,
pursuant to the terms of the underlying license agreements and are included in
other income.
 
  Cash and Cash Equivalents
 
  Cash equivalents consist of highly liquid investments with an original
maturity of three months or less when purchased.
 
                                      F-7
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  Inventories
 
  Inventories are stated at the lower of cost (first-in, first-out) or market.
 
  Quota
 
  The Company purchases quota rights to be used in the importation of its
products from certain foreign countries. The effect of quota transactions is
accounted for as product costs.
 
  Permanent quota entitlements were principally obtained through free
allocations by the Hong Kong Government pursuant to an import restraint
between Hong Kong and the United States and are renewable on an annual basis,
based upon the prior year utilization. Permanent quota entitlements acquired
from outside parties are amortized over three years on a straight-line basis,
and amounted to $211,000, net of amortization of $730,000 at December 31, 1996
and $145,000, net of amortization of $925,000 at December 31, 1997.
 
  Temporary quota represents quota rights acquired from other permanent quota
entitlement holders on a temporary basis. Temporary quota has a maximum life
of twelve months. The cost of temporary quota purchased for the current year
utilization has been assigned to inventory purchases while the cost of
temporary quota acquired for usage in the year following the balance sheet
date is recorded as a current asset.
 
  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, 5 to 7 years.
Leasehold improvements are amortized using the straight-line method over the
lesser of their estimated useful life 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 statements of income.
 
  Income Taxes
 
  The Company utilizes Statement of Financial Accounting Standards 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.
 
  The Company and its U.S. affiliates (other than NO and GTS) were treated as
Subchapter S Corporations for federal and California income tax purposes
through the termination date of the S Corporation status on July 28, 1995 in
connection with the Reorganization. S Corporations pay tax to the State of
California on their taxable incomes at rates of 1 1/2%. Effective with the
termination, the Parent Company is subject to federal and state corporate
income taxes.
 
  Upon termination of the Subchapter S election, deferred income taxes became
an asset of the Company and were recorded in the balance sheet with a
corresponding credit to the statement of income. The deferred tax asset,
principally relating to the temporary difference arising from the treatment of
the allowance for returns and discounts for book and tax purposes, as of July
31, 1995 was approximately $785,000.
 
  The Company's Hong Kong corporate affiliates are taxed at an effective Hong
Kong rate of 16 1/2%. No domestic tax provision has been provided for $30.2
million of unremitted retained earnings of these Hong Kong corporations, as
the Company intends to maintain these amounts in Hong Kong on a permanent
basis in support of its working capital requirements.
 
                                      F-8
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  Net Income Per Share
 
  Net income per share has been computed in accordance with Financial
Accounting Standard Board (FASB) Statement No. 128, "Earnings Per Share" (see
Note 10).
 
  Pro forma net income per share in 1995 is based on the weighted average of
the 4,500,000 shares outstanding prior to the Offering and the 2,000,000
shares issued pursuant to the Offering.
 
  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
operating expenses in the accompanying statements of income (excluding the
costs of manufacturing samples) amounted to approximately $1,475,000,
$1,419,000 and $1,528,000 in 1995, 1996 and 1997, respectively.
 
  Foreign Currency Translation
 
  Assets and liabilities of the Hong Kong and United Arab Emirates
subsidiaries are translated at the rate of exchange in effect on the balance
sheet date; income and expenses are translated at the average rates of
exchange prevailing during the year. The principal foreign currency in which
the Company transacts business is the Hong Kong dollar.
 
  Foreign currency gains and losses resulting from translation of assets and
liabilities are included in the statements of income. Historically, such gains
and losses have been immaterial. At December 31, 1997, the Hong Kong
subsidiaries have retained earnings of $30.2 million and an intercompany
receivable due from Tarrant Apparel Group of $30.9 million.
 
  Financial Instruments
 
  The fair value of financial instruments is determined by reference to
various market data and other valuation techniques as appropriate. Unless
otherwise described, the fair values of financial instruments approximate
their recorded values.
 
  The Company has adopted Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" (SFAS No.
115). Under SFAS No. 115, marketable securities portfolios consisting of debt
and equity securities held primarily for sale in the near term (trading
securities) are valued at fair value, with realized and unrealized holding
gains and losses included in the statements of income. The Company realized
losses on the sale of marketable securities of approximately $0 and $16,000 in
1995 and 1996, respectively, and a gain of $237,000 in 1997.
 
  Concentration of Credit Risk
 
  Financial instruments which potentially expose the Company to concentration
of credit risk consist primarily of cash equivalents, trade accounts
receivable and amounts due from factor.
 
                                      F-9
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  The Company's 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. The Company makes
substantial sales to a relatively few, large customers. In order to minimize
the risk of loss, the Company assigns a significant portion of its domestic
accounts receivable to a factor without recourse or requires letters of credit
from its customers prior to the shipment of goods. For nonfactored
receivables, credit limits, ongoing credit evaluations and account monitoring
procedures are utilized to minimize the risk of loss. Collateral is generally
not required. The following table presents the percentage of net sales
concentrated with certain customers. Customer A represents a group of
customers under common ownership.
 
<TABLE>
<CAPTION>
                                                               1995  1996  1997
                                                               ----  ----  ----
     <S>                                                       <C>   <C>   <C>
     Customer A............................................... 55.3% 67.1% 69.7%
     Customer B............................................... 13.6  24.3  18.7
     Customer C............................................... 19.3   1.9    --
</TABLE>
 
  Products representing approximately 85% of the Company's net sales, on the
basis of the free on board cost at the supplier's plant, were manufactured by
third party contractors located in foreign countries. There can be no
assurance that the Company will not experience difficulties with third parties
responsible for the manufacture of its products.
 
  The Company maintains demand deposits with several major banks. At times,
cash balances may be in excess of Federal Deposit Insurance Corporation or
equivalent foreign insurance limits.
 
  Use of Estimates
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
  Stock-Based Compensation
 
  In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). SFAS 123 established a fair value-based method of
accounting for compensation cost related to stock options and other forms of
stock-based compensation plans. However, SFAS 123 allows an entity to continue
to measure compensation costs using the principles of APB 25 if certain pro
forma disclosures are made. The Company has elected to account for its stock
compensation arrangements under the provisions of APB 25, "Accounting for
Stock Issued to Employees." The Company adopted the provisions for pro forma
disclosure requirements of SFAS 123 in fiscal 1996.
 
                                     F-10
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 2.ACCOUNTS RECEIVABLE
 
  Accounts receivable consist of the following:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                       ------------------------
                                                          1996         1997
                                                       -----------  -----------
     <S>                                               <C>          <C>
     U.S. trade accounts receivable................... $22,024,048  $13,411,719
     Foreign trade accounts receivable................   8,198,978    9,466,193
     Due from factor..................................  16,034,018   12,028,633
     Other receivables................................     141,996      727,619
     Allowance for returns and discounts..............  (1,915,156)  (1,555,812)
                                                       -----------  -----------
                                                       $44,483,884  $34,078,352
                                                       ===========  ===========
</TABLE>
 
  The Company has accounts receivable-secured credit facilities with
NationsBanc Commercial Corporation ("NBCC") and The CIT Group/Commercial
Services, Inc. ("CIT"). Prior to January 1, 1998, NBCC acted as the Company's
factor for accounts receivable. Effective January 1, 1998, the Company
substantially eliminated its use of the factor. The Company may receive an
advance from NBCC of up to 90% of certain accounts receivable. Such advances
approximated $2.1 million and $11.8 million at December 31, 1996 and 1997,
respectively. CIT will advance up to 100% of the amount of certain accounts
receivable plus an over-advance of up to $10 million, up to a maximum amount
of $25 million. Interest on advances from both NBCC and CIT accrues at the
rate of one and one-quarter percent below the bank's respective prime rates
or, at the option of the Company, one and one-quarter percent over the
respective LIBOR rates. As of December 31, 1997, the prime rates equaled eight
and one-half percent and the LIBOR rates equaled six percent.
 
 3.INVENTORY
 
  Inventory consists of the following:
 
<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                        -----------------------
                                                           1996        1997
                                                        ----------- -----------
     <S>                                                <C>         <C>
     Raw materials..................................... $ 2,113,849 $ 4,022,298
     Work-in-process...................................   1,701,023   4,315,703
     Finished goods shipments-in-transit...............   2,252,118   5,655,461
     Finished goods....................................   4,753,179   9,272,734
                                                        ----------- -----------
                                                        $10,820,169 $23,266,196
                                                        =========== ===========
</TABLE>
 
  Raw materials are composed of fabric and trim accessories.
 
4.PROPERTY AND EQUIPMENT
 
  Property and equipment consists of the following:
 
<TABLE>
<CAPTION>
                                                              1996       1997
                                                           ---------- ----------
     <S>                                                   <C>        <C>
     Equipment, furniture and fixtures.................... $2,641,250 $3,300,921
     Leasehold improvements...............................  2,098,986  2,147,474
     Vehicles.............................................     69,826     94,826
                                                           ---------- ----------
                                                            4,810,062  5,543,221
     Less accumulated depreciation and amortization.......  2,191,193  2,835,964
                                                           ---------- ----------
                                                           $2,618,869 $2,707,257
                                                           ========== ==========
</TABLE>
 
                                     F-11
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  In May 1995, the Company agreed to transfer certain residential real
property to one of the Original Shareholders in exchange for the assumption by
the Original Shareholder of the mortgage loan relating to the property.
 
 5.INVESTMENT IN AND ADVANCES TO JOINT VENTURE
 
  In 1994, the Company entered into a corporate joint venture, Litex Ltd.
(Litex), a Hong Kong corporation, with a third party in Hong Kong to establish
and operate a garment manufacturing facility in the People's Republic of
China. The Company sold its 50% interest in the joint venture to the third
party in March 1995. The 50% investment in Litex has been accounted for under
the equity method.
 
  For the year ended December 31, 1995, the Company had sales of fabric of
$2,011,000 and purchases of $2,739,000 of finished garments from companies
controlled by the joint venture partners of Litex.
 
  In March 1995, the Company entered an agreement with the third party in the
Litex joint venture whereby the third party acquired the Company's interest in
Litex for consideration of $2,000,000, of which $545,000 was paid in cash with
the balance to be received through deductions taken against a future
production purchase agreement with the third party ($391,000 and $225,000 was
received through deductions taken against 1995 and 1996 production,
respectively). The deferred gain on the sale of approximately $839,000 was
settled by the payment of approximately $419,000 from the third party to the
Company in February 1997.
 
 6.BANK BORROWINGS
 
  Bank borrowings consist of import trade bills payable of $6,810,000 and
$4,288,000 as of December 31, 1996 and 1997, respectively.
 
  The Company has credit facilities of $33 million and $10 million with the
Hongkong and Shanghai Banking Corporation Limited ("HKSB") and Standard
Chartered Bank ("SCB"), respectively, for borrowings and the purchase and
exportation of finished goods. Under these facilities, the Company may arrange
for the issuance of letters of credit and acceptances, as well as cash
advances. These facilities are subject to review at any time and the right of
either lender to demand payment at any time. Interest on cash advances under
HKSB's facility accrues at HKSB's prime rate for lending U.S. dollars plus
one-half to three-quarters percent per annum. As of December 31, 1997, HKSB's
U.S. dollar prime rate equaled seven and one-quarter percent. Interest on cash
advances under SCB's facility accrues at SCB's prime rate for lending Hong
Kong dollars. As of December 31, 1997, SCB's Hong Kong dollar prime rate
equaled nine and one-half percent. These facilities are subject to certain
restrictive covenants including a provision that the aggregate net worth, as
adjusted, of the Company will exceed $30 million, that the Company will not
incur two consecutive quarterly losses and that the Company will maintain a
certain debt to equity ratio. As of December 31, 1997, this aggregate net
worth, as adjusted, amounted to approximately $48 million and as of December
31, 1996 and 1997, there were no outstanding borrowings, under the HKSB and
SCB facilities.
 
                                     F-12
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
 7.INCOME TAXES
 
  The provision for domestic and foreign income taxes is as follows:
 
<TABLE>
<CAPTION>
                                                1995        1996        1997
                                             ----------  ----------  ----------
   <S>                                       <C>         <C>         <C>
   Current:
     Federal................................ $  637,565  $2,673,505  $2,470,848
     State..................................     66,046     757,017     741,581
     Foreign................................    996,439   1,324,636   1,424,298
                                             ----------  ----------  ----------
                                              1,700,050   4,755,158   4,636,727
   Deferred (credit):
     Federal................................   (572,527)    (70,081)    702,539
     State..................................   (163,080)    (53,704)   (112,257)
     Foreign................................     (4,187)     (3,587)      7,991
                                             ----------  ----------  ----------
                                               (739,794)   (127,372)    598,273
                                             ----------  ----------  ----------
       Total................................ $  960,256  $4,627,786  $5,235,000
                                             ==========  ==========  ==========
</TABLE>
 
  The source of income before the provision for taxes is as follows:
 
<TABLE>
<CAPTION>
                                                 1995       1996        1997
                                              ---------- ----------- -----------
   <S>                                        <C>        <C>         <C>
   United States............................. $2,396,904 $ 7,425,497 $ 7,459,582
   Foreign...................................  5,873,630   7,203,915   8,561,882
                                              ---------- ----------- -----------
     Total................................... $8,270,534 $14,629,412 $16,021,464
                                              ========== =========== ===========
</TABLE>
 
  For federal and state income tax purposes for fiscal 1995 through the
Reorganization, no deferred taxes had been recognized because the taxpaying
entities within the Company and its affiliates were S Corporations. The
effective rate paid by these S Corporations is immaterial to the financial
statements. Foreign deferred income taxes result primarily from temporary
differences in the recognition of bad debt and depreciation expenses for tax
and financial reporting purposes. The resulting foreign deferred income tax
liability amounted to approximately $62,000 and $70,000 at December 31, 1996
and 1997, respectively.
 
  Upon termination of the Subchapter S election, federal and state deferred
income taxes were recognized as an asset by the Company with a corresponding
credit to the statement of income.
 
  A reconciliation of the statutory federal income tax provision to the
reported tax provision on income is as follows:
 
<TABLE>
<CAPTION>
                                            1995         1996         1997
                                         -----------  -----------  -----------
<S>                                      <C>          <C>          <C>
Income tax based on federal statutory
 rate..................................  $ 2,811,981  $ 4,974,000  $ 5,447,297
State income taxes.....................       43,590      464,186      415,354
Effect of Subchapter S tax status......     (191,223)          --           --
Deferred income taxes recorded upon
 change in tax status from an
 S Corporation to a C Corporation......     (785,375)          --           --
Effect of foreign income taxes at lower
 tax rates.............................   (1,000,595)  (1,128,282)  (1,478,751)
Valuation allowance and other..........       81,878      317,882      851,100
                                         -----------  -----------  -----------
                                         $   960,256  $ 4,627,786  $ 5,235,000
                                         ===========  ===========  ===========
</TABLE>
 
                                     F-13
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  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 are as follows:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                       -----------------------
                                                          1996        1997
                                                       ----------  -----------
     <S>                                               <C>         <C>
     Current deferred tax assets:
      Provision for doubtful accounts and unissued
       credits........................................ $  557,961  $   370,691
      Provision for other reserves....................    271,185      363,309
      Deferred compensation and benefits..............     95,439      150,108
      State taxes.....................................    250,384      242,724
                                                       ----------  -----------
         Total current deferred tax assets............  1,174,969    1,126,832
     Current deferred tax liabilities:
      Accounts receivable valuation...................         --     (479,929)
      Other...........................................         --     (858,373)
                                                       ----------  -----------
                                                               --   (1,338,302)
     Valuation allowance for deferred tax assets......   (371,487)    (371,487)
                                                       ----------  -----------
     Net current deferred tax asset (liability)....... $  803,482  $  (582,957)
                                                       ==========  ===========
</TABLE>
 
 8.COMMITMENTS AND CONTINGENCIES
 
  The Company has entered into various noncancelable operating lease
agreements, principally for executive office and warehousing facilities, with
unexpired terms in excess of one year. The future minimum lease payments under
these noncancelable operating leases are as follows:
 
<TABLE>
<CAPTION>
                                                             RELATED
                                                              PARTY     OTHER
                                                            ---------- --------
     <S>                                                    <C>        <C>
     1998.................................................. $1,268,898 $ 95,880
     1999..................................................  1,268,898    7,303
     2000..................................................  1,298,666       --
     2001..................................................  1,298,666       --
     2002..................................................  1,329,924       --
     Thereafter............................................  1,666,698       --
                                                            ---------- --------
       Total future minimum lease payments................. $8,131,750 $103,183
                                                            ========== ========
</TABLE>
 
  Certain of the operating leases contain provisions for additional rent based
upon increases in the operating costs, as defined, of the premises. Total rent
expense under the operating leases amounted to approximately $1,468,000,
$1,535,000, and $1,509,000 for 1995, 1996, and 1997, respectively.
 
  The Company had open letters of credit of $16,534,000 and $14,432,000 as of
December 31, 1996 and 1997, respectively.
 
  The Company had two employment agreements, which expired December 31, 1997,
with the Original Shareholders providing for base compensation and other
incentives. Commitments under these agreements for base compensation amounted
to $1,500,000 for 1997. The Company currently is negotiating to extend the
terms of these agreements.
 
  The Company recorded a $400,000 charge in other expense during the year
ended December 31, 1996 to reflect potential obligations to the Original
Shareholders with respect to an agreement entered into concurrently with the
Offering.
 
                                     F-14
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  The Company is involved from time to time in routine legal matters
incidental to its business. In the opinion of the Company's management,
resolution of such matters will not have a material effect on its financial
position or results of operations.
 
  In 1997 the Company and the Original Shareholders were named, among others,
as co-defendents in a civil lawsuit brought by the American Textile
Manufacturers Institute (ATMI). The civil lawsuit alleges, among other things,
that the defendents knowingly filed improper statements about the country of
origin of imported merchandise with the United States Customs Service. On
November 13, 1997 the civil lawsuit was dismissed with prejudice and final
judgement was entered to that effect, subject to appeal. On December 22, 1997,
the Federal judge granted ATMI's motion to excuse himself from the case. At
the same time, the judge denied the motion to vacate the decision and judgment
previously entered dismissing the case. Consequently, a new judge will
consider whether the decision should be altered or amended. In the opinion of
the Company's management, resolution of such matter will not have a material
effect on its financial position or results of operations.
 
 9.EQUITY
 
  The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, when the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
 
  The Company's 1995 Stock Option Plan, as amended and restated in January
1997 (the Plan), has authorized the grant of both incentive and non-qualified
stock options to officers, employees, directors and consultants of the Company
for up to 1,300,000 shares of the Company's common stock. The exercise price
of incentive options must be equal to 100% of fair market value of common
stock on the date of grant and the exercise price of non-qualified options
must not be less than the par value of a share of common stock on the date of
grant. The Plan was also amended to expand the types of awards which may be
granted pursuant thereto to include stock appreciation rights, restricted
stock and other performance-based benefits.
 
  Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions: weighted-average risk-free interest rate of 6% for 1996 and 1997;
dividend yields of 0% for 1996 and 1997; weighted-average volatility factors
of the expected market price of the Company's common stock of 0.52 for 1996
and 0.53 for 1997; and a weighted-average expected life of the option of four
years.
 
  The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimates, in the management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
 
 
                                     F-15
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
  For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:
 
<TABLE>
<CAPTION>
                                                             1996       1997
                                                          ---------- ----------
     <S>                                                  <C>        <C>
     Pro forma net income................................ $9,681,860 $9,999,383
     Pro forma earnings per share........................ $     1.47 $     1.50
</TABLE>
 
  A summary of the Company's stock option activity, and related information
for the years ended December 31 follows:
 
<TABLE>
<CAPTION>
                                         1996                     1997
                                ------------------------ -----------------------
                                             WEIGHTED                WEIGHTED
                                             AVERAGE                 AVERAGE
                                OPTIONS   EXERCISE PRICE OPTIONS  EXERCISE PRICE
                                --------  -------------- -------  --------------
<S>                             <C>       <C>            <C>      <C>
Outstanding at beginning of
 year.........................   545,665      $ 9.00     747,555      $10.75
 Granted......................   376,000       12.18      39,000       15.24
 Exercised....................   (52,276)       7.28     (57,688)       8.59
 Forfeited....................  (121,834)       8.80     (19,000)       7.17
                                --------      ------     -------      ------
Outstanding at end of year....   747,555      $10.75     709,867      $11.27
                                ========      ======     =======      ======
Exercisable at end of year....   148,164                 284,283
Weighted average per option
 fair value of options granted
 during the year..............                $ 5.93                  $ 3.42
</TABLE>
 
  Exercise prices for options outstanding as of December 31, 1997 ranged from
$6.00 to $18.875. The weighted average remaining contractual life of those
options is 8.75 years. Options vest over a period of three or four years from
respective grant dates.
 
10.EARNINGS PER SHARE
 
  In February 1997, the FASB issued "Earnings Per Share" (Statement No. 128)
establishing standards for computing and presenting earnings per share for
publicly-held common stock or potential common stock. Statement No. 128
supersedes the standards for computing earnings per share previously found in
APB Opinion No. 15, Earnings Per Share and simplifies the standards for
computing earnings per share. In addition, Statement No. 128 replaces the
presentation of primary earnings per share with a presentation of basic
earnings per share, requires dual presentation of basic and diluted earnings
per share on the face of the income statement for all entities with complex
capital structures and requires a reconciliation of the numerator and
denominator of the basic earnings per share computation to the numerator and
denominator of the diluted earnings per share computation. The statement is
effective for financial statements for both interim and annual periods ending
after December 15, 1997, with earlier application not permitted. All periods
presented reflect the adoption of Statement No. 128. The impact of amounts
previously reported was not material.
 
                                     F-16
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  A reconciliation of the numerator and denominator of basic earnings per
share and diluted earnings per share is as follows:
 
<TABLE>
<CAPTION>
                                                  YEAR ENDED DECEMBER 31,
                                             ----------------------------------
                                                1995       1996        1997
                                             ---------- ----------- -----------
<S>                                          <C>        <C>         <C>
Basic EPS Computation:
 Numerator.................................. $7,310,278 $10,001,626 $10,786,464
 Denominator:
  Weighted average common shares
   outstanding..............................  5,353,261   6,507,933   6,587,628
                                             ---------- ----------- -----------
    Total shares............................  5,353,261   6,507,933   6,587,628
                                             ---------- ----------- -----------
Basic EPS................................... $     1.37 $      1.54 $      1.64
                                             ========== =========== ===========
Diluted EPS Computation:
 Numerator.................................. $7,310,278 $10,001,626 $10,786,464
 Denominator:
  Weighted average common shares
   outstanding..............................  5,353,261   6,507,933   6,587,628
  Incremental shares from assumed exercise
   of options...............................         --      39,898     195,999
                                             ---------- ----------- -----------
    Total shares............................  5,353,261   6,547,831   6,783,627
                                             ---------- ----------- -----------
Diluted EPS................................. $     1.37 $      1.53 $      1.59
                                             ========== =========== ===========
</TABLE>
 
11.SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
 
<TABLE>
<CAPTION>
                                                  1995       1996       1997
                                               ---------- ---------- ----------
   <S>                                         <C>        <C>        <C>
   Cash paid for interest..................... $3,433,049 $  525,690 $  659,599
                                               ========== ========== ==========
   Cash paid for income taxes................. $1,036,908 $6,036,049 $2,824,753
                                               ========== ========== ==========
</TABLE>
 
12.RELATED-PARTY TRANSACTIONS
 
  The Company has provided management and administrative services to
noncombined affiliates, including executive and employee compensation. The
management fees were based on net sales until the last such noncombined
affiliate ceased to operate in the second quarter of 1996. The Company charged
management and administrative fees of $1,068,000, $60,000 and $0 for the years
ended December 31, 1995, 1996, and 1997, respectively.
 
  Other related-party transactions, consisting primarily of purchases and
sales of finished goods and raw materials, are as follows:
 
<TABLE>
<CAPTION>
                                                    1995      1996      1997
                                                 ---------- -------- ----------
   <S>                                           <C>        <C>      <C>
   Sales to noncombined affiliates.............. $4,399,000 $248,000 $       --
   Sales to other related parties...............    809,000  139,000  3,531,000
   Purchases from other related parties.........  3,379,000   19,000    620,000
</TABLE>
 
  As of December 31, 1996 and 1997, noncombined affiliates were indebted to
the Company in the amounts of $96,000 and $3,000, respectively. Total interest
paid by noncombined affiliates and the Original Shareholders was $140,000 and
$71,000 for the years ended December 31, 1996 and 1997, respectively.
 
                                     F-17
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
  The Company has, from time to time, advanced funds to officers including the
Original Shareholders and to corporations owned by the Original Shareholders.
The maximum outstanding amounts of such loans during 1996 and 1997 were $3.0
million and $1.6 million, respectively. Loans made to the Original
Shareholders in 1995 bore interest at the lesser of 12% or the highest rate
permissible by law. These loans were repaid in full, in part by offset against
distributions made to the Original Shareholders at the closing of the
Offering. Loans in 1996 and 1997 bore interest at the rate of 8% and 7% per
annum, respectively.
 
  In each of 1996 and 1997, the Company advanced an aggregate of $2.0 million
to a corporation controlled by parties related to one of the Original
Shareholders. Such advances were repaid within 30 days.
 
  Under lease agreements entered into between the Company and two entities
owned by the Original Shareholders, the Company paid $1,259,000 in 1995 and
$1,241,000 in 1996 and 1997, for rent for office and warehouse facilities.
 
13.OPERATIONS BY GEOGRAPHIC AREAS
 
  The Company operates primarily in one industry segment, the design,
manufacturing and importation of private label, moderately-priced, casual
apparel. Information about the Company's operations in the United States and
Asia is presented below. Intercompany revenues and assets have been eliminated
to arrive at the consolidated amounts.
 
<TABLE>
<CAPTION>
                                                      ADJUSTMENTS
                              UNITED                      AND
                              STATES        ASIA     ELIMINATIONS      TOTAL
                           ------------ ------------ -------------  ------------
<S>                        <C>          <C>          <C>            <C>
1995
Sales..................... $200,006,020 $  5,167,696 $          --  $205,173,716
Intercompany sales........           --  117,216,683  (117,216,683)           --
                           ------------ ------------ -------------  ------------
Total revenue............. $200,006,020 $122,384,379 $(117,216,683) $205,173,716
                           ============ ============ =============  ============
Income from operations.... $  5,089,066 $  5,137,443 $          --  $ 10,226,509
                           ============ ============ =============  ============
Total assets.............. $ 45,705,989 $ 39,457,225 $ (27,322,816) $ 57,840,398
                           ============ ============ =============  ============
1996
Sales..................... $226,919,733 $  2,941,291 $          --  $229,861,024
Intercompany sales........           --  140,167,389  (140,167,389)           --
                           ------------ ------------ -------------  ------------
Total revenue............. $226,919,733 $143,108,680 $(140,167,389) $229,861,024
                           ============ ============ =============  ============
Income from operations.... $  9,478,767 $  6,980,103 $          --  $ 16,458,870
                           ============ ============ =============  ============
Total assets.............. $ 51,149,844 $ 41,675,253 $ (29,405,399) $ 63,419,698
                           ============ ============ =============  ============
1997
Sales..................... $252,136,375 $  7,956,402 $          --  $260,092,777
Intercompany sales........           --  148,613,075  (148,613,075)           --
                           ------------ ------------ -------------  ------------
Total revenue............. $252,136,375 $156,569,477 $(148,613,075) $260,092,777
                           ============ ============ =============  ============
Income from operations.... $  8,580,940 $  8,498,666 $          --  $ 17,079,606
                           ============ ============ =============  ============
Total assets.............. $ 56,351,902 $ 46,656,041 $ (31,147,265) $ 71,860,678
                           ============ ============ =============  ============
</TABLE>
 
                                     F-18
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
14.EMPLOYEE BENEFIT PLANS
 
  On August 1, 1992, Tarrant HK established a defined contribution retirement
plan covering all of its Hong Kong employees whose period of service exceeds
12 months. Plan assets are monitored by a third-party investment manager and
are segregated from those of Tarrant HK. Participants may contribute up to 5%
of their salary to the plan. Annual matching contributions are made by the
Company. Costs of the plan charged to operations for 1995, 1996 and 1997
amounted to approximately $28,000, $46,000 and $59,000, respectively.
 
  On July 1, 1994, the Parent Company established a defined contribution
retirement plan covering all of its 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 the Parent Company. Participants may
contribute from 1% to 15% of their pre-tax compensation up to effective
limitations specified by the Internal Revenue Service. The Company's
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, the Company
may also make a discretionary annual contribution to the plan. Costs of the
plan charged to operations for 1995, 1996 and 1997 amounted to approximately
$68,000, $121,000 and $143,000 respectively.
 
  On December 27, 1995, the Company established a deferred compensation plan
for executive officers. Participants may contribute a specific portion of
their salary to such plan. The Company does not contribute to the Plan.
 
  On December 20, 1996, the Compensation Committee of the Company's Board of
Directors established the Incentive Compensation Plan, which provides for both
discretionary bonuses and bonus amounts upon achieving certain earnings
thresholds for certain members of management. The adoption of this plan
received shareholder approval at the 1997 annual meeting.
 
15.LDA OPTION
 
  The consolidated statements of income reflect a charge related to the
granting by the Original Shareholders of a four-year option (the LDA Option)
to Limited Direct Associates, L.P. (LDA), a limited partnership, the general
and limited partners of which are subsidiaries of The Limited, Inc. and the
granting by the Parent Company of registration rights to LDA pertaining to the
option shares. Historically sales to divisions of The Limited, Inc. have
represented a significant portion of the Company's sales. Subject to certain
anti-dilution provisions, the LDA Option grants LDA the right to purchase from
the Original Shareholders an aggregate of approximately 10% (649,999 shares)
of the Parent Company's common stock at a price per share of $7.20. For
accounting purposes, even though the LDA Option was granted by the Original
Shareholders and will not cover any shares of the Parent Company's unissued
common stock, the LDA Option has been treated as though it was granted by the
Parent Company.
 
  Accordingly, in the quarter ended September 30, 1995, the Parent Company
recorded a nonrecurring charge to earnings, in the amount of $1.7 million,
which equals the $1.4 million estimated fair market value of the LDA Option
plus the $300,000 estimated value of expenses of registration for the offer
and sale of the option shares. The $1.4 million component of this charge was
offset by an equal credit to contributed capital because the Parent Company's
capital structure was not affected by the grant of the LDA Option. The
$300,000 component of this charge was recorded as an accrued expense. Because
of the credit to contributed capital, the net impact of this charge on
shareholders' equity was $300,000.
 
                                     F-19
<PAGE>
 
                             TARRANT APPAREL GROUP
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
16.PRO FORMA DATA (UNAUDITED)
 
  For federal and state income tax purposes, Tarrant Apparel Group and certain
of its affiliates were treated as S Corporations under Subchapter S of the
Internal Revenue Code of 1986, as amended, and comparable provisions of state
income tax laws through termination on July 28, 1995 in connection with the
Reorganization.
 
  Pro forma income taxes have been determined assuming that the Company was a
C Corporation for 1995, and therefore, that its U.S. income is taxed at an
effective pro forma tax rate of 40% for each of those years. Based upon the
Company's expressed intention to permanently maintain its Hong Kong earnings
outside the U.S., no federal or state income tax has been provided on
unremitted earnings of the Hong Kong operations.
 
  A pro forma presentation has been provided to reflect net income and net
income per common share adjusted for pro forma taxes and the elimination of
the nonrecurring charge to earnings related to the LDA Option in 1995 (Note
15). Such charge is considered an unusual event and not indicative of the
operations of the on-going entity. In addition, in 1995, pro forma net income
and income per common share has been presented adjusted only for income taxes.
 
17.SUBSEQUENT EVENT (UNAUDITED)
 
  On February 23, 1998, the Company purchased certain assets of MGI
International Limited, a Turks and Caicos corporation. The assets purchased
consist primarily of pending orders and related inventory. The purchase price
consists of (i) $4,550,000, together with an amount equal to seller's cost of
the inventory purchased, payable in cash on closing, (ii) $500,000 payable on
July 31, 1998, together with interest at 7% per annum, and (iii) 2% of the net
sales of goods booked by the Company's newly formed Men's Division for
delivery during 1999, provided the orders accepted for delivery in 1999 on
March 1, 1999 meet specified gross profit and gross profit margin
requirements.
 
  On February 23, 1998, the Company also purchased certain assets of Marshall
Gobuty International U.S.A., Inc., a California corporation ("MGI USA"). The
assets purchased consist primarily of pending orders and related inventory.
The purchase price consists of (i) $500,000, together with an amount equal to
seller's cost of the inventory purchased, payable in cash on closing and (ii)
$500,000 payable on July 31, 1998, together with interest at 7% per annum.
 
  MGI International Limited and MGI USA each designs, contracts for the
manufacture of and sells men's and boy's apparel, including knit and woven
tops, jackets and other outerwear, for national retailers. The purchase price
was financed by the Company from its cash flow from operations.
 
                                     F-20
<PAGE>
 
                             TARRANT APPAREL GROUP
 
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
18.QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
 
  The following is a summary of the quarterly results of operations for the
years ended December 31, 1996 and 1997:
 
<TABLE>
<CAPTION>
                                       QUARTER ENDED
                         ----------------------------------------- YEAR ENDED
                         MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 DECEMBER 31
                         -------- ------- ------------ ----------- -----------
                                 (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                      <C>      <C>     <C>          <C>         <C>
1996
Net sales............... $42,093  $68,870   $50,008      $68,890    $229,861
Gross profit............   7,067   11,267     8,237       11,002      37,573
Operating income........   2,360    5,504     3,739        4,856      16,459
Net income.............. $ 1,490  $ 3,558   $ 2,209      $ 2,745    $ 10,002
Net income per common
 share(1):
  Basic................. $   .23  $   .55   $   .34      $   .42    $   1.54
  Diluted............... $   .23  $   .55   $   .34      $   .41    $   1.53
Weighted average shares
 outstanding(1):
  Basic.................   6,500    6,500     6,500        6,532       6,508
  Diluted...............   6,500    6,515     6,513        6,663       6,548
1997
Net sales............... $53,605  $73,879   $69,218      $63,391    $260,093
Gross profit............   8,782   11,068     9,690        9,557      39,097
Operating income........   3,393    5,091     4,063        4,533      17,080
Net income.............. $ 2,022  $ 3,265   $ 2,711      $ 2,789    $ 10,787
Net income per common
 share(1):
  Basic................. $   .31  $   .50   $   .41      $   .42    $   1.64
  Diluted............... $   .30  $   .48   $   .40      $   .41    $   1.59
Weighted average shares
 outstanding(1)
  Basic.................   6,555    6,589     6,601        6,605       6,588
  Diluted...............   6,772    6,796     6,806        6,760       6,784
</TABLE>
----------
(1) Pursuant to the adoption of FASB Statement No. 128, "Earnings Per Share,"
    basic and diluted earnings per share have been presented for all periods
    (see Note 10).
 
                                      F-21
<PAGE>
 
                                                                     SCHEDULE II
 
                             TARRANT APPAREL GROUP
 
                       VALUATION AND QUALIFYING ACCOUNTS
 
<TABLE>
<CAPTION>
                                    ADDITIONS
                         BALANCE AT CHARGED TO    ADDITIONS                  BALANCE AT
                         BEGINNING  COSTS AND     CHARGED TO                   END OF
                          OF YEAR    EXPENSES   OTHER ACCOUNTS DEDUCTIONS(1)    YEAR
                         ---------- ----------  -------------- ------------- ----------
<S>                      <C>        <C>         <C>            <C>           <C>
For the year ended
 December 31, 1995
  Allowance for returns
   and discounts........ $1,250,251 $1,251,789      $ --         $(154,290)  $2,347,750
                         ========== ==========      =====        =========   ==========
For the year ended
 December 31, 1996
  Allowance for returns
   and discounts........ $2,347,750 $ (432,594)     $ --         $     --    $1,915,156
                         ========== ==========      =====        =========   ==========
For the year ended
 December 31, 1997
  Allowance for returns
   and discounts........ $1,915,156 $ (359,344)     $ --         $     --    $1,555,812
                         ========== ==========      =====        =========   ==========
</TABLE>
----------
(1) Amounts represent direct write-off.
 
                                      F-22
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on February 23, 1998.
 
                                          TARRANT APPAREL GROUP
 
                                                     /s/ Gerard Guez
                                          By: _________________________________
                                                        Gerard Guez,
                                                  Chief Executive Officer
 
  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 Company
and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
             SIGNATURE                           TITLE                    DATE
             ---------                           -----                    ----
<S>                                  <C>                           <C>
         /s/ Gerard Guez             Chairman Chief Executive      February 23, 1998
____________________________________  Officer and Director
            Gerard Guez               (Principal Executive
                                      Officer)
           /s/ Todd Kay              President and Director        February 23, 1998
____________________________________
              Todd Kay
       /s/ Mark B. Kristof           Vice President--Finance,      February 23, 1998
____________________________________  Chief Financial Officer and
          Mark B. Kristof             Director (Principal
                                      Financial and Accounting
                                      Officer)
      /s/ Karen S. Wasserman         Executive Vice President,     February 23, 1998
____________________________________  General Merchandising
         Karen S. Wasserman           Manager and Director
          /s/ Barry Aved             Director                      February 23, 1998
____________________________________
             Barry Aved
         /s/ Donald Hecht            Director                      February 23, 1998
____________________________________
            Donald Hecht
       /s/ James R. Miller           Director                      February 23, 1998
____________________________________
          James R. Miller
</TABLE>